Industry “condemned to innovate”By Alain Thériault | August 19 2013 03:22PM
The life insurance industry is wary after the perfect storm that forced it to take refuge in more prudent practices, but despite everything it is not lacking in innovation. On the contrary, it is obliged to innovate.That is the answer Yvon Charest has for industry critics who say there is a dearth of new products. In an interview with The Insurance and Investment Journal, the CEO of Industrial Alliance Insurance and Financial Services said that this obligation to innovate will result in a series of changes that has only just begun.
Charest recognizes that the industry is facing a “very difficult” situation in terms of new capital requirements and actuarial reserves. These circumstances are forcing insurers to reconsider their long-term guaranteed products.
“Canadian bonds with a 30-year duration have an interest rate of 2.2%, I do not remember seeing anything like it,” says Charest. In 2011 interest rates were in a free fall, reaching a low point in 2012. During the same period, there was a series of price increases in individual permanent life insurance. They have continued ever since.
Have these pressures frozen insurers’ ability to innovate? No, says Charest spontaneously. He even uses a competitor as an example to illustrate the industry’s innovative powers.
“We are in a situation that forces insurers to innovate. Along with Empire Life, we were the first to launch a guaranteed individual life insurance product with adjustable premiums,” he says. “In my opinion, this is only the beginning of changes in the industry.” (Editor’s Note: UL Mutual also has a range of products with adjustable premiums.)
The conditions that support this prediction are here to stay, says Charest. He has no illusions about a return to 2007 interest rates. “It would not be prudent to dream,” he says. “If one were to survey executives as a whole to ask if returns of stocks and bonds will be better, the same, or lower than what they have been over the last 30 years, they would probably reply that they will be less. Experts believe that the returns on these asset classes will not be as high over the next ten years.”
In these circumstances, Charest believes adjustable products could become a very important part of risk management in the industry. This product gives insurers a better profit margin with pricing that is more consistent with the reality of current interest rates. However, the insurer promises policyholders that it will reduce prices should interest rates rise.
“The insurer will continue to assume mortality risk, but it will share interest rate risk with policyholders. It will be easy to explain to a client that the capital requirements for a guaranteed product are now more expensive.” This risk sharing gives consumers access to a product with less of a guarantee, but at a more reasonable price.
Guarantees vs. regulation
Now that the industry has seen the consequences of the perfect storm, insurers must adjust their products, both in individual life insurance and in segregated funds – and not only because of the economic environment. “Things would have gone well if it had been just that,” he comments. In fact, he believes that the regulations governing capital requirements have made the situation worse, especially for segregated funds.
“The increased capital requirements are responsible for 50% of all guaranteed withdrawal benefit (GWB) product closures,” says Charest. Introduced to the market in 2006 under the leadership of Manulife Financial, the product went through a difficult period in 2009 because of low interest rates and volatile financial markets. “And then the regulator jumped in with expensive and very volatile capital standards,” comments Charest.
Charest would like to see the Office of the Superintendent of Financial Institutions (OSFI), the regulatory body responsible for setting capital standards in Canada, recognize insurers’ efforts to hedge risk in products that are sensitive to interest rates and volatility. This recognition would take the form of credits which could be used to reduce capital requirements.
The capital requirements that apply to segregated funds are based on the product’s risk profile. Since Jan. 1, 2011, the standard for new business (new deposits) has become expensive, and if the insurer hedged the risk, it received zero credit for it. “Common sense is that we should get credit if we hedge our exposure adequately,” says Charest.
Have regulations, volatility, and low interest rates made insurers shy of risk? “The capital requirements are a short-term risk and IFRS [the International Financial Reporting Standards] are a medium-term risk. Are we looking at a short-term or more long-term time horizon? We do not know.” Charest feels no discomfort about this uncertainty. “Risk management is making decisions under uncertainty. “
The bank threat
Some advisors are also concerned that the banks, which are more accustomed to taking deposits than taking on risk, will use their high profile to steal clients away from insurers. In one case, for example, an insurance advisor brought a cheque to a deceased client’s family in the morning. When he returned in the afternoon to offer investment advice, he discovered that the client’s bank had already taken the business.
Charest is not afraid to cross swords with the banks in this kind of situation. In his opinion, insurers can go after a good slice of the pie. He believes that the industry’s solution needs be based on paying out retirement income.
The argument that a life annuity is a poor retirement option compared to a RRIF – because one loses one’s capital – should be rejected, says Charest. “It underestimates longevity risk.” He believes that insurers are better positioned to meet the needs of an aging population. “Young people want to maximize their returns. After a while, they want to manage income taxes, their estate, withdrawals, and longevity risk. The RRIF does not take longevity risk into account.”
The best way to manage this risk is with an insured annuity. Backed by an insurance policy for the same amount of the capital invested, this annuity provides the retiree with income for life, and the estate can recover the annuitant’s capital in the event of death.
Despite their popularity, insurers have all dropped their 5% guaranteed lifetime withdrawal benefit at age 65 (GLWB), although some players still offer GLWB products with lower withdrawal amounts. At the end of last year, Empire Life announced that it was putting an end to its 5% at age 65 withdrawal benefit. The insurer took this measure for the same reasons given by its competitors: low interest rates, stock market volatility and the severity of the capital standards that were introduced in 2011.
From the time of their launch in Canada in 2006, GWBs enjoyed a resounding success with baby-boomers. To fill this gap, Charest believes that insurers need to revive the product in another form.
“What remains to be done is to combine the features that interested our customers with the regulatory capital requirements. We need to invent a capital light GWB.”
What would this be? A product that offers the annuitant a stable retirement income, investment protection, and requires less capital from the insurer. Charest said that Industrial Alliance is looking into it.
Industrial Alliance’s growth will continue to come primarily from individual wealth management. This sector includes segregated funds, mutual funds, and private banking through Jovian Capital, which the insurer has recently agreed to acquire.
To illustrate, Charest points to a tool the insurer has introduced to its financial results recently in order to make them easier for investors to understand: source of earnings. Increasing significantly, Industrial Alliance’s earnings went from $103.3 million in 2011 to $311.9 million in 2012. The annual report says that these results are due to the improving macroeconomic situation, growth in businesses, and hedging strategies.
Over ten years, the net profits from the individual wealth management division has quadrupled, from $30 million in 2003 to $118.2 million in 2012. “As for profits from individual life insurance, they have only been multiplied by two [from $ 72.8 million ten years ago to $154.9 million in 2012],” comments Charest. During this time, through 17 acquisitions and organic growth, the insurer increased its assets under management in mutual funds and segregated funds from a little more than $2 billion to $18.2 billion.
He points out that sales of life insurance have increased by about 5% annually in the industry in recent years, while those in wealth management have increased by 10%. “There are a lot of players in the game and they capitalize on their strengths. Wealth changes hands, which creates growth opportunities. In contrast, life insurance contracts sold over the last 30 years will not move much from one provider to another,” notes Charest.
In addition, 69% of sales of the insurer in this area took place outside of Quebec in 2012, compared to just 43% in 2005. The proportion of group savings and retirement sales outside Quebec was 34% in 2012 compared to 18% in 2005. A total of 58% of premiums and deposits of the insurer originated in provinces other than Quebec, up from 49% in 2005.
Niche markets play bigger role
Specialty markets and creditor insurance for automobile dealers are also playing an important part in the insurer’s growth. Like mutual funds, these products favour the insurer because they do not require as much capital. In 2010 these products only accounted for 28% of operating income compared to traditional products, but this number increased to 37% in 2012. The individual disability insurance product sold by The Excellence Life Insurance Company and Industrial Alliance Auto and Home Insurance also figures on this list of less capital intensive products.
Accidental death and dismemberment insurance remains the best source of growth in the special risks niche, followed by travel insurance and direct insurance for associations. “We like niches such as creditor insurance for auto dealers and solutions for special markets because there are not as many competitors on the ground as there are in traditional markets,” explains Charest.
In creditor insurance as in general insurance, the insurer is taking advantage of cross-selling. From a car dealership, Charest says there will be referrals to an advisor not only for the sale of creditor insurance on the car loan, but also for auto insurance. “This is a model that we have been putting into place in a more systematic way over the last two years,” he explains.
The company’s general insurance subsidiary now has 3.7% of the market in Quebec. More than half of the sales are made through referrals from other distribution networks, mainly representatives in the career life insurance agency channel. “The volume of our property and casualty insurance premiums is increasing 10% per year, while that of the industry is growing by an average of 2%.”
Whole life unprofitable
Traditional products such as individual life insurance occupy the most crowded markets. While it is at the heart of insurers’ activities, traditional individual life insurance is also more capital-intensive. “This is not the most profitable sector,” says Charest.
An insurance company takes an average of seven years to recoup its investment in the sale of an insurance contract, he explains. As a result, it becomes crucial to manage the surplus strain, which is to say the expenses borne by the insurer when an insurance contract is sold. As for the surplus strain on Industrial Alliance’s individual life insurance sales, it has gone from being 53% in 2011 of $111.4 million to 38% in 2012, or $93.6 million. This reduction is mainly due to price increases in permanent life insurance products. The company expects to reduce this strain to 25% in 2013.
Without wishing to overly commit himself, Charest predicts that permanent products will not return to their former prices, even if the long-term interest rates were to rise. “Between 2002 and 2009, rates were already in decline and prices did not change...The industry lacked discipline and then had to catch up, starting in 2010, with belated increases.”