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From Resource,
February 2007
Copyright by LOMA
The Outlook for the Industry
Some additional perspectives
on the future of the insurance industry, on both overall direction and in
technology.
B
y The Resource Staff
In the January issue of Resource,
we published the 2007 Industry Forecast by the LOMA Board of Directors. In this
issue, we publish some additional perspectives on the future of the industry.
These perspectives include the 2007 life industry outlook from Ernst &
Young, an analysis from Fitch Ratings, technology predictions by Celent and
Gartner, and an investment study from Conning.
Ernst
& Young Outlook
In 2007 the life insurance
industry is looking forward to a year of continued good performance, opportunity
and tough competition for the loyalty of a new generation of retiring consumers,
according to Ernst & Young’s
Global
Insurance
Center
.
“With
an aging population and an increasing number of retirees, we anticipate good
sector performance in 2007 with solid fees, dependent on stock market
performance and premiums across product categories,” said Pete Porrino,
Insurance Leader, Ernst & Young LLP and the Global Director of Insurance,
Ernst & Young Global Insurance Center. “For global companies, the
weakening dollar will be good for earnings growth.”
Six key issues will shape
2007 for the life insurance market, according to the Center:
1. Economic and industry
fundamentals: Long-term consolidation will likely continue among both stock and
mutual companies and weaker competitors will be squeezed out of the market. In
the
U.S.
, general unease about long-term economic security and concerns about social
security, Medicare/Medicaid and reduced employer-paid health and retirement
benefits, will compel interest among consumers in self-funding and insuring
their retirements.
2. Organic growth: There is
an opportunity for growth in the “middle wealth” retirement market, the
middle two-thirds who are less than truly wealthy but also far from
impoverished. Life insurance companies have the opportunity to introduce both
new forms of advisory services and innovative income-generating protection
products.
3. Risk management: Insurers
will continue to improve their risk management frameworks, governance, risk
measurements and reporting. Solvency II developments in Europe will likely
impact many of the larger insurers in the United States and International
Financial Reporting Standards (IFRS) Phase II exposure draft is likely to be
released soon. Specific areas of importance in 2007 will be: economic capital,
suitability and market conduct and hedging.
4. Capital management:
Capital management discipline will continue to be integral to business and
acquisition strategies. Life insurance companies will continue to seek
securititzation and other market solutions, while facing continued pressure to
retain more of the risks on their balance sheets. When principles-based
statutory reserving approaches are adopted in the
United States
, capital management strategies will be re-examined and adjusted accordingly.
5. Finance transformation:
Internal finance and actuarial organizations need to do more with less, better
support strategic and tactical decision-making and manage under multiple
reporting regimes. Infrastructure and cost-cutting are still a high priority and
off-shoring may come of age in a year or two.
6. Regulatory and compliance:
Companies will place a greater emphasis on compliance and ethics practices
including assessing and documenting compliance risk and related controls. In the
U.S.
, the federal charter is still an open issue.
“In 2007, changing
demographics will offer the greatest opportunity for growth. An aging population
will be looking for a full-spectrum of retirement services from helping fund
longevity to providing financial protection to loved ones in the event of
death,” said Porrino. “To fully leverage this trend, life insurance
companies will need to develop innovative services to compete against financial
services companies and to win customer loyalty in this lucrative market
segment.”
The
Ernst & Young
Global
Insurance
Center
is the hub of the Ernst & Young network of professionals dedicated to
serving the global insurance market and connects its people around the globe,
sharing information and experience on current and emerging industry issues.
Fitch
Ratings Looks into 2007
Fitch’s primary concerns
for the life sector in 2007 include the difficult interest rate environment, the
proliferation of product guarantees and intense price competition, and companies
over-reaching for yield in a period of low interest rates and tight credit
spreads. The ongoing industry shift from protection to asset accumulation
products is creating competitive challenges for life insurers who lack scale and
distribution, and is altering the industry’s risk profile, Fitch says. Fitch
posted this summary on its website:
“Fitch Ratings’ Stable
Rating Outlook for
U.S.
life insurers reflects the industry’s significant near-term credit strengths
and longer-term challenges. We expect strong industry balance sheet fundamentals
and stable operating performance to continue into 2007. The industry has
benefited in recent years from low
bond defaults and improved equity markets. Fitch’s primary concerns include
interest rate risk, the proliferation of product guarantees and intense price
competition, and companies overreaching for yield in a period of low interest
rates and tight credit spreads. The ongoing industry shift from protection to
asset accumulation products is creating competitive challenges for life insurers
who lack scale and distribution, and is altering the industry’s risk profile.
Strong industry balance sheet fundamentals include very strong risk based
capitalization, improved asset quality, strong liquidity and moderate use of
financial leverage. Fitch believes that a positive industry development in 2006
has been the increased use of capital market solutions to fund “excess”
reserve requirements and provide catastrophic mortality coverage, which reduces
reliance on traditional reinsurance and the use of bank letters of credit.
“Macro and industry trends
associated with the shift towards lower margin, scale-oriented asset
accumulation products have significant implications for the industry’s risk
profile and distribution strategies. In this environment, the importance of
franchise, size, scale and diversity as a means of competitive advantage is
increasing for life insurers. The ability to leverage these advantages is
critical to long-term success. Fitch expects that life insurers that do not
possess these attributes will be challenged to stay viable, and will likely face
declining credit trends.
“Industry mergers and
acquisitions (M&A) activity continues to be a key driver of rating changes.
Fitch sees insurance industry management increasing their focus on businesses
that perform well, and rationalizing their participation in businesses that
don’t perform well, which is leading to an increase in the acquisition of
blocks of businesses rather than whole companies.
“Growth in industry assets
and net cash flows has been and continues to be negatively impacted by high
surrender activity and the inability to increase penetration into target
markets—external replacements/exchanges of insurance and investment contracts
continue to be a major source of new business activity. Further, the sale of
core individual life insurance continues to be impacted by estate tax
uncertainty and shrinking distribution.”
Tech
Outlook from Celent
In the fall of 2006, Celent
surveyed 29 insurer senior IT executives to provide a deep information resource
about priorities, behaviors, initiatives, and infrastructures at
U.S.
insurers. Overall, the respondents represented US$50 billion in premium, or
roughly 5 percent of the total
U.S.
insurance market.
“There is continued focus
on meeting market demands for speed to market and ease of doing business, and on
new projects involving core systems, data mastery, and distribution,” said
Matthew Josefowicz, manager of Celent’s insurance group and author of the
report, Insurance CIO/CTO Pressures, Priorities, Projects, and Plans for 2007:
Survey Results. “Budgets and staffs are generally flat or growing modestly,
but strategic investments continue. However, there are some indications that
large P/C insurers may be keeping their powder dry until they can gauge the
impact of the softening market.”
Other key findings include:
Top areas of significant new project spending vary
by size and sector, but include initiatives focused on underwriting, claims,
product development, and data mastery. Document handling, policy administration
system replacement, ACORD XML adoption, and agent portals, and BPM all show up
among the most common areas of significant new project spending. The report
lists the top areas of “significant” and “some” new project spending by
four size-and-sector groups of insurer respondents.
Web services/SOA is real. Adoption of enterprise
service buses and UDDI infrastructures may not yet be widespread, but the
average insurer had approximately 15 services live within its enterprise, and
about half of the sample is using Web services/SOA for internal and external
integration to enable new business and underwriting. ACORD XML continues to play
a role in more than half of these initiatives.
The incremental mainframe migration is continuing,
and Linux is becoming an important element of platform modernization along with
Windows. While most large insurers rely on at least partially on mainframes for
their core policy systems, the overall role of mainframes continues to wane
gradually.
Celent, LLC is a research and
advisory firm dedicated to helping financial institutions formulate
comprehensive business and technology strategies.
IT
Spending: Gartner’s Forecast
Organizations with more than
$1 billion in revenue have reforecast their IT spending increase for 2007 to 2.8
percent, according to a Gartner Consulting Worldwide IT Benchmark Report. These
spending projections are down from research collected by Gartner during the
first half of 2006. At that time, IT spending for 2007 was forecast to grow at 6
percent.
“A
number of factors have combined to force enterprises to lower their IT spending
forecasts from the first half of 2006,” said Jed Rubin, director, Gartner
Consulting. “Looking back at the distribution of spending in 2006, enterprises
spent more to support core business operations. This includes spending to
support increasingly complex infrastructure and applications requirements,
rising energy costs, regulatory requirements and other non-discretionary
spending to keep the business running. This increased ‘run the business’
spending has consumed budget resources that were originally earmarked for more
strategic and transformational investment. IT leaders are now planning to
optimize their spending in these areas in the year to come.”
According to the research,
growth and transformation remain the top priorities for enterprises in 2007, but
any new investments need to be funded by a significant reduction in existing
‘run-the-business’ spending. To support these priorities, IT organizations
will subsequently need to reduce their ‘run the business’ budgets by nearly
five percent in 2007.
In the insurance industry,
Gartner said the IT spending increase should be 0.6% and in banking/financial
services, an increase of 3.2%
Conning
on Investments
Although life insurers
suffered a steep decline in gross investment returns over the last five years,
there were signs of a recovery in 2005, according to a study by Conning Research
& Consulting, Inc. Overall,
gross investment income returns on investable assets for the period 2001 to 2005
dropped from 7.10 percent in 2001 to 5.93 percent in 2004, before increasing to
6.02 percent in 2005. Accident &
Health companies posted the most favorable average investment return over the
period due to their heavy allocation to bonds, while Annuity companies reported
the lowest return.
“A
combination of economic conditions and Federal Reserve activity caused interest
rates to decline, and insurers took a significant hit in overall return,” said
George McKeon, analyst at Conning Research.
“For the first time over the study period, returns increased, albeit
slightly, in 2005, suggesting that the worst is behind us.”
The Conning Research study,
“Investment Profile of the Life Insurance Industry-2006 Edition,” examines
statutory investment information over a five-year period for the industry and
compares investment returns and sector strategies for peer groups within each of
the key investment classes. New with this edition of the annual Conning study is
a listing of holdings in each of the major asset classes for the 452 companies
that comprise the study universe.
“Of course bonds dominate
life insurer investments,” said Stephan Christiansen, director of research at
Conning Research. “accounting for more than 80 percent of the industry’s
investable assets over the past five years. Bonds are one of only two (out of
six) asset classes that grew both in amount and as a percent of total assets
over the study period. Schedule BA is the other. And while investment strategies
differed among the peer groups we analyzed, all peer groups held a larger
proportion of long-term bonds in relation to their investable assets at the end
of our review period than at the beginning.”
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