To Assure Continued Growth and Profitability, The Insurance Industry Needs Another Revolution

 

During the last quarter of the 20^th century the life insurance industry was forced into a period of structural and product change that had not been seen in over 100 years. Most of the established insurance institutions, comfortable with the way things were, not only did not recognize the need for change, but they also stubbornly tried to ignore and resist it.

The needed change was driven by several factors, but the primary trigger was the consumer who began to reject the traditional business model of the life insurance industry. At the time, the industry’s business model was predicated on offering, through a cadre of exclusive sales agents, long term products designed to protect against the economic cost of dying young. For almost a century this approach resonated with consumer needs and concerns and insurance companies grew to become financial behemoths. 

However, during the 20^th century medical advances increased male life expectancy from 42 to 73 years.  As a result, consumers became less concerned about the cost of dying to soon and began to worry about the cost of living to long in retirement.

Meeting the changing consumer needs and goals was the antithesis of the traditional life insurance company business model and this disconnect caused expenses to increase, a decline in sales and reduced profits.  At the same time, consumers were presented with more options for their funds as banks and investment firms began to introduce a portfolio of savings and investment products that outstripped those offered by the life insurance industry.

While change is often seen as a threat to be resisted by established companies, it can be an opportunity for newer, more nimble and creative companies. This is exactly what happened in the life insurance industry.

In a highly edited version of the industry's reaction to unwanted changes, companies moved away from the traditional “captive agent” distribution system, making agents independent. This action triggered the development of Independent Marketing Organizations (IMO). The IMOs gathered the newly independent agents into groups to support their product knowledge and sales efforts. In addition, companies shifted away from traditional long term life insurance products and began to emphasize the sale of the long ignored fixed annuity product.

The fixed annuity was more in tune with the consumer’s concern about the cost of living too long, which included the fear of running out of money and the need for income in retirement. As a result, over the past 30 years the industry's shifted emphasis on annuity sales stimulated renewed growth and profitability. So much so that the industry could now be referred to as the “annuity industry” rather than “life insurance” industry. (The bulk of life insurance sales shifted to low cost “term insurance.”)

NOW THERE IS A NEED FOR NEW CHANGES

Despite continued record sales, I have come to believe that the marketing of Fixed Income Annuities (FIA) through the independent agent IMO distribution system has become the most risk-filled and least rewarding business model for a company. 

There are numerous reasons for this, but one of the main drivers is the plethora of “bells and whistles” that have been attached to the basic FIA contract. The intent of these added “benefits” has been to make the product more attractive to the agent and consumer by positioning the product as superior to those offered by other annuity companies. However, the actual result has been a cloud of FIA products offered by a variety of companies that are complicated and difficult to understand for both agents and consumers. Not to mention the costs for the companies to develop, market, issue and administer this wide variety of FIAs.

Another reason for the failing FIA business model is the continued erosion of the independent agent distribution system. The story is too nuanced for this communication, but suffice to say that this distribution system under the Independent Marketing Organization (IMO) has become increasingly unwieldly, inefficient, expensive and worst of all, ineffective.

From my perspective, confirmation of this is evident in the actions of companies aggressively selling “access and control” of their distribution system to aggregators who have a business model of buying independent IMOs. For the aggregators, the idea seems to be that “bigger is better,” but my belief is that this approach compounds the problems for companies, the agents involved, the consumer and ultimately the aggregators.

While the market for accumulation and income products remains expansive, the conclusion derived from all this is that the time for IMOs spearheading the sale of FIAs via independent agents may have even passed. My experience tells me that the FIA market is at a tipping point akin to the life insurance industry of the 1980s and '90s. If so, this creates a significant risk for FIA focused companies that continue to compete with, rather than against other companies for annuity market share. But this situation also creates a unique and highly profitable opportunity for companies willing to lead change.   

To take advantage of this new opportunity, old concepts, rules and products need to be discarded and replaced with a new way of doing business and a new product concept. Interestingly, many of these changes may take a “back to the future” approach. In essence this means the company once again taking ownership and control of the entire marketing and customer relationship.

For the balance of this communication, I offer a macro-overview of how the business model and new product might emerge and function.

COMPANY STRUCTURE

Moving forward, companies should begin to utilize existing technology to convert all home office functions – marketing, underwriting, policy issue, policyholder service and benefit payments – to a totally paperless and on-line system.

MARKETING AND SALES

The company should control the entire marketing and sales process, employing all forms of “Social Media” and advertising to identify potential sales prospects. The company will develop and operate a “national call center” that will funnel all responding prospects to licensed employees of the company who will pre-qualify the individual, explain the product, close the sale and help the prospect complete the application. Most of this process can be accomplished utilizing Skype, Zoom or new AI technology. (Existing IMO organizations could be converted to this approach, but that is for another discussion.)  

NEW OLD PRODUCT

When life insurance companies shifted away from permanent life insurance, they did not invent a new product but just repositioned an old product – the annuity. Annuities had been in the insurance portfolio for 100 years, but they were considered only good for “widows and orphans.” Under the new approach, companies simply shifted the “objective” of the annuity to a product that enabled individuals to accumulate assets, growing on a tax-deferred basis and then convert those assets into a guaranteed income at retirement..

Likewise, the answer to today’s FIA problem is not the invention of an entirely new product, but rather the repositioning of a little used existing product – the endowment. (Decades ago, insurance companies sold endowments to young parents to accumulate funds to pay for a child’s college education.)

Smaller companies or those just entering the market should announce that (for whatever reason) they WILL NO LONGER SELL FIAs. Instead, they will introduce a new product – the GUARANTEED INCOME ENDOWMENT (GIE). (Companies currently dependent on the sale of FIAs by IMOs and agents could create a "parallel universe" at first, with agents selling FIAs and the company offering the GIE as a non-commission product.)

The GIE would be introduced to the consumer as a true alternative to existing fixed annuity products. A product with more simplicity, flexibility and consumer control, but with the same protections against running out of money and income in retirement. Indeed, this product would be targeted to compete against rather than with annuities.

HIGHLIGHTS OF THE GIE

This is a conceptual broad overview of a new product (using an old concept) called a Guaranteed Income Endowment. (GIE)  

1   Single premium purchase of the endowment with a guaranteed maturity value at the end of the term (2yrs, 3yrs, 5yrs). A little like buying a bond, the consumer could (as an example) deposit $95,500 that would guarantee to mature at $100,000 at end of term in 3 years. The buyer may, at any time during the term, withdraw the full amount initially deposited. (Interest previously credited is forfeited as a form of surrender charge.)

4.      At end of the selected term the buyer may: A) withdraw all funds, B) roll over funds to purchase a new GIE at the then current rates, C) the buyer can exercise a “settlement income option” in the endowment that provides monthly income for a guaranteed fixed term.

5.      Settlement Income Option: Owner can elect guaranteed income for 10 – 15 – 20 or 30-year period. Because income is for a specific period, payout rates are not gender specific. If the owner dies prior to the end of the payout period, continued payments will be made to a named beneficiary until then end of the selected period.

6.      If the owner selects the settlement income option, they will receive an immediate “lump sum income bonus” determined by the years of income selected. For example, if 15 years of income is selected, the bonus is equal to 15% of the endowment amount. Twenty years of income garners a 20% bonus and so on. The bonus is added to the endowment value and used to increase the monthly income.

Advantages to Consumer – The product is easier to understand than the current crop of annuity products. Unlike typical annuities, consumers do not have to give up long term access to their funds. The policy owner can elect options when interest rates are most advantageous to them. Likewise, they have the power to decide if they want income from the product and how long they want income to continue.

Advantages to Company – Easier to explain and sell the product. Fewer “suitability” and compliance issues. Escape from all the political and competitive misconception issues in the current crowded annuity market. The biggest advantage for the company is that the GIE creates a whole new accumulation and income market, with no current competition. The GIE totally eliminates the mortality risk of life income annuities. (The consumer assumes the mortality risk in exchange for what could be higher income compared to a like amount in an FIA.) All liabilities are known and fixed. With known liabilities, it is easier for the company to match and manage investment durations. Interest rate disintermediation risk is significantly reduced, if not eliminated.

One powerful advantage for a company offering this type of product is, because of its simplicity, the product can be offered directly to the buyer, thus circumventing the need for a field agent distribution system. Currently available technology can be used to market, issue and administer the product. (There are some independent agent organizations successfully selling MYGA annuities using this technology.) As a result, companies can significantly reduce acquisition, marketing and administration costs.

SUMMARY

Forty years ago, changing consumer needs and increased financial options forced a reluctant life insurance industry to change. Fortuitously the industry turned to a seldom used product – the fixed annuity – to respond to new consumer needs. Soon annuities became the industry’s largest asset accumulation product, revenue generator and profit maker. It is not an exaggeration to say that shifting to marketing fixed annuities may have saved the industry.

As the annuity became ubiquitous it became more and more difficult for companies to differentiate their product from the competition. The result was that annuities became overloaded with “options and benefits” to the point that the very simple concept of the annuity was lost. Neither the consumer asked to purchase the product nor the agent attempting to sell it really could understand or explain it. This created the current confusion, controversy and conflict in the market. The need and potential for an accumulation and income product is even greater today, but the current crop of FIA products sold through the IMO independent agent system is not a business model a prudent company would want to operate in or enter today.

What is needed is change – a new revolution. Real change in product. Change in how the product is marketed, issued and administered. The future is bright, but that future will belong to those who recognize and take advantage of the opportunity brought on by change. 

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Robert MacDonald is a 50-year veteran of the life insurance industry. The former president and CEO of ITT Life Insurance, founder and CEO of LifeUSA and retired chairman and CEO of Allianz Life of North America. Author of a number of books on business, management and leadership.  bobmac5201@gmail.com