Happy new year? According to members of LOMA’s board of directors, 2004 could very well be just that for the insurance and financial services industry.

Resource recently surveyed board members, seeking their feedback on where they see the industry heading in 2004. This year’s survey covered such topics as how sales, premiums and profits are likely to perform; the anticipated rate of mergers, acquisitions, and consolidation; the pros and cons of outsourcing; which technological innovations have the potential to give the industry a boost; and the validity of financial supermarkets.

With the U.S. economy showing signs of gradual recovery, board members who participated in this year’s Industry Outlook seem to mostly agree that, barring any major unforeseen developments or crises, things are looking up for sales, premiums, and profits for the industry. In addition, they say, it’s a safe bet that the current rate of mergers and acquisitions will continue, especially in the wake of recent mergers such as MONY-AXA and Manulife-John Hancock. Furthermore, they say, despite the complexities and potential risks that often accompany it, outsourcing could prove an effective cost-cutting tool for companies (see sidebar, "Outsourcing: A Potential Cost-Saver … With Risks" at end of this article).

But while board members cited changing policyholder demographics and regulatory issues as some of the larger challenges facing the industry, they seemed to differ the most on which technologies could help advance the industry—as well as on whether the concept of financial supermarkets is still viable in light of customer preferences, the current "playing field" of the industry, and the major players that now dominate it.

Board members who participated in the 2004 forecast survey are:

• David M. Holland, FSA, MAAA, president and CEO of Munich American Reassurance Co. in Atlanta, Ga., and LOMA chairman;
• Lawrence J. Arth, CFA, chairman, president and CEO of the Ameritas Acacia Companies in Lincoln, Neb.;
• Richard E. Bauer, chairman and CEO of The Philanthropic Mutual Life Insurance Co. in Plymouth Meeting, Pa.;
• Robert E. Chappell, chairman and CEO of Penn Mutual Life Insurance Co. in Horsham, Pa.;
• Marla G. Friedman, FSA, senior vice president of Allstate Financial in Northbrook, Ill.;
• John O. Gilbert, chairman of the board at Thrivent Financial for Lutherans in Minneapolis, Minn.;
• Mary L. Holloway, CLU, ChFC, vice president of life and health operations at Nationwide Financial in Dublin, Ohio;
• John H. Jacobs, CLU, president and CEO of The Union Central Life Insurance Co. in Cincinnati, Ohio;
• David J. McFarlane, FSA, FCIA, senior vice president of specialty markets at Maritime Life Assurance Co. in Markham, Ontario, Canada;
• James M. Middleton, president and CEO of USAA Life Insurance Co. in San Antonio, Texas;
• Clyde C. Schoeck, CLU, ChFC, LLIF, president of Modern Woodmen of America in Rock Island, Ill.;
• Susan D. Waring, COU, senior vice president, CAO Life Affiliates, State Farm Life Insurance Co. in Bloomington, Ill.;
• James W. Zilinski, chairman, president and CEO of Berkshire Life Insurance Co. of America in Pittsfield, Mass.

The questions and responses follow.

HOLLAND: The third quarter of 2003 was very strong, and subsequent developments seem to indicate the economy is recovering. The fact that 2004 is an election year also adds impetus for continued economic improvement. Accordingly, I’m moderately optimistic about sales and profits for next year.

Fixed annuities have been a safe haven for people concerned about the investment volatility of variable annuities; as the investment markets improve, the demand for variable products will again increase. The current low-interest environment makes it difficult for companies to earn the necessary spreads. As the economy improves, a gradual increase in interest rates may be expected; a rapid rise in interest rates would be more problematic as consumers may be tempted to lapse current products to chase new money rates.

As more states adopt the new 2001 CSO mortality table, there will be increased product development work and systems changes to implement and administer new products. The surplus required to support term products with high-XXX reserves will be in short supply, creating significant pressure for those companies in the term market.

ARTH: The outlook for sales, premiums and profits for the industry for 2004 is mixed. The current levels of interest rates will make it difficult to design and sell fixed-income products, life or annuity, that have acceptable margins for the insurance industry. Consequently, there will be pressure on the profit margins for companies that sell fixed products. In the variable sector, an improving economy should translate into more normal return levels for the equity markets, which should make variable products relatively more attractive and have a positive impact on sales. Improved equity market performance should allow companies to realize anticipated margins in variable products, as well as reduce the need for reserve strengthening caused by certain guaranteed features that exist within variable annuities. Overall, assuming interest rates do not decline from current levels and assuming more normal equity market performance, the industry should achieve better earnings levels with sales growth, dependent on the mix of product offerings.

BAUER: I believe that sales will remain soft and that profit margins will continue to be strained. I also believe that our industry may be facing a crisis of epic proportions if the investment outlook does not brighten significantly in the foreseeable future and if the burden and cost of new regulations does not abate somewhat.

CHAPPELL: For the industry, I look for both life and annuity sales to increase in 2004. I also forecast an increase in both fixed and variable product sales. The momentum for variable product sales will be tempered by the issues concerning mutual funds that are currently making headlines. Profits will be up marginally but will also be dampened by the squeeze on net interest margins caused by portfolio yield declines.

FRIEDMAN: I anticipate that life and annuity sales growth in 2004 should more than double 2003’s rate of less than 3 percent. The equity market’s strength, perhaps somewhat mitigated by the current mutual fund market timing and after-hours trading investigations, should have a favorable impact on variable annuities sales. Fixed annuity sales will continue to be constrained due to the rising equity markets and the shift by insurers to improve margins, making fixed annuities less attractive in 2004. Life sales will see a very slight (1 percent) positive growth, led by variable universal life products; universal life (UL) sales, which have experienced robust growth in the past two years, will most likely begin to slow in 2004. Profits for our industry should improve as insurers increase fixed annuity margins, rational term life pricing returns as low-cost players are eliminated through acquisition, and rising stock prices increase revenues on equity-based insurance products.

GILBERT: I’d say moderate growth in sales and premiums, and probably also moderate growth for profits. And I think that given where the equity market is now and what the expectations are for 2004, variable products—both variable annuity and variable life—are probably going to be the strongest product lines. As for weak products, I think sales of traditional whole life insurance products are going to be a struggle again; that would probably be the product I would see as having the biggest weakness. Disability income is a product that meets a real need in the marketplace, but it struggles to get traction.

HOLLOWAY: I expect sales, premiums and profits for our industry will continue to improve for 2004. I also expect improvement in the sales of variable products. Key to these expectations will be sustained economic recovery and improvement in consumer confidence.

JACOBS: Based on historical trends, I think we can see sales and premiums be flat for the coming year, but we will see profits increase due to improvements in the investment markets. I think that we could expect variable products to become strong again, with life and disability income remaining flat, since that has been the historical trend.

McFARLANE: I’m going to give my perspective from Canada, although I think a lot of it will probably apply to U.S. companies. I predict stronger sales growth, and I think there are generally a couple of things that will be driving that. The first is continued economic improvement, and I think there are three areas in particular where you’re going to see strong product growth. One would be universal life/index/equity-linked products. Due to the improvements in the equity markets, I think lower-premium and lower-margin products, such as term insurance, are going to be displaced. Another area in which I see strong product growth for Canada is the critical illness product market. Over the last couple of years, we’ve seen very strong growth in that product area, and I think that will continue as a result of greater awareness, both amongst sales personnel and the public. I also think growth in that area will persist due to continued concerns in Canada about the inability of governments to adequately fund the Medicare health system to meet the increased demand of an aging population.

The third area in which I see strong growth is the individual health insurance market. It’s going to be driven by three things: the continued concern about governments being able to adequately fund the Medicare health system, the growth in small business, and the increase in early retirement.

As for products that look weak for 2004, the "Term to 100" product will continue to see declining sales. That’s a product that’s not available in the U.S., but it’s a product that provides life insurance coverage with no cash values or forfeiture value.

I foresee continued improvement in company profitability in our industry for 2004, for a couple of reasons. First, there’s the influence of large stock companies in Canada, which, up until recently, were mutual companies. They dominate the insurance marketplace here in Canada. These companies are starting to see the benefits of acquisitions they’ve made over the past two to three years. That includes Maritime Life, who has had three acquisitions over the last five years. You also have Great-West Lifeco in the process of acquiring Canada Life, which itself acquired Crown Life four years ago. Also, Sun Life has acquired Clarica Life, and Manulife recently announced a potential merger with John Hancock. These companies are very profit-focused and are looking to improve their earnings per share.

MIDDLETON: I predict low to moderate growth in sales, premiums and profits. I think term and universal life products will be strong, with variable products being weak.

SCHOECK: I feel 2004 will be another good year. With the recovery we see in the market, we should see increased sales of variable products. The importance of using our products to provide guaranteed life income will also become more important in the future as boomers retire.

WARING: I predict an increase in sales and premiums of between 2 and 5 percent from 2003’s depressed levels. With low interest rates, variable annuities and variable universal life products should show double-digit growth. Profits should continue to remain under pressure.

ZILINSKI: I expect modest growth in sales and profits in 2004. The economy continues to show modest improvement. The investment environment will have the greatest impact on earnings and capital positions of companies.

HOLLAND: According to the ACLI, the number of life insurance companies in the U.S. decreased from 1,944 to 1,171 over the past 10 years. The mega-merger of Manulife and John Hancock is a sign that such changes will continue. However, there is already a tremendous concentration with the U.S. life market. Of $3.7 trillion assets controlled by the life insurance industry, 97 percent, or $3.6 trillion, is controlled by the top 100 companies. The top 25 companies average more than $100 billion of assets each, while the bottom 1,000 have only $100 billion to split amongst themselves. Over the next five to 10 years, the smaller companies will have to concentrate on niche markets, merge to obtain critical mass, or be acquired.

ARTH: The trend toward mergers/acquisitions/consolidation in the industry will continue in 2004. The need for economies of scale continue to be present, with competition continuing to exert downward pressure on margins. In five to 10 years, there will be fewer companies than exist today, but the companies remaining should be financially stronger.

BAUER: There will be fewer players, some of which will be mega-companies and some of which will be niche players that will grow through normal growth and/or consolidations.

CHAPPELL: The trend of mergers will continue to be strong. The timing will be lumpy but will continue until and through the time when we have several large international insurance companies, with a few headquartered in the United States, and a number of smaller U.S.-only companies. For the next five years, the trend toward mutual conversion to stock will proceed at a much slower pace than it did in the prior five years. Several of the mutual holding companies will find a way to merge.

FRIEDMAN: Consolidation in the life industry has definitely returned in 2003. Recent large deal announcements in the third quarter have marked the beginning of the next wave of consolidation. Although certainly less publicized, the pace of small block transactions actually started picking up in late 2002 and continued to be prevalent in 2003. While consolidation has picked up in our industry, this wave of consolidation is different than in years past. The glory days of high-premium, all-cash bids by European insurers for U.S. firms have been replaced by book-value sales prices.

As we look forward, we expect that consolidation in the market will continue because (a) life insurance is a mature industry but remains highly fragmented; (b) rating agencies are continuing to place pressure on required capital; and (c) small firms are finding it harder to compete in a consolidating shelf space market where the cost to deliver products is increasing.

Looking forward, there will be fewer, larger players dominating the life/financial services landscape. The big players have the ability to squeeze margins and muscle distribution shelf space, giving them significant advantages in the market. Five years ago, the top 10 life players controlled less than 40 percent of the life market; today, they control nearly 55 percent and growing. This phenomenon is even more apparent on the variable annuity (VA) front, where the top 10 players now control nearly 70 percent of the market, compared to less than 50 percent five years ago.

GILBERT: Given what we’ve seen in the very recent past—the mergers between MONY and AXA and between Manulife and John Hancock being examples—I think there’s going to be a continuation of consolidation within the industry. Five to 10 years from now, there will be fewer players, and the ones that are going to be there will either be very large or will occupy a specific niche in the marketplace.

HOLLOWAY: I believe mergers and acquisitions will continue, provided it makes good economic sense for those involved. The industry will have fewer players and increased competition in the next five to 10 years.

JACOBS: I think there will be a dual trend, with regard to mergers/acquisitions/consolidations in the industry. I think that the larger companies will do complete mergers, whereas medium and smaller companies will enter into strategic alliances, cooperating with each other on particular lines without engaging in full mergers. In five to 10 years, I think our industry will consist of fewer larger companies but not a great deal of difference in medium and smaller size companies. But with the medium-size and smaller-size companies strategically cooperating, they will be able to compete effectively with the larger companies.

McFARLANE: I foresee a slowing of the activity we’ve seen over the last five years. The number one reason for this is that the number of acquisition targets is much smaller now. There’s been such a pace of acquisition lately that you now have a smaller number of companies that could be acquired. A number of large companies have been involved in acquisitions recently, and over the next couple of years, they’re going to be focused on successfully integrating these acquisitions.

As for what the next five to 10 years holds, I think the Canadian market will consist of a few large insurance companies and a few small niche players. I think the medium-sized companies will be gone. And you’re also going to see the possibility of mergers between banks and insurance companies in Canada, possibly over the next couple of years. One of the main catalysts for this is the fact that we’re going to get a new Canadian prime minister [Paul Martin] soon—one who is much more receptive to financial services consolidation.

MIDDLETON: I predict further activity with regard to mergers, acquisitions and consolidations in 2004. The number of unique life insurance company groups will decrease 10 percent by 2010.

SCHOECK: There will be fewer companies in five to 10 years, but most of the prime merger candidates have been absorbed; there are just fewer opportunities. Also, not all mergers have resulted in the benefits many people anticipated.

WARING: After the John Hancock-Manulife merger, few of the top 30 companies in our industry are obvious acquisition targets. Most activity could be by larger groups acquiring many small companies. What’s less predictable is whether we will see mergers of the mega-companies. The latter is where the banking industry has gone.

ZILINSKI: Consolidation will continue in both companies and in distribution at a modest role. Weakened capital positions will drive this, as well as intensified competition.

HOLLAND: I feel that the vast middle market is underserved because of the cost of our traditional distribution systems. As we develop new systems to facilitate mass distribution and to speed up the collection and aggregation of underwriting requirements, we should be able to develop more economical ways to service this market. Data mining can help identify prospects and changes in needs as they occur.

ARTH: We have yet to realize the potential for enhanced service opportunities created by the Internet. While the Internet probably will not evolve into a major distribution opportunity over the next few years, it does provide a platform for a significant enhancement of service and communications to both our customers and our distribution systems. At the same time, the Internet creates the opportunity to lower our communication and service costs. Developing technologies such as wireless technology offer the opportunity to access information from almost anywhere. Other technologies, such as business intelligence and contact management systems, offer the opportunity to provide individual customized service to our customers.

BAUER: The business that my companies are in is not dependent upon new technology, per se.

CHAPPELL: Computer and systems technology will continue to help our industry reduce costs and improve service. Mortality management has potential for improvement with medical advances and better tools for risk selection. There will be considerable political sensitivity to any potential advances, so benefits to clients and firms may be a considerable time in coming.

FRIEDMAN: There are several new or undeveloped technologies that offer potential for our industry, including enterprise application integration (EAI), mobile applications, speech and voice technologies, and digital signatures. EAI includes technologies such as middleware, XML, and B2B exchanges. EAI helps reduce the overall complexity and maintenance overhead for administration and back-office systems, as well as improving time to market for new products and simplifying business integration efforts such as mergers and acquisitions. Mobile applications should have a major impact on the insurance industry, from the ability to input a claim from a remote location to the ability to sell a new policy to a customer from their own home, along with online client information. And of course, digital signature technology, along with these types of mobile applications, can really streamline our processes and dramatically improve cycle time. Another technology opportunity for us is a proven one, but not fully exploited within the insurance industry, and that is speech and voice. These technologies can streamline customer service and facilitate data entry, resulting in expense reductions while still providing hassle-free service.

GILBERT: I continue to feel that as we put more computing power in the hands of the agents, there are opportunities to explore, with regard to managing the customer base, customer information files, and just providing a much stronger flow of information. The speed will increase, and the cost of moving information from one location to another will continue to diminish, especially with the rise of broadband capabilities and so forth. So I think one of the ways in which technology is going to work to the advantage of this business—and all businesses—is the fact that speed and capacity are going to increase without costs going up proportionately.

HOLLOWAY: I’m not aware of any one technology that can help our industry. My bias is that investment in any technology needs to be based on a cost/benefit analysis that results in improved profitability. The technology needs to drive efficiencies, and it needs to have the potential to appeal to consumers and lead to profitable growth for the company.

JACOBS: I don’t pretend to know what is newest on the horizon, with regard to new technologies, but currently I do not see anything that could make a major difference in three to five years.

McFARLANE: I think the technologies that can help our industry are all about the computer. I see this in three areas.

First, there’s the continued advancement of Web technology, on the front end, for improving the acquisition of business, including some automation of the underwriting function. Web technology’s advancement is also impacting the service component—that is, providing policyholders with information and making it easier for them to make changes to their policy and to get information on their coverages.

The second area in which I see improvement in technology is process automation in areas with high transaction volumes. We’re going to see continued improvements in health claims processing, in terms of how much of the process can be automated.

The third area in which I see improvement in technology—or hope to see it—is document imaging technology. We still deal with so much paper, and we’d like to eliminate as much of that as we can, whether it’s in applications, claim forms, or any internal administration documents.

MIDDLETON: Customer relationship management (CRM) solutions can help companies "know what they know." Continued Internet capabilities will expand this distribution channel, and improvements in policy administration and underwriting systems will make the issue process more efficient.

SCHOECK: Imaging, as well as faster and less expensive communication, will help to reduce costs over time. We can also allow our policyholders to have access to more information, saving costs and time.

WARING: The technologies that I believe have great potential for helping our industry are Web-based customer service, imaging for document retrieval, and wireless technology for sales representatives.

ZILINSKI: The Internet is a key device in support of all functions of a home office in speeding communications and support to customers, field and remote personnel. Imaging technology is key to paper file reduction and speed of processing. Cellular/wireless connectivity of PCs and PDAs are enabling capabilities to enhance responsiveness. Finally, software that is easy to use and install is the vital component of technology that creates the enabling capabilities to improve productivity and create competitive advantage.

HOLLAND: We feel that improving profitability means working the fundamentals rather than looking for a silver bullet. Basically, profit is the excess of revenue over expenditures. This means that to increase profits, you need to increase revenue and reduce expenditures. A fundamental question is whether or not your products are priced to achieve the desired return on equity; if your prices are adequate, the next issue is to increase volume. On the investment side, increasing income can be tricky; for example, you may increase yield by investing for longer durations or investing in lower-rated investments, only to find that risk-based capital is increased and increased defaults reduce actual returns. Reducing expenditures often means reducing expenses, which may be achieved a number of ways, including outsourcing or merging to improve scale. Careful underwriting and analysis of results by source may help determine problem areas which can be improved, and thus reduce costs.

ARTH: The overall profitability for the insurance industry, as measured by return on capital, is very low when compared to other financial services industries, such as banks and mutual funds. Growing the profitability of the insurance industry in the years ahead will be difficult. Consolidation within the industry that leads to increased scale should help improve profitability. Competition within the life insurance industry, which exerts downward pressures on profit margin, has been intense. Over the years, the life industry has offered too many free "options" in various product features in an attempt to compete with other companies within the life insurance industry. These "options" also require higher levels of risk-based capital. Improved home office and field productivity going forward will help the industry to achieve higher levels of profitability, but whether improved productivity by itself will be sufficient remains to be seen. Consolidation activities that lead to scale, plus rational pricing margin decisions, will be required to allow acceptable return on capital levels.

BAUER: We need to be more vigilant regarding general expense. We also need to develop new and creative ways to provide new opportunities for personnel at all levels in the organization. This can put us in a position to "hit home runs"—or perhaps a double or two—by achieving variable compensation objectives and keeping merit salary increases to a minimum over time. We also need to do a better job of involving all of our people at all levels in addressing work process improvement opportunities, as well as rewarding them for their contributions in that regard.

CHAPPELL: The industry will increase its profitability as it is able to demonstrate more perceived and real value to our products. We can make the case for higher revenues by our value. Simultaneously, we can continue to improve on our cost structure and risk mitigation capabilities.

FRIEDMAN: Life insurance companies, like all companies, need to grow to thrive. The industry needs to expand its customer base in the underserved life protection market and its footprint in the asset management and wealth accumulation business. As an industry, it needs to stop cannibalizing its in-force business and expand the size of the pie. To achieve acceptable returns on equity, and to increase its share of the pie, the industry must maintain a rational pricing discipline, reduce distribution cost, and improve back-office administrative processes. Lowering distribution cost and back-office expenses through the use of technology will not only make it easier for consumers to do business, it will allow the industry to improve the efficiency of its transactional processing. Eliminating the inefficiencies in distribution and transactional processing will allow the industry to pass more benefits on to the consumer, thereby increasing its perceived value and allowing the industry to increase its share of the pie.

At Allstate Financial, we are addressing a number of these common industry issues. We are reviewing and managing distribution cost by focusing on those distribution partners that provide long-term value. We are addressing the cost of doing business by rationalizing our product portfolio, reducing product customization, eliminating legal entities, and reducing the number of administrative systems utilized in managing our business. These efforts, in addition to utilization of the Six Sigma methodology to improve back-office processes, will improve our processing efficiency and effectiveness, and they will lower our cost of doing business. We are also committed to maintaining pricing discipline and leveraging our investment/asset liability management (ALM) expertise to improve risk management and product profitability.

GILBERT: I think there are probably three ways we can increase our profitability. One, there’s got to be top-line growth, and so sustainable sales growth has got to occur. I certainly think attention to expenses is going to have to continue; we’ll have to continue making our operations as efficient and effective as possible—on the distribution level as well as the corporate level. And that’s an ongoing journey.

What we’re doing at Thrivent is very much in the same vein: We’ve put forth a lot of effort toward building the capacity and capability of our distribution system. We’re taking $100 million worth of costs out of the corporate, or home office, part of our operation. So we’re doing exactly what I suggest others have to do. The third thing that we’re doing is looking at the profitability of our products and making sure that they are as competitive as they can be, while still being profitable for our organization.

HOLLOWAY: Companies need to keenly understand the key components of their profitability, along with the scenarios of internal and external forces that can influence profitability. I believe the past three years, although difficult, have also been a great learning experience for many companies. Company ethics and the fiduciary responsibility that our industry has to consumers are critical, as current events have repeatedly shown us. The need for profitable growth and expense management, even in the best of economic times, has been a key lesson learned by most companies.

JACOBS: The only way I can see the industry increasing its profitability over the long-term is to rationalize expense structures, either through more rational pricing of expenses within our products or finding ways to reduce expense structures in the companies to meet the pricing. Our company is focusing on finding scale in our product lines so that we can meet the expense assumptions that are priced in that, while actively looking to be as effective as we can possibly be in the home office, and thus bringing expenses in line with pricing.

McFARLANE: I think our industry needs to do three things. First, companies need to determine the areas in which they can excel over their competition and really focus on those areas. An example of that would be the business that Maritime Life has now: the individual health business. Maritime Life recently purchased Liberty Health’s insurance business, recognizing that by doing that, they could be the best in that business in Canada. I think the second thing they need to do is hire and develop the best people and instill in them a passion about the business. And third, they need to focus on doing what they can to make sure that employees are satisfied in their work and making sure that customers/distributors are getting quality service.

There are several things Maritime is doing to increase its own profitability over the long term. First, in terms of developing people, we have what we call a career investment account, in which every employee in the company is given a percentage of their salary to spend however they choose on personal development. The company also runs annual employee satisfaction surveys, with close follow-up with staff to determine areas of improvement. They also run annual customer and distributor satisfaction surveys. Finally, everyone in the company shares in a customer satisfaction bonus.

MIDDLETON: Our industry can increase its profitability in a number of ways. First, it needs to continue to reduce and manage expenses. Second, it needs to open more markets created by Third World countries. Continued technological advances will improve processes, which will result in more efficient operations. Finally, our industry needs to take advantage of the Internet distribution channel.

SCHOECK: We have to think "outside the box." Just because we have been doing something for years doesn’t mean we need to continue. Stop doing some of these things and see if anyone notices. We are working toward a much less paper-intensive organization.

WARING: Our industry needs to reduce its expenses, improve its economies of scale, and reduce the regulatory burden.

ZILINSKI: Absolutely key is a well-crafted investment strategy with strong alignment to their respective liabilities. Equally important is a mortality/morbidity risk management focus that is aligned with product pricing. Company initiatives aimed more at market share than managing to valid pricing assumptions have led to significant profit downturns and exits. At our company, we are very focused on the critical core competencies that affect the profitability factors for the company. Key metrics are in place to measure progress, and major investment in technology and people are made to assure best-in-class capability and performance.

HOLLAND: Consumer preferences change over time. Some like to go to a large shopping mall, while others may prefer a specialized boutique, a mega-store or even online shopping. Similarly, a consumer may prefer the one-stop shopping convenience of a financial supermarket; however, the real advantages may be for the supermarket. Customer acquisition is much more expensive than customer retention; accordingly, once you acquire a customer, you want to provide as many services as possible. This not only aids with customer retention, but there are significant savings from cross-selling. For instance, a bank may be able to identify "insurance events" such as marriage, birth of a child, purchase of a new home, etc.

Putting together such a supermarket requires tremendous resources. A decision has to be made as to whether to manufacture or just market. A consumer wants "best of brand," and if you use your own company, will you have the best variable annuity, fixed annuity, long-term care policy, term policy, etc. Marketing alliances with others to provide product meets the best-of-brand issue, but it is tremendously complicated to set up and maintain, and it exposes your customers to other vendors.

ARTH: The concept of "financial supermarkets" probably remains valid today. What maybe has changed over the years is the extent to which any single company can participate across the entire spectrum of financial services. Branding is one of the major challenges to becoming a "financial supermarket," and that has proven to be very difficult across the entire financial services spectrum. I suspect that to some extent, many organizations have scaled back their attempt to offer all financial services products.

BAUER: It is a valid concept over the long pull, but I believe that most consumers and businesses still depend on personal relationships more than a supermarket approach.

CHAPPELL: The concept of the financial supermarket is still more a concept than a reality. For it to work, it takes more coordination of skills than most organizations can muster … and it may be that people don’t want financial services bundled but would rather work with a series of specialists. The value, complexity, and frequency of purchase of many of the products are very different, which also make the financial supermarket concept hard to execute on the part of providers and clients.

FRIEDMAN: It appears that the idea behind financial services supermarkets, at least on the product manufacturing side, was strategically flawed. Put simply, banks and other institutions do not need to purchase a life insurance manufacturer in order to sell life products. Citigroup has attempted to adopt a bank assurance strategy and has now abandoned it. The general trend is for banks to take on more of a broker/dealer structure, allowing them to offer broader life and annuity products without the risk and overhead associated with maintaining a leading life product line. While Bank One has acquired Zurich’s term life business, we do not see this as part of a broader supermarket strategy for them as well.

The financial supermarket concept was based on the assumption that consumers wanted to place all their financial assets with one firm. This premise has now all but vanished as we see consumers seeking the best products from differing manufacturers that meet their needs.

GILBERT: There was a lot of discussion when Citigroup formed that this was going to become a trend. I think there are going to continue to be financial supermarkets like Citigroup; Manulife and John Hancock may be another example. But I don’t think it’s going to be a singular solution. I think there will continue to be smaller shops that are more defined in what their market is and what their product offering is than the huge ones. So there will be some, but I think over the years, history has shown that people don’t necessarily want to buy all of their financial-related products from one organization.

HOLLOWAY: I believe this continues to be a valid concept because the consolidation of companies will continue, and in certain circumstances, a financial supermarket type of business will continue to make economic sense and provide value to consumers.

JACOBS: The concept of financial supermarkets is not a valid concept for today, as most of our products are bought by people through their relationship with an agent rather than because there is convenience. The relationship with the agent is absolutely critical, and for that reason, it is the agent that provides the one source to touch most of our products, not an outlet.

McFARLANE: I don’t think it’s a valid concept. I think one of the problems with financial supermarkets is that they require companies to be the best they can be in so many different areas. This makes them vulnerable to companies specializing in any particular financial services area. Also, I don’t think it’s good at accommodating customer preferences or independent choice. So no, I don’t see it as a valid concept now, and I didn’t see it as such when financial supermarkets started developing in Canada and the U.S.

MIDDLETON: Very few organizations can put together the right combination of offerings, break down the silos for the benefit of the customer, and maintain a consistent culture. But there will be exceptions.

SCHOECK: I don’t think this has worked, and most have moved away from that concept. Marketers can’t be experts in all areas of the business. Most models were built on someone sitting behind a desk and people would come. I think we have to be proactive. People don’t just decide to buy insurance without a salesperson.

WARING: Many companies have diverse product lines, but very few companies are successful in distributing all these products through any one distribution system.

ZILINSKI: This is a long-term trend that will continue to grow over time. Banks and brokerage firms and insurance companies offer wide varieties of financial products. Key companies continue to take increasing stakes in this concept. It is, however, evolutionary. Its impact has had its greatest play in the more transactional products, such as annuities and term insurance, where simpler needs match with simpler products in the marketplace. This blending is more challenging where sophisticated advice-oriented consultation is required. Here we will continue to see a trend toward greater integration amongst the professional advisors, such as accountants, attorneys and financial planners. These more complex roles will be slower to migrate into the larger national supermarket conglomerate.

HOLLAND: The insurance industry is under tremendous pressure from a number of external sources. Convergence of financial services results in additional competitors for life insurance companies. Time to market for new products is hindered by the current state regulatory environment; the life insurance industry is not represented in Washington by a single regulator the way banks and other competitors are. Recent changes in the tax law dealing with capital gains did not provide favorable treatment for variable annuities; there have been challenges relating to corporate-owned life insurance and bank-owned life insurance (COLI/BOLI) and split-dollar insurance. Even though the repeal of the estate tax law would have a significant impact on life insurance products, it is recognized that it would be to the benefit of many of our customers. There is increased reporting and financial scrutiny as a result of the Sarbanes-Oxley Act, the Graham-Leach-Bliley Act (GLB), the Health Insurance Portability and Accountability Act of 1996 (HIPAA), etc. The adoption of international accounting standards and the move to fair value accounting could result in increased volatility in life insurance financial statements. Finally, life insurance companies need to improve their return on equity (ROE) in order to attract the necessary capital for growth.

ARTH: From a strategic perspective, the biggest challenge facing our industry is our inability to date to stem the decline in the number of customers that are sold our products in any given period of time. We must find cost-effective methods to reach the middle market, which is vastly underserved today. This market has a significant need for what we sell, which is affordable protection against life’s uncertainties. We must find ways to stop the decline in our number of customers. Too many of our companies are competing in the "upscale" market and are ignoring the lower- and middle-income markets, where the needs might be the greatest.

BAUER: I believe that the investment market and the ongoing burden and cost associated with current and proposed regulation is a two-pronged priority for our industry.

CHAPPELL: We continue to be confronted with the challenge of teaching people the value of life insurance and its relevance to them. We must continue to do this and provide cost-effective products that are valued by our clients. This will help influence legislators who put tax and regulatory hurdles in our way in some instances, and provide help toward our effort in other instances.

FRIEDMAN: There is a very significant consumer need for the products we sell. Retirement savings, protection needs for families, wealth transfer, financial protection for living too long, and complex business needs all represent great opportunities for our industry.

One challenge that isn’t often mentioned, but deserves discussion, is the increasing commoditization of our business. Growing pressure on prices, greater 1035 exchange activity, and greater risk-taking embedded in our product designs are signs of increased commoditization of the individual life and annuity business.

When your core products become commoditized, there is pressure on product profitability that requires an effective response. Commoditized products require more efficient cost structures. Scale becomes a method that allows a company to compete with a more competitive cost structure. One response we have seen is the consolidation of our industry. Others have become more focused on uses of technology to improve their cost structure.

Product innovation is another solution that allows a company to avoid being commoditized by having a product that can’t easily be compared to others. However, we have all seen the speed at which product innovations are copied and often enhanced by others, making this an imperfect solution at best.

Powerful and unique relationships with a distribution channel can provide a good opportunity to share risk and rewards from the products they sell for us. These relationships can help reduce the negative impact of commoditization through shared financial success.

Finally, any company that effectively serves niche markets can avoid the risk of commoditization through operating in less competitive markets, or with unique and value-added knowledge or processes.

GILBERT: One of the biggest challenges, certainly, is the changing demographics that put more emphasis on accumulation products, which have thin margins. The sales of life insurance continue to decrease, and I think that represents both an opportunity and a challenge. Increasing the productivity of a company’s distribution system has been and will continue to be a challenge, regardless of what kind of distribution system an organization uses.

As for how to address this particular challenge, some of it will be handled by consolidation and critical mass. Some of it can be addressed by paying attention to the fundamentals of the business. There’s a body of thought that suggests there is a lot of need, particularly in the middle market, for life insurance that is not being met, simply because there are not enough people to interface with the prospects. At Thrivent, our life insurance sales have decreased as annuities and variable products have grown in demand. However, we still think there is a legitimate need for life insurance, and we are taking actions to make sure it is not overlooked.

HOLLOWAY: Recent events in the financial services industry, which reflected a lack of business ethics with no regard to the fiduciary responsibility to consumers, will not help our industry. Companies that walk and talk the "core value" of ethical behavior will be winners in the short and long run.

JACOBS: The biggest challenge facing our industry is regulation. There must be a rationalization of state regulation to reduce the expense of operation, or the industry will have to embrace federal regulation in a way to provide some rationalization. The current method of regulation is an outdated model that needs to be corrected, and a new model needs to be put in place. If the states will not or cannot deal with the fact that the model is outdated, then federal regulation will become a must.

McFARLANE: I think the biggest challenge, but also the biggest opportunity, is changing demographics. With an aging population, we’re seeing less demand for insurance risk-type products, such as life and disability income. So we need to shift the focus. The challenge is to shift our focus to products that will appeal to this aging population, such as "living benefit products," which include critical illness products, long-term care, and individual health plans.

In order to address that, I think the industry needs to do research, in terms of specific requirements for this emerging customer base. They need to educate not only customers but also their distribution network, i.e., agents, brokers, etc. This research also needs to include identifying the information gap, because there are a lot of people who don’t understand the need for these products or how to fund them. They need to be convinced of the need for these products, and they need advice on how to pay for them.

MIDDLETON: The state-based regulatory structure costs the industry a lot. We should work together to make a federal charter viable.

SCHOECK: A major challenge for our industry is providing the personal service that is needed, especially in the sale of life insurance, and being able to do it in a cost-effective manner. Technology is helping to make this work.

WARING: The biggest challenges facing our industry are low interest rates, the risk of sharply rising interest rates, a need to decrease expenses, and slippage in policyholder taxation versus some other financial service providers.

ZILINSKI: The biggest challenge facing our industry is effectively managing our capital for effective returns. This can best be handled by assuring that our business strategies are sustainable on a prudent basis beyond just a market share game, and assuring we have managed investments in line with our abilities.

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Sidebar:

The fact that outsourcing can result in staff reductions emphasizes the importance of self-renewal. Continuing professional education and development, such as what LOMA provides, can help you be ready for new opportunities as change comes about.

From a management point of view, outsourcing creates business risk, and for international outsourcing, political risk. Due diligence on the financial condition and business integrity of an outsourcing provider is essential before turning over any mission-critical applications. International outsourcing also brings cultural issues as well as questions of political stability.

ARTH: Outsourcing offers many opportunities to achieve lower costs, but at the cost of less control over the functions that are outsourced and the resulting increased complexities. The cost savings can be significant, and outsourcing may be necessary in order for companies to remain competitive in a global economy. The effect on the overall economy might be negative due to the impact of exporting jobs and the loss of domestic jobs. However, competition and thin margins might force companies to outsource in order to remain competitive.

BAUER: The more that ancillary functions can be successfully outsourced, the more that management can focus upon the most critical functions related to its business. Outsource partners can often perform much more efficiently and effectively due to specialized expertise and critical-mass issues. The cons of outsourcing usually relate to being certain of the deliverables, associated expense, and legal liabilities.

CHAPPELL: Outsourcing overseas is described as providing the potential of savings of costs with at least as good, if not better, service levels. On the other hand, the complexity of organizing the activity is a large enough challenge that the results may not achieve the goals. The downside risk of failure to properly execute is significant and often outweighs the possible benefits.

FRIEDMAN: The pros can be twofold. First there is, of course, the reduction in costs. Depending on what functions and where you outsource, the potential for savings can be relatively large.

In addition, if you outsource your non-core business, it will allow you to focus on core activities. This will allow you to improve the processes you already do well and ideally let someone else focus on improving processes they do well.

The cons can vary in degree, depending on what country you go to for outsourcing. The risks include things like political unrest, bureaucracy or the vendor getting bought out or going under. You need to have a solid backup plan if your outsourcing hits a major complication, so resumption planning should be included in the cost structure. The possibility of negative publicity when you outsource to a foreign country should also be considered in your decision-making process.

One of the most overlooked cons is trying to get a solid cost measurement on the current process you want to offshore. This is key because you may find out that outsourcing will not save you any money, or at least not enough savings to justify the risks. Knowing your current cost would also be critical as you benchmark improvement.

It is hard to decide what processes other than IT functions to outsource. There are no standard industry measurements on how well one business process is done by one vendor compared to another. IT outsourcing can at least use the CMM (Carnegie Mellon Maturity) model as a common way to compare IT development vendors, but there is not that type of tool to measure business processes. Not having an objective way to measure the competency of a vendor adds to your risk.

GILBERT: I think one of the pros is that it can certainly reduce costs. And depending on what you’re outsourcing, it can provide perhaps a more reliable workforce, in terms of persistency, than what can be done domestically. So there are some advantages that exist, but I think that some of those advantages are probably going to diminish over time. But right now, there are clearly cost advantages. In our own case, we streamlined our own processes. We determined what the costs would be to do it offshore or internally, and by cleaning up and making our own processes more efficient, we didn’t find enough cost advantage to do some particular segments of service offshore. We are putting maintenance of our legacy IT systems offshore, because we can get the talent and capability of people who understand old systems and old languages offshore more readily than we can domestically. Our internal IT resources can then focus on new applications.

On the con side, there can certainly be some loss of control. And there’s the potential of different kinds of political instability in some of those countries. I remember a comment Dave Holland made at LOMA’s 2003 Annual Conference; he said that as a company, you could encounter different kinds of risk, for reasons that we don’t even think about on the domestic level.

HOLLOWAY: The industry and individual companies will continue to outsource to other countries because of the need to improve profitability. Individual companies need to determine their core competencies and what makes most sense to outsource overseas, from a risk/benefit perspective. Lessons will be learned along the way as companies gain more experience with this process.

JACOBS: I think outsourcing has one pro, and that, of course, is cost. The cons to outsourcing are that you are subject to changes in other countries’ economic profiles, which could cause a decrease in the number of people willing to do the outsourcing work or in the quality of the work. In addition, if you outsource anything that reflects upon corporate culture, you run a tremendous risk of destroying that culture.

McFARLANE: One of the pros of outsourcing is that it provides a cost advantage. It allows companies to focus on their core competencies, as opposed to having to divert resources to managing something that may just diminish their focus. It also allows these companies to reap the benefits of concentration, in terms of their area of expertise. That applies to both offshore and in-country outsourcing. For example, among Canadian companies that have health insurance, be it group or individual, it’s quite common for them to outsource their automated claims processing. You’ve only got a couple of companies that specialize in that, and because they specialize, you’re getting some economy passed on to the companies that use them.

I see three basic cons of outsourcing. First, it involves a loss of control over this part of your business. Second, there’s a risk of supplier loss or demise—your supplier going out of business, in other words. Third, there’s a risk that the company to whom you’re outsourcing won’t conform to your standards.

MIDDLETON: The pros of outsourcing are cost reduction, the availability of strong technical resources at a reasonable cost, and the fact that Third World countries will benefit from this trend. The cons of outsourcing are threefold: the fact that it can be difficult to manage from a distance and that issues like communications difficulties can ensue; the fact that it depresses the U.S. job market; and the fact that it creates a foreign exposure risk.

SCHOECK: I think we still have much to learn with regard to outsourcing. One of the pros is possibly lower costs, but we also have the social issue of moving jobs outside the country. Disaster recovery could also present a problem.

WARING: The pros are reduced expenses and improved time to market. The cons are loss of direct control, geopolitical risk, and loss of quality.

ZILINSKI: One of the pros of outsourcing is significant labor cost reductions in selected disciplines. The cons are the loss of American jobs and the risk of making yourself vulnerable to business disruption from another country’s instability. We must adopt home company competencies to deal with outside vendors, which can add complexity due to unfamiliarity in dealing internationally.