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Driving force

Life offices have had to adapt to survive, with rising costs and regulation forcing many to outsource their processes. But what effect has this had on the sector, asks Exaxe managing director Norman Carroll

The life insurer of 2006 faces a challenging agenda. What is the role of a life office in today’s financial services industry?

The industry’s travails over the past five to 10 years have been well-documented with the “perfect storm” of falling stockmarkets, rising costs and consumer disillusionment, the impact of regulation and legislation which pushed so many of the life companies towards outsourcing deals to keep their costs under control.

To examine the future of the life industry, it is worth looking quickly at where the industry has come from and where it is now.

The origins of life providers were as risk takers and mutuals. They were not driven by profit but rather the protection of communities, particularly widows and orphans. Those communities have, of course, now evolved into affinity groups.

A hundred years ago life insurers were fulfilling two main functions – providing a service and taking risks on behalf of their members. This was not a complex business model. The trick to success and survival was to ensure that underwriting profits covered the cost of paying out claims and administering the book of business.

It was usually good for the consumer, too. This straightforward approach meant they found it easy to understand and deal with. The position of the average life company used to be well understood by the policyholder, as epitomised by The Man from the Pru. The old industrial branch business with door-to-door sales and premium collection. Life companies distributed their own products, made their own investments, paid claims and administered the policies.

This situation, however, is long gone. The pace of change in the life and protection industry has accelerated at such a rate that we are left with an industry that seems occasionally to be a little unsure of its role, particularly for the life provider. The direct salesforce has been removed, back-office processes are outsourced, along with IT and perhaps, worst of all, responsibility for distribution has been outsourced to the IFA. Life providers have spent tens of millions on building their brands but no longer have control over their distribution. The Man from the Pru has gone and the industrial branch business has all but disappeared. It would not be a ridiculous question to ask: what is the Prudential? Is it a bank, alife office or a financial services group?

We can observe the much written-about trend of closing life books to new business, where in effect these providers have stopped taking on new risk.

Open books are now also becoming fair game. Zurich’s outsourcing deal earlier this year with Capita for its open book is yet another step in the shoring up of the traditional activities of the life provider. Life offices have also ceded more of their risk management activities to the reinsurance industry.

Finally, we have the industry’s switch in emphasis from protection business to savings and investments. In making this strategic shift, life insurers have moved away from their raison d’etre – life protection cover.

So with all this outsourcing going on, we are entitled to ask: what’s left? Have life insurers outsourced themselves out of existence? If not, what now defines a life insurance company?

They have outsourced risk to the reinsurer, IT and core processes to the BPO providers. They have outsourced product distribution to the IFA networks. Investment management has gone to the fund managers. That leaves today’s life insurer with one primary responsibility, as product innovators. But the last truly innovative product offering in this market was critical-illness cover, which was introduced a few decades ago.

So let’s look at the drivers behind these changes. The two key factors are, and have been for some time, regulation and cost reduction. In theory, the model that understands and concentrates its resources on its core competences while outsourcing non-core processes is a winning one. Outsourcing core administration for closed and marginal-sized books makes sense. The economies of scale argument for BPO does stack up. The ability of the outsourcer to spread development costs across several books and clients, to cope with changes in legislation for instance, is a good economic model. But, in many cases, practice is still removed from theory.

Experience now shows that the cost reductions anticipated through systems integration and rationalisation has often not materialised. Conversely, new risks associated with these activities and with data migration have arisen. Anecdotal evidence suggests that some providers have been stymied in their efforts to deliver new products, never mind innovative, new products, by their BPO partner, which is unable to meet the time deadlines or deliver in a cost-effective manner.

Many outsource contracts are not profitable, with cut-throat deals being signed up to win the business and add scale, the key factor for any third-party administrator. For the providers, all too often the golden rule of “don’t try to solve a broken business unit by outsourcing it” has been ignored. Compounding this problem is the fact that the outsourcer is often hamstrung by legacy systems and agreements to maintain staffing levels. With some of the contracts in the market soon up for renewal, we may see new trends emerge, switching providers or taking func-tions back inhouse.

We have yet to touch on the customer’s role in all of this.The sheer volume of companies now undertaking responsibility for the various aspects of a life policy begs the question, to whom are the customers loyal? When a policyholder receives a letter from Zurich/Capita with respect to change in ownership and responsibilities for their policy, are they confused, annoyed or just not bothered? And do the life companies care anymore? When they ring the call centre and the operative is responding from a captive operation overseas, does it make any difference to their relationship with the provider, financial adviser and future buying patterns?

To reference the FSA, the industry needs to start asking customers if they feel they are being treated fairly under this new model?

Technology also has a role to play as the industry moves forward. The reuse of existing applications and the use of niche applications such as quotation engines’ commission-management systems are an alternative, less risky and costly methodology to systems and data migration under an outsourcing arrangement.

Manufacturers need to be able to cost-effectively connect to a variety of distribution channels. Speed and quality of support by the manufacturer and user-friendly technology are high on distributor’s priority lists.

For example, service levels, with respect to the preparation of illustration requests, can vary dramatically with responses for “what if” scenarios on illustrations ranging from three days to three months. In many cases by the time an enquiry is processed the current valuation or quotation is out of date.

Furthermore, providers are finding it difficult to match client details with product-based legacy systems. Requests for multiple scenario illustrations and quotations are too often dependent on ad hoc “manual work-rounds”, often involving costly technical services resources.

Regulation and legislation are compounding the issues around service delivery even further. Technology solutions are out there to eliminate such inefficiencies.

Having come this far, the industry needs to hold its nerve now and resolve the inefficiencies in the current model rather than throw it out. Problems need to be rectified before any outsourcing takes place. More equitable contracts between the insurer and outsourcer need to be negotiated with an equitable sharing of profit for both parties. Distribution and distribution deals need to be sorted.

Finally, technology needs to be used innovatively with less big bang and more incremental steps.

Exaxe is a specialist IT software and services provider to the life & pensions industry

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