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Life Insurance Industry Optimism...
How Much of it Reflects the Absence of Facts???

Overview prepared by:
Bob Shapiro

This year’s symposium, entitled “Achieving Success as an Insurance Company in the Emerging New World” featured three outstanding speakers:

Eric Berg, Managing Director at Lehman Brothers, Inc., and a frequent first team member of Institutional Investor’s All American analyst team.
Dan McCarthy, Principal of Milliman, Inc., and recognized life insurance industry thought leader for many years.
Dave McDonough, President of Trustmark, who has a long record of successful management of health insurance operations.

The symposium attendees were treated to an outstanding two hours of insight into the challenges and opportunities facing life insurance companies today.

Dave McDonough opened the symposium with a presentation that clearly mapped the forces acting upon the health insurance industry (e.g., consumerism, social priorities, regulation, evolving medical technology, shifting demographics, litigation, politics, the cycle and ignorant competitors), and outlined things that management must do well to make money in the risky, every-evolving health marketplace. He made the point that health insurers design and price products suited to transfer risk and protect policyholders from financial hardship due to unforeseen illness or injury. However, spurred by a sense of entitlement, buyers are increasingly seeking ways to transfer complete responsibility for their health care costs, i.e., “Someone else should pay my health care expenses, not me.” He also spotlighted tough questions that face stakeholders in the health marketplace regarding (1) cost/benefit assessment of new pharmaceuticals and medical techniques, (2) approaches to controlling the terrible litigation environment and (3) dealing with the ever-increasing number of conditions that are classified as “illnesses” by an imaginative marketplace (e.g., obesity, shyness, etc.).

Mr. McDonough believes that companies in the health insurance market must be sure that their portfolio diversification is well conceived, and that it is truly diversification and not diversion. He said that Trustmark looks carefully at the product, distribution and customer dimensions in their health portfolio and looks for “sweet-spots” in this matrix where they can leverage core strengths of the operation. He identified a handful of factors that he thought were critical to successfully managing health insurance operations:

Building strong customer intelligence, particularly identifying areas where consumers place a high value on benefits or services that the organization can deliver at relatively low cost.
Understanding and leveraging the core capabilities of the organization.
Maintaining strong government relations, as the regulatory and political aspects of the health business are important factors in determining future success.
Identifying and exploiting marketplace niches… Don’t play “in the middle of the street”!
Assuring that all of the operating silos of the company are connected and communicating via continuous feedback loops, and that all the connections are understood and managed carefully.
Assuring that the selection process (for consumers and agents) lets in the “right” risks appropriate to the product/price, and persuades those that are not going to be profitable to “go away”.
Managing through the cycle in a way that does not damage the bottom line… Let the cycle show up in revenue, not in profits!

After Mr. McDonough’s cogent picture of how to manage a health insurance operation, Eric Berg gave a powerful presentation on the state of the life insurance business. Mr. Berg started by identifying a number of challenges facing the life insurance industry and the companies within it… more complex and often more risky balance sheets, significant and often increased risks (in areas like morbidity, mortality, investments, capital guarantees, competitive strategies), and under-appreciated, under-priced options imbedded in coverages that are being sold. He asked the key question “What can the industry do (vs. organizations such as Fidelity, Vanguard and Merrill Lynch) to succeed in the future and remain relevant as an institution?”.

Mr. Berg then presented a stunning analysis of significant risk challenges that could negatively affect various segments of the life insurance company universe. Each challenge was quantified under clearly stated assumptions for various companies exposed to them. The specific challenges addressed included:

The risk of low interest rates in disability income and long-term care portfolios… “Who might be the next UNUM?”
The risk of forced reinvestment of substantial sums of money in periods of low interest rates because of calls and other pre-payments, such as the situation experienced by a number of life companies in 2003.
The risk of a letter of credit explosion (and related price increases) created by the plethora of offshore reinsurance of XXX business.
Who will likely be the future variable annuity winners and losers?
Who will make money on LTC, and how will the winners achieve such success?
What companies are exposed to significant risk because of their secondary product guarantees?

Mr. Berg acknowledged that there are also potential opportunities for life insurance companies in areas such as assisting retirees in managing their retirement finances, providing products and services to needy middle class consumers around the world, and providing long term care on an attractive and profitable basis. However, he believes that the outlook regarding the life insurance industry, in general, is not favorable… for example, rating agencies view the marketplace as providing better investment opportunities (i.e., risk adjusted return) elsewhere in financial services arena. Those life companies that are successful need to have leverage special competencies to establish prominence, if not dominance, in a specific niche. They must also manage their balance sheets and other management processes effectively, and have the strength and discipline to stay the course in their selected segment(s).

The clean up speaker was Dan McCarthy. Mr. McCarthy gave an overview of the life insurance company marketplace, spotlighting a number of issues (sometimes new and sometimes corroborating issues raised by the other speakers) in the process. During the course of his presentation, he laid out a number of principles including:

Align your ratings with the businesses you serve, and know the minimum tolerable rating at which you can successfully operate in those businesses.
Focus on guarantees, the one area where no other financial institution can provide what the life insurance companies can provide.
Anticipate how to manage significant changes in key underlying assumptions so that effects of change can be mitigated effectively. For example, persistency has improved for many years; if persistency deteriorates (i.e., lapse rates increase), there could be significant negative implications on customers, agents and life insurance companies. What can a company do to address this potential challenge?