Life Insurance Closed Books And Related Management Challenges
M.M. Shyam Sankar Kartik
Insurance closed books have been a serious topic of discussion especially in the UK in recent years and to a lesser extent in US and EU. Various perspectives have been provided on insurance closed books, new market operators have emerged to address the opportunity (in the UK) and companies have addressed this issue in various ways. The focus of this article is on the challenges of managing life insurance and pensions closed books. Closed books and major global insurance trends A few global trends that have led to the emergence of insurance closed books as a phenomenon in specific geographies are listed below: ? investment returns In the early part Decreased of 21st century, global investment returns decreased substantially, affecting not only insurers but other financial services companies as well. The insurers most affected were with product portfolios that had a high guarantee portion. So insurers were forced to discontinue such risky investment products and redesign their product portfolio. ? regulatory scrutiny Increased Increasing regulatory scrutiny, especially in the UK by Financial Services Authority (FSA) into 'With-Profits' product portfolio opened up a debate into how such portfolios were managed and administered. FSA has brought in new regulations like 'Twin-peaks' approach and Individual Capital Adequacy Standards (ICAS). These regulations have virtually reduced the 'With-Profits' market to a miniscule part of its original size. ? reduce operating costs The above Pressure to factors combined with pressure to reduce policy administration and operational costs in general has added to the woes of insurers. Solvency risks and Reputation risks associated with 'WithProfits' portfolio focused market attention to managing this 'discontinued' business portfolio. Innovative solutions have been developed to address this new phenomenon with considerable regulatory support. Characteristics of life insurance closed books Life insurance closed books have no new policy sales except for contractually allowed increases. Renewal premiums are received as per the contract. Normally, no large-scale sales and marketing organizations are retained (except for client retention purposes). Many times the policy holders have lost touch with the servicing agents and no major avenue for on-going advice or service. As no new policies are sold, the portfolio size steadily decreases over time. Insurance closed books are also regarded as weak and a drain on the company's capital. The lack of transparency into their workings adds to the problem. Many times such problems and misconceptions leads to high employee attrition further affecting customer service. Business drivers behind life insurance closed books ?business strategy Some key players in Change in the UK are focusing on their more profitable open books as a business strategy leaving their closed books to other players or specialized consolidators. ? economic and regulatory environment Changes in FSA has brought in extra regulations for closed books business in addition to stringent solvency standards like 'Twin-Peaks' and 'ICAS'. Increased regulatory focus on transparency has opened a Pandora's Box with respect to closed books business. This has forced the less efficient players to either exit or restructure their business portfolio. ? Market innovations New market operators have emerged in the UK insurance market like closed fund consolidators. For e.g., Pearl is a well known closed fund consolidator in UK insurance market. Innovations from these firms have been one of the primary reasons for development of closed books as a market phenomenon. Innovations have also emerged from the solution / service providers offering long-term cost-effective solutions like Third-Party Administration (TPA) to consolidators and insurers alike. ? mergers & acquisitions (M&A) in Increased Insurance Increased M&A activity in insurance business offers scope for fund rationalization and a valuable opportunity for revolutionary business restructuring. M&A regularly consider closed books business as a separate option now-a-days. For e.g., Pearl in the UK has become one of the largest players in UK Life & Pensions space through a large number of mergers & acquisitions (recent acquisition of Resolution, another closed fund operator ). ? growth in some products Significant Profitless' 'Churning' of back books into new business in the UK has resulted in new business growth without any 'real' growth. As growth stagnates and churning becomes prominent, increased attention is focused on managing existing back-books even if they are closed for new business. If new business is not sufficiently profitable, the products could be discontinued. ? Financial weakness A financially weak insurance firm may consider multiple options for managing a closed book. There is enough evidence to show that poor fund performance is a reason for closure, not a result of closure. Decline in solvency levels means low possibility of surplus distribution in the future. This could lead to low persistency thereby forcing an insurance book to close for new business. ? and Compliance Costs of mis-selling Mis-selling
and compliance to emerging requirements like Treating Customers Fairly (TCF) has forced firms to revise their product terms and conditions as well as selling strategies. This has resulted in at least some of the existing products being closed to new business. Closed books phenomenon is found in both individual as well as group business. In group pensions business, this phenomenon is similar to the Bulk Purchase Annuities (BPA) in the UK. Market response to insurance closed books ? of open and closed books with Separation separate management focus. This trend is more prevalent in the UK but European insurers have increasingly started to adopt such policies. ? of consolidators like Pearl Emergence ? service contracts on closed books Long-term administration mirroring the portfolio size over time ? on inherited estate Closed books Litigations have resulted in increased litigations on the inherited estate, especially on with-profits policies. Recent examples in the UK include AVIVA and Prudential. Key challenges in insurance closed books management Without a pro-active management of closed book, it could destroy value in the remaining section of insurance business and reduce returns to share holders. Some of the challenges of a closed book scenario are as follows: ?estate - Reattribution of the inherited Inherited estate is likely to be contentious issue between shareholders and policy holders. Some insurers have used the inherited estate to make legal payments for mis-selling cases. ? Profit sharing - Closed firms face the challenge to demonstrate fairness of their payouts especially in with-profits portfolio and proportion of surplus allocated to shareholders. There are challenges to regulators if they are to ensure that value is not transferred from with-profits policyholders to shareholders. For e.g., in the UK FSA is likely to ensure that there is no cross-subsidy between open and closed funds, if any. ? Operational cost management - Steadily decreasing portfolio size demands parallel reduction in policy administration costs to keep the business profitable. As there are no commission expenses for a closed book, on-going expense management will be critical. The primary need is to convert any fixed cost into a variable cost and manage these variable costs as per business volumes. Organization structures, technology infrastructures and business processes
will need to be re-engineered to convert as much fixed cost as possible to variable. Existing service contracts will need to be renegotiated at specific times or even before renewal stages. For e.g., closed book operator Pearl has a long-term partnership with Diligenta to provide predictable per policy administration costs for the back-books. Such predictability is achieved through transferring all operational resources (infrastructure, people, applications, networking & hardware) to the partner and allowing the partner a free-hand in running the operations based on SLAs. ?service - Due to inter-play of factors like Customer staff retention, transition management and bad publicity, customer service could suffer in a closed book. If service standards deteriorate, it could reduce persistency further exacerbating the problem. ? - As portfolio size decreased steadily in Retention a closed books business, any unexpected surrenders or terminations could prove disastrous to closed books business. It is common that clients in a closed books business will not have any advisor / agent contacts for on-going advice or service. This places special attention on retention. One of the primary retention strategies is to annuitize maturing pension contracts rather than executing an open-market option. ? workings of a closed book is likely to Scrutiny - The be scrutinized by the regulators and capital markets (for public companies). Conclusion Management of Insurance closed books needs a management focus, separate from the open business, due to their special challenges. Insurers have adopted different courses of action, depending on the size of their closed books. With the right management focus, Insurance closed books do provide value to policy holders and share holders, as has been demonstrated by specialists like Pearl. It is imperative for insurers to at least start to understand the size and impact of their closed books and design suitable management responses for the same. Regulatory developments like risk based capital requirements and IFRS will only accelerate these developments. References 1. www.pwc.com PriceWaterHouseCoopers website 2. www.deloitte.com Deloitte website 3. http://www.nottingham.ac.uk/business/cris/ - The Centre for Risk and Insurance Studies, University of Nottingham 4. www.fsa.gov.uk UK Financial Services Authority website
M.M. Shyam Sankar Kartik is a Senior Domain Consultant with Wipro Technologies. Kartik has over 12 years experience engaging global insurers in the UK, Asia-Pacific and Japan and providing technology enabled business solutions.
The opinions expressed and conclusions reached by the authors are their own and do not represent any official position of Wipro Technologies. Unless explicitly stated, the information and views expressed in this article may not be construed as those of Wipro Technologies.
