Life Insurance Growth Markets Insights Report 2012

Introduction

Life insurers (with a few exceptions) and the life insurance industry have emerged from the GFC in relatively good shape. While companies may have been forced to tighten their belts, bolster balance sheets and re-set short term expectations for growth and margin (given the outlook for equity markets, for interest rates and for consumer sentiment), they have for the most part avoided the industry-wide restructuring seen in banking, or the continuing weakness impacting brokers and asset managers. In fact in our interviews with over 1,000 life insurance executives and functional managers across 40 countries (as part of our 2012 global life and health reinsurance programme cycle) it is clear that more life insurers are cautiously optimistic about the long-term macro outlook, and that priorities are shifting from cost and capital management back to growth through the next plan cycle. At the same time insurers in some of the largest life markets (notably the UK, Japan and Canada per Figure 1) expect further pressure on domestic profitability, and are therefore looking for growth outside their home markets. Whether they are starting from scratch, or building on an existing portfolio, most are focused on a small number of perceived growth markets in Asia (notably China and India) and to a

lesser extent in the Middle East and Latin America, which they believe offer more attractive growth and margin opportunities based on developing demand demographics, low life insurance penetration, and limited regulatory or competitive intensity. The broader shift in emphasis from cost and capital to growth is entirely understandable in the context of the current cycle, and we can see why large insurers in mature, lower-growth markets are attracted by (apparently) faster growing markets beyond their own borders. However our analysis suggests that most of these aspiring multinationals will fail to deliver expected growth rates or margins, as a result of: Over-estimating target market attractiveness (size, growth and profitability) relative to alternatives (international or domestic) Under-estimating the level of regulatory and competitive intensity, and the extent to which new entrant capability (as opposed to simply being in the game) is critical to participation in growth and margins Under-estimating the complexity of market entry and ongoing business management, and the longerterm implications of entry structures or agreements on competitiveness and performance

Figure 1 Life Insurer Expectations of Future Profitability (Insurer Executive Interviews)

Increasing Decreasing

Direction of Future Profit Margins

US

Western Europe

Japan

UK & I

Canada

The list of life insurers that have established a truly successful and diversified international portfolio is very small, compared to the number of insurers that have tried and failed, or have chosen to persevere with a jumble of non-performing international businesses. We do not expect that this will dissuade the next wave of insurers from trying the same strategies in the same markets, even though the insurers they seek to emulate entered 20 years ago or more, when these territories really did conform to the growth market stereotype (large and fast growing populations, very low penetration, permissive regulation and limited competition) and when the development gap to home markets was far more pronounced. But many of the territories most commonly cited as growth markets no longer fit that mould: they are not experiencing the kind of frontier growth rates associated with very low penetration (penetration levels have increased rapidly, at least in the most economically attractive segments and regions), they are by any standard highly regulated (having rapidly assimilated and built on learnings from international markets), and they are if anything over-contested, to the point that even long-established participants are struggling to achieve their target growth and margins. In short, we believe that insurers are focusing too much attention on a handful of high profile middle ground countries that are no longer growing as fast as is commonly perceived, and that offer limited entry and participation opportunities. At the same time, they are overlooking more compelling options at either end of the development spectrum: in very large, low growth mature markets that offer volume, scope for innovation and (in certain cases) a broader range of entry and participation options, and in those markets that do offer near zero penetration, underdeveloped regulation and limited competition albeit initially at small scale and with a significant level of country risk.

As a result, insurer growth portfolios are increasingly concentrated (on fewer, bigger bets in markets with limited exit options), but there is little or no appetite to invest selectively in the next generation of true growth markets: in Asia, the Middle East and Latin America as well as in Africa, Central Asia and Eastern Europe. We believe that insurers need to fundamentally re-think their approach to developing international strategy, addressing the common failings cited above. Specifically they need to adopt a model for decisionmaking based on:

A bottom-up, fact-based approach to determining whether and where to expand, based on holistic market size and growth Prior consideration of domestic market alternatives and implications including the organisational issues arising from separation of international and domestic accountabilities A realistic assessment of market development paths and implications for participation Market prioritisation driven by competitive advantage and market entry model rather than primarily by abstract market metrics

Life Insurance Growth Markets - Insights Report

Holistic Life Market Size and Growth

Why have so many life insurers pinned their international growth strategy on a few large, high profile (highly contested, difficult to enter) markets? We would suggest that too many make the decision to pursue an international growth agenda top-down, based on views from members of the Board or senior executive (or pressure from investors) and without an holistic analysis of global markets, an explicit business case or consideration against domestic alternatives or implications. By the time they commence any meaningful bottom-up analysis there is already a strong target market hypothesis, and the focus and scope has often moved to how rather than whether or where to grow. Even where this is not the case, insurers tend to rely on data sources that will only confirm the attractiveness of the usual suspects, notably: Macroeconomic indicators it is surprisingly common for insurers to rely on growth in demographics or national economic indicators (notably GDP) to evidence the growth prospects of the life insurance market Historical trends we will see that many insurers assume that life insurance market development plays out slowly and predictably, such that any positive growth and margin readings from last 5-years can be reasonably extrapolated forward Best practice reference points there is an understandable tendency to extrapolate from the investor presentations of the few established multinationals and domestic champions with longstanding franchises (who can hardly be blamed for accentuating the positives arising out of their incumbent positions)

Third-parties finally, insurers turn to reinsurers and consultants for information, even though both groups have an implicit interest in promoting relatively high profile markets (where they have expertise, or at least experience) rather than nascent markets (where they do not) There is no question that good data is hard to come by, despite the best efforts of regulators and insurer associations in many markets. But these are major decisions that are not easily reversed, and it does not seem unreasonable to suggest that insurers should take the trouble to start with an holistic view of potential markets rather than a pre-determined short list, and to build meaningful datasets (insurance takeup/penetration, new business sales volumes, real volume growth and realised product margins) rather than relying on what is readily available (such as meaningless insurance density statistics expressing premium over GDP, nominal growth rates or target margins). In our experience, hypothesising target markets too early and anchoring to available data will tend to obscure the attractiveness of alternatives to the path most trodden. For example, Figure 2 shows that while North America, the UK and Europe may not offer double digit nominal growth rates, they may still be attractive based on new business volume and potential share gains, given the scope for innovation or niche specialist participation strategies as well as alternative entry models. Germany is a case in point: a low-growth, mature market by any definition, with ~100 domestic life insurers focused on traditional insurance products and intense competition on pricing of guarantees impacting mainstream margins, in which a handful of UKbased international insurers have been able to establish very profitable, growing cross-border businesses selling investment-linked business via the broker channel.

Figure 2 Global Life Insurance Market Size (NB) and Growth by Region
New Business APE Annual Growth Forecast 10% 3% 5% 5% 3% 6% 4% 15% 18% 15% High High

New Business APE (USD) $200b

Account for >77% of global life new business Global Life Market North America UK & I Western Europe Japan North Asia India South East Asia Latin America Middle East Africa Eastern Europe

Domestic Market Alternatives and Implications

Insurers aiming to expand internationally must presumably believe that their home market offers limited opportunities for growth at target margins, and that either their domestic capabilities are sufficiently portable, relevant and difficult to replicate as to form a basis for competitive advantage internationally, or that target international markets are so under-developed that any capability at all is a basis for advantage. But we can think of only a handful of insurers that could be justifiably confident that they have a basis for real competitive advantage in their own home markets, let alone internationally. And we have already identified the lack of appetite to invest in truly under-developed markets, not least given the very real regulatory, operational and political risks. At the same time, our experience working with incumbent insurers is that most if not all have growth options at home: in new customer segments, or channels, or product categories, or to drive earnings growth through optimising risk management and costs. We think insurers over-emphasise the challenges associated with these domestic options relative to international alternatives (perhaps anchoring on the facts that they know too well, over the glamorous unknown). And as stated above too few insurers explicitly compare international and domestic options side-by-side (at inception, and on an ongoing basis) to identify which is more compelling on a risk/return basis. Finally, few if any consider the potential negative implications of international expansion in terms of domestic focus and investment driving business performance, despite the fact that our analysis suggests that these are material (per Figure 3).

Far from trying to mitigate this disconnect between domestic and international opportunities, we would observe that insurers actively entrench it. Having decided to pursue an international growth strategy, common practice is to sequester a project team and steering committee with a remit to finalise target markets, develop the detail around how to execute and build the investment case. Once this case is accepted, organisational responsibility for the international business is typically separated, with distinct international roles, decision processes and metrics from inception. Of course separation of domestic and international functions at some point is inevitable, but we would argue that if considerations of domestic capability are central to market selection and entry strategy, then separating too early merely inhibits decision-making, organisational buy-in and effectiveness. We know this is a cause of considerable frustration for the executives running the domestic businesses: they may feel they could do better with the capital committed to the international arm, and fear that they will bear the costs of building transferable capability (not to mention carrying the load if the international businesses do not perform). At the same time the international executives may feel that their needs are not appropriately understood and prioritised, and believe there is a lack of appreciation from investors and management of the realistic time horizons to build an international business. Of course execution is complex, but we feel some degree of complexity could be avoided by ensuring that domestic alternatives and implications are considered from the outset, by recognising the need for organisational alignment rather than segregation early on, and by ensuring an ongoing basis for comparison between domestic and international portfolios.

Figure 3 Impact of International Operations on Domestic Performance

Life insurers with domestic operations only Life insurers with domestic and international operations

Life Insurer Forecast Growth Rates (2011/12)

US

Canada

UK

Western Europe

Life Insurance Growth Markets - Insights Report

Market Development Paths

Having settled (all too easily) on the imperative to grow beyond their home market, insurers tend to underestimate the extent to which capability (as opposed to simply being in the game in markets they regard as fundamentally attractive) will be critical to participation in growth and margins, and the relevance and portability of their own sources of competitive advantage. They also underestimate the complexity of entry, and the longer-term implications of licensing, joint venture or partnership structures required to enter, on their subsequent ability to compete. Our interviews show these misjudgements are linked to a widely held assumption that growth markets follow a linear development path similar to that of the insurers home market, including an inevitable move away from joint venture structures, from investment-linked to risk products and (at least in the case of UK insurers) from tied to broker/IFA distribution. We understand why insurers look for predictable development patterns, but the subjective belief that market evolution will enhance a new entrants participation and competitive position entrenches the focus on macro market dynamics and being in the

game, and compromises appetite and capacity to adapt to (or influence) alternative evolutionary paths down the track. We feel there is a need to develop a more objective framework based on market maturity (defined in terms of insurance takeup or penetration the proportion of the economically active population holding an insurance product which we consider to be a key driver of demand dynamics and competitive outcomes) rather than subjective concepts of development relative to the norms of any specific market. Our analysis shows that markets with very low life insurance penetration do initially develop in a more or less linear fashion (albeit with significant variation in pace) driven by the evolution of consumer demand and leading to fairly predictable channel, product and competitive outcomes as the level of penetration, familiarity and sophistication increase. However at some point (at insurance penetration between 15 25%) the pace of evolution accelerates and outcomes fragment, based on the impact of regulatory settings or economic shocks which become the primary driver of subsequent evolution.

Figure 4 NMG Market Development Framework

Increasing insurance penetration, competition and substitution Increasing supply-side regulatory intensity (around product, capital and corporate/joint venture structures) Professional tied advisory channels (agency and bank) Distribution productivity focus

Phase 3a

Tied advice models (DSF and bank) dominate Traditional life (savings) product, funded commissions Product/risk/capital focus given product structures Tied and broker advisory models plus corporate/EB Linked and traditional savings products, funded commission Sales/share focus given uncertain business economics Broker advice, corporate and direct sales models Permanent insurance and pure protection, funded commission Scale and efficiency focus given revenue margin pressure

Passive

Phase 1

Phase 2

Phase 3b

Retirement and advice regulation

Near-zero penetration; little product/price competition Minimal awareness necessitates active selling Limited/permissive regulation Semi-professional direct sales channels (agents) Distribution build focus

Phase 3b

High penetration, large stock increases exposure to demand volatility Increasing demand-side (advice, incentives) regulation Outcomes fragment based on regulation as well as market/risk shocks 5 - 25% > 25% High

Active

Penetration Maturity

0 - 5% Low

Generalisations are always dangerous, and this model is far from perfect. The boundaries between the three phases are not definitive (so that a number of markets are best described as being in transition) and categorisation at country level is not always satisfactory (in South Africa the HNW segment is in Phase 3 and the mass market exhibits characteristics closer to Phase 1, while in India or China the state of the market in the major metro cities will be quite different to that in regional and rural areas). And we should be clear that we are not saying that there is no scope for subsequent development beyond what we have described as Phase 3, though the scope for insurance penetration rates to grow clearly diminishes, such that vertical oscillation between Phase 3 states seems more likely than further progression. A summary of analysis from over 40 markets (Figure 5) shows that Phase 1 markets exhibit the characteristics expected of growth markets. Participants report very high target new business margins (and with more than 85% of insurers indicating that they are performing in line with or better than assumptions), high percentage growth rates (albeit initially from a low base), limited entry barriers and significant (potentially diversifiable) country risk. At the other end of the spectrum, incumbent participants in Phase 3 markets are targeting and achieving lower margins and lower growth rates,

though with significant volumes and lower entry barriers presenting opportunities for innovative new entrants. On average, participants in Phase 2 markets expect realised margins and growth rates that are somewhere in between. But averages are misleading: the polarisation between top tier participants and the rest is most pronounced in Phase 2 markets, and if we exclude the outliers (top-3 and bottom-3) from our analysis we end up with realised margins that are in line with outcomes in Phase 3, and expected growth rates that are only marginally better. And the observed squeeze is most pronounced in the most popular Phase 2 markets: in India for example, penetration is up in the most economically attractive segments in major metro cities, market growth is expected to be in the single digits (following a decline of new business premium by 9% in 2011-12), but competitive intensity and regulatory risk continues to impact product mix and margin. So at either extreme, insurers have a reasonable expectation of higher margins and higher growth in smaller and higher risk markets, or lower margins and lower growth in very large, lower risk markets. But as we asserted at the beginning of this report, many life insurers are focused on a small number of Phase 2 markets - China, India, Malaysia and the UAE - that occupy a sub-optimal middle ground offering lower margins, higher growth, higher entry barriers and higher risks (at least for new entrants and second-tier participants).

Figure 5 Life Insurer Growth and Profit Experience by Phase

Phase 1 Markets Phase 2 Markets Phase 3 Markets

New Business Growth (%) New Business Margins Individual >50 % Below Margin Realisation Above Target Target eg Kenya, Egypt, Cambodia, Ukraine Strong future growth prospects Low formal entry barriers Low competitive intensity, few competitors Very high target margins, high confidence of realisation eg China, India, Malaysia, Brazil, Poland Growth rates stabilising or declining High entry barriers, scarce/highly contested entry opportunities High competitive intensity, diverse competitors (varying objectives) High target margins, polarised participation, uncertain realisation Above Group Individual 25 50 % Below Above Below Target Group Individual <25 % Group

eg Germany, UK, US, Japan Low overall growth prospects (though growth niches may exist) Variable formal entry barriers High competitive intensity though scope for innovation/disruption Lower target margins, low confidence in realisation of target margins

Life Insurance Growth Markets - Insights Report

Market Entry Model

So why do new entrants prioritise market entry or investment in the most heavily contested Phase 2 markets, when even the established top-tier participants are less than optimistic on growth and margins? And why are they so reluctant to look selectively at next generation growth markets in Phase 1 (for example Kenya, Egypt, Cambodia or Ukraine) and in transition from Phase 1 to 2 (we would suggest Sri Lanka, Vietnam, Indonesia or Turkey)? We have already identified contributors in the way insurers approach international strategy development; these are compounded by market selection processes that emphasise market attributes (population, penetration and historical growth) then considerations of accessibility (ability to enter and restrictions on participation) over competitiveness (capability, relevance and portability) as a basis for market selection.

The majority of market entry initiatives we have seen in Asia (or in the Middle East, or in Eastern Europe) have been premised on a traditional market-back approach: the selection of a set of markets perceived to offer high levels of growth and low levels of sophistication, entry by any means possible in the hope that over time a rising tide will float their boat, or alternatively that a basis for differentiation will emerge as the market matures. Our view is that insurers need to consider reversing this approach: starting with what they have to offer (internal attributes providing a basis for competitive advantage) and how they can offer it (market entry and business model) and then seeking to identify markets aligned to these elements. This approach may seem counterintuitive, but we are not advocating that insurers ignore external market and demand dynamics, just that they change the emphasis and order of consideration. Figure 6 outlines three examples of strategies premised on organisational attributes, and illustrates the parameters for market entry model and for market selection arising from these.

Figure 6 Illustrative Strategy Models

Target Market/Entry Models Model A (Appetite-Based) Focus on Phase 1 markets Composite or bank-aligned insurer Organic entry and growth Ad hoc business structures Capital supporting business build Model B (Capability-Based) Focus on Phase 2 markets (including markets in transition) Integrated life insurer Consolidation/entry via M&A Prescriptive (traditional) structures Regional capability supporting productivity and growth Model C (Innovation-Based) Focus on Phase 3 markets Segment or functional specialist Organic or partnership market entry Flexible (non-traditional) structures Expertise or innovation driving competitiveness

Organisational Attributes Appetite for risk and timeframes Organisational flexibility and capacity to build Diversification across many small, long-term bets

Examples Tokio Marine MAPFRE Hollard

Business management and functional (distribution) capability Organisational structure and scale driving efficiency Financial capacity and diversification against existing business portfolio

Prudential AIA MetLife

Demonstrated functional expertise or innovation Organisational model supporting transfer of competitive advantage Flexible entry and participation parameters

ReMark Discovery Lombard

These three models are not intended as an exhaustive list, but do illustrate the dynamics and differences of approach required under each: Model A is relatively more dependent on appetite than on capability, with flexibility in strategy, structure and timeframe being key success factors Model B turns on the existence of an existing international footprint (commonly built out from earlier Phase 1 foundations), international or regional management infrastructure and transferability of people and processes expediting execution (often via acquisition of an established second-tier player or bank distribution partner) Model C rests on the existence of some portable basis for competitive differentiation, often based on innovation outside the core insurance manufacturing model (in customer engagement, or distribution, rather than risk assessment) and with scope to execute outside a traditional corporate structure Of course these models will not work for every insurer. We know that appetite to invest in Phase 1 markets is in short supply, and we also know that only a very small number of insurers can boast an established foundation and organisational model providing a basis for differentiation in execution. And innovation is useful only if it is both relevant and portable: being the leading manufacturer of VAs or impaired annuities in one market does not provide a platform for growth if these products do not fit with demand dynamics or regulation in markets that are otherwise attractive (as a number of the US providers have found in the UK) or if entry or regulatory constraints impact the portability of the manufacturing model.

Life Insurance Growth Markets - Insights Report

Epilogue Implications for Insurers

We suspect there is little in this report that will interest the lucky few insurers that have an existing, diversified and successful international strategy (whether premised on much earlier entry into todays Phase 2 markets or else selective participation at either end of the development spectrum). They have existing growth portfolios and the capability, structure and capacity to grow them (organically, or through consolidation as second-tier players exit). In many cases they will have devolved decision-making down to regions, such that the domestic versus international dynamics cited above will no longer be a bone of contention. And they have a level of portfolio diversification, such that they can afford to selectively exit or scale back in less attractive markets. While some themes may still ring true (in respect of specific countries/businesses, and the commentary and expectations of investors and brokers) existing capability and management structures should provide a basis for continuing growth. There is more here for insurers with an existing but subscale portfolio of international businesses, particularly where the international division has failed to deliver promised growth or margin relative to their domestic business. Our experience is that these companies tend to explain past non-performance by reference to short-term market factors or management execution (with predictable results for management) without addressing the strategic issues which are the root cause. Worse, the failure to deliver across the international portfolio (notably in Asia) typically leads to growth targets being passed down to the few performing country units, driving unsustainable behaviours and ultimately jeopardising performance in the very markets that should be carefully nutured. Lamenting past

decisions is pointless, but these companies need to ask whether the basis for their initial decision to enter remains valid, whether their current portfolio can reasonably be expected to deliver growth and margin relative to the broad range of alternatives, and what alternatives exist to continuing to build out the current portfolio. In the months leading up to our publication of this report, we are encouraged to see a number of instances of life insurers apparently deciding to exit non-performing international markets, or to curtail their activities in specific Phase 2 markets (notably in India, albeit on a temporary basis). At the same time, with an unprecedented number of international portfolios up for sale (formally or informally) we fear that insurers in this category may be tempted to try to bulk up through acquisition, even though this is unlikely to address their fundamental strategic issues. The primary intended audience for this report are those life insurers embarking on (or considering embarking on) an international growth path for the first time. We aim to encourage at least a few to re-consider their domestic prospects, and to ask whether they really have the appetite, structure and capability to succeed. For those that decide that they do, we have sought to propagate a different approach to determining how and then where to participate, starting with capability rather than market dynamics. Finally we hope that we can convince more insurers intent on participating outside their home market, to seriously consider investing in the next generation of life insurance growth markets, with an eye to building a growing, profitable and diversified international portfolio over the long-term.

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About NMG

NMG Consulting is a specialist multinational consultancy focused on the insurance, reinsurance and investments industries. We provide strategy consulting, actuarial, marketing and research services to financial institutions including banks, insurers, reinsurers and fund managers. NMG Consulting is part of the NMG Group, a global financial services business with operations across employee benefits, pensions administration and advisory, underwriting services, product origination and strategic equity. NMGs Strategic Insights programmes use interviews with key clients and intermediaries as a basis to analyse industry trends, competitive positioning and capability. Established programmes exist in wealth management, life insurance and reinsurance across North America, the UK and Continental Europe, Asia-Pacific, South Africa and the Middle East. Insights reports draw on NMGs research and consulting experience to advance a perspective on topical, macro industry issues, relevant to product providers, distributors and clients and with a view to driving long-term change.

Ashwin Field Partner Strategy Consulting ashwin.field@nmg-group.com Paul Ernest Manager Strategic Insights paul.ernest@nmg-group.com

Tom Dunbar Principal Strategy Consulting tom.dunbar@nmg-group.com Jane Cheng Senior Consultant Strategy Consulting jane.cheng@nmg-group.com

Hamish Worsley Director Strategic Insights hamish.worsley@nmg-group.com Roshan Perera Manager Actuarial Consulting roshan.perera@nmg-group.com

Sydney NMG Consulting Level 22, Grosvenor Place 225 George Street Sydney NSW 2000 Australia P.O.Box R1863, Royal Exchange Sydney NSW 1225 Australia Tel: +61 2 9251 7888 Fax: +61 2 9251 2888 Hong Kong NMG Consulting 2410 Fortis Bank Tower 77 79 Gloucester Road Wanchai, Hong Kong Tel: +852 9539 5699

London NMG Consulting 5th Floor, Holden House, Rathbone Place, London W1T 1JU Tel: +44 207 631 3087 Fax: +44 207 462 5719 Montreal NMG Consulting 6795 Des Coquelicots St-Hubert Quebec J3Y 8P1 Canada Tel: +1 450 656 4694 Fax: +1 450 462 8358

Singapore NMG Consulting 65, Chulia Street, #37-07/08, OCBC Centre, Singapore 049513 Tel: +65 6325 9855 Fax: +65 6325 4700 Kuala Lumpur NMG Consulting A-13A-5 Block A, Northpoint Mid Valley City, No 1 Medan Syed Putra Utara 59200 Kuala Lumpur, Malaysia Tel: +60 3 2283 6478 Fax: +60 3 2283 6487

www.NMG-Group.com

Life Insurance Growth Markets - Insights Report

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