The way that the life and pension business is structured and distributed encourages customers to switch frequently between providers, resulting in poor levels of persistency.
The result is undesirable and unsustainable reliance on churn rather than the development of a genuinely vibrant market and the situation looks set to get worse.
The market is stagnant, with product providers continuing to chase the same money rather than looking for new business. Around £7bn a year is paid out in “new” acquisition costs – including commission – while the overall size of the market has remained stagnant.
For some products, almost half of the policies written lapse within four years. Given that it takes around a decade for an individual pension product to deliver positive value to a provider, this is unsustainable.
Four social and market trends are exacerbating the situation. The first is that consumers’ attitudes and behaviours have changed. They are now more disposed to switch providers, aided by increasingly accessible technology that enables them to compare and migrate between products. This has already affected the protection market and other complex personal financial products, particularly mortgages.
The second factor is ongoing regulatory and legislative change, which is both driving the development of new products (for example, A-Day changes to pension legislation) and intensifying competition for traditional ones (for example, the introduction of personal accounts).
Changes in the 2007 pre-Budget report on the capital gains tax treatment of bonds are another recent example of how legislative action can have a massive impact on the market.
These changes, together with increased financial literacy, will increase the likelihood that existing clients will seek and find viable alternatives.
Third, we are seeing value flow away from the manufacturer and towards distributors.
The experience of other industries suggests that this will be a continuing trend, with potentially devastating consequences for traditional manufacturers.
The fourth, related, trend is the growing number of new entrants with strong brands or access to consumers, competing aggressively for market share.
Some of these trends have already had an impact. The line-up of top UK providers of life and pensions has changed markedly over the past decade. However, the factors described above will drive even more significant upheaval over the next 10 years in combination with new technology, low-cost (outsourced) servicing and evolving product design and distribution. That will lead to the decimation of traditional life offices’ balance sheets.
Faced with this changing competitive landscape, many manufacturers are already starting to address persistency issues. Some have successfully protected the level of funds under their control by changing commission structures or intervening when policies seem likely to lapse, based on tell-tale behavioural triggers. Acquiring distribution capabilities provides further opportunity to influence customer behaviour.
However, we see these as tactical responses. The threat is so great that a more fundamental strategy is required.
To build businesses capable of competing with big banks and consumer brands, life and pension providers must revisit their understanding of customers’ needs and build propositions accordingly.
In some cases, such as inheritance tax planning, this means complex solutions that require specialist advice. Most of these cases, if not all, relate to the high-net-worth segment, which is already well served by the industry, more often than not through IFAs.
Persistency is especially poor in products sold to the mass market, particularly pension and other investment products. Interestingly, the essence of these propositions is simple: “We will manage your money, increase its overall value and provide you with a return at some point in the future.”
The big catch is that the industry does not usually offer any certainty about the outcome. On the contrary, providers take a definite fee regardless of performance. In our view, this is a fundamental flaw in today’s life and pension products – they are risky for the customers but not the providers.
The solution is to offer products whose outcomes are better defined and if there is a risk-reward element, it should be shared fairly between the provider and the customer.
If the industry is unwilling or unable to provide these features, it should not be surprised that the majority of the population – many with limited incomes – are not prepared to entrust it with their money and will seek out solutions that appear to offer greater assurance, such as bank accounts, cash Isas or property.
An additional weakness is that many of today’s products are inflexible. How many people have no significant changes in their financial needs or disposable income over a five-year period, much less the quarter-century or more spanned by many life products? Yet most of the policies offered today provide limited flexibility to deal with changes.
As mentioned above, IFAs provide an ideal distribution channel for highly complex products, such as those aimed at tax optimisation. But this approach is too expensive and cumbersome for simpler products, for which low-cost direct distribution capabilities should be developed.
The experience of other industries demonstrates that this is eminently feasible despite traditions of personal service and stringent regulatory requirements.
For example, the legal profession has historically been conducted on a highly bespoke basis but over the last 10 years a number of routine legal services have been commoditised and automated.
Services such as convey-ancing can now be cond-ucted via the internet at a fraction of the cost of traditional channels.
A similar trend is evident in healthcare, many aspects of optometry, for example, are now conducted without the need for specialist consultation. Other medical services are following suit, particularly in North America.
In summary, we believe the mindset needs to change fundamentally. The industry must accept that it is not enough to tweak existing models slightly.
The response to the FSA’s retail distribution review perfectly illustrates the tendency to ignore customers’ needs, instead rehashing solutions that have previously proven unsuccessful.
The solution lies in products that are clearly linked to customer needs, where advisory and compliance burdens are lower and delivered through appropriate channels.
Such products are likely to be more flexible, have more certainty in their outcomes and have clear incentives for customers to remain.
A simple example of the latter would be offering bonus units after a number of years rather than at inception.
This may be a difficult course for the industry to take but traditional providers face a significant risk of extinction if they continue to put misplaced loyalty to existing models ahead of customers’ demands.
A radical new approach is required. Other industries offer plenty of examples of how dramatic change can boost the fortunes of an entire sector, particularly those who get it right and get it right early.