Canadian life and health insurance companies have pulled out more than a few surprises, along with a lot of the stops in recent years. You might even describe them as being somewhat nimble in response to the shocks threatening company balance sheets.Regulatory pressures, economic pressures, and plain old growth constraints, have all lined up to swing at the industry’s carriers. In turn, the companies have shown a fair measure of resilience.
As it turns out, carriers have more pricing power than was previously assumed. The market also seems willing to accept the complete restructuring of product and business lines alike.
Other themes have shifted in the meantime. International business is one example, as long-held enthusiasm about expansion in Asia begins to temper a little. Regulatory capital requirements are another example, as the industry waits for new guidelines that might ease business pressures considerably for some companies.
Interest rates, low interest rates in particular, are one of the industry’s biggest challenges, the catalyst for product, and business restructuring, risk management, and cost containment efforts that have become a priority for senior executives charged with the task of delivering on profitability objectives.
Restructuring and risk shifting
Since 2010, companies have been “de-risking” their holdings in a number of different ways. Variable annuity business lines in the United States have been shut down, then sold off in some cases. Product restructuring, and price hikes, meanwhile, are widespread across the industry.
One large task has been to restructure the risk related to legacy products that companies have already sold, primarily by hedging. Robert Sedran, executive director of financial services equity research at CIBC World Markets, says incremental hedging of in-force business is largely complete for most insurance companies at this point.
Although hedging lowers a company’s overall risk profile, the effort does not come without some operational risk. “These are not uncomplicated hedges,” he says. It’s as much a strategic decision as anything they’ve ever done. You’re transforming the nature of your in-force block in a lot of ways. The risks to getting it wrong are simply too high. I don’t think you can overstate the importance of what’s been going on for the past two years.”
He says the amount of work that companies needed to do, depended on their individual risk profiles at the start of the financial crisis. Manulife Financial, for example, “entered the crisis with the most risk on, so they had the most to do, but everyone’s been doing it to a certain degree,” he adds. “Some (product) features were never perfectly hedgeable, so you’ve had to redesign the products a little bit, as well.”
As for product pricing, he says all companies have been moving in the same direction, but again, the magnitude of the moves needed, “depended on the risk profile you had coming in.”
Re-pricing efforts, and overall market conditions have created a few obvious sales trends in the industry. Tom MacKinnon, managing director at BMO Capital Markets, says following several rounds of universal life (UL) product re-pricing, UL product sales have declined (market conditions have contributed to the trend), while companies have started increasing their sales of participating life insurance product.
He adds that adjustable insurance products could be making a comeback after Empire Life launched a new permanent product with both guaranteed and adjustable features, back in April, and Industrial Alliance announced it was launching a universal life product with adjustable features in June.
Still, he says although price hikes have helped profitability, companies are still not hitting pricing targets for individual insurance sales in Canada.
Group insurance sales, meanwhile, is discussed in the early pages of the most recent annual reports issued by each of the big three insurance companies. Analysts say this is part of a wider focus on products which can be re-priced annually, if need be.
“Insurance companies need to live with their mistakes for a long time,” says Mr. Sedran. “That’s true of some products, but it’s not necessarily true for all of them, so they’re going to focus much more on areas where they can adapt to a changing environment more rapidly.”
Not only are group insurance sales relatively steady – growth tends to follow economic or GDP growth – the risk is also relatively predictable. “People go to the dentist twice a year, and on average a certain number of people will die or claim on disability,” says Standard & Poor’s director, Donald Chu. “They’re fairly good at predicting these things. Even if they get it wrong, next year they can re-price it.”
Size and scale help as well. Once the technology needed to serve group business is in place, companies can move up or down market, to take on larger and smaller groups, without much additional modification needed to their systems.
In Canada, with large cases being something of a zero-sum game, carriers could now be using the benefit of their established technology platforms to collect blocks of smaller group business.
In the U.S., meanwhile, Mr. MacKinnon says there could be future investments made in the 401K market as well, with companies moving in the other direction – from the 50-100 lives market into larger cases serving 100-250 lives.
The U.S. market, however, is no easy place to make a living. Not only is competition from mutual companies rather intense, regulatory capital requirements further impair a Canadian company’s ability to compete in many cases as well.
The decision to stop selling annuities in the U.S. is one sign of this challenge. Mr. Sedran describes the market as being “hyper-competitive,” where competitors are highly disciplined in managing fixed costs.
“This makes it difficult to get the right return for the risk you’re taking. Then, from a Canadian perspective, the capital rules have been tightened for what (companies) are holding against the new annuities being written today. You’re being forced, in Canada, to hold more capital against that annuity being sold in the U.S.,” he says. “It makes it a difficult place to do business.”
Leaving the U.S. market
Pulling out of the U.S. market was not a small, run of the mill decision either. “It was as dramatic as it seems,” Mr. Chu agrees. He points out that Sun Life Financial spent a lot of money making acquisitions in the U.S. “Without question, they have taken a financial hit on that. All the other companies are pretty much in the same boat,” to some degree, he adds. “They’re all coming to the realization that the U.S. market is not as attractive as they once thought.”
In other international business lines, meanwhile, companies continue to look to Asia to provide growth, but enthusiasm about the region is notably more temperate than it has been in the past.
Mr. Sedran says this expansion has been less of a focus in the past two years, because companies have needed to be more internally focused as they repositioned and restructured their core businesses.
As well, to expand in Asia requires a large outlay of capital. “Manulife and Sun Life are not the only two companies in the world that have realized that Asia is a more rapid grower,” he adds. “The competition for those assets is (also) intense.”
At issue, too, is the disconnect between top-line sales, and bottom line results. While companies spend a lot of money, the impact “doesn’t really move the financials as much as you might like.” Mr. MacKinnon says although compound, annual sales growth has come in around 25 per cent since 2008, the compound annual growth in earnings “has probably been in the four to five per cent range.”
The region is still attractive, however, because companies need growth that generally can’t be obtained with a domestic focus on Canada alone.
Despite its challenges, and despite the tempered optimism about the market in Asia, financial services penetration is still low there, Asia’s population is young, and continues to grow rapidly, and the region is still described as being an opportunity for companies.
“Top line progression is fairly easy to see, or at least fairly easy to expect, because these factors are conducive to a strong top line,” Mr. Sedran says. “Getting the bottom line to grow in the manner in which the top line is growing has become the big challenge.”
In Ireland, meanwhile, the acquisition of Irish Life by Great-West Life, has analysts optimistic. They say Great-West has proven to be a good operator and the analysts are curious to see how things play out in the future.
“It does seem like an odd one, but when you get in there and understand it a little better, it makes a lot of sense,” says Mr. Chu. The company, he says, is more focused on wealth management business that delivers fee revenue, rather than more traditional “long-tail” insurance products. “It’s a nice little franchise, and because it has Ireland in the title, it scared everybody away.” The analysts generally agree that Great-West purchased the company for an attractive price.
In the United Kingdom, meanwhile, the company hasn’t faced the same pressure as it would if it were operating in Greece, Italy or Spain.
Finally, India continues to be a challenge for Sunlife, after the government implemented new product rules back in 2011. “It’s significantly hurt top line growth,” Mr. MacKinnon says.
At the time of this writing, analysts tell The Insurance and Investment Journal that insurance carriers’ shares are generally fairly valued. The first quarter of 2013 has been good for companies too, thanks to interest rate and expense management efforts, and as companies continue to make better use of new and existing technologies. Companies being selective about the businesses they operate in have also helped results.
“Either you put a whole pile of resources in to improve your franchise position, or you make a financial decision, a business decision, and say, ‘We can’t compete against the big guys, we’re going to walk away from that business because it’s not worth our effort to be there,’” Mr. Chu says.
When looking at the core business fundamentals, he says companies are well positioned, with high capital levels. “They’ve trimmed the products that are less profitable and they have adequate reserves. They’re in a relatively good position. The prospects of them improving in the future are good, but it’s going to be at a slow, measured pace.” (One wildcard to that outlook is the prospect of an extremely prolonged period of low interest rates.)
Analysts also expect the focus on fee-based products, and those where clients assume more market risk than companies, will remain for the foreseeable future. Even with this focus, companies do require equity markets to help them deliver results.
“You can turn yourself into a mutual fund manager, but you’ll still need assets under management to grow to make more money,” Mr. Sedran says. “The markets remain a key variable.”
Finally, as for international expansion, although attention has returned, it’s expected that companies will be more controlled about their spending going forward. Profit growth is also expected to emerge in the coming months and years. Mr. Sedran points out that new business, even in Asia, is already more profitable today than it was five to seven years ago. “I think that profit will emerge. I’m not convinced it will emerge rapidly, but we should start to see a little bit of that profit emerge this year and next.”