Life insurers tweak business models amid turbulence, McKinsey report

OLIVIA NNOROM

• Performance disappointing in recent years 

• Industry struggling to generate returns in excess of cost of capital

The life and retirement segment of the global insurance industry has seen disappointing performance in recent years, with nominal GDP growth far outpacing premium growth, the industry struggling to generate returns in excess of cost of capital, carriers not having structurally addressed their cost base, and declining relevance of life insurers in capital markets.

But life insurers have responded by reevaluating their traditional business models and could well be positioned to weather the persistent challenges in the coming years, global consulting firm McKinsey & Company said in a new report.

The report, “Global Insurance Report 2023: Reimagining life insurance”, said amid the increasing instability in the life and retirement industry over the recent decades, pockets of optimism and opportunity exist for insurers who can identify, invest in, and capitalise on their distinctive capabilities to meet the expectations of their owners and stakeholders.

Elaborating on the recent challenges, McKinsey said insurers haven’t been growing at the same rate as the economies in which they operate, while the industry has struggled to generate profitable returns after the cost of capital.

“In the United States and Europe, nominal GDP grew at a CAGR of 4 percent over the past 20 years, but premium growth grew at a CAGR of 2 percent. In Asia (excluding Japan), economies grew at a CAGR of 10 percent while premiums grew just 3 percent,” said the report released last week.

Furthermore, it said life insurers have not structurally addressed their cost base compared to other industries. At the same time, the lack of returns after cost of capital, muted growth, high volatility in earnings, opacity of risks and sources of earnings and value, and lack of individual insurer performance mobility have caused the global life insurance industry to gradually lose its relevance with investors, particularly in the public markets.

“This trend is most apparent in the United States, where the largest US life insurers’ share of market capitalization relative to other financial-services peers has decreased over the past 35 years—from 40 percent in 1985 to 17 percent in 2005 to only 9 percent in 2020,” McKinsey said, citing its analysis of data of the top 20 publicly traded life insurers, banks, and asset management and securities brokers in the US.

Pointing to the opportunities, McKinsey said over the coming decade, four paramount forces will continue to shape the industry globally, including growing awareness of personal risk and uncertain availability of socially funded benefits; near-term tailwinds from rising nominal rates, but with real rates likely remaining low for long; the growing role of technology; and rise of Asian economies and the return of geopolitics.

As governments of advanced economies become more indebted and government health and retirement programmes, like the US Social Security program and Japan’s National Pension System, face funding gaps, McKinsey said more citizens are realising that they are personally responsible for their future health and retirement costs.

“This realisation, however, is creating opportunity for insurers in the industry,” it said.

On the growing role of technology, McKinsey said customer expectations are increasing in terms of level of service, including the desire to integrate digital technology with conventional products. This is leading many companies to shift their business models to increase their adoption of disruptive technologies such as cloud computing and applied AI. They have also and have used more agile ways of working, as well as new talent attraction strategies.

The emerging new middle class in Asia and other developing economies, projected to grow in China, India, and Southeast Asia to 1.2 billion people by 2030 and make up nearly 14 percent of the total global population, the report said, presents huge opportunities, but “seizing the full potential of these opportunities won’t be easy given renewed geopolitical risks and concerns”.

In the prevailing circumstance, McKinsey said insurers, as well as investors, will have a dizzying number of options available to them in the coming years, adding that what is important is what strategic strengths insurers can depend on to generate growth in the coming turbulence.

The report – authored by Vivek Agrawal, senior partner, McKinsey’s Minneapolis office; Ramnath Balasubramanian, senior partner, New York office; Alex Gestal, associate partner, New York office; Pierre-Ignace Bernard, senior partner, Paris office; Henri de Combles de Nayves, partner, Paris office; Kristin Cummings Cook, consultant, Stamford office; and Bernhard Kotank, senior partner in the Singapore office – said whereas insurers have traditionally achieved profit and growth by identifying attractive products and markets, such as individual protection and annuities, and structuring their end-to-end value chain to support these products and markets, all of that is changing as the industry is reconsidering its approach to the value chain in two notable ways: product bundling and functional unbundling.

Dwelling on the unfolding changes, the report said when it comes to products, those that meet the needs of the same customer segments—such as retirement and wealth and asset management services or group and retail sales—are converging, pushing insurers into new territory.

“Some insurers will even go so far as to branch into the health and protection ecosystems if there is a demand from their customers. Insurers are also expanding and evolving their product shelf, shifting the mix away from traditional and balance sheet–heavy products to capital-light products and combining distribution points to create a simpler, more integrated customer experience,” it said.

Going forward, the report said that insurers will increasingly “unbundle” their value chain and focus on sources of distinctive value creation while seeking partnerships or leaving the other parts of the value chain to those who are advantaged. It added that unbundling helps uncover value within the integrated business model and focuses on distinctiveness while creating new sources of growth and value.

“Four insurance functions will take centre stage during this change: product design and underwriting, balance sheet management, distribution, and technology and administration,” McKinsey said.

“Insurers can start by determining how the strengths of their business model map to these four functions. Balance sheet specialists, for example, might consider finding a distribution partner, while distribution specialists tend to be best served by partners in product design and underwriting or balance sheet management. Those insurers can then use those strengths to differentiate themselves, achieve profitable growth, and appeal to investors,” it said.

McKinsey said this shifting industry structure will create new opportunities for where and how life insurers create value, elevating the industry’s relevance to consumers and its attractiveness to investors. It said insurers will have to chart a course through these shifts and choose their mode of value creation, which will be partly informed by their organisational goals and investor expectations.

“In the life and retirement industry, six themes dominate the investment attraction agenda: top-line or market share growth, diversification (via geographies and products), societal and customer impact, low volatility of results and dividends, ROE, and capital generation,” the report said..

“Insurance companies are likely to focus on some combination of these themes based on their ownership type and specific owners. Even within the broader classifications of insurers, however, individual insurers will have unique situations—and thus unique expectations,” it said.

On how to respond to organisational goals and investor expectations, the report suggested that insurers backed by private capital and alternative-asset-management players could proactively develop new growth vectors, such as more flow-based business beyond pure legacy M&A and international or geographic expansion.

“They may also continue to strengthen risk management capabilities (given the relatively higher-risk profile of their investment portfolio), further enhance their investment management capabilities through more dynamic portfolio rebalancing, and develop additional sources of value creation beyond pure investment alpha (for example, by becoming more ingrained in operations and technology to find value),” it said.

For mutuals, McKinsey said they could innovate more in their product offerings to capture growth through distinctive product specialisation that better matches customer needs, as well as to transform their distribution and customer engagement capabilities. They could also focus on their operational efficiencies to bring down costs and focus on their quality of governance to improve productivity and capital allocation, it said.

On their part, stock-traded insurers need to address the issue of where they have unique competitive advantage and can generate capital, such as in certain geographies, lines of business, or parts of the value chain, McKinsey said.

“For example, these insurers may build or partner with others to achieve table stakes investment-management capabilities, which would help them compete with insurers backed by private capital or alternative-asset-management players and take advantage of opportunities that others are slow to capture. They might also want to find innovative ways to harness their growth opportunities and ensure they are properly valued by investors,” it said.

For state-owned insurers, the report said as demand for life products changes and becomes more specific for each consumer, they should develop innovative products that are better suited to evolving customer needs.

“They also need to keep up with the pace of digital transformation seen in the private sector, all while balancing these large investments with their solvency position. Finally, these insurers may have to address talent attraction—for example, to improve their underwriting capabilities and compete with insurers in the private sector,” it said.