The challenge before the insurance industry in 2022 and ahead

GLOBAL INSURANCE SECTOR TRENDS IN?2023: REIMAGINING LIFE INSURANCE

?INTRODUCTION

??In this digitalization era, most things became powered by sophisticated technology, and the progressive growth happening in this sector is transformational. It has also advanced as any other industry. The industry has become leaner and thinner. Therefore, taking stock of the sector, in terms of the number of users, the amount involved is exceptional. Just a decade passed, It has been chronicled the increased instability the life insurance and retirement industry has experienced has been. They’ve also reanalyzed the trends that have been causing industry players to rethink their operating models, such as digital transformations; the rise of environmental, social, and governance (ESG) concerns; and the shifting economic environment. More importantly, they’ve worked to inspire insurers to consider new avenues for value creation. Global Insurance Report offered a comprehensive overview of the challenges and opportunities facing the global insurance industry.1?The 2023 report will be released in chapters and builds on that work with a new level of granularity and precision of recommendations for how insurers can accelerate growth and exceed performance targets. This covers life and retirement, including the major forces at play in the current life insurance industry, several ways insurers have adapted, and opportunities that life insurers and stakeholders can consider going forward in addition to the structural fundamental consequences for their business models as a solution.

?PROGRESS IN INSURANCE DIGITAL TECHNOLOGY WHICH TRANSFORMED THE SECTOR

?The global life insurance industry is facing a turning point inflection point. A fundamental reevaluation will enter in a significant transformation. We observe some paramount forces creating opportunities and hurdles for the industry. Over the past decade, the life and retirement industry has undergone increasing instability and potential risks involved. Four paramount forces will continue to shape the industry globally over the coming decade.

IMPORTANT PARAMOUNT FORCE

1.????Wide-spread awareness of personal risk, and uncertain access to socially funded benefits

The widespread awareness among our national people is understanding the importance of an insurance product and proactively showing keen interest in various insurance products. So that, that they are personally responsible for their future health and retirement costs: advanced economies’ governments have become more indebted, and government health and retirement programs—such as the United States Social Security program and Japan’s National Pension System—are experiencing funding gaps, resulting in a nearly $41 trillion global pension gap.?Our country has also a substantial pension gap. This realization, however, is forming an opportunity for insurers in the industry.

2. Near-term tailwinds from rising nominal rates, but real rates may remain low for long

Nominal interest rates will remain elevated in the foreseeable future as central banks look to get inflation under control. This is in stark contrast to what we have seen over the past two decades, which have largely consisted of quantitative easing and ultralow nominal rates. In the near-term, life insurers may use these tailwinds to passively capture growth opportunities, especially as asset rotations on the investment side happen quicker than adjustments on the liability side, which results in higher spread

3. The emergence of novel insurance technology

Customer demands for quality products are increasing when it comes to the level of service, including the desire to integrate digital technology with traditional products. As such, many companies have shifted their business models to increase their adoption of disruptive technologies such as cloud computing and applied AI and have used more agile ways of working, as well as new talent attraction strategies.

4. Rise of Asian economies and the return of geopolitics

A new middle class has begun to emerge in Asia and other developing economies. The population in China, India, and Southeast Asia is projected to grow to 1.2 billion people by 2030 and makeup nearly 14 percent of the total global population.?However, seizing the full potential of these opportunities won’t be easy given renewed geopolitical risks and concerns. But, in favorable times penetration is possible for untapped businesses.

An industry at the interceptions

These forces have been affecting industry performance, shifting the sources of value creation, and accelerating structural changes. A look at the current dynamics in the industry offers a compelling case for action. Disappointing performance and declining industry relevance are caused due to after-sale service. Conversion of many factors, some in direct control of life insurers and others exogenous, has harshly impacted the industry’s performance in recent years. Nominal GDP growth has far outpaced premium growth.?Life insurers have faced several challenges in delivering growth and returns. In the past two decades, economies progressed faster than insurance premiums, indicating insurers haven’t been growing at the same rate as the economies in which they operate. In the US and Europe, nominal GDP grew at a CAGR of 4 percent over the past 20 years, but premium growth grew at a CAGR of 2 percent. In Asia (excluding Japan), economies grew at a CAGR of 10 percent while premiums grew just 3 percent. The industry has combated to earn returns more than the cost of capital.?In the same period, the industry resisted earning profitable returns after the cost of capital. Insurers have also to change their performance relative to peers: of insurers that were in the bottom quintile of performance, nearly two-thirds remained in the bottom quintile ten years later.?Carriers have still not structurally addressed their cost base.?Compared to other industries, life insurers have still not structurally addressed their cost base. Since 2003, costs as a share of revenues have increased by 23 percent for life insurers—compared to a 5 percent increase for P&C insurers—while other industries, including asset management, have been able to address costs. While these structural costs have been rising for two decades, the imperative to address them may have arrived.

Life insurers’ significance in capital markets has declined.?The lack of returns after the cost of capital, subdued growth, high volatility in earnings, no transparency of risks and sources of earnings and value, and lack of individual insurer performance mobility has caused the global life insurance industry to gradually lessen its relevance with investors, particularly in the public markets. This trend is most apparent in the US, as the largest US life insurers’ share of market capitalization relative to other financial-services peers has shaded over the past 35 years from 40 percent in 1985 to 17 percent in 2005 to only 9 percent in 2020.

SOURCES OF VALUE SHIFTING

The value pools and sources of creation across the life insurance industry are not homogenous. Carriers face choices in products, components of the value chain, and geographies.

Huge scattering in growth platforms.?While overall industry performance has been despairing across the globe there are some notable pockets of growth and opportunity. In the United States, products that provide principal protection with some upside based on market performance (fixed and fixed-indexed annuities and variable universal life, for instance)—in addition simple, protection-oriented products (such as accident and health products distributed through worksite channels)—are expected to grow more than 5 percent between 2021 and 2026. Over the same period, market-oriented annuity products where the customer bears most or all of the risk are expected to reduce to only 5 percent. Value creation shifting to investment alpha.?As interest rates have declined over the past two decades, the importance of investment alpha as a source of competitive advantage has increased. Despite near-term nominal tailwinds, low-for-long real rates will continue this shift toward investment alpha. Returns on conservative investment allocations have diminished below the cost of holding traditional insurance liabilities, and in an environment in which it is cheap to raise capital, life insurers gain a competitive advantage from growing high-yield assets.

Carriers are now pondering the risks and fiscal costs to operate in developing economies.?Companies have started to rethink what it means to be a “global insurer.” Historically, life insurers looked toward markets that were similar to theirs which also tend to be closer geographically to enlarge market share and drive top-line growth. As technological advancements accelerated the globalization process, insurers began to expand globally, particularly into Asia, to diversify their portfolios and increase valuations. As the economics of the world have changed, insurers are weighing the risks and fiscal costs to operate in several regions

Major structural changes in the process

Entrants and new sources of capital are disrupting and pushing the structural evolution of the sector. Private capital–backed platforms gaining relevance.?The past decade has seen a continuous rise of private capital-backed platforms—typically fully or partially owned by alternative asset managers, which find the life insurance industry attractive for several reasons.

Primarily, they’re attracted by the chance to drive development in performance and by the potential to access “permanent” capital in form of a stable pool of liabilities, which can be deployed into various asset strategies, from traditional fixed income to more structured products or alternatives. Besides, they can generate more predictable fee-based earnings streams while reducing the overall fundraising burden. In the US the private capital-backed platforms logged almost $292 billion in general account reserves, making up about 9 percent of the industry stock. These platforms also have significant market share in some sectors of new business generation: among the leaders within each product line, private capital-backed platforms accounted for 40 percent of fixed-indexed annuities sales in 2021, up from 7 percent in 2011, and 19 percent of fixed-rate deferred annuities sales in 2021, up from zero a decade prior.

The structural shift toward more independent, third-party distribution.?In recognition of the power of earning streams from distribution, investors have been inclined to reward the capital-light earnings generation of pure-play distributors, such as brokerages, independent marketing organizations, and field marketing organizations. Those players have generated 2.6 times the TSR of life insurance companies since 2010 and currently trade at nearly 2.8 times the price-to-earnings multiple of their life insurance counterparts. Beyond continued innovation and the shift in value toward distribution, the industry is also experiencing a structural shift toward more independent distribution. Many companies have moved away from captive or affiliated distribution because of the increased services into a product of many insurance and annuity products and the increasingly open technology architecture and choice offered by insurance distributors. In the US, third-party distributors are increasingly becoming more dominant, expanding their share of the market from 49 percent in 2010 to a forecasted 55 percent in 2021; conversely, proprietary distribution networks are declining in prevalence, from 30 percent to 26 percent during the same period. In Europe and Asia, we can see a similar—although smaller—increase in third-party distributors. Within this timeline, Europe increased its market share from 17 percent to 18 percent, and Asia increased its share from 8 percent to 11 percent. Within Asia, the share of third-party distribution is still low overall, and select insurers with high-quality, proprietary distribution will continue to see high-value creation from this model.

Fundamental reimagination of life insurance business model horizon

Insurers will have a dizzying number of options available to them in the coming years—as will investors. In the balance of this report, we detail how insurance companies will shift their priorities in the near future and how different types of insurance models can help determine how best to meet the objectives of their investors. The question is clear: what strategic strengths can insurers depend on to generate growth in the coming turbulence?

Four ‘unbundled’ business models to drive value creation

Traditionally, insurers have achieved profit and growth by identifying attractive products and markets, such as individual protection and annuities, and structuring their end-to-end value chain to support these products and markets. Ownership of most of the value chain was important to simplify operations and maintain control over the end-customer experience. Today, the industry is reconsidering this approach to the value chain in two notable ways: product bundling and functional unbundling. When it comes to products, those that meet the needs of the same customer segments—such as retirement and wealth and asset management services or group and retail sales—are converging, which is pushing insurers into new territory. Some insurers will even go so far as to branch into the health and protection ecosystems if there is a demand from their customers. Insurers are also expanding and evolving their product shelf, shifting the mix away from traditional and balance sheet–heavy products to capital-light products and combining distribution points to create a simpler, more integrated customer experience.

Looking ahead, insurers will increasingly “unbundle” their value chain and focus on sources of distinctive value creation while seeking partnerships or leaving the other parts of the value chain to those who are advantaged. Unbundling helps uncover value within the integrated business model and focuses on uniqueness while creating new sources of growth and value. Four insurance functions will take center stage during this change: product design and underwriting, balance sheet management, distribution, and technology and administration. Insurers can start by determining how the strengths of their business model map to these four functions (exhibit). Balance sheet specialists, for example, might consider finding a distribution partner, while distribution specialists tend to be best served by partners in product design and underwriting or balance sheet management. Those insurers can then use those strengths to differentiate themselves, achieve growth, and appeal to investors.

Imperatives and priorities for life insurers

This shifting industry structure will create new opportunities for where and how life insurers create value, elevating the industry’s relevance to consumers and its attractiveness to investors. Insurers will have to chart a course through these shifts and choose their mode of value creation, which will be partly informed by their organizational goals and investor expectations. In the life and retirement industry, six themes dominate the investment attraction agenda: top-line or market share growth, diversification (via geographies and products), societal and customer impact, low volatility of results and dividends, ROE, and capital generation. Insurance companies are likely to give attention to some combination of these themes based on their ownership type and specific owners. Even within the broader classifications of insurers, however, individual insurers will have unique situations—and thus unique expectations. Below we offer a simplified overview of how four broad insurance models could respond to organizational goals and investor expectations by using their strengths to differentiate themselves in the industry.

Insurers backed by private capital and alternative-asset-management players.?As they look to the future, these insurers will want to proactively develop new growth vectors, such as more flow-based business beyond pure legacy M&A and international or geographic expansion. They may also continue to strengthen risk management capabilities (given the relatively higher-risk profile of their investment portfolio), further enhance their investment management capabilities through more dynamic portfolio rebalancing, and develop additional sources of value creation beyond pure investment alpha.

Mutuals.?As they look toward the future, mutuals may want to innovate more in their product offerings to capture growth through distinctive product specialization that better matches customer needs, as well as to transform their distribution and customer engagement capabilities. They also might have to focus on their operational efficiencies to bring down costs and focus on their quality of governance to improve productivity and capital allocation.

Stock-traded insurers.?Moving ahead, stock-traded insurers need to address the issue of where they have a unique competitive advantage and can generate capital, such as in certain geographies, lines of business, or parts of the value chain. For example, these insurers may build or partner with others to achieve table-stakes investment-management capabilities, which would help them fight with insurers backed by private capital or alternative-asset-management players and take benefit of chances that others are laggards. They might also want to find unique ways to harness their growth opportunities and ensure they are properly valued by investors.

STATUS OF THE INSURANCE INDUSTRY

Even before 2020, the insurance industry encountered difficulties. Now, those issues have taken on even greater urgency:

Headwinds on revenue growth.?Three structural factors are challenging industry growth (Exhibit 2):?persistently low interest rates, which pressure spread-based businesses such as life insurance;?pricing pressures?are driven by fee transparency, digital attackers, and lower-cost options—pressures that in some markets are made worse by price comparison websites; and?organic demand?that is growing only slowly in mature markets. The latter is particularly serious because growth in developed economies is coming mostly from price increases rather than from volume or new risks covered, displaying a risk that the industry might lose its relevance over time.

An ongoing ‘fight for the customer.’?Insurtechs are?driving digital innovation and disruption in the industry, with investments in insurtechs worldwide growing from $1 billion in 2004 to $7.2 billion in 2019 to $14.6 billion in 2021. More than 40 percent of insurtechs are focused on the marketing and distribution segments of the insurance value chain enabling them to solve customer pain points through a digitally enhanced client experience that could pose a competitive threat to incumbents. And while some of these players have seen their share price flip since their IPOs, we believe that a characteristic digital customer experience from attackers or incumbents will be a precondition for industry-beating growth. And beyond distribution, superior technology and healthy margins in insurance service businesses will challenge the traditional method of many insurers to own the whole value chain—they will be forced to form partnerships or make outsize investments to keep up.

A value shifts toward intermediaries.?Last five to ten years, brokers have emerged as the clear winners of the industry, with both public and private investors recognizing their position of strength in the insurance value chain. ?Total shareholder returns are more lucrative for brokers than for other industry segments, and?private-equity firms are investing. In 2019, for example, CVC Capital Partners invested in April, and GTCR invested in AssuredPartners. PE-backed brokerage deals completed in the United States accounted for roughly three-quarters of all insurance transactions from 2016 to 2019. Because insurers do not control their distribution channels as strained as other financial sectors, they might run an even greater risk of becoming pure balance-sheet providers, while intermediaries keep an asset-light client relationship model. The shift toward digital is perhaps the last chance for insurers to regain the upper hand in this “fight for the customer.

Limited productivity improvement.?Though many insurers have undertaken cost-saving programs, the combined results have not been fruitful. Industry-wide,?productivity improvements have been limited. between 2014 and 2019, expense ratios fell for only 45 percent of global P&C carriers (with important variations across regions). For many, ratios did not shift or actually rose. That’s a despairing result for an industry that has linked so much to the need for productivity improvements. As a result of these longstanding challenges, economic profit—that is, profit after cost of capital—in the insurance industry is practically at a halt.

Restarting value creation, The challenges very hard. And insurance leaders must also contend with a tranche of trends unchecked by COVID-19. It’s a unique moment; insurers now face several fundamental strategic questions. How can they create more value for shareholders? Can they unlock latent demand and improve the customer experience? How can they regain momentum on the long-running quest to improve productivity? Also, what about talent? How can they reimagine the employee proposition to attract and retain the brightest and best after the pandemic? Finally, how can insurers, individually and collectively, reframe the role and purpose of insurance in society?

LEADERSHIP TEAMS NEED TO CAPITALIZE ON NINE VALUE LEVERS:

Make environmental, social, and governance (ESG) considerations a core feature of the business model.?ESG issues increasingly affect how all companies do business. Consider climate risk, an area in which?evidence is mounting?that P&C insurers will soon need to revisit their business models. However, while many insurers have begun to incorporate climate-risk considerations in their investment processes, new product launches and underwriting processes are mostly unchanged.

Regain relevance through product innovation and coverage of new risks.?While the insurance industry has built financial resilience recently, some substantial risks have been left uninsured. A fast-changing world is creating many new and evolving risks. In P&C commercial lines, for instance, data and cybersecurity risk and ML liability are coming to the fore. New risks call for new products and a resifting provision of priorities and represent significant opportunities for P&C and life insurers that are willing to innovate.

Enhance and personalize customer engagement and experience.?New customer behaviors require a change in distribution. Consumers are accepting digital channels and have become used to delightful experiences with leading tech companies. They expect the same when buying insurance both online and offline.?A seamless, consistent “multi-access” experience?in every channel is now the gold standard for insurers.

Engage with ecosystems and insurtechs.?The progress of digitalization's ongoing drive toward digitalization has also put the insurance industry on the verge of a paradigm shift: as traditional industry borders are eliminated. The ecosystems will greatly influence the future of insurers, with insurtechs aiming to play a role in this rearranging of the value chain.?The research suggests that ecosystems could involve $60 trillion in revenue by 2030. Many insurance executives are looking at ways to engage with emerging ecosystems in areas such as mobility, healthcare, and the connected home.

Develop new businesses for the digital age.?Private investors have spotted the potential for improvement and the near prospect of attractive returns in insurance. They are investing heavily in insurtechs, whose attractive talent pools can rapidly create and scale new businesses. In this context, incumbent carriers must reinvent their business models to fulfill the imperative to grow and, ultimately, to deliver stakeholder value.

?Scale impact from data and analytics.?Most insurance executives would agree that?data and analytics capabilities are becoming table stakes in the P&C and life sectors in Europe, North America, and Asia. Leaders see enormous potential in best-in-class data and analytics abilities across the value chain, even for the highest-performing companies. For example, even the leading P&C insurers can see loss ratios improve three to five points, new business premiums increase 10 to 15 percent, and retention in profitable segments jump 5 to 10 percent. However, after years of investing and testing, most insurers have not yet seen the return on their investments at the enterprise level.

?Modernize core technology platforms.?From 2012 to 2020, technology’s average share of operating costs rose by 36 percent (for P&C) and 10 percent (for life). The key driver is growing digitalization—at both the front end, where technology augments the customer experience, and the back end, where digital drives productivity gains and operational performance. Digitalization is straining legacy systems, some of which are decades old, and many insurers are considering an alternative to core systems with tech platforms that support the requirements of the digital age.

Address the productivity imperative.?In the current conditions,?addressing structural expenses?has become an even more important source of value—especially given the limited progress to date. Insurers need more than mere piecemeal attempts at improvements. Only a?transformative approach?will allow an insurer to survive and thrive in a post-COVID-19 world. Each carrier is unique, but any company can begin the process to improve productivity by establishing the trajectory and full performance potential of the business across the value chain—including sales and distribution, product development, operations, technology, and corporate functions.

Reimagine culture, diversity, and ways of working to attract and retain talent.?Once in a generation (if that), we have the opportunity to reimagine how we work. In the 1800s, the Industrial Revolution moved many in Europe and the United States from fields to factories. In the 1940s, World War II brought women into the workforce (if not the C-suite) at unprecedented rates. In the 1990s, the explosion of PCs and email drove a rapid increase in productivity and the speed of decision-making, entering the digital age as we know it today. And in 2020, the COVID-19 pandemic drove employees out of offices to work from home.?The return to the workplace?is a chance to create a new, more effective operating model that works for companies and people navigating a world of increasing uncertainty. Finding solutions to the above imperative will help carriers answer strategic questions about “how to play.” But the challenges and recent trends facing the industry will force some insurers to also think about “where to play” and rebalance their portfolios of businesses and review their capital allocation.?

Grow or exit?is one of the vital questions. Overcoming the scale trap in life insurance closed books

?The COVID-19 pandemic has aggravated challenges for insurers in continental Europe. M&A deals with closed-book players can help insurers continue to create value. Life insurers in continental Europe?have been wrestling with a combination of cost, regulatory, and interest rate challenges for much of the past decade. The COVID-19 pandemic has accelerated those challenges by adding pressure on life insurers’ costs, solvency, and investment yield, forcing necessary investments in digitalization. Now the challenge for leaders is to learn from these developments so they can be better prepared for the future and avoid becoming trapped in a downward spiral. Some players have been better able to cope with these challenges than others. Insurers employed cost-reduction programs and investments in the digitalization of their back and front end. Many shifted their product focus from traditional guarantees toward hybrids and unit-linked solutions. Yet, growth has been limited to markets where the majority of players adapted to the new environment, and performance has been mixed as a result. Meanwhile, the underlying challenges affecting the sector persist. First, since 2010, insurers have failed to reduce their overall costs (as opposed to costs as a percentage of reserves). Cost ratios fell in each of the top five European markets, except Spain because of increasing reserves. Second, regulatory pressure is showing no signs of abating. Rules such as the IFRS 17, which will come into force on January 1, 2023, and rules tightening up local consumer protection significantly deplete capacity and are challenging the traditional value proposition of life insurers.?Last, the era of ultralow interest rates has brought challenges. While insurers have naturally sought to boost returns to offset the meager returns from traditional fixed-rate investments, the relatively high regulatory capital requirements involved have made this a difficult proposition. Even with increasing rates driven by the unprecedented inflation since the first quarter of 2022, life insurers still need to deal with these issues due to the long duration of low-yielding assets in their books. This can be particularly challenging for smaller insurers that do not have the scale to justify assigning large teams to monitor risks associated with smaller asset classes such as renewables and infrastructure. Despite this challenging environment, new players, such as consolidators, have entered the market and have shown that insurers can still create value. Incumbents can learn from such players to become better prepared for the future. The time has come for insurers to make some bold strategic decisions.

M&A: The neglected activity

Many insurers still focus on organic growth by coming up with attractive new products or by cooperating with strong digital partners for greater distribution. To truly create value from this lever, insurers need to generate a minimum of roughly €2 billion in annual premiums to remain competitive, meaning an insurer with €500 million in premiums would need to grow by 15 percent per year for the next ten years. Another way to accelerate this growth journey is through consolidation. M&A helps create scale, thereby aiding in a reduction of costs and enabling insurers to finance investments in digitalization, new product offerings, and superior asset and liability management (ALM).?In life insurance, although the acquirer can profit from scale, the seller benefits from divestments because those result in freeing up capital at the group level. The seller, however, needs to keep fixed costs under control if only part of the business is sold. Moreover, companies with a more targeted approach outperform those that focus simply on the scale. This means that insurance amalgamators aim for scale while focusing on acquiring portfolios that fit their own strengths or that help them build the skills, they need to improve efficiency. Companies active in M&A also benefit from the ability to divest unprofitable parts of their business. Despite a decline in M&A since 2012, we expect sector consolidation to rising in priority in the medium term as a response to the combination of pressures of scale, worsening market conditions, and the increasing difficulty of growing organically. Historically, consolidation has tended to follow periods of crisis. This introduces the prospect of more active dynamics in the life insurance M&A market, potentially improving overall performance. In a February 2021 report, we discussed how insurers can create value from their closed books.

Learning from successful closed-book consolidators

In a declining life insurance M&A market, closed-book deals have become an increasingly important part of life insurance M&A in continental Europe since the first deal in 2012. Momentum accelerated from 2014 to 2015, with the deal count in the European Union overtaking that of the United Kingdom and Ireland combined and with Germany becoming the strongest continental market. Deal flow leveled off in 2020, however, because of the pandemic.

Three types of closed-book players have emerged in Europe:

Internal runoff.?In Germany, at least six life insurers have said they are now managing their closed books via a different entity. These entities typically try to keep their costs under control, leverage their customer base for scale, cross-sell, or simply avoid complex transformations.

Purely external closed-book consolidators.?Most consolidators began as purely closed-book consolidators, acquiring closed books or closing them during the acquisition. This ensured that they could focus on their core strengths and the efficient management of the in-force business. These consolidators typically focus on operational excellence, improved capital management, or superior asset and investment management.

External closed-book consolidators with new business.?Some consolidators that have been unable to achieve their target growth rates through acquisition alone have started opening their books in certain markets or acquiring new open books in an effort to grow. These consolidators typically generate incremental additional value by selling products with a better new-business margin, such as biometric-risk coverage or unit-linked products.

The external closed-book category has two identifiable subtypes:

Efficient operational platform.?These consolidators focus on an efficient operational model via improved processes, digitalization, and a strong IT platform. They rethink their sourcing strategy and optimize their office locations. These insurers often outsource the asset management function or reduce interest rate risk, enabling them to cash out freed-up risk capital.

Superior asset management platform.?These consolidators run on a solid IT and operational platform but mainly leverage sophisticated investment management skills, such as using cash-efficient ALM and improved strategic asset allocation (SAA) or deploying a higher risk appetite. The ultimate owner of the platform often handles asset management, which typically delivers higher returns and offers the owner a source of permanent capital. The closed-book consolidators are better suited than incumbent life insurers to pull the required growth levers.

In Germany, for example, there are signs that external closed-book consolidators add value to the entire life insurance market. First, they reduce costs, increase investment yield, and manage their capital more efficiently, resulting in a significantly improved ROE after the acquisition of a closed book.?Second, there are no signs of increasing churn rates after an insurance group sells its closed books to consolidators.

Compared with external closed-book consolidators, current data for Germany indicate that internal runoff entities haven’t managed to reduce administrative cost ratios. Furthermore, they haven’t improved investment yield and ROE in the same way that external closed-book consolidators have done. Additionally, internal runoff portfolios have experienced a slightly higher churn rate after closure, while external closed-book consolidators have managed to reduce churn.

Moving consolidators to the next level

Most consolidators have specialized in their respective strengths, often focusing only on some of the five levers for value creation we discuss operational excellence, investment, capital management, technical excellence, and commercial led. ?Yet to be fully optimal, insurers should apply all of them, while at the same time focusing on building a lean, specialized business model and not being abstracted by regulatory and other add-ons.

Operational excellence.?Within the first five years after the acquisition of a closed book, consolidators that focus on building efficient operating platforms have desired to cut costs, while internal runoff entities have not been able to do so. However, consolidators with a focus on superior asset management platforms still have some potential if they strengthen their operational platforms.

Investment.?The consolidators that are focusing on the investment lever normally have already managed to improve investment yield. But other consolidators have been derisking their portfolios by shifting into safe-haven assets such as government bonds to free up risk capital.

Capital management.?Most consolidators have already reduced their equity after acquiring closed books. However, others especially internal runoff entities can still improve on their capital management.

Technical excellence.?Life insurers have three sources of profit: returns from risk, investments, and cost management. Indications suggest that most external consolidators lack sufficient focus on the required skills, making them unable to improve their risk results. In an increasingly competitive environment, consolidators should pay more attention to the talent and skills required for achieving effective risk returns.

Commercial uplift.?While external consolidators have experience with reducing churn, internal runoff entities have a mixed track record and need to improve the management of their churn rate.

The following three trends could emerge among consolidators in the near future.

Consolidator deals

In the medium term, we estimate expect to see more M&A deals by consolidators. In the past two years, an increasing number of incumbent life insurers have been rethinking their geographic footprint, selling to other incumbents or consolidators, and narrowing their portfolio focus to their core markets. While this momentum will be slowed down by current market volatility, the underlying trend is likely to persist.

Customized portfolio deals

Specifically, we expect to see more activity in relation to customized insurance portfolios, rather than the outright acquisition of a company, for two reasons: First, within closed-book deals, the number of portfolio deals has increased recently, indicating that consolidators are starting to focus on acquiring portfolios that match their own strength.

Second, as observed in the US, smaller deals with more focus on skills and product diversification create more value.?This is because portfolio deals typically involve the transfer to the acquirer of employees who are highly specialized. However, to ensure value creation, fixed costs need to be addressed on the seller's side. The price of the acquired portfolio reflects this.

More open-book acquisitions by closed-book consolidators

In the past two years, closed-book players have entered the open-book market, possibly because of lower supply and increased competition in the closed-book market. However, certainly, all consolidators followed different strategies. While some focused their open-book activities only on specific markets, others acquired portfolios across Europe and in markets with an initial closed-book strategy. The evolution of consolidators in the United States shows the potential size of the prize for applying the proven value creation playbook from closed books to open books, with consolidators now marking 30 percent of new business in select product lines. Life insurers, especially those in continental Europe, need to adapt to the continued cost and regulatory challenges. To achieve growth, insurers should proactively assess the right strategic options as they plan the future.?This should involve assessing their books and taking a fact-based approach to assessing whether they have the required skills to create value from them.

Insurers who have the required skills to extract value from their closed books should consider how to maximize value creation from these capabilities, including exploring further acquisitions. They have an opportunity to refine their value creation playbook based on lessons from market leaders. Insurers will need to ensure that sophisticated deal-making and IT migration skills are already in place before executing their first deal. But if creating value from closed books proves challenging, insurers should explore potential value creation by offloading their book to a consolidator. These consolidators are well-equipped to create value from a portfolio and can share part of the value creation back to the insurer. This will free up the capital and management capabilities needed to invest in digitalization and growth in other areas of the business and can augment returns.

?CONCLUSION

It can be noticed based on the above, that the insurance industry needs proactive action to formulate new products. The insurance players' Mergers and Acquisitions are bound to happen but they will succeed or not, depending on the wise decision. The consolidation is also continuing. The actual beneficiary is the consumer.?They will feel delighted experience.