Significant market forces will confront U.S. life insurers in 2013, challenging all aspects of their business models and operations. Although these trials are expected to continue beyond the year, successful companies will be those that proactively address these forces now, rather than postpone action and be compelled to react in a more competitive future environment.
Macroeconomic challenges derive from the persistently sluggish recovery. Real GDP is expected to grow only modestly, although the unemployment rate could improve during the year. Given current low interest rates and the Federal Reserve's pledge to keep them low, U.S. life insurers should anticipate an enduring low interest rate environment.
Equity markets are likely to remain volatile in 2013, directly impacting insurers' financial positions through management and expense fee instability. This volatility is causing reluctance among consumers to purchase variable products, and the low crediting rates on fixed products are not perceived as a particularly attractive alternative.
Regulatory forces also are challenging. At the federal level, life insurers with banking operations, or those designated to be a Systemically Important Financial Institution (SIFI), confront increasing regulation by the Federal Reserve. Life insurers also must prepare to respond to possible actions taken by the Consumer Financial Protection Bureau (CFPB), as it begins in 2013 to review assorted financial services transactions like insurance sales.
At the state level, life insurers continue to adapt to current and prospective NAIC regulations, such as the Risk Management and Own Risk and Solvency Assessment (ORSA) model act.
Against this backdrop, life insurers also are competing against financial products from outside the insurance industry, in an economic environment when many consumers are increasingly questioning the value proposition of life insurance. Indeed, the average household expenditure on life insurance has declined 50 percent over the past decade. Consequently, the U.S. life insurance industry must cope with a shrinking share of the consumer wallet.
In this uncertain climate, life insurance companies will need to address the following issues:
- Prepare for a scenario of long-term low interest rates.
Now that the Federal Reserve has announced its third official program to attempt quantitative easing, there is little possibility of returning to a higher interest rate environment in the near future. While interest rates have been decreasing since the early 1980s, the required interest rate to maintain policyholder reserves and profitability was low enough compared to prevailing rates that margin squeeze came primarily from competition. Now the margin squeeze is coming from the interest rate environment itself.
Insurers must move from managing this environment purely as a short-term crisis, as it now appears to be a long-term operating challenge. To obtain greater yield, insurers may need to increase risk-taking in their asset portfolios, with an understanding that they will have to be adequately compensated in yield for taking on the additional risk. And insurers may be able to mitigate the impact of lower interest rates by adjusting liabilities and pursuing stronger enterprise risk management and asset liability management practices.
- Intensify cost-reduction efforts to improve margins.
Not surprisingly, the low interest rate environment and reduced demand for insurance products are squeezing profit margins, making future success highly dependent on expense efficiency and reduction. This challenging environment increases the need for sustainable cost reductions.
Typical cost reduction techniques such as outsourcing and the shedding of non-core businesses can still be effective, but to attain long-range gains more fundamental changes in processes are required, such as investments in predictive modeling and consumer analytics. Companies that have invested in these areas have improved the efficiency and cost-effectiveness of their underwriting and sales processes.
- Organize and plan for accounting change.
Both the Financial Accounting Standards Board (FASB) and International Accounting Standards Board (IASB) are revisiting areas of insurance contracts accounting in U.S. GAAP (Generally Accepted Accounting Principles) and IFRS (International Financial Reporting Standards). Current exposure drafts indicate that approaches to insurance contracts accounting will change under both standards, with the final standards from both bodies arriving in second quarter 2013 with an effective date of Jan. 1, 2016.
