For years I have watched companies struggle with the concept of aligning the interests of consumers, advisers, the life offices and reinsurers when it comes to driving for quality business. A great deal of the issue arises from companies not being able to articulate what “quality” actually means for them. Without this clear guidance, consumers continue to buy and advisers continue to sell in a way that suits them.
Before we dive into looking at quality it is important to understand what is actually going on in the value chain and a quick tour through the value chain, using me as an example, reveals the following insight into how the market works.
Mick James as a customer is 42 years old and needs some life insurance to cover his family of two young children in the event of his death until his oldest has left home (in 20 years time). Mick is happy to budget £20 a month to obtain £100,000 of cover over a 20 year term. Mick wants the cover and wants to know he will get the money if there is a claim.
Mick goes to his IFA who recommends he uses ABC Life Office and the IFA leaves the application form with Mick to fill in. Mick does this and sends it back to the IFA who rekeys the information into the life office online system, the policy is issued and Mick goes on risk.
The IFA wants the commission and also wants to know Mick will get the money if there is a claim – otherwise Mick may sue him and the IFA’s professional indemnity premiums will go through the roof.
THE LIFE OFFICE
ABC Life Office underwrites and sets up the policy on its systems at a cost of £100, pays the IFA £480 commission, pays off the sales and marketing people and contributes to the CEO’s bonus, at a further cost of £100, and sits back to wait for the first premium. The first £20 comes in from Mick and the life office keeps £12 and gives the other £8 to the reinsurer. Out of the £12 it has kept, it puts £1 aside to reserve in case there is a claim and another £1 is put aside to cover ongoing policy servicing costs and trail commissions and the rest (£10) goes to pay off the debt (£680) created when the policy started. So, typically, in about five to seven years time the policy starts to make the life office some profits (the graph below shows how the cash emerges).
The life office wants the promise of future cash flows that should emerge over the 20 year lifetime of the contract and also wants to ensure Mick will get the money if there is a claim as they don’t want to be on TV’s Watchdog.
The life office has been worried about holding onto the liability and what may happen if Mick died so they have sold 90% of the risk on to a large, trusted reinsurer, RGA. In order to take on the £90,000 of risk RGA wants £8 each month and they place £7 into reserves to pay for any claim that may occur, and keep the £1 to cover costs and pay for profit.
The reinsurer wants the promise of future cash flows too, and is happy to take on the liability as they have a good understanding of the risks Mick poses.
Within this value chain there are a few fundamental levers which create good business and these are essentially the drivers of quality.
Disclosure Good disclosure by Mick at the application stage means the contract will have been appropriately priced and there will be no shocks in the profile of claims payments later on down the line. Life offices like this because it means they can reserve for claims payments with greater certainty, and reinsurers like it for the same reasons. Appropriate disclosure is also good for consumers as it means their claims will be paid and it is also good for advisers as it means they will not face any awkward situations in the event of a claim.
Lapses You can see that early lapses destroy the profits for the life office and also call into question the integrity of the advice process – after all, why was a long-term (20 year) product recommended when the client lapsed it after three years? This has Treating Customers Fairly implications too and is an area that is increasingly drawing the attention of the Financial Services Authority. So, generally a product that has been well sold and matches a consumer’s needs should stick around on the books for a long time – this seems to be good for life offices and also seems to be good for customers.
Business mix, (or in layman’s terms, the sick versus the healthy) This is a tricky one; you can see the life office must pay the cost of the underwriting, and the unhealthier the customer the greater the costs–with a GP report(GPR) at£85 and a full medical anywhere up to £350. These costs come straight off the bottom line in the first year so they drive up the life office expenses and prolong the time it takes for profits to emerge.
So a company attracting only healthy lives will have lower costs and hence lower prices–but where does this leave the sick? Most life offices tend to budget for amix of healthy and sick people applying within their expenses, so again if this business mix is not met then profits will be hit. You could argue sick people get loaded to cover these additional costs but in practice loadings only really cover the deterioration in mortality (the chance of someone dying) or morbidity (the chance of some one getting acritical illness) and so, in general, healthy people are subsidising the real cost of underwriting sick people.
Volume Fundamentally, it costs a lot for a life office to set up the infrastructure to sell life insurance. For example, companies will spend at least £1m on an online underwriting system. In addition, they will have to pay for systems, people, marketing, servicing, claims, underwriting, literature – plus it will have to contribute to all of the shared costs existing within a large corporation (executives, risk managers, HR, IT, support staff etc). These costs can mean that at the start of any trading year the life office already knows just to turn on the lights for the year they will have to spend at least £5m and in most cases much, much more. So, for a company to succeed they must sell buckets of business with around £15-£20m of volume (annual premium income) being a rough rule of thumb, after which acceptable profits can emerge.
SO WHAT DOES ALL OF THIS REALLY MEAN?
Life offices would ideally like to see lots of healthy people who stick around for a long time coming onto their books, and they would like these people to be telling the truth about what is wrong with them on their application forms. It really is this simple.
PruProtect is really the first life office to publicly enter this arena with a set of terms and conditions. It made its move on 27th April by announcing it would enhance commissions to IFAs by up to 15% if the IFAs encourage their clients to start using their Vitality program (gym memberships, stop smoking initiatives etc). PruProtect showed that customers who used the programme became healthier (and so were less likely to claim) and also stayed around longer – both key long-term profit drivers. For the life office and reinsurer there is a greater certainty of profits emerging; for the adviser there is enhanced commission and healthier customers, who by living longer will provide greater earnings potential (eg for funds under management charges or for recurring fee income from reviews). For the customer. there is improved mortality and morbidity which is surely a good thing. All in all there has been an alignment of interests which has produced additional value for all the key stakeholders in the value chain.
Within the banking channels companies are also now getting to grips with this and some are actively incentivising their face-to-face advisers to reduce lapses in order to secure tomorrow’s profits.
There are a number of companies currently looking at the dynamics of these kinds of a models and I predict within the next two years quality scoring will become common place in the UK with life offices starting to have adult conversations with advisers about what makes good business for them and rewarding advisers who can demonstrate good practice.
A FUTURE VISION
In the next two years we will see life offices increasingly measuring disclosure rates on an IFA or business writer level – effectively looking to see how many times there are serious non disclosures which would have led to a change in the underwriting terms. Also, we will see IFA lapse rates being measured and IFAs being rewarded differently according to the level of lapses. I also predict we will see some companies starting to unbundled the cost of underwriting – effectively transferring the real cost of the GPR, underwriting and medical directly back to the consumer as either a one off cost or as an increase in their policy fees, thereby creating a model where the healthy are no longer cross subsidising the unhealthy or more risky.
For the bulk of consumers this may mean lower prices and greater certainty at claims stage, for advisers it could mean commissions will vary by 10-30% depending on the quality profile they exhibit and for life offices and reinsurers this should lead to greater certainty around the emergence of long-term profits.
So the message for advisers is clear. Do what you do best. Advise people to buy appropriate products which they will value and hold onto, and make sure that they understand the importance of disclosures. In the future world these traits will be actively measured and will directly impact upon your commissions.