“Life insurance is dead” is probably the most provocative thing a life insurance executive can hear. While such a statement may sound unnecessarily pessimistic, many senior life insurance executives with whom we’ve spoken agree that their business needs to fundamentally change. In this and a subsequent article, we will address some of the challenges facing the life insurance industry and offer constructive suggestions on how the industry can reinvent and redesign its business model.
First, let’s take a hard look at the facts supporting the view that life insurance is dead (or at least badly stagnating). In 1950, there were 22.8 million life policies in the US, covering 14.6 percent of a population of 156 million. In 2010, there were 28.6 million policies covering a population of 311 million. In other words, the US population has nearly doubled in the past 60 years, while life policies have increased by just over a quarter. More recently, the number of families owning life insurance assets has decreased from 34.8 percent in 1992 to just 23 percent in 2007. The stagnation or decline of life insurance contrasts with the rise of mutual funds; 23.4 percent of the population owned such investments in 1990 but 43.7 percent (or 51 million households and 88 million investors) did by 2009.
A number of socio-demographic, behavioural economic, competitive, and technological changes explain why this has come to pass:
1. From demographic “pyramids” to “skyscrapers”: By age, the U.S. population has been tapering from a “pyramid” to a “skyscraper” over the past few decades. As Figure 1 shows, around 11.7 percent of men and an equal number of women were between the ages of 25-40 in 1950. However, only 10.2% of males and 9.9% of females were between the ages of 25-40 in 2010, and the percentage is set to drop to 9.6% and 9.1%, respectively, by 2050. There are two related factors that impact life insurance as the pyramid tapers. First, the segment of the overall population that is in the typical age bracket for purchasing life insurance decreases. Second, as people see their parents and grandparents live longer (and, in many cases, remain in good health at advanced ages), they tend to de-value the death benefits associated with life insurance.
2. From product simplicity to complexity: The life insurance industry initially offered simple products, namely term and then the whole life insurance. In the 1980s, universal life and variable universal life became popular. The 1990s saw the proliferation of various riders to existing products, like the GMWB, GMIB etc. There was a similar proliferation of products in the annuities sector. In response to socio-demographic changes and longer life expectancies, the industry tried to appeal more to these products’ living benefits rather than (or in addition to) death benefits. These living benefits are not always easy for policyholders and customers to understand, and in the wake of the financial crisis, some complex products had both surprising and unwelcome effects on insurers themselves.
3. From institutional decision-making to individual decision-making: The baby boomers and the previous generation, the so called Silent Generation, were used to the government and employers providing them benefits in the form of life insurance, disability coverage and pensions. Over the past three decades, changes in government and employer policies have progressively pushed often complex retirement investment decisions onto individuals. Behavioral economics clearly shows that when individuals have to choose between near-term gratification (e.g. spending) and delayed gratification (e.g. saving), they invariably choose the former. Now free to make decisions about purchasing life insurance for themselves, many people have eschewed it and elected to spend their money elsewhere; if they have elected to avoid instant gratification and invested, they often have chosen mutual funds, which grew exponentially on the back of the strong stock market and resulting high returns of the mid-1980s to early 2000s.
4. Growth of Intermediated distribution: The life insurance industry started with a simple distribution model (i.e., captive agents and a mutual structure), a simple product set, and a simple value proposition. However, changes in governmental policies, individual decision-making, changing demographics and behavioral attitudes, increased competition from the mutual fund industry, and the need to explain the complexity of products, led to the growth of intermediated distribution. Increasing life insurance product shelf space became most insurers’ primary strategy. Many insurers now distribute their products through independent brokers, captive agents, broker-dealers, bank channels, aggregators and also directly; it is expensive and difficult to effectively recruit, train, and retain such a diffuse workforce, which has led to problems catering to existing policyholders and customers.
5. Increasingly unfavourable distribution economics: Product complexity and the difficulty in maintaining networks of effective sales professionals mean that insurance agents are paid high, front-loaded commissions. Commissions for life insurance products vary by the type of product (e.g., lower for term life insurance and higher for whole life insurance) and typically could be as high as the entire first-year premiums and a small recurring percentage of the premium thereafter. The distribution structure of individual agents, who are part of the Master General Agent (MGA), adds additional layers to distribution, with each layer taking a percentage commission of the premiums. This increases costs for insurers and consumers (although the latter typically are unaware of how much distribution costs increase the price of products). Contrast this with mutual fund management fees of 0.25 percent for passive funds and 1-2 percent for actively managed funds. In addition, it is relatively easy to compare the management fees of the literally thousands of available mutual funds.
6. Rapidly changing customer preferences and expectations: Over the past 30 years, buying power has shifted from the Silent Generation to baby boomers and now Gen X and Gen Y. Unlike their more patient forebears, Gen X and Gen Y consumers demand simple products, transparent pricing and relationships, quick delivery and the convenience of dealing with insurers whenever and wherever they want. Online and associated mobile/social channels are emerging as key channels for education, exploration, engagement, and eventually purchase. This cuts across all age groups – LIMRA recently reported that nearly 86 percent of consumers are willing to use the Internet for researching life insurance.
The life insurance “death trap”
The above factors have resulted in a vicious cycle or “death trap” for insurers. Insurers claim that, in large part because of product complexity, life insurance is “sold and not bought,” which justifies expensive, intermediated distribution. For customers, product complexity, the need to deal with an agent, the lack of perceived need for death benefits, and cost of living benefits makes life products things they’d often simply rather not purchase. In contrast to the life industry, the mutual fund industry (the alternative to life insurance as an investment or living benefits) has grown tremendously by exploiting a more virtuous cycle: It offers many fairly simple products (individual stocks and funds, mutual funds, ETFs, indices that track specific risk profiles, and more) that often are available for quick, direct purchase at a minimal fee.
Despite the bleak picture this article paints, we believe that life insurance still has a very worthwhile purpose and think that a thoughtful response to today’s market conditions can help life insurers not just survive, but also thrive. This will require a fundamental rethinking of value propositions, product design, distribution and delivery mechanisms, and economics. We will address these challenges in our next instalment. While life insurance might be dead as we currently know it, the industry can reinvent itself and once again regain the high ground.