Saturday, December 31, 2011

International Investment Strategy - Professionalizing Investment and Risk Management

International Investment Strategy

Investment management is a critical pillar of the insurance business, and one that is particularly important for large incumbents who have significant assets under management. The stakes are high. If they get this right it can serve as a structural advantage; on the other hand, the risk of not getting this right can be fatal - Asian life insurers are under tremendous pressure due to the high cost of their liabilities and, thus, any mis-steps in investments can ruin the entire franchise.

Local incumbents have traditionally viewed investment management as an afterthought. For decades, in many companies, the investment function has been organized as a department under finance. This is because for a long time, in most Asian markets, investment options have been rather limited by regulation and an immature capital market. Hence, the investing of insurance assets has been rather straightforward, mostly involving fixed deposits, government bonds, and in some cases, large real-estate holdings. During long periods when interest rates were high, this investment strategy served the incumbents well. However, the situation has changed considerably in recent years.

First, many insurers have issued long-term, high-guaranteed products in periods when interest rates reached heady levels (mostly during the late 1990s). However, during that period, there were not as many long-term assets, such as 20-year government bonds, to invest in - most insurers held their assets for a significantly shorter duration, assets such as short term government bonds and bank deposits. Therefore, as interest rates declined insurers were landed with a big problem - their investments yielded less than the cost of their liabilities. International Investment Strategy

This negative spread is a very serious issue - as is well known, it has brought many Japanese life insurers to the brink of collapse. But this is not just a Japanese phenomenon. For example, the average liability of Taiwanese insurers was in the region of 6.5 percent in the late 1990s while returns on their own investments were around 4.5 percent resulting in a 2 percent gap. South Korean and Chinese insurers have similar legacy issues.

Second, regulators have loosened restrictions on insurers, allowing them to invest in a greater variety of domestic and foreign asset classes, Much of this deregulation is due to the realization of regulators that insurers needed to find ways to alleviate their negative spread problem and to generate attractive returns for policyholders in low-interest-rate periods.

For example, in Taiwan the restrictions on investments in foreign markets have been raised from 5 percent of total investments in the 1990s to 45 percent in 2007. China now allows companies to invest in domestic equities and domestic alternative asset classes, particularly infrastructure products. And in 2006, the Qualified Domestic Institutional Investor (QDII) scheme was launched allowing Chinese insurers to invest part of their assets overseas. The pressure of the negative spread and the opportunity to diversify investments into new asset classes are creating an urgent need for Asian insurers to professionalize their investment management function. The urgency is not only in investment management, but also in risk management, since investing in these new asset classes brings a lot more volatility to the insurer.

There are three ways for Asian life insurers to make their investment management function more professional in the short term.

First and foremost, they need to upgrade their investment management talent. This sounds obvious until one realizes the extent of the culture changes that need to happen in an incumbent insurer. Investment management is a very talent-intensive business, which is not something that insurers are good at managing (retail insurance is much more about size and scale). In particular, domestic insurers have a very tough time attracting the best investment talent since they are competing with local and foreign fund management houses as well as hedge funds. Part of the problem is the pay scale - many Asian life insurers have adopted a very rigid compensation structure and hierarchy over the years, and their approach to investment management falls within that construct. 

Compared with the much more flexible and professional environment that fund houses provide, it is not surprising that insurers are far behind in this war for talent. One insurance executive mentioned to us that he had to go through layers and layers of paperwork just to hire one portfolio manager, and there were so many constraints and so much bureaucracy that the new hire just gave up and went to a foreign fund-management company, The asset-management pay structure has also increased substantially in recent years, and presents a shock for most local insurers. In the past, investing was a low-cost activity, where the life insurers would find investment professionals to place their assets into long-term government bonds or they simply negotiated bank deposits. However, as the insurers venture out towards hiring professionals to manage more international asset classes, they are finding that salary expectations are often significantly more than the company's culture and bureaucracy can absorb.

Second, with the right talent in place, life insurers in Asia will need to significantly upgrade investment, asset liability management (ALM), and risk-management processes by learning from best practices. Despite all the peculiarities of the Asian markets (for example, lack of deep fixed-income markets, a legacy of high-guaranteed policies, structural mismatch of assets and liabilities), there is no excuse for not adopting some of the best practice tools that are used by many of the leading global players. 

Life insurers in many mature markets have learned the hard way that excessive risk-taking can endanger the very existence of the company. Asian life insurers are well advised to learn from those examples and build the analytical tools required to assess the economic value that is created with more risky investment strategies. The accounting-based, absolute-return number that most insurers focus on - even if required to service liabilities from high-guaranteed, interest rate products in the in-force book - is not a good measure to determine value in the investment function. International Investment Strategy

Using modern analytical tools to derive investment decisions from a rigorous strategic asset allocation is key to improving investment decisions. Many consulting firms and insurance IT vendors can provide the tools and processes that can be adapted to local Asian market situations. While localization of these tools is a significant effort, it is a necessary process that can involve quite a bit of learning for the local insurer. Controlling risks and increasing risk-adjusted returns can be facilitated in a number of ways including ALM, strategic asset allocation (the science of allocating the asset base to different asset classes), stock picking, and running a professional and systematic investment process. 

Having a proper risk management process is also critical. The combination of chasing returns to minimize losses on the negative spread and investing in unfamiliar foreign asset classes can be lethal in terms of risk management. For example, a few of the Asian life insurers invested in subprime assets, which led to significant write-offs and subsequent capital calls. Another significant risk is currency exposure - with substantial volatility in currency markets, investing in foreign asset classes can lead to a myriad of new exposures that are very complex to manage. The foreign currency exposures of many assets cannot be easily hedged, and there are also market circumstances where the hedging costs are prohibitively expensive and will take away any incremental gain from the investments. For these incumbent insurers, hiring a proper chief risk officer could be one of their most worthwhile investments at the start of their journey toward upgrading skills and practices in investment and risk management.

The risk of not getting this right is huge. From Japan to South Korea to Taiwan, the contribution of investment management to total returns is higher than it has ever been, and, subsequently, risks have also increased significantly. For example, in October 2008, Yamato Life in Japan filed for bankruptcy after significant losses from its securities holdings. Life insurers have a disproportionate value at stake due to the large sizes of their portfolios, and it is imperative that they upgrade this area as quickly as possible.

Some insurers, once they have successfully professionalized their investment management function, may consider taking the next step - separating the asset-management unit into its own profit center and expanding into third-party asset management. Many European and US insurers have made asset management an important, independent part of their business. Global insurers such as Allianz, AXA, and Prudential (UIO have sizeable asset-management businesses with assets under management (AUM) in the hundreds of billions of dollars. 

A significant part of this business comes from third-party institutions and retail investors. Some of the players in Asia have started on this trend. In China, Ping An and China Life are seeking to replicate the Western development and have started to build their own asset-management businesses. In January 2007, China Life announced a partnership with Franklin Templeton to form a joint venture in Hong Kong for its overseas asset-management business. Ping An announced a joint venture with Singapore's UOB to create a new domestic funds business in China, and paid US$154 million for a 9 percent stake in Value Partners, one of Hong Kong's leading asset managers in November 2007.

Building a brand in the third-party, asset-management business will take time and a track record. On the retail side insurers need to develop distribution channels with banks and other distributors (for example, securities brokers) in order to reach customers. In most Asian countries, banks dominate mutual fund distribution; a strong distribution team that can work closely with banks will be one of the critical factors for success. It typically takes over five years to achieve the required scale when building a third-party, asset-management business (meaning that as a percentage of total assets, third-party assets need to reach 20 percent or more), and insurers embarking on this road should ready themselves to learn quite different skills in order to compete. 

Acquisitions may be a way to accelerate this process; indeed most leading global insurers with sizeable asset-management businesses have at some point relied on acquisitions to grow. For example, Allianz bought PlMCO in the US, while AXA bought Sanford Bernstein's asset-management businesses and Rosenberg, a well-regarded, quantitative asset manager. To find out more, you can check out International Investment Strategy.

Friday, December 30, 2011

Life Insurance Product Development Process - Winning Through Product Innovation

Life Insurance Product Development Process

We have already talked about the shift across Asia from traditional life products to investment-linked vehicles, along with the need to tailor products much more to the needs of individual channels and customer segments. All this requires an upgrade of product development capabilities at life insurers across Asia.

First, life insurers need to link product development much more closely to channels and customer segments, systematically understanding their specific needs better and incorporating their insights into the product development process. For example, Prudential (UK) has been very successful in South Korea with products that are linked to specific investment themes that hit the nerve of the market - such as a Viemam fund incorporated into a investment-linked policy in 2007 (although given the volatility in these emerging markets these products obviously have a highly speculative element and can pose large risks mis-selling).
Second, many life insurers need to upgrade their skills in understanding the value creation of individual products and product components. The more complex products are becoming more important and it will be vital to fully understand their economic impact. For example, in South Korea many life companies are selling riders with such additional protection elements as health insurance - but without the data and experience to price these riders adequately. And more often than not, it is unclear if the additional benefit is worth the cost from the customer perspective.
Many life insurers today have no clear understanding of the exact value contributions of the different products they are selling and the channels they are using to sell them. Revisiting the product portfolio through a "value lens," pruning less profitable products, and adjusting product features to enhance value contributions, (for example, through riders or longer durations), are often sources for major improvements in the value of new business. Life Insurance Product Development Process

Analyzing the channels with regard to their value contributions, adjusting commissions to align with product profitability, and defining clear targets for value improvements by channel are also major value drivers. We often hear the argument that this is a clear trade-off between profitability and growth - but frequently companies are claiming this without having a full understanding of the value drivers they could leverage in the product and channel composition. This is not about closing channels or product families, but about the transparency of economics and the alignment of value creation and incentives. Better understanding leads to a multitude of little changes that add up to significant value creation over time.
Third, life insurers need to think through the organizational implications of product innovation. Many global insurers have begun to drive the actuaries out of their ivory tower and marry the product development with a strong product-management function. This integrates marketing, channel management, and actuarial skills. It also allows for more rapid reaction to changes in market trends and for constant re-evaluation of the product portfolio in terms of sales effectiveness and value creation. However, many Asian life insurers have yet to build up the talent pool and the cultural readiness to adopt these types of organizational changes.
Revolutionizing IT and Operations
The life insurance industry around the world is not well known for world class IT and operations skills. This is often a neglected function that suffers from a dependency on legacy systems and that is not recognized as a source for value creation. Asia is no exception - but we believe this might change. First, in the vast markets of China and India, IT and operations play a crucial role in allowing continued fast growth by running massive distribution networks across enormous countries, delivering customer and agent service to the most remote places, and tapping into rural opportunities. Life Insurance Product Development Process

The large local players in these markets have begun to realize that they need very strong IT and operations functions to gain full control over their networks and to guarantee customer satisfaction (and lower churn rates) across geographies. Most of the time, they realize quickly that gradual improvement is not sufficient to address these challenges. Some players in these markets will jump directly to state-of-the-art IT and operations models to cope with the enormous challenges resulting from their size and growth. Ping An in China has already embarked on this journey of revolutionizing IT and operations by centralizing the back-office functions in a nationwide operating center and by centrally building and managing customer service and call centers. 

Second, as more insurance companies operate across Asia they are looking at ways to create synergies across the region. This is a huge challenge given the different regulations, languages, and maturity of the various markets. But the case is compelling for the few players who have sufficient scale to build some key functions centrally that will allow for more control and quality. AIG is the natural leader in this field, given their footprint across the region. They have already begun to operate some back-office functions across Asia and are continuing down this path. Others will follow.
Third, IT and operations are, of course, key enablers to control cost. While most life insurers have not focused on this topic in the past, given the priority to grow the top line during the landgrab stage, this is likely to change with increasing margin pressure. In particular, in markets where growth rates are coming down, fierce competition requires tight cost management to maintain margins. In a similar fashion to Western life companies only a few years ago, many Asian life insurers measure operational efficiency by cost ratios only. This is a highly misleading indicator, and best practice globally has moved to more industrial measures like unit cost.
Given that centralization, or even regionalization, of operations, streamlining of processes, and effective operations management take time to achieve, the leading life insurers of tomorrow have to start to address these issues today. To find out more, you can check out Life Insurance Product Development Process.

Thursday, December 29, 2011

Job In Bancassurance - Creating Value In Bancassurance

Job In Bancassurance

Bancassurance has grown from almost zero in the year 2000 to a range of 30-50 percent share in most Asian markets. However, insurance companies have found it increasingly hard to generate value in this channel that is proportionate to the top line. Banks have been able to negotiate very competitive commissions across Asia, and products are mostly very simple, single-premium, investment products that offer little differentiation in the market beyond price. Life insurers and banks often have arm's length relationships where the life company is barely more than a capacity provider.
Banks have mostly focused on converting their customers' deposits into simple savings products that have a more attractive interest rate - and hence, the product has generated strong customer demand. In this scenario it is very difficult for the life company to add a lot of value to what the banks are doing; since the banks are adding all the value, the low share of the profits to the insurer is probably justified. But, as we described, we believe that in most Asian markets, banks will soon have collected the low-hanging fruit and growth in these types of products will max out - if they don't change their model. 

This should create an interesting opportunity for life insurers to create a second generation bancassurance model - with much closer relationships between insurer and bank, selling more complex, higher margin products that allow life companies to generate a lot more value in this channel. Job In Bancassurance
Banks across Asia are discovering the retail and wealth-management opportunity. While in markets such as China, corporate lending has been the key profit driver for banks, the retail and wealth-management businesses are catching up fast. We predict that in China the retail and wealth-management business will grow from 29 percent of financial services profits, in 2007, to 59 percent by 2015. To capture this opportunity, banks are building client advisory and sales skills in their often vast branch networks. The pace of this development varies by market - and it will, of course, take time in markets such as China and India with their huge institutions and relatively weak starting positions. 

But eventually this development will enable banks to advise their customers much more holistically on financial products - including more sophisticated insurance products. From a life insurance perspective, the key to unlock this potential will be to build much more integrated business models with the banks. Experience in Europe has shown that bancassurance is really successful when products are bundled based on customer preferences, life insurance is integrated into the banks' incentive systems, processes are tightly integrated, and the insurer delivers value-added support in the form of tailored marketing materials, training, and customer relationship management.
We are seeing some initial signs of banks and life insurance companies moving in this direction. For example, Prudential (UK) and Standard Chartered have built a much more integrated business model in Hong Kong.
We believe we will see a lot more of this in the next decade - including more joint ventures between banks and foreign insurers who have built the relevant skills in other markets and can leverage them in Asia. This will change the nature of the bancassurance opportunity and create a win-win situation - for those players who manage to find the right banking partners and build and apply the required skills in the local market context.
Compared to bancassurance all the alternative channels are still miniscule in size. But they are growing fast - and if the mature markets in Europe and North America are any indication these channels will continue to capture market share. While for most players this is still a niche opportunity, we believe that this is an area worth exploring. We already see retailers selling life insurance products in countries like Japan and South Korea - and increasingly India. Brokers and independent agents are also on the rise. They usually have a higher credibility with customers given their independence from single producers and can capitalize on the increasing affluence and sophistication of customers across Asia who are demanding higher quality advice. Job In Bancassurance

As described previously on South Korea, the Mirae Asset Group approach of using investment centers to sell financial products is one example of this. In China, CNInsure is an independent agent company listed on the NASDAQ. And even the direct channel - that is, selling life insurance through call centers and the Internet is building some scale. In China, Ping An and MetLife have been pioneers in this field with encouraging results. Although still at an early stage, the prospect of building a nationwide call center network with tens of thousands of sales representatives is very real and can be extremely compelling if done properly.
Experience from Western markets shows that the prize in these channels goes to players that build a specific business and support system and tailor products to these channels' needs. Some of the multinationals in Asia should be able to leverage their experience but we also see some of the leading local companies, such as Ping An in China, conquering this space.

Upgrading the Business Model to Combat Intensifying Competition

Growth has been the key value driver in life insurance in Asia in the past decade and is likely to remain so - but the basis of competition is changing. In the past, insurers achieved high growth using a "landgrab model" - being one of the first into many regions and segments. However, this model is beginning to run out of steam. There is hardly any uncovered territory in Asia and competition from local and foreign companies is increasingly fierce. 

Maintaining rapid value creation going forward, therefore, requires players to be able to outcompete the competition through superior business models. These require higher quality skills along the value chain, not just in distribution but also in product innovation, IT and operations, and investment and risk management. And it will also require them to significantly strengthen their management bench. To find out more, you can check out Job In Bancassurance.

Wednesday, December 28, 2011

Success In Insurance Sales - Restructuring Of Sales Force

Success In Insurance Sales

We see rejuvenating sales forces as the number one priority for most established insurance companies in Asia, in particular the local incumbents. However, it is also probably the most difficult endeavor for them, since this involves facing up to a lot of legacy issues, and potentially challenging some highly engrained cultural values at these companies. The pace of these changes reflects the resolve of the top management.
There are some encouraging signs. A few of the large incumbents have started to hire new, better-educated agents and provide them with improved training while gradually eliminating unproductive sales people. Some of the bigger players in Japan and South Korea have started to cut down the size of their housewife agency sales forces.
One of the biggest challenges in building a more sustainable agent channel is to standardize the way it operates. Sometimes these sales forces, especially in countries with large geographical spreads, look so different from region to region that they give the impression that they belong to different companies! This is due to the fact that during the ramp-up period, the entrepreneurial branch managers each dictated the direction and culture of the sales force in their region. However, without standardization and a sharing of best practices across the organization, it is very difficult to improve beyond the initial buildup. 

These sales forces are also extremely vulnerable to the turnover of their founding managers. Tough decisions will have to be made as standardization takes away some of the local flavor. In extreme cases, it may even involve removing some of the founding managers and agency leaders in order to direct change.
A restructuring program typically is designed around four key elements: 
(i) best practice agency management, 
(ii) improving the quality of recruiting; 
(iii) systematic improvements in agent productivity; and 
(iv) an overhaul of the incentive system. 

This kind of program has been proven many times in mature markets, but nowhere at the scale of some of the Asian sales forces. Implementing such a program in rapid growth markets, for hundreds of thousands of agents, is a unique challenge.
Part of the restructuring involves more rigorous management of the agents. Since agents are paid entirely on commission, it has long been the tradition to "leave them alone." However, in order to upgrade the agents' skills and improve their productivity, it is important to start managing these agents in a more systematic and professional manner. For example, even the simple task of getting the agents to show up more frequently for reviews and morning meetings runs into fierce resistance. This often brings into conflict the "old guard" versus the "reformers." Given the large resistance of the agents to change, their behavior, and the management's fear of alienating the top producers, a lot of change programs never get off the ground.
Improvements in the sales force model also entails finding better recruitment methods and abandoning the practice of simply recruiting large numbers (which used to mean employing anyone who walked through the door). Finding better qualified agents also involves fundamental reassessment of compensation (especially base compensation), as well as training in the initial ramp-up period.
Furthermore, as the quality of agents improves and productivity rises, there is a counter process of reducing the number of unproductive, part time agents, many of whom rarely sell anything and have other jobs. In many cases, up to a third of the overall agents could be part-timers, which creates a significant challenge since in absolute terms, their contribution is still quite substantial.
Finally, the incentive system is often purely top line and growth focused - with little incentive for pulling the improvement levers laid out above - and does not reflect the profitability margins of individual products. Given the high share of variable pay and the enormous responsiveness of agent forces to changes in the commission structure, this is a highly sensitive topic. The risk of getting it wrong, thereby endangering growth and losing top producers, has led many companies to shy away from touching the commission system. Yet, without this any substantial progress in the transformation program is unlikely. In fact, we see a lot of commission systems that continue to reward agents who sell large amounts of barely profitable products.
Revamping the sales forces will take years to implement. Radical change is probably unrealistic - what is required is continuous improvement that becomes part of company culture, There are no silver bullets for upgrading a large sales force and the process is extremely painful as difficult decisions need to be taken on legacy issues. It may even involve a temporary dip in revenues. The likely winners are those players who adopt a long-term perspective to ensure the sales forces that have served them so well in the past continue to be a strength of their strategy for the future.

Developing the Next Generation of Agents
The restructuring of legacy sales forces is likely to be a long-term exercise and the traditional sales forces will largely remain focused on the mass market. Therefore, to capture the fast-growing, affluent-customer segment, a new approach is required. New sales forces that can target this segment with a more professional advisory approach and with a larger arsenal of financial products are likely to emerge and grow very fast. This requires recruiting agents with higher quality backgrounds and providing better infrastructure support.
An example of how this can be achieved comes from Germany where MLP has built a sales force that targets specific niches of affluent customers. For example, MLP recruits agents from specific professions, like doctors, who will then cater mainly to doctors and others in the medical field. By having a sales force specialized in the same profession, MLP has managed to capture a large market share within these highly valuable segments since its sales force has the unique credibility and capabilities to understand and connect with their target segments. This model has been very successful, and provides a good example of how to develop a more professional and highly targeted sales force.

We anticipate that a few insurers in Asia will be successful in developing much higher quality, advisory sales forces that will be able to penetrate deeply into the more affluent customer base. While the scale of such sales forces will be small compared to the traditional, mass market agency forces, the quality, and thus value, of such sales forces will be significantly higher. As such, one can anticipate much greater diversity of life insurers as they each develop their niches in various customer and product segments.
The affluent segment opens up an opportunity for newcomers to the market who cannot, and probably should not, replicate the model of the large local incumbents if they want to be among the winners in Asian life insurance markets at the end of the next decade. But even some of the large local companies should take a close look at this opportunity and consider setting up a separate channel to capture the affluent customers in a more systematic way. As the incumbents restructure their legacy sales forces, creating new, high-quality, agency forces alongside could be an effective shortcut to addressing the fast-growing affluent segment. This is not easy though, since the buildup of such targeted sales forces is slow and their financial impact is insignificant in the beginning, thereby making it very difficult to get the proper attention during the development stage.
Channel conflicts will surface with existing sales forces that also have some agents serving affluent customers. Long term though, this initiative may well be one of the most important investments an incumbent insurer can make today. To find out more, you can check out Success In Insurance Sales.

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