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Open and shut case

Change is the word perhaps most often applied to the life and pension industry nowadays. For years, everything was the same. Now it is not.

New business volumes are, at best, static and the market is oversupplied and the seemingly never-ending equity slide is dramatically affecting economics.

With challenges to product design and pricing and the polarisation about-turn set to create a massive shift in power between providers and distributors and their servicing requirements, hoping that the storms will pass is no longer an option for life offices.

The obstacle to overcome for firms which want to be significant players in the 1 per cent world is to compensate for tighter margins by reducing expense ratios.

The importance of low unit costs will be vital. High new business volumes will not be enough to survive and, in the context of closed books, it will be the ability to lower the costs of maintaining these existing portfolios that will make the crucial difference between a short profitable period in run-off and a longer profitable term.

Life companies must realise that they have little choice but to continue down the path of innovation if they are to reduce costs and stave off competitors.

This will have an enormous impact on admin infrastructures, both in enabling straight-through processing and also by pushing some of the admin burden out to customers, agents and intermediaries. But as Sandler indicated, the rigid structures of legacy systems do not easily accommodate these requirements.

The usual state of life companies&#39 heritage is the number of systems that still have to be maintained. Over many years, it has been common for new products to be installed on new systems, leaving old products to be phased out on legacy platforms.

Tens of millions of policies now exist within closed books and as traditional product types lose favour with consumers and regulators alike, the number of closed books will increase further.

These policies will remain in force for 20-40 years or longer. But the natural falloff in the value of these assets over time relative to the ongoing total systems and admin costs of maintaining them means that unit costs will increase as the overhead is spread across fewer policies.

So there is a simple cross-over point on a graph that indicates when it is uneconomic to carry on, that is, when total maintenance costs exceed the residual asset value of the book. For a life company that is operating entirely as a closed book or where closed book portfolios make up the majority of their business, this point needs to be calculated carefully and all the implications for its business and its profitability fully understood.

Life companies have a number of options for regulating the costs of their closed books of business:

•Sell off the book to another carrier.

•Rationalise the number of existing products to be maintained by converting them to newer product types or by buying out the policyholders.

•Outsource all operational functions to a third-party admin service provider.

•Redesign business processes to improve the efficiency and cost-effectiveness of policyholder and intermediary support activities.

•Build new technology layers around legacy systems to add extra functionality or create new interfaces that will streamline the admin.

•Replace old systems with a modern system.

These options reflect strategic, economic and cultural considerations. Whichever of these choices a life company makes, it must be sure to consider the needs of intermediaries who need to be able to extend the same level of customer service to their closed book customers as they offer to those with policies in a live environment.

If a life company sells the book on to another carrier, then it must consider the intentions of the buyer. A vulture company looking to strip the book of its asset value is likely to neglect the servicing needs of policyholders and dent the image of both the life company and/or the intermediary.

Choosing the right TPA can be tricky, too. Some TPA companies may be able to deliver low costs by relying on cheap labour pools but will they deliver the right level of service?

Companies aiming to drive costs out of their closed books operation by migrating all policies on to a single IT system must aim for one that is geared specifically to the demands of administering mature books of business. For this, it must be designed to increase the automation of in-force policy maintenance and claims processing and be rich in customer servicing functionality.

Life companies in acquisition mode will obviously be looking to spread the costs of their operations across the acquired books. It is likely that a single solution onto which they can migrate the acquired closed books and administer them at reduced cost will be a very attractive solution.

For any life company expecting to be in business after the UK has decided to join the euro might see a single system that removes the predicted big one-off conversion cost as an ideal solution. There is perhaps a strategic window of opportunity here.

What is clear is that progressive life companies are looking for new avenues for cost-cutting. As well as examining ways of reducing non-commission new business acquisition costs, they must recognise that the economic viability of continuing to run closed books on old systems is dwindling fast.

Many predict that the number of life companies in the UK will shrink by up to 70 per cent over the next 10 years because of competitive pressures and an inability to adapt. Life companies must act fast to regulate the costs of their businesses in the face of great change.


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