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The differential price of survival

Consultant Bacon and Woodrow claimed in a recent report that one of the key issues for insurers in the survival game is to ensure that acquisition costs are competitive against their bancassurance rivals.

Companies with high acquisition costs have two choices – to increase new business significantly but maintain the same overheads or to reduce fixed costs significantly and maintain the same new business levels.

For those at the bottom of the league, such as Royal & Sun Alliance and Scottish Provident (see table below), the reality of achieving lower acquisition costs through either of these strategies alone is remote. In fact, it would require a combination of both.

The heat in the oven is growing. The evidence is the spate of mergers in 1997 of Scottish Amicable and Prudential, Zurich and BAFS, Royal Insurance and Sun Alliance and, finally, Sun Life and Axa.

The latest deal three weeks ago by General Accident and Commercial Union underlines the battle to achieve critical mass and drive down costs.

The merger is not surprising when you refer to the table of acquisition costs. In 1996, CU&#39s acquisition costs were double of that of Standard Life. Not only is there commercial pressure to compete against bancassurers but the fast looming European dimension is another very important factor.

What lessons should insurers providers learn from this?

Certainly, multi-distribution strategies have proved an expensive diversification. Following the introduction of the Financial Services Act 1986 and polarisation, there was a rush into alternative distribution channels.

As a result, direct sales, appointed representatives and direct marketing all become very much the flavour of the month. These resulted in insurers shelling out considerable amounts to establish these channels from invariably greenfield sites. Many offices are still struggling to get their acquisition costs down to pre-1986 levels.

Tillinghast&#39s study of acquisition costs demonstrates that sales of products through IFAs are over 40 per cent cheaper than through appointed representatives and direct sales (see chart above). But life offices do not price their products differently for each channel. I believe that IFAs and consumers are getting a poor deal as a result of these cross-subsidies.

Even within the IFA sector, there is a need for product providers to differentiate between those relationships which add value and commission clubs which contribute nothing to bottom-line profit. These are created to increase commission and, therefore, costs on the basis of volume.

Many networks contribute significantly to reducing costs for product providers. This is a fact which has not always been recognised.

The political will, rightly or wrongly, interprets current financial services products as expensive – thus, the current drive into Individual Savings Accounts and stakeholder pensions.

It is very important that consumers get the value for money they are entitled to. This should be achieved by dealing with IFAs and providing products which are priced taking all the relevant savings into account.

What has created a smokescreen is the complexity of the disclosure regime. The debate rages on over commission versus fees, changing structures, indirect benefits, and so on. But what the consumer is really interested in at the end of the day is value for money. Reduction in yield is an accurate statement of how much investment goes into the product and how much is taken out in costs. It is easy to understand that if the projection is 7.5 per cent and the reduction in yield is 1 per cent, the return is likely to be 6.5 per cent.

If the regulators recognised this, I am sure we could cut down on the paper mountain generated by current disclosure. It does not support investor protection but confuses the consumer.

PIA Ombudsman Anth ony Holland highlighted just these kinds of problems three weeks ago in a Money Marketing conference.

In the ever changing world that we live in, commission and fees are only part of total costs. Increasingly, cost centres are changing. What historically were expenses inc urred by the product providers are now being switched to intermediaries such as M&E Network.

The price of getting it right will be a win for the consumer, insurance provider, regulator and intermediary alike. The resulting good news would be a welcome change for our much maligned industry.


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