Does anyone remember the days when life offices were risk takers? I do not mean prolific gamblers but rather when they last ran a book of business that included profits and losses on each contract with the ultimate aim of delivering profit to the company.
Since investment business became the key focus for life offices, the relative risks to the business have diminished.
Consider single-premium bonds. When these products were first introduced, the heavy front-end loads were sufficient to meet the set-up costs, pay commission and ensure that all future cashflows from each sale generated margin for the office.
As up-front charges began to be eroded due to so-called competitive pressure, the office was left in a position where no profit was being made on day one although costs were covered to such an extent that a loss was very unlikely.
Next to come along was the back-end charge, where all the money is invested on day one. “No initial charge,” claimed the marketing material. What was a little less clear was the enormous annual charge levied throughout the duration of the bond and the severe back-end penalties incurred in the event of withdrawal in the first few years.
Loyalty was generally encouraged by not allowing investors to leave without penalty. There was sometimes a loyalty bonus after 10 years but the office could take comfort from the fact that the bond had probably been surrendered by then or it had made so much money that it could afford to give some back.
So what is going to happen when real competitive pressures begin to arise? When investors realise that a life bond is simply a low-value wrapper for the same product they can buy elsewhere, sometimes for a fraction of the cost?
Life offices may be accelerating the arrival of this time. By extending fund ranges to incorporate external, professional fund managers, they are accepting that they cannot themselves provide a sufficiently attractive fund range for investors. So what are they adding ? In a world when margins become split between manufacturers and distributors, where do life offices sit? Are they middlemen between the two entities and, therefore, at risk of being marginalised?
If they are to avoid this, they must learn how to manage risk again and appreciate that an Isa or a unit trust is a direct competitor. They must understand that, like it or not, we now live in a consumer-oriented world with league tables of costs and intense media-scrutiny of business practices.
The evolution of charging structures will result in persistency becoming the biggest risk to life offices. Why not ensure strong persistency by developing long-term client relationships? Call me old fashioned but perhaps initiatives such as fair deals from day one would be a good start.
Even at Equitable Life, an enormous market value adjuster is not managing to retain clients.
Although strong investment performance cannot be assured, I still find it staggering that ours is the only industry in which the biggest winner in times of client dissatisfaction is the product provider.
Albert Einstein said: “Happiness is just an illusion caused by the temporary absence of reality.” To replace “happiness” with “profit” may neatly sum up the position for life offices. Over the next couple of years, reality will begin to bite. I believe that unless life offices begin to understand their competition, they run the risk of ending their period of temporary happiness.
Whether life offices retain their market dominance is in their own hands. they must be careful not to drop it.
David Ferguson is a director of product design and marketing consultancy, the abacus.