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Signs of life in dna analysis

A city analyst has accused consultant Ned Cazalet of exaggerating the level of churning in financial services, arguing that persistency problems lie primarily with life products rather than pensions.

The paper from analyst Fox-Pitt Kelton, entitled The DNA of Life, claims market growth is real and not just churned business.

The claims break from growing industry consensus headed by analyst Ned Cazalet and his influential Polly Put the Kettle On Report, which was published earlier this year.

This painted a bleak picture of a shrinking and unsustainable life and pensions market, characterised by epidemic levels of churning and low persistency driven by high commission and negligible transfer penalties.

Cazalet argues that the life industry has haemorrhaged £30bn over the last four years in a desperate bid to win new business which has contributed to a net decline of £15bn from £95bn in 2001 to £80bn in 2004.

The paper has proved something of a wake-up call for the life industry and helped generate increased calls for change to remuneration structures and an emphasis on net business figures rather than on new premium growth.

Even the FSA appears to have taken the Cazalet’s report to heart, with chairman Sir Callum McCarthy recently using it to berate the industry for churning.

He said: “This merry-go-round, as it has been so characterised, not only reduces, if not eliminates, the profitability of the business, but it also proves a major obstacle to firms establishing long-term relationships with their customers. Questions also have to be asked as to how much of this recycled business is of negligible advantage to the customer.”

But the FPK report presents a much more rosy picture of the life and pension industry. It says growth in insurers’ reserves is a better indicator of companies’ growth and also an indication of higher persistency.

It says reserves have grown by 8.8 per cent a year in the last decade, ahead of new business premium growth of 8 per cent a year.

Fox-Pitt Kelton analyst Mikir Shah claims the report is based on FSA returns from life offices but recent FSA figures would appear to tell a different story.

These suggest that 95 per cent of single-premium pension policies sold in 1993 would still have been in force four years later compared compared to a persistency of 88 per cent for policies sold in 2001.

But persistency of single-premium life business improved. Eighty-nine per cent of policies sold in 2001 were still in force after four years while only 84 per cent of policies sold in 1993 were still in force after four years.

The figures also show that half of all regular-premium pensions policies written in 1999 lapsed within four years. The figures for group pension regular-premium business are worse, with up to 60 per cent of more of policies lapsing by year three.

Scottish Life head of communications Alasdair Buchanan says the figures suggest that the basis of the FPK analysis is incorrect and argues that growth in reserves has little to do with persistency.

He says: “I find it incredible that this report can argue that the problems of persistency and churning in the industry are overstated.”

Cazalet claims that the new report critically fails to look at the right information and overlooks the fact that the industry has paid out more in claims than it has taken in premiums. He argues the report also appears to assume that business becomes profitable after year one, when it will take many years for stakeholder-style contracts to move into profit.

But Legal & General pensions strategy director Adrian Boulding has some sympathy with the main points of the FPK report and believes the basis of Cazalet’s aggregated calculations miss the point.

He says: “More money going out than coming in does not mean the industry is shrinking. We are an investment business and paying out claims higher than premiums is what we are in business to do. These figures are symptomatic of a vibrant and mature industry.”

Boulding says the FSA needs to look under the surface of Cazalet’s figures and look at whether the information and industry practices that his research has unearthed is detrimental to consumers.

He says: “The IFA is a winner, the consumer is a winner and the insurer that gets the business is a winner. The only loser is the insurer that loses the business. This is a perfectly proper evolutionary business environment.”

Boulding subscribes to Shah’s view that churning, or, as he prefers to call it, switching is simply the survival of the fittest and is done in the best interests of the consumer in the vast majority of cases.

“We do not work in an industry where people put their money in a contract and have to keep it their for 25 years. People are just transferring their money into the winners – or the stronger companies,” he says.

But Standard Life head of pensions John Lawson says the truth lies somewhere between Cazalet and FPK’s take on things. He says the industry has undoubtedly been shrinking at the lower end of the market but the high-net-worth end is “going like a train”, with, for example, a huge amount of money being transferred into Sipps.

He also says money moving out of the industry is, in a sense, a sign of a maturing industry as the baby boomer generation approaches retirement. But he says that while some money is moving for legitimate reasons, there is undoubtedly money being churned in the pejorative sense of the word.

But rather than rely so heavily on the research of others, he believes that the FSA should conduct its own research into why money is switching.

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