UNLOCKING INFORCE VALUE IN ASIA-PACIFIC · in customer analytics capabilities. For example, many insurers have developed customer lifetime value (CLV) models, but these are either

UNLOCKING INFORCE VALUE IN ASIA-PACIFICThe $10 billion opportunity for life insurers

Angat SandhuHeiko FaustSteven ChenKetat Sarakune

SUMMARYLife insurers in Asia Pacific have experienced strong growth over the past decade. Strong economic growth, increasing urbanization have increased incomes, especially in emerging Asia, contributing to an increase in life insurance penetration rates. That robust growth has slowed down recently and the outlook remains uncertain. With low interest rates here to stay, increasing volatility in investment markets and risk-based capital regimes becoming prominent in most markets, insurers need to re-examine how they can create value for their customers whilst delivering attractive returns for shareholders.

The Inforce book contributes a relatively large share of the profit, revenue and operating cost, but in the race for new business, has not received adequate scrutiny. European life insurers faced a similar outlook of depressed yields, low growth after the 2007-2008 global financial crisis. As a result they pivoted their focus by introducing significant Inforce programmes, many of which continue to this day. In our experience, players were able to unlock 12-14 bps of reserves in additional operating profits over five years.

With $7 trillion of life insurance reserves across the life insurance sector in Asia, similar levels of success would equate to ~$10 billion in profit uplift. Furthermore, a sustained focus on the Inforce book will allow insurers to build stronger and more meaningful relationships with their customers.

In this paper, we share our insights on the key factors that need to be considered to successfully execute these programmes.

Source: AXA investor day presentations

Source: Zurich investor day presentations

AXA Group’s Inforce optimization programme, which is composed of over 300 projects during 2010-2015, has managed to release €2.6 billion of capital for life and savings business, and delivered €500 million in additional underlying earnings.

The programme aims to deliver an additional €350 million in underlying earnings by 2020.

In 2014 Zurich has embarked on phase one of their Inforce management programme and targeted to deliver $80-100 million in additional operating profits in two years.

By the end of 2016, the programme has managed to deliver more than $150 million. Phase two of the programme from 2017 to 2019 have also exceeded the $100 million target, delivering $172 million in additional operating profits in 2019.

Initiatives to simplify operations also have managed to reduce operating expenses by $600 million.

CASE STUDY Global examples of successful Inforce management programmes

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Unlocking Inforce value in Asia-Pacific

WORSENING ECONOMICS

Global life insurance gross premiums grew at two percent CAGR over the past decade, driven by the growth in Asia-Pacific (APAC), with growth rates in Americas and EMEA flat or negative. Within Asia, Mainland China, Taiwan, and India were the region’s growth engines, offsetting the decline in premiums observed in Japan, South Korea, and Australia for the past five years.

Exhibit 1. Premium growth of life insurers

1,104

1998

2,266

2008

2,636

2018

Americas EMEA Developed APAC Developing APAC

351

443

292

609

1,043

450

164

623

984

597

433

CAGR

Americas

EMEA

APAC

— APAC Developed1

— APAC Developing2

World

1998–2008 2008–2018

0%6%

9% -1%

5%

3%

10%

2%

7%

4%

25%

7%

1998–2008, Trillion (USD)

17

+7%

+2%

1. Developed APAC includes Japan, South Korea, Hong Kong, Singapore, Taiwan, Australia, and New Zealand2. Developing APAC includes Mainland China, India, Indonesia, Malaysia, Philippines, Thailand, and VietnamSource: AXCO, Oliver Wyman analysis

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Traditionally, APAC life insurers have focused on growing new business. In recent years the ratio of the new business premium to Inforce premium has been low, and declining in many APAC countries, signifying that new business is becoming a smaller contributor to total revenue (See Exhibit 2).

Whilst the growth outlook is still relatively positive, profitability remains challenged. Low interest rates, which are expected to persist, are subduing investment returns and increasing the cost of maintaining guarantees that are attractive to customers. In several APAC markets the profitability has been either flat or decreasing, with Australia and Indonesia reporting a net loss for the total life insurance industry last year (See Exhibit 3).

Exhibit 2. Ratio of New Business (NB) annual premium equivalent (APE) per Inforce (IF) premium for life insurance industry in APAC countries

0.1

0

0.2

0.3

0.4

0.5

0.6

0.7

Malaysia Philippines Thailand Vietnam Taiwan SingaporeIndia Hong Kong South Korea Japan Australia

2015 2018/20191

NB APE/IF premium

1. 2018 for Vietnam and India, 2019 for other marketsNote: Mainland China numbers is not shown due to high volatility of new business volume driven by regulatory changes; Indonesia NBAPE numbers are not availableSource: Insurance regulators, Industry associations, CEIC, Oliver Wyman analysis

Exhibit 3. Life insurance industry ROE by market for 2015-2019 (%)

-52015 2016 2017 2018 2019

0

5

10

15

20

25

Indonesia1Australia

India

South Korea

Japan2

Singapore2

1. For Indonesia, excluding PT Asuransi Jiwasraya which was involved in a financial scandal2. 2019 numbers for Singapore and Japan not yet available at the time of writingSource: Insurance regulators, Industry associations, CEIC, Oliver Wyman analysis

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THE BUILDING BLOCKS

In our view, there are three broad categories of actions that APAC insurers can take to maximize value of their Inforce portfolios: customer, cost, and capital. All of them should be explored in a coordinated effort as part of the broader Inforce management programme.

Exhibit 4. Oliver Wyman’s 3Cs of Inforce Value Optimization

Customer Cost Capital

Engaging customers and maximizing customer value across their lifecycle

Reducing cost to serve while improving customer experience

Strengthen capital management by incorporating new avenues

• Improve retention• Accelerate cross-sell/up-sell• Restructure/reprice policies

• Review allocation of cost and resources to in-force

• Rationalize in-force servicing cost through automation and variabilization

• Optimize asset liability management (ALM)

• Strategically leverage risk transfer

Source: Oliver Wyman analysis

CUSTOMERInsurers can improve their revenue and profitability by better understanding and meeting their existing customers’ needs over time. This typically involves focusing on some of the following levers:

1. Customer retention

2. Cross-selling and up-selling products & services

3. Restructuring or repricing existing policies as regulatory and product structures allow

Whilst each of these levers itself isn’t new, the potential to extract greater value in each is large, particularly as minute changes in each can have a disproportional impact on the overall portfolio.

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Customer retentionFor life insurers with a cross regional footprint, lapse rates (policy cancellation rates) vary radically across markets. Market specific and product structure differences across markets contribute to this variation. But the questions that life insurers should be asking and actively trying to solve for are: Why are insurance customers leaving them? Are they moving to competitors and if so why? Or simply don’t have a need for the product? And if so, why?

By simply applying the microscope on such questions, insurers can start to better understand customer needs, behaviors and align their product and service proposition to meet them. Given the long-term nature of most life insurance contracts and the high acquisition costs associated with getting new customers, even basis point improvements in lapse rates can unlock millions in profit and embedded value.

Exhibit 5. Life insurance industry lapse rates by market percentage (%)

Singapore

1.6 1.8

4.0

Indonesia India Japan Malaysia Thailand Philippines South Korea Australia

5.76.6 6.6 7.0

9.9

13.6

Note: 2018 data. Definitions vary by market and whilst efforts were made to make comparable, differences remainSource: Industry associations, Insurance regulators, CEIC, Oliver Wyman analysis

Given the long-term nature of most life insurance contracts and the high acquisition costs associated with getting new customers, even basis point improvements in lapse rates can unlock millions in profit and embedded value.

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Cross-sell and up-sellThe protection gap across Asian markets remains high for both mortality ($158 billion) and health ($321 billion), according to the Swiss Re Institute. Whilst consumers realize the importance of insurance, it still remains as product that requires active selling rather than being proactively pursued by the consumer. This is true even for customers that have some policy coverage. As their life circumstances change, very few actively seek out and reassess if their protection needs are adequate. Life insurers have typically not had the data, the processes, the focus, or the customer permission to more proactively engage. Given the increasing size of the protection gap, we believe there is significant opportunity for insurers to better serve the needs of their existing customers.

Restructuring or repricing existing policiesThis lever is often limited by regulatory or policy limitations but where these constraints are limited, insurers can unlock significant value by re-examining the underlying risk profile of their existing book and seeing whether policy terms such as crediting rates or guarantees could be adjusted. In markets like Australia, where protection policies are priced annually, significant value can be unlocked by looking more granularly at the emerging experience and better differentiating the pricing of the portfolio. Finally and importantly, conduct considerations need to be incorporated in making such decisions.

These value levers are not new but unlocking them requires insurers to take a more integrated approach to customer value management. This needs to be underpinned by a significant uplift in customer analytics capabilities. For example, many insurers have developed customer lifetime value (CLV) models, but these are either too simple in their calculation approach or inadequately used in decisioning. Developing more effective customer life time value models requires bringing together multiple internal data sources, supplementing with relevant external data sets and deploying more sophisticated analytical techniques. Deploying these models effectively requires not only embedding this information within the operations and servicing teams as well as the distribution teams, but also effectively training them on how to use this information.

COST

Coronavirus (COVID-19) has already demonstrated to most insurers that their operations can continue remotely, without the high real-estate costs and arguably with fewer employees at full productivity. Most insurers are already working through how they incorporate the lessons learnt from the pandemic around operational resiliency and ways of working. In many ways, this is the perfect backdrop to re-examine the cost base associated with the Inforce more closely.

A closer inspection of the operating cost of life insurers across markets in Asia suggests operational costs have continued to increase, with significant variation in growth rates across markets.

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Whilst the growth rates in operational cost base themselves are not a worry, they do hide within them a worrying trend around the slow pace of automation of digitization of back-end processes in the sector. The above is particularly important in a low growth environment where marginal reductions in operational costs will have a material impact on the bottom-line.

We believe it is time for APAC insurers to conduct an intensive review of Inforce cost levers and rationalize their cost to serve. The Inforce book is hardly homogeneous, comprising of many product lines, vintages, and customer sub-segments with varying degree of profitability. Insurers must first understand the profitability of their own Inforce by conducting a detailed review of their cost base, attributing various operational costs to specific blocks and determining profitability by sub-segments. This would enable appropriate prioritization and allocation of resources to the most impactful actions.

Insurers then will need to relook at their existing end-to-end processes around Inforce servicing, such as claim processing and payments, which are often plagued with inefficiencies and low-value manual tasks that could be expedited and automated through process re-engineering and automation. A number of insurers have completely digitized many of these processes with built-in decision rules that can enable straight-through processing (STP). These not only reduce cost to serve, but also reduce claim leakage and improve customer experience in a number of ways. These include improved response time due to straight through processing, faster turnaround time for customer requests, more predictable outcome and experience, and increased level of personalization.

Exhibit 6. Compound annual growth rates of life insurance industry’s operating cost from 2015-2018, excluding acquisition-related cost (%)

Singapore

1.8

3.7

Indonesia

3.9

IndiaJapan

5.1

Malaysia

5.2

Thailand

5.5

9.8

South Korea

10.3

AustraliaTaiwan

13.5

Source: Industry associations, Insurance regulators, Oliver Wyman analysis

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Insurers will also need to look at their existing IT infrastructure and assess whether there are opportunities for cost variabilization and optimization through outsourcing. Many APAC insurers are adopting cloud-based solutions which offers to convert high capital expenditures associated with maintaining physical data centres to a more pay-as-you-go model, with much faster deployment time and ability to scale on demand. Many software-as-as-service (SaaS) providers are also offering cloud-based policy administration system that not only reduce complexities associated with in-house customizations but also have many downstream benefits such as faster and more seamless customer response and more autonomy to agents through self-service portals.

These cost initiatives could be quite fundamental and will lead to changes in activities, functions, and interaction, and in essence become an opportunity to reinvent the business model.

CAPITAL

Most APAC insurers have worked on some forms of capital management optimization, with a particular focus on reinsurance. We believe further value can be extracted through a closer look at their approach to asset liability management (ALM) and re-examining their approach to risk transfer.

ALMOne of the ALM challenges faced by insurers is the lack of sufficiently long duration assets. Insurers can leverage derivative instruments to extend the duration of the asset portfolio to enhance the ALM position. Furthermore, insurers may not always seek to precisely match asset and liability positions because such a strategy could be inflexible and expensive. Insurers could deliberately choose to create a temporary mismatch if such a strategy allows to generate incremental returns.

Lastly, under the current persisting low interest rate environment, there have also been increasing interest from insurers in alternative assets, which could provide good risk-adjusted returns and low correlation to traditional assets. Insurers can invest beyond real estate and private equity, to those assets such as infrastructure, natural resources, and private debts. Inforce blocks which have longer terms and low cash value are more suitable to be backed by alternative assets. Successful implementation of these strategies is not straightforward for insurers as it requires capability uplift in investment teams, systems and stronger governance and controls, particularly where third parties are involved.

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Exhibit 7. Japanese life insurers’ evolution in asset allocation over time

1990

Yield (%)

2000 20192010

Investments by asset class1990-2019, JPY denominated

7

6

5

4

3

2

1

0

22%

13%

37%

4%4%

21%

14%

11%

25%

19%

15%

5%

14%

13%

8%

45%

12%

6%

26%

8%

7%

41%

Japanese government bonds Japanese corporate bonds Financial loans

Foreign securities Equities Others

20%

Yield of 10-yr Japanese government bond

10%

Sources: Life Insurance Association of Japan, AXCO, Oxford Economics, Oliver Wyman analysis

Japan has mostly experienced zero to negative premium growth since 2010, and has been in a low interest rate environment since the 1997 Asian Financial Crisis.

For much of the 2000s, the investment margin for insurers was negative, forcing insurers to re-think their product and ALM strategies. More robust ALM programmes were established to better manage asset-liability mismatch on an economic basis. Insurers’ investment strategy also has evolved, including reduction in Japanese equities which has persistently underperformed expectations, increased allocation to overseas and illiquid investments which has better risk-adjusted returns, and more active management of the yield curve.

CASE STUDY Lessons from Japan experience

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Risk transferRisk transfer can be used to optimize the insurer’s balance sheet and effectively monetize the Inforce book by transferring all or part of the liability to third parties. Depending on the insurer’s desired level of residual exposure, this can be achieved through a number of ways. These include: outright sale where both the policy ownership and operations are transferred to another party; reinsurance agreement with a reinsurer to pass through the balance sheet risk but retaining the customer relationship and policy administration; or outsourcing the operations to a specialist closed book manager.

Insurers will need to consider the trade-off between optimizing the Inforce book in-house through operational levers and transferring the book to another party. There are three key considerations for an insurer to enter into a risk transfer transaction. Firstly, there’s strategic alignment and considering how important the block of business is in delivering on the long-term objectives and ambition. Second is the financial implication and looking at how the business contributes to its results versus the gains/losses from the risk transfer. Finally, there’s risk assessment and asking whether the block of business generates significant risks that the insurer would like to limit.

Insurers in Asia are becoming more interested in more sophisticated risk transfer transactions to optimize balance sheet, as more countries move towards a risk-based capital framework. We have also seen increasing interests from global insurers and specialist players in closed book management in more developed APAC markets. Resolution Life, a Bermuda-based specialist legacy book manager, is seeking regulatory approval for acquisition of AMP’s wealth protection and mature businesses in Australia and New Zealand for AUD 3.3 billion, at 0.82x of the business’s embedded value. We expect there will be increased demand for similar activity in Asia going forward.

Insurers in Asia are becoming more interested in more sophisticated risk transfer transactions to optimize balance sheet, as more countries move towards a risk-based capital framework. We have also seen increasing interests from global insurers and specialist players in closed book management in more developed APAC markets.

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EXECUTING SUCCESSFULLY

Inforce optimization programmes are not easy. Insurers that have not harnessed adequate value from these programmes have struggled because they have either underestimated the organizational change required and/or not committed the resources and investment needed. Many management teams have also treated these initiatives as short-term projects rather than longer-term transformational programmes. As a result, they become impatient when material uptick in results do not emerge in the first three to six months.

The reality is that these programmes can and do touch multiple processes and functions in the organization, and the large amount of organizational change required can be intimidating and paralyze progress. Based on our experience, insurers should undertake the following steps to increase their chances of success:

• Articulate investor & customer narrative: Clearly articulating the investor and customer narrative helps get buy in from external stakeholders, the board and galvanizes the executive team into action. Highlighting the customer benefits also helps motivate employees and distribution partners.

• Prioritize focus: Organizations should not rush into execution mode. Conducting a thorough data led diagnostic of where the greatest opportunities lie, the practical challenges in unlocking them is critical. It is even more critical to share and challenge this with the executives to give them a chance to debate and shape the prioritization.

• Communicate clearly: Given the cross-functional and organization-wide potential of many activities, it is critical to have a clear communication plan to the organization that strikes the trade-off between emphasising the importance of the initiative, demands of individuals whilst maintaining sensitivities.

• Execute effectively: It is important to have clear and senior executive accountability for execution for the overall programme. For most insurers, this has meant appointing a senior executive to drive the overall programme and empowering them to influence the desired changes.

• Govern diligently: Finally, it is important that executive teams, the board and investors are updated on the progress of the programme, the value it has created for shareholders, the benefits for customers, agents and employees.

Historically, focusing on the Inforce books was an option that many life insurers in Asia chose to deprioritize for new business growth. And whilst the macroeconomic outlook has deteriorated, investor expectations of financial returns and customer expectations of experience, both remain high. We believe successful life insurers in the future will renew their focus on the Inforce books as a source of sustainable value creation.

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Oliver Wyman is a global leader in management consulting that combines deep industry knowledge with specialised expertise in strategy, operations, risk management, and organisation transformation.

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AUTHORS

Angat Sandhu, CFA, FRMPartner and Head of Asia Pacific Insurance Practice, Financial Services

Heiko Faust, CFA, FRMPartner, Insurance

Steven Chen, FSA, FCIA, CFAPrincipal, Insurance

Ketat Sarakune, CFA, FRMEngagement Manager, Financial Services

Oliver Wyman – A Marsh & McLennan Company www.oliverwyman.com

UNLOCKING INFORCE VALUE IN ASIA-PACIFIC · in customer analytics capabilities. For example, many insurers have developed customer lifetime value (CLV) models, but these are either

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