Creating Breakthrough Value in Life Insurance

8/11/2019 Creating Breakthrough Value in Life Insurance

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Creating Breakthrough Value in Life Insurance

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insurers to all others (including the S&P 500, diversified financials and the financial sector), the returns

of life insurers have risen only slightly while the returns of others are as much as five times higher thanthe original investment. In fact, the economic returns of life insurance companies would have toincrease by almost five percentage points to match the average performance of leading financialservices institutions.

Some analysts assert that a wave of consolidation is the only way to close the earnings gap in theinsurance industry citing as proof the more than 175 life and health insurance deals valued atmore than US$80 billion that have been signed since 1998. This includes the purchase of AmericanGeneral by AIG. In fact, many analysts believe that intra-industry consolidation will accelerate asglobal players with global brands, technology and distribution resources gain economies of scale

and build sustainable customer franchises. Other analysts, including those at ING and Citibank,support another viewpoint, saying that it is only a matter of time before life insurers become divisionsof much larger financial-services firms.

Which of these competing groups of analysts is right? They are both right. The reality is that thetwo trends will persist concurrently in the coming years.

In this paper, we offer insurance executives a way to capture a competitive advantage during thisperiod of change. Our remedy resides in A.T. Kearney s virtual integration strategy a proprietary approach to reworking the business model that helps life insurers bridge performance gaps by focusing on core, value-creating activities. Central to the strategy is an unbundling of the existing businessmodel that allows an insurer to focus on specific activities that will generate the highest possiblevalue for the company. In essence, what we propose for the insurance industry is a movement from vertical integration to virtual integration.

Virtual integration is an emerging approach to business system transformation and optimization. By itssimplest definition, virtual integration is the unbundling of the insurance industry s existing businessmodelenabling an insurer to individually manage specific activities that will generate the highestpossible value for the company.

Briefly, instead of thinking of insurance as a single business, in a virtually integrated company insurance becomes three unique businesses: processing and servicing (operations), product creation(design and underwriting) and sales (distribution). Whether the company is actually broken upinto three distinct entities, or a major function is outsourced, the aim is to think of the company asa portfolio of distinct businesses in which each component is focused on value creation(see figure 2).

Clearly, this trend of individually managing and thus unbundling the value chain is fairly well developed. The financial services industry, especially the mortgage and credit card sectors, is well versed in the concept(see sidebar: Unbundling the Value Chain) . Players in these sectors have

demonstrated how quickly this concept can be adopted and integrated, as well as how profitable theprocessing and servicing business can be.


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Nonetheless, life insurers have been hesitant to fully embrace the concept due, in part, to the uniquenature of their business and to significant, inherent barriers to change. For example, the complexity of products and slowing industry growth have led to a dependence on expensive face-to-face producerssuch as agents and brokers. The insurance industry also suffers from a lack of homogeneity and data standards for sharing information as well as a vast number of proprietary, inflexible IT systems(a wide range of systems can exist within a single institution). Furthermore industry governanceunder a mutual structure has delayed both innovation and decision-making.

These challenges, coupled with policies that stay on the books for decades, have prevented theinsurance industry from taking advantage of the significant economic benefits that can be derivedfrom virtual integration.

Until now.

Today, several A.T. Kearney clients are exploring virtual integration strategies. Our work focusesprimarily on evaluating ways to unbundle traditional functions and create new businesses witha basis for long-term competitive advantage. In our experience, processing and servicing traditionally viewed and managed as an unfortunate cost black hole is the key anchor of this transformationapproach (see sidebar on page 11: A Shift in Focus) . Indeed, based on our own estimates, the impact of outsourcing just the processing of in-force policies can be impressive. For example, in analyzing theimpact such a move would have on the 10 largest individual life insurance providers, our estimatesreveal the potential for an average increase in market capitalization in the range of 2 to 6 percent.Consequently, while value increases in the sales and product-creation areas, the realbreakthrough fromvirtual integration comes from transforming the processing and servicing area into a value generator.

Of course, the ideal configuration of a virtual organization and the role of processing andservicing will differ according to an insurers size, focus and core competencies. For example,a regional insurer may decide to outsource its policy servicing and processing in an effort to focuson specific product and segment niches. By comparison, an international diversified financial servicescompany would likely partner with a third-party administrator (TPA) to create an enterprisewideprocess and servicing shared-services utility, which would free the business segments to focus ontheir core operations. Finally, a large traditional insurer might decide to partner with a TPA tocreate an industry-wide utility to process and service policies. This move would not only create new revenue sources but also allow the company to redeploy resources to pursue alternative distributionmodels for its products. The result is a virtually integrated insurance company with processing andservice, sales and distribution, and product creation and underwritingutilities that can be ownedand managed solely by the insurer or with a strategic partner.

Essentially, this discussion is about addressing processing and servicing capabilities to create new

strategic options for insurers. It begins with variations on two themes:fix the old and createthe new.


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Fix the oldFor years, servicing of in-force books of business has placed a significant burden on insurance organi-zations. (Many of the giants are supporting millions of old policies at a time.) The overall enterpriseoperations and systems platforms are complex, costly and often inflexible, which means thesecompanies are not in a position to accommodate the upgrades and innovations that will be requiredto support a competitive marketplace. Indeed, it is estimated that insurers spend 60 to 70 percentof their general expense costs supporting these blocks of business. This represents significant capitaland resources that could be focused on developing new products and courting new customers.

True virtual integration, therefore, calls for releasing the company from the constraints of aninfrastructure dedicated to supporting individual life in-force policies(see figure 3) . This is accomplished

by forming a strategic partnership with a third party partner to create a new businessone that takesresponsibility for servicing this book of business and can reinsure liabilities to free up capital.

Clearly, the growth of a new wave of TPAs provides insurers with this option, enabling them todrive down operational costs by leveraging the scale economies and capabilities of the TPA. In fact,a good number of insurance companies have already built alliances with third parties to handle someor all of their processing and servicing. Fidelity & Guaranty Life, for example, outsourced a numberof key business processes to CSC, including new business applications, underwriting, policy services,claims processing and customer service. Chubb exited life insurance altogether and sold off two millionpolicies to Swiss Re, which turned the business over to third-party administrator Cybertek, which isnow residing under the CSC umbrella. IBM is offering externally hosted claims handling andprocessing services for the P&C industry.

A more recent example is Lincoln National. Lincoln, the third-largest seller of variable annuitiesand seventh in life insurance sales, contracted with EDS to administer its entire business function,

which accounts for 90 percent of its traditional whole life and term policies. EDS is performing allongoing business functions for the life insurer including in-force processing, customer service,premium billing and reporting. EDS will also provide Lincoln with the IT services to support thesebusiness functions.

The benefits of exiting the in-force business are as follows(see figure 4):

Immediate capital relief and improved efficiency Consider that a typical large insurer spends close to 40 percent of its costs on processing and servicing.Once this function is restructured the insurer reduces its operating expenses, often on the order of 25percent, and could potentially increase its market capitalization from 2 to 5 percent. Furthermore,a portion of the insurers liability costs can be fixed or transferred to a reinsurance partner, whichreduces ongoing capital requirements and provides surplus relief.

Predictable cost structure for in-force policy servicing Transitioning the in-force business helps to stabilize controllable operating costs (especially for


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insurers that must re-invest to maintain older systems) through guaranteed cost controls over a five- toten-year period.

Resources redeployed to support new, higher margin initiatives The qualitative benefits of such a plan are equally compelling. Companies that exit the in-force businessare no longer bogged down in the day-to-day minutia of administering policies. Management is free tofocus on core capabilities and new business development. Technology resources can be redeployed tosupport CRM and e-business initiatives. All things considered, pursuing new business initiatives, whichis the logical next step in attaining future advantage, will call for time-consuming tasks such as deciding

which strategic partnerships can help the company reposition for future success.

Sends a strong profit and growth signalThe movement away fromold books of business and redeployment of resources sends a strong growth and profitability message to the marketplace and capital markets. This createsa unique competitive advantage that can help support acquisition activity in the future.

Possibility for release of capital through securitization or reinsurance Whatever profitability is built into the in-force business could conceivably be captured by transferring capital requirements and management responsibilities to a capital deployment partner. Companiessuch as GE Capital, Swiss Re or Lincoln Re could essentially reinsure or buy an insurers in-forcebusiness. This is attractive to insurance providers because it allows them to exit the in-force businessimmediately while obtaining needed capital for any new business initiatives on the horizon. In many

ways, it is akin to securitization of banking receivables and makes just as much economic sense giventhe large number of old policies that the major insurance providers are handling. Through reinsurance,insurers are able to fix a portion of their liability costs and reduce ongoing capital requirements. Also,they can release capital and achieve RBC relief.

Capture and use of customer data The insurer is able to more accurately capture and access customer data and potentially enable itsuse in pursuing cross-selling strategies. The TPA guarantees the highest possible service standards

with the insurer continuing to control all critical customer information.Importantly, from the customers standpoint, there is no difference . The company still looks like

their old insurance provider. And while customers continue to see the same corporate face behindthe words on the computer screen, or the person working the phones at the call center hotline,processing and support is, in fact, being performed at the utility level.

The longer-term opportunity is for the insurer to partner with others to help solve the in-force

business problem. In many cases, it may make sense for the insurer to continue to retain partownership of the business and sell these processing services to other carriers. This newsuper-TPA


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could provide the scale to handle the insurers own books as well as the books of business of otherinsurers that is, only if the insurer has chosen solid alliance partners with excellent service levels,a good cost structure and scale. The right TPA partner should actually improve quality because thebusiness function is a core competency. And, in the long run, those costly and complex infrastructurereinvestments which will undoubtedly be necessary to compete in the new economy will beborne by the TPA. A rosy picture indeed, but one of the challenges in exiting the processing andservicing business is finding a partner with sufficient scale to take on a sizeable closed-book operation.The insurer must be confident that the TPA will both stand behind its work and make good on itscommitment to ensure service levels.

As this trend gains steam, A.T. Kearney estimates that the in-force TPA market could reach

several billion dollars annually. And it is likely that a combination of large-scale technology andprocess outsourcerssuch as EDS, IBM and CSC with selected insurance partners will capturemost of this market.

Create the new Today, the battle for revenue growth and for profitability in the insurance industry is focusedsquarely on new product development with a goal of capturing and retaining new customers.Through virtual integration, insurers disaggregate all product-related infrastructures from theirorganizationsmoving products either to an internal unit or to an external third party. Essentially,the insurer creates what we call agreenfield utility to design, issue and service new business. Thisutility allows the insurer to dramatically reduce time-to-market, improve customer service and simplify operating effectiveness and efficiency. The new business utility is able to support future growth andto offer third-party services to other insurers to realize nontraditional revenue streams.

The following provides a closer look at the attributes of a processing and servicing utility.

Preissue In preissue processing and servicing, the insurer builds an integrated channel for processing, under-

writing and issuing policies to the customer. Partners, such as credit bureaus and medical informationcompanies, are all linked to the insurer via technologies such as the Internet. For example, suppose anapplicant for life insurance needs a blood study performed as part of the underwriting requirement.The blood sample can be sent to a lab for processing and the results can be transmitted electronically to the insurer. Such technology-enabling automation can shave weeks off the application process andincrease cost savings anywhere from 10 to 20 percent.

Consider the other types of value that can be generated. By blending originating and underwriting, the insurer eliminates duplicate steps. And by automating the process there is a significantincrease in efficiency trading the hard-copy paper trail for an electronic trail. Lead times shrink,

service levels increase and, importantly, the company is able to compete more effectively in a market where customer expectations for service and timely transactions are on the rise.


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Creating Breaktrough Value in Life Insurance

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Post-issue In post-issue processing and servicing, the old servicing infrastructure is replaced with a utility thatis built on new technology and web-based alliances and partnerships. By using XML and Internetformats, an insurers third-party alliance partners become members of a digital value network.Service departments, billing specialists and technology providers, among others, communicate withthe insurer and each other in real time and all have access to the same information.

The utility also communicates with its customers: Agents use their laptops to send email, andbranch offices and learning centers are set up with the customer in mind. In effect, the lines of communication are wide open. It no longer matters whether the partner is in the next office, the

next town or the next state they are simply a keystroke away from the insurer and its customers.The benefits in customer service are impressive. Through web alliances, insurers are able to move

from mass marketing tactics to personalized service. Consider, for example, an insurer that offersonline advice-based financial products. The customer who takes a minute to complete a financialprofile receives a personalized financial plan that includes products from multiple providers. Nomatter what channel the company uses, customers are able to participate in highly personalizedinteractions. Further, the Internet can be used to support revenue-generating e-commerce projectsand business efficiency, which have implications for the larger enterprise. Websites will evolve into saleschannels used to support traditional sales. The company can introduce self-service options, allowing customers to go online to perform a wide range of functions from locating an agent and reporting a claim to renewing a contract. And there is a dramatic reduction in employees manning 24-hour callcenters when customers log onto websites to find answers to the most frequently asked questions.

Clearly, there are costs for such an ambitious undertaking which alone argues for constructing a processing and service utility via a partnership between insurers and technology providers. It willrequire a major upfront investment in time, resources and capital. Initially, it may cause a disruptionin the day-to-day business, and key stakeholders may balk at the changes. But the long-term gainsare well worth the short-term costs.

Once a processing and servicing utility is established and generating economic value, the insurer canfocus again on the sales and product-creation portions of the value chain. The following describeshow additional virtual integration strategies are likely to develop.

Selling and distributionGrowth and innovation are the keys to survival for the financial services industry, and historically many insurers find themselves behind the eight ball in this regard. However, one area of potential

advantage for insurers is in the area of sales and distribution. In the United States alone, the targetmarket for insurance is approximately 38 million people. An estimated 11 million people in this


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group want insurance or increased coverage terms but have limited or no access to sales and distribution

(agents, for example). This represents an overall market opportunity estimated to be several billionsin premiums.To tap into this market, many insurers are pursuing a variety of different product and channel

strategies. Most have created online distribution offerings to match all types of customer needs andto provide high quality, reliable and personable customer service. Insurance companies are aligning

with independent brokers, employers, banks and, of course, using the Internet as a distributionchannel. The key challenge is to become theeasiest to do business with. To do so, requires an open,effective and integrated processing and servicing capability either owned or through a partner.

Without such a capability, all the investments in distribution are nothing more than facades on

a movie set they look nice from the outside but who would want to live there?

Underwriting and product creationSuppose an insurance providers core competence is design and underwriting. To bolster creativity and innovation, the company decides to diversify and is now creating products for other companies,even private labeling its own products, and devising new products to address the needs of theupcoming retirement bubble to manage distribution of assets in the golden years.

Now that U.S. regulatory conditions have legalized convergence, insurance companies are freeto sell their product to banks that are looking to enter the insurance business. Few banks haveendeavored to go it alone, however. Instead, banks and insurers are creating partnerships at anunprecedented rate, and bancassurance has become an accepted part of the financial services spectrum.

A survey by the Association of Banks-In-Insurance estimates that 22 percent of banks are selling group life and health insurance, and another 23 percent plan to do so within two years. Yet, whilebanks are keen on enhancing their role as insurance distributors they are in no hurry to assumeunderwriting risk, choosing instead to form alliances with insurers. In fact, only 7 percent of bankssay they arelikely or very likely to assume underwriting risk within the next three years and, asan alternative, plan to form alliances with insurance agencies and insurance carriers. An insurancecompany with the wherewithal to produce a specific product can offer it to all types of financialservices companies to sell under their own labels.

In the future, product profitability will rest on an insurers ability to design products that willnot only sell but also be efficiently underwritten and servicednecessitating a processing and servicing capability that supports product innovation. Insurers that focus on underwriting and product creationhave an opportunity to broaden their role: providing customers with greater financial security as theirneeds progress from asset protection to asset accumulation and ultimately to asset distribution.

Critical to the success of virtual integration is leadership that emanates from the top of the organization.The changes that are required are fundamental, and the level of partnerships forged requires strong


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Conclusion

The insurance landscape has forever changed. Virtual integration represents a bold approach for lifeinsurance companies that compete in the new environment to work outside the industry to transformtraditional servicing and processing functions to create new sources of advantage. By disaggregating the existing business model and focusing on core, value-creating functions, players in the insuranceindustry can achieve:

Improved efficiency A predictable cost structure New initiatives pursued through redeployment of resources A strong profit and growth message

Improved capture and use of customer data Potential long-term capital relief

direction and organizational commitment. Before embarking on virtual integration, the insurermust know that its management team is comitted to change.

In addition, virtual integration requires a sound structuring of cross- and intra-industry strategicpartnerships. Insurers must focus on selecting partners with care and building new businessstructures with creativity. Each strategic partnership should begin by defining common goals andobjectives, and formulating a way to measure progress against the goals. It is also critical to havea comprehensive view of the value creationparticularly in terms of cost transparency and valuesharing. The economic attractiveness of the alliance will rest on the insurers cost structure and theopportunities for cost displacement. Therefore, before making any decisions with long-term implica-tions, it is important to consider all costs that will be incurred including conversion costs and the

cost of an internal restructuring and then determine how best to share the displaced operating costs with a partner.

Also, all partnerships must be based on a good cultural fit. This is particularly important whenalliance partners make up what was previously a core part of the insurers organization.

Finally, insurers will need to make a commitment to fundamentally changing andchallenging their business. This involves a careful consideration of the potential risks that surroundthe organizational changes and the strategic implications of new approaches and relationships. Forexample, the following questions should be answered: Is it possible to disengage from the allianceif the relationship sours? Are there switching costs? Are there barriers to exit? Will business bedisrupted if the relationship ends? What are the financial and strategic risks of an unsuccessfuloperating model? Answering these questions and persevering through transformation challenges

will separate winners from the rest of industry.


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Unbundling the Value Chain

Virtual integration is not a new concept. Years ago, the financial services industry reacted to many of the same mket pressures that are now hammering the insurance industry in much the same way. Financial services organizatbegan by using their technological know-how to improve simple transactions, which eventually led to an industry formation.

The mortgage industry epitomizes the unbundling concept. More than a decade ago, pressure from sharehol for higher financial returns as well as increasing competition from new entrants drove the industry to rethink its bness model. Profit margins were a factor in the decision, or rather a lack of profit margins in loan origination (crerisk management, for example). The entire experience culminated in credit-mortgage securitization, and the stdardization and simplification of products. Today, loan origination in the mortgage industry is separate from procing, which is dominated by a handful of large traditional players that have established industry-wide processing util

Case in point: Homeside Lending, a Bank of Boston creation. In a radical departure from traditional mortgagbanking, Homeside was launched in 1995 to sell and service mortgages of new banking partners. Shortly thereaHomeside exited the retail side of the business to focus exclusively on servicing. By originating loans largely as asale lender, Homeside keeps loan acquisition costs low and does not need to support a brick-and-mortar francHomeside built its servicing portfolio by forming strategic alliances with preferred partners that originate the loanincluding Barnett Bank, Cendant, Bank One, Peoples Bank and Merrill Lynchand offers co-branding servicito its partners. Today, Homeside ranks sixth in the United States for residential mortgages with approximately 2 mlion loans and US$150 billion in servicing volume.

Credit cards evolved along a similar path. Today the processing and servicing of credit cards has consolidated aroa handful of firms that, like mortgage firms, benefit from economies of scale. One leader is First Data Resources (Fwhose sole focus on processing makes it among the largest third-party processors of credit cards. FDR handles atransaction processing and card-portfolio management for credit, debit, stored-value, commercial, private label oil-card issuers. The company now boasts a client base of nearly 1,500 card issuers and processes more than one mtransactions an hour, settling, on average, more than US$3 billion daily. For the most recent two-year period, the st price of FDRs parent company (FDC) outperformed the S&P, Dow Jones and NASDAQ indices.

Insurers that embrace these strategies will have an opportunity to reposition their companies and

become effective competitors in the new financial services marketplace.


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Source: A.T. Kearney

Generate andqualify leads

Communicate benefits and features of

products Collect client information

Provide quotes/ illustrations

Primary functions

Key activities

Percentage of totaloperating expenses

Gather underwriting information Review application and make risk assessment Issue policy and complete with the insured and agent/

sales entity Set up policy onthe administrative

platform

Manage the policy, billing and state- ments Respond to queries Complete all

policy-relatedtransactions/

changes

Develop theproduct strategy

Design product features and pricing Manage the overall book of business Manage regulatory and reserving

requirements

Overhead costs shared by the entire organization (e.g., real estate, legal fees, directors fees)

Marketing and sales

46%

Processing

14%

37%

Servicing

23%

Product development

2%

Support

15%

Figure A: Breakdown of operating expenses by function


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Atlanta BostonBuenos Aires

CaracasChicagoClevelandDallasDetroitLos AngelesMexico City

MiamiMinneapolisNew York

PlanoSan DiegoSan FranciscoS o PauloSilicon Valley StamfordToronto

Washington, D.C.

Bangkok Beijing Hong Kong

Jakarta Kuala LumpurMelbourneNew DelhiSeoulShanghaiSingaporeSydney Tokyo

Amsterdam AthensBarcelona

BerlinBrusselsBudapestCopenhagenDsseldorf FrankfurtGeneva HelsinkiIstanbulLisbon

LondonMadridMilan

Moscow MunichOsloParisPragueRomeStockholmStuttgartVienna

Warsaw Zurich

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A.T. Kearney, Inc.222 West Adams Street

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fax 1 312 223 6200email: [email protected]

www.atkearney.com

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Creating Breakthrough Value in Life Insurance