The Life Journey: Winning in A Risk-Driven World: Financial Services Practice

Financial Services Practice
The Life Journey:

Winning in a Risk-Driven World
The Life Journey:
Winning in a Risk-Driven World
Contents
Executive Summary 1
A Changing World Is Challenging the U.S. Life 3

Industry
Risk Skills Drive Major Differences in Company 9

Performance
Powerful Forces at Work: A Challenging 19

Environment with New Opportunities
Strategic Implications for Life Insurers 25
Conclusion: The Way Forward 51

The Life Journey: Winning in a Risk-Driven World 1
Executive Summary
The U.S. life industry has been under increasing stress. Since 1985, it has not in
aggregate covered its cost of capital, and results have been particularly poor over the
past decade. A major share of this stress has come from the rising cost of capital
fueled by increasing beta driven by volatility and declining returns. The impact has
been profound; the industry’s market valuation has shrunk significantly compared to
banks and asset managers.
However, this overall decline in industry performance has masked a stunning spread
in value creation among the 30 largest life insurers. Over the past decade, those in the
top quintile have increased in value by about 10 percent annually while those in the
bottom quintile declined in value by about 3 percent annually—creating a 400 percent
difference in adjusted book value growth between the top and bottom quintiles.
What do the winners do differently? Do they have a more attractive product mix?
Execute better within product lines? Achieve higher investment returns? Several
years ago, McKinsey launched the “Life Journey,” a long-term effort to develop
fact-based answers to these questions. We analyzed publically available data for
the industry since 1985 and for the top 30 life insurers since 2000, and
interviewed dozens of industry analysts and executives.
While many factors have contributed to the performance differentials among the
top 30 insurers, none has been more important than skill in managing poolable
risk—a risk type that has delivered close to three-quarters of the industry’s profits
using less than half its capital. This is striking given how little mindshare and
resources life insurers are investing in risk skill innovation.
To win, carriers should focus on four imperatives: building core risk and capital
management capabilities, including recognizing the differences in cost of capital
by line; using analytics to build competitive advantage in distribution; unlocking
value in the in-force book; and leveraging customer insights and finding growth in
retirement, the middle market and developing countries.
In this report, we explore the downward trend in industry returns and what, in addition
to risk skills, drives the huge spread in company performance. We examine the
opportunities in developing markets and in the U.S. retirement and middle markets,
and we explore strategic imperatives with a focus on building risk skills. We close with
the critical need to invest in organizational health to execute on these imperatives.
A Changing World Is Challenging

The U.S. Life Industry
The U.S. life insurance industry, in aggregate, has

returned less than its cost of equity since 1985.
The long-term trend is clearly negative (Exhibit 1),
with a decline of about four points from the early period
of 1985-1993 to the most recent period of 2003-2011.
Exhibit 1
The life insurance industry barely covers its cost of capital1

Return Average annual change
minus cost
of capital +1.6% +0.6% -2.5%
Percent
5.7
4.6 4.8
4.4 4.2
3.9
3.3 3.0
2.6 3.0 2.7
2.2 2.0
1.9
1.5
0.7 0.5
-0.5 -0.4
-2.1 -1.9 -1.9

-3.2 -3.0
-6.0
-6.8
1985 1990 1995 2000 2005 2010
-30.6
1
Statutory net income, including realized capital gains, divided by average capital and surplus. To make our estimates, we calculated
industry beta for 15 representative life insurers and used a capital asset pricing model.
Source: A.M. Best; SNL; Bloomberg
Some may argue that 2008 was a “hundred-year event” and should be set
aside. But while the magnitude of the losses was exceptional, we believe
those losses reflect the cumulative impact of actions taken since 2000:
4 The Life Journey: Winning in a Risk-Driven World
unsound guarantees, hedges that could not withstand high capital markets
volatility, and investments in high-risk instruments that unraveled in the
subprime mortgage crisis. In effect, the huge losses in 2008 were the flip
side of overstated returns from 2003 to 2007. Further, the continuation of
lower-than-cost-of-capital returns from 2009 to 2011 is in sharp contrast
to the turnaround in industry results following poor returns in 2002. In
short, we see 2008 as an indicator of the fundamental shift in the
industry’s risk profile rather than an aberration.
The industry looked much different in previous eras. Before 1985, the industry
enjoyed limited volatility and relatively consistent returns above its cost of
equity. Its cost of capital was lower, and investors perceived it as a more stable
and profitable sector.
What has changed? How did we get here?

We believe the answers lie in the industry’s shift from doing business where it
enjoyed a distinct competitive advantage—underwriting poolable risk—to
guaranteeing market-based risk with a higher beta and lower returns.
Before 1985, the industry took a long-term economic view, focusing on

protection products and primary long-term savings vehicles. Life insurers’ core
value proposition—managing poolable risk—served clear social and economic
needs, and the industry was uniquely positioned to provide it. Average returns
on equity exceeded the cost of capital by 3 to 4 percent between 1965 and
1985 and were relatively stable.
The landscape changed in the 1980s. With the introduction of variable savings
products—mutual funds and qualified savings and retirement plans—and a
shift to independent distribution, carriers ceded some control and took on
more risk in their search for growth and higher returns. Competition increased
within the industry as some leading mutual life insurers demutualized and many
European carriers entered the U.S. market. Competition from outside the life
industry also increased as asset managers, securities firms and banks ramped
up to take share in the rapidly growing variable long-term savings market,
which they dominate today.
In response, the industry shifted its focus from managing poolable risk to
competing for consumers’ savings with return guarantees for variable
annuities and variable life products, and secondary guarantees for universal
life products. The industry also took on greater investment risk in its search
for higher returns and made extensive use of hedging to manage its risks.
Meanwhile, more companies turned to third-party channels as they

attempted to grow without the costs of recruiting or training career agents.
Not surprisingly, these third parties used their bargaining power to increase
compensation and pricing pressure.
Taken together, these new product portfolios and riskier investment portfolios
have raised the life industry’s overall risk profile and earnings volatility. The
investor community has responded by increasing the industry’s beta, raising
the cost of equity even in a period of declining interest rates (Exhibit 2).
Exhibit 2
Rising volatility has increased beta and the cost of equity

Long-term expected volatility (beta)
1.4
1.2
1.0
0.8
0.6
0.4
0.2
0
2000 2005 2010
10.8 9.2 8.6 7.5 8.2 8.2 8.5 9.2 11.0 10.8 10.8 11.0
Average cost of equity

Percent
Note: Betas for 2008 and 2009 are adjusted to better reflect analysts’ long-term estimates
Source: Bloomberg; McKinsey Corporate Performance Center
Today, the life insurance industry plays a smaller role in the financial industry,
having lost share in terms of market capitalization to banks, asset managers
and brokers (Exhibit 3, page 6).
A challenged industry model

A range of pressures continue to challenge the industry’s economic model:
• The high cost of agent-based distribution. The cost of distribution has

declined for the vast majority of retail banking, asset management and
brokerage products in the U.S. and abroad. Life insurers’ distribution
costs have not declined in the U.S., however, forcing the industry to focus
Exhibit 3
The life industry has lost ground in financial services

Market capitalization
Billions
$84 $1,535
Banks 44%
55%
Asset managers
16%
and brokers
20%
Life insurers 40%

25%
1985 2010
Source: Compustat; McKinsey analysis
on the mass affluent and affluent markets and leave the middle market
behind. This shift leaves the industry increasingly vulnerable to any erosion
in tax benefits, which are particularly important to affluent consumers.
• The slow development of alternative distribution. Alternative channels,

such as direct and worksite, with lower distribution costs are still in their
infancy, representing 8 percent and 5 percent of the industry respectively.
Few carriers have adopted the more sophisticated consumer marketing
techniques, such as elasticity, conjoint and propensity-to-buy analyses,
sophisticated segmentation techniques and use of social media, that have
driven growth in consumer credit, direct response auto and other personal
financial markets. This slow rate of adoption obviously reflects the primacy
of agent-based distribution.
• Employers’ reduction in group benefits. Group life, the traditional

coverage for the middle market, has diminished structurally as some
employers have dropped coverage from three times to one times salary,
and as payrolls have been thinned by unemployment and an increase in
part-time labor. A key driver of the cutback in group life has been the
rising cost of health care and retirement benefits.
• The absence of products that respond to changing consumer needs.

In these tough economic times, people are more interested in living
benefits than intergenerational wealth transfer. The risks of illness,
disability and end-of-life care are growing in importance, but the
industry’s product offerings and distribution have not been able to
achieve more than modest penetration.
The news, of course, is not all bad. The life insurance industry, though hurt by
the economic meltdown of 2008, took a smaller hit to its finances and
reputation than many other financial sectors. In fact, the industry’s historic
strengths of long-term guarantees and financial advice have never been in
greater demand. And although the industry overall has produced weak results
in recent years, a number of top performers have excelled.
What’s different about those companies? How are they adapting to the new
economic and competitive environment? What’s different about their strategy,
product mix, distribution footprint, investment performance or execution skills?
If the industry is to learn from the past, we believe it should seek a fact-based
perspective on what drives outperformance. In this report, we share the results
of our research into what has been working over the past ten years and why,
and how carriers can achieve strong returns over the coming decade.
Risk Skills Drive Major Differences

In Company Performance
Despite lackluster returns in the life industry as a whole,

individual companies show dramatic differences in
performance. Over the past 10 years, top performers
have delivered over 400 percent more growth in
adjusted book value than those at the bottom,
or about 13 points per year (Exhibit 4).
Structural factors alone do not explain this difference. Mutuals and public
companies perform similarly on average, as do domestically owned and
foreign carriers.
Exhibit 4
Performance varies widely among the top 30 companies

Annual adjusted change in surplus based on net income, 2000-11
Percent
Top quintile 10.1
2nd quintile 7.8
3rd quintile 6.4
4th quintile 4.4
-2.9 Bottom quintile
Note: Does not include AIG

Source: A.M. Best; SNL; McKinsey analysis
Risk skills drive performance differences

What drives the significant performance difference between the top quintile
carriers and the rest? Analysis shows that performance within product lines,
such as individual life, has the strongest impact on carriers’ relative
performance, followed by investment performance. Difference in product mix
accounts for a smaller portion of the difference in performance (Exhibit 5).
Exhibit 5
Performance within lines drives differentiation

Contribution to delta in performance
Percent (100% = about 13 points in annual adjusted growth in surplus)
Product mix 25
Performance
43
within lines
Investment performance 33
Source: A.M. Best; McKinsey
Looking at performance from this perspective, we see patterns emerge. Results

within product lines have the strongest correlation with overall performance, for
example. Investment performance is not as well correlated, though the top two
quintiles clearly outperform the third and fifth (Exhibit 6).
While investment performance was the second-largest driver of differences, the

rewards and penalties attributable to investments were significantly lower than
those for product performance. (For details on our calculations, please see the
text box on the page 12.) The top quintile performed well in every category, while
the bottom quintile lagged significantly on both product lines and investment.
Exhibit 6
Risk skills drive performance differences

Growth in adjusted book Performance
value, 2000-20111
Percent Within lines Product mix Investment
Percent Percent Percent
Top quintile 10.1 3.2 0.4 0.9
2nd quintile 7.8 1.4 -0.9 2.0
3rd quintile 6.4 3.2 -0.5 -1.6
4th quintile 4.4 -1.7 0.8 0.3
-2.9 Bottom quintile -6.1 0.1 -1.7
1
Based on statutory financial numbers.
Note: Does not include AIG.
Source: A.M. Best; SNL; McKinsey
The primary conclusion of this analysis—that performance in life insurance

is driven by risk skills to this extent—strikes many industry observers as
counterintuitive. The industry sees risk management as critical table stakes
but not as a true differentiator of performance. In other words, risk
management can lead to underperformance, but risk skills are not seen as
a source of competitive advantage. As a result, the life industry has
attempted little innovation and risk selection—many carriers use the same
models to select and price risk as their competitors. Over the years, when
asked about their company’s performance, most executives would cite
premium growth rate first. Discussions about product risk performance,
despite its central role in driving results, seem to take place largely among
actuaries and finance executives.
Senior property and casualty (P&C) executives, in contrast, have always

focused on risk and organized their management accordingly. When asked
about their performance, they talk first about underwriting performance as
measured by the combined ratio.
Apples-to-apples performance metric

We believe that the most revealing performance metric is growth in
adjusted statutory book value—the ability to grow surplus, adjusting for
dividends to shareholders and capital transactions. It is relevant for all
carriers because it rewards profitability as well as growth. It measures the
success of public carriers, since “price-to-book” is a common way to
value them, and mutuals, as they strive to grow their surplus. It also
correlates well over time with other measures, including return on equity,
total return to shareholders and economic value creation.
The mathematics of decomposing life insurer performance

To understand what drives performance, we split the differences
between each company’s performance and the average for the 30
companies into three components: those attributable to performance
within a product line, product mix and investment returns. To calculate
the impact of product mix, we computed returns assuming every
company’s returns were equal to the industry average for the product
line but applied each company’s product mix. For investment
performance, we compared income plus realized capital gains and
losses as a return on surplus with the average for the 30 companies.
For product performance, we compared the return on surplus with
industry averages by product line and applied each company’s actual
product mix. We determined for the 30 companies how much of the
difference in average performance was attributable to each of the three
factors. We then grouped the results in quintiles to examine the
patterns behind high and low performance.
Poolable risks have created the most value

Life insurance carriers take several types of risk: poolable risks, such as
mortality, morbidity and longevity through traditional life, annuity, health and
disability products; equity and fee product risks, primarily through variable
annuities; spread risk through fixed annuities and GICs; and investment risks
with their own funds.
The industry has enjoyed much more attractive returns on poolable risk
than on equity, spread or investment risks. In fact, poolable risk
business has historically generated about 70 percent of earnings—
Exhibit 7
Carriers have made most of their profits by managing poolable risks

Earnings by type of risk, 2000-20111 $5 $200
Billions
$20
$33
$143
Poolable Equity/fee Spread 2 Investment 3 Total

risks products
$108 $36 $28 $58 $230

Average capital employed
Billions
1
Based on statutory financial numbers
2
E.g., fixed annuities
3
Returns incremental to "risk free" and capital to support this incremental investment risk
$143 billion—while consuming less than half of the industry’s capital, or

$108 billion 1 (Exhibit 7).
Two main factors drive high earnings in poolable risks. First, developing risk
skills is complex and challenging, leading to high rewards. Second, the life
industry owns this market; other financial institutions are precluded from
participating unless they own a life company, and few find it financially
attractive, given the relative capital intensity. This control of the poolable risk
market is in sharp contrast to investment-based products which compete with
asset managers, securities firms and banks.
Both fixed annuities/spread and variable annuities/equity have been

unattractive for the industry as a whole. They theoretically incorporate longevity
risk, but relatively few policyholders hold them to maturity. The other challenge
of annuities is that they compete broadly in the asset management space
1 In computing earnings, we attributed investment income on the float at the risk-free rate to the poolable risk earnings.
against institutions with generally stronger brands and lower expenses and
fees. To compensate for these disadvantages, insurers have created an array
of guarantees, some of which can be hedged but at a growing cost and not
without risk, as we saw in the financial meltdown.
And despite great effort, the industry in aggregate has only marginally
exceeded the risk-free rate while investing roughly $60 billion of its own capital.
Some companies have done well, of course, but the poor overall performance
raises questions that need to be addressed.
Career distribution has created more value

Distribution has also been a core driver of performance within lines. Although
the share of career distribution has declined, insurers that control their
distribution, including career and direct, have created substantially more value
than companies who focused on third-party channels. Carriers that relied
primarily on career channels delivered returns, excluding investments, that
were three to four points higher on average than returns for third-party-focused
carriers, as shown in exhibit 8.
Exhibit 8
Career distribution creates more value than third party
Annual adjusted 20
growth in book
value of 10
individual
businesses1 0
Percent
-10
-20
-30
Primarily third party Mixed Primarily career
Share of
individual < 40% 40-60% > 60%
premium through
Average growth 7.1%

in book value
5.0%
2.8%
1
Excludes investment gains and losses; individual lines only; 2000-2011
Source: LIMRA; McKinsey
Product returns for companies with career distribution are consistently

higher, in part because they distribute a higher proportion of permanent
life insurance and fewer lower-margin annuities. Their second obvious
advantage is that they are less
vulnerable to the shopping
While the returns from third-party
pressures that are inevitable with
third-party distributors. Many distribution are low on average,
have also won some measure of the spreads are wide:
loyalty with a combination of
some companies have achieved
personal relationships and value-
added services. returns above the average for
While the returns from third-party proprietary distribution.
distribution are low on average,
the spreads are wide: some companies have achieved returns above the
average for proprietary distribution. Others have delivered poor returns,
however, driven partly by the meltdown’s impact on hedges. Overall,
while third-party distribution has served as a growth engine for some
insurers, it has come at a price.
Group lines have delivered more than individual lines

Product lines deliver a wide range of returns (Exhibit 9, page 16).
Historically, group insurance has been a profitable and broadly based
business with many players. Group profitability has benefited from
insurers’ ability to regularly re-price the in-force book. With the loss of
group health to payor/providers, it has become a far more specialized
business anchored by a few major companies, namely MetLife and
Prudential, and many more focused players. Group voluntary or worksite
marketing is also a growing part of this business as employers and the
public sector pull back.
Traditional individual life and health businesses have performed

reasonably well, with the mutuals doing particularly well, thanks to their
proprietary distribution and immunity from the short-term earnings
pressures that face stock companies.
The poor performance of annuities is even starker when compared with

other individual and group lines. Many annuity writers have responded
by substantially de-risking the product. How attractive those products
will be to consumers will become clearer in the years ahead.
Exhibit 9
Group lines have delivered more profit with less capital
Average capital and cumulative net income,

2000-2011
100 100
7 2 Annuities
Variable annuities 17
15
Fixed annuities 13
Individual
poolable
Individual A&H 11 25
8
Individual life 35
19
Group
Group life 5 lines
Group annuities1 12
23
Group A&H 8
Capital allocation Contribution

to profitability
1
Group annuities are 403(b) plans
Scale has not mattered much

Contrary to what industry observers expect, greater scale has not
translated into higher performance. This does not imply that scale cannot
be a source of competitive advantage—only that lines for major carriers
have not captured much benefit from scale over smaller companies. At
the company level, but also within each product line, performance and
size are not closely correlated. We believe several factors are at work:
– Systems and operations fragmentation: Large life insurers that operate
as a series of smaller life insurers, with fragmented operations in different
legacy books, do not capture the full operational benefits of scale.
– Data analytics: Standardized underwriting tables and rating systems
limit the ability of large carriers to leverage their data advantage,
unlike P&C, where large carriers can use proprietary data as a
strategic differentiator. P&C carriers also benefit from far higher

claims frequencies than in life insurance, giving them far more
credible data.
– Risk-related factors: Risks such as hedging for variable annuities or

savings in capital markets have significantly impacted performance
regardless of size.
* * *
Looking back over the last few years, we can see how an increasingly risky
environment has had an impact on industry returns, but as our analysis here
shows, many companies have thrived in difficult times, largely through
superior risk management skills. In the following chapters, we explore the
challenging economic and regulatory environment facing insurers, three
significant growth opportunities on the horizon, and what will be required to
achieve top-tier performance in the years ahead.
Powerful Forces at Work:

A Challenging Environment
With New Opportunities
Outperforming in the years ahead will require not just

leveraging drivers that have historically enabled
winners but also recognizing the powerful forces that
are shaping the marketplace of tomorrow. The life
industry, still recovering from the meltdown of 2008,
will have to cope with a challenging macroeconomic
and regulatory environment marked by high volatility,
low interest rates and slow GDP growth. But there is a
silver lining: new opportunities. The shift of financial
responsibility from governments and employers to
individuals, strong growth in developing markets, and
an aging population not prepared for retirement will all
offer profitable growth potential for life companies that
can navigate the risks in the coming decade.
Understanding the challenging economic and regulatory

environment
Slow economic growth will dampen premium growth, but the most significant
threat, at least for stock companies, is likely to be sustained low interest rates.
This threat takes multiple forms. Lower rates mean higher hedging costs, for
example. According to the Milliman Guarantee Index, the average cost of a
variable annuity hedging structure went from about 25 bps in May 2008 to 160
bps four years later. Interestingly, the increase has been driven more by interest
rates than by equity volatility. Low interest rates also drive up reserve
requirements for policies with long-dated liabilities, such as annuities, universal
and whole life, and long-term care.
In the aftermath of the great recession of 2007-2009, regulation is becoming

stricter in the insurance sector. We expect meaningful impact on returns,
including higher costs of compliance, generally higher capital requirements or
capital buffers, more complexity (often requiring advanced statistical tools) and
higher volatility, as new models incorporate mark-to-market price volatility in
capital requirements.
Transfer of risks from business and government to individuals

For medical care and retirement, generations of Americans have relied on the
collective sources of Medicare, Medicaid, Social Security and employer-
sponsored life, health and retirement programs. But economic pressures are
forcing employers and state and federal governments to cut back on benefit
levels and eligibility, leaving millions of Americans unprepared for medical crises
or retirement.
Individual insurance products continue to be available, but agent-based

distribution has moved toward the affluent and mass affluent. Given the size of
the middle market, some estimates have suggested a need at least as large as
the industry is today; the key is to find alternative models that can convert this
need into demand that can be served profitably.
Middle-market consumers are underinsured (Exhibit 10). They spend about

$80 billion a year on life insurance premiums even though penetration has
declined by 14 percentage points since 2004, indicating latent demand. Simply
returning penetration to 2004 levels could raise annual premiums by $20
billion. At typical margins of 4 percent, this could imply an increase in the
industry profit pool of $800 million annually.
The economic shift to developing countries

The U.S. life insurance industry has long been primarily a domestic
business, given varying regulations, distribution models and customer
needs. But the life industry is rapidly following the lead of many others that
have globalized as carriers build multi-country footprints. Revenues and
profits are shifting from the U.S. and Europe to developing markets at an
Exhibit 10
Fewer than half of U.S. middle market households have life insur-
Annual Life insurance ownership in U.S. households, 2010

household
income Do not own Own
<$35,000 69% 31%
$35,000-50,000 60% 40%
$50,000-100,000 54% 46%
$100,000-125,000 47% 53%
>$125,000 41% 59%
Source: 2010 LIMRA Household Trends Study; McKinsey. Aggregate household counts from MacroMonitor, distribution by income segments
from CPS
accelerating rate. Should this trend continue, as seems likely, U.S.-based life
insurers could better capitalize on the opportunity.
Winning in developing markets is not without challenges, including regulatory

hurdles, a scarcity of management talent, and different consumer mindsets and
behaviors. But some companies are achieving strong positions in developing
markets, driving growth, profits and higher valuations through major
acquisitions (MetLife/ALICO), joint ventures, and long-term development from
the ground up (AIA).
The opportunities for life insurers in the years ahead will be driven by two
powerful forces: the low penetration of life insurance premiums and overall
economic growth. Developing economies have been growing about twice as
fast as developed economies, but life insurance penetration in developing
markets is generally less than half that in developed markets. History shows
that penetration increases rapidly once GDP per capita approaches $30,000
(Exhibit 11, page 22).
Given these two powerful forces, we expect that developing countries will
account for more than 80 percent of global growth in the life market in the
next decade.
Exhibit 11
Penetration rises rapidly in emerging markets as GDP per capita

approaches $30,000
Life insurance penetration versus GDP per capita
Life GWP/ 10
GDP 8 South Korea Hong Kong
Japan
Percent
7
6 France
5 United
States
4 India Australia
Italy
3 Canada
China Poland Spain
2
Brazil Mexico
1 Argentina
Colombia Russia
0
0 5 10 15 20 25 30 35 40 45 50
GDP per capita
$ thousands
Source: Swiss Re; CIA World Factbook; McKinsey
An aging population fuels the retirement market

Demographic and market forces are creating enormous opportunities in the
retirement market. A record number of baby boomers will hit retirement age
over the next decade. Many pre-retirees and retirees are not financially
prepared for retirement, and few have enough savings or protection against the
risks of lower investment returns, higher inflation, end-of-life medical costs and
expected increases in their life expectancy. Government programs—Social
Security, Medicare and Medicaid—are under increasing pressure from growing
budget deficits and an unwillingness to raise taxes.
Life insurers can play a major role in helping people meet their retirement
needs, and the flow of funds will be unprecedented. Life insurers once
dominated institutional and retail retirement with protection and annuity
products focusing on interest rate guarantees. In the last 30 years, asset
managers and wealth advisors have capitalized on the introduction of qualified
plans, the shift from defined benefit (DB) to defined contribution (DC) plans and
strong equity markets to capture 70 percent of the retirement profit pool.
Capitalizing on this opportunity will challenge life insurers in several ways.

First, many consumers in the middle market simply do not have the
resources to fund their retirement needs; life insurers will need to focus on
consumers in a position to invest in retirement products. Meanwhile, few
consumers trust financial advisors, and they view life insurance agents as
pushing products rather than offering help with creating holistic retirement
plans. These consumers are looking for plans that reflect their family,
employment and real estate status and aspirations—issues that require much
more than insurance products. The third challenge is that products that deal
with critical illness exposures, end-of-life care and longevity risks are difficult
to understand, suggesting that the sales process needs to be preceded by
consumer education.
* * *
In short, the industry will have to raise its game to deal with a challenging
macroeconomic and regulatory environment while capitalizing on several major
opportunities—each of which presents its own challenges.
Strategic Implications
For Life Insurers
The landscape for life insurers has shifted enormously

over the past 10 years. Before 2000, stable industry
returns led top management to focus on growth. More
recently, top management’s focus has shifted to
include risk-related subjects that had been the domain
of actuaries, such as the cost of equity, hedge
performance and conditional tail expectations. This
shift is sound, since risk performance drives wealth
creation, as we saw in Chapter 2. The top-performing
P&C companies, in a classic risk-driven business,
have focused first and foremost in recent years on
underwriting profit margins and are now covering their
cost of capital. The life industry today is failing to do
so, which means that margin enhancement is the
primary path to value creation for most carriers.
We begin this chapter by outlining the key dimensions of top-tier risk

and capital management skills in financial services. We then explore
avenues to strengthen distribution skills, which we believe play an
important role in driving not only growth but margins. We then follow
with a section that suggests that in-force management can play a key
role in margin enhancement and stimulate profitable growth with
existing customers. This chapter concludes with our perspective on
requirements for winning in the three major growth opportunities:

retirement, the middle market and developing country markets.
Building core risk and capital management capabilities

To develop best-in-class risk management, carriers should explore five
dimensions:
1. The financial and capital management discipline to focus on value rather

than premium growth
2. A compelling capital management framework and foundational principles

that help CEOs and their teams make better decisions
3. Robust metrics to manage capital and govern risk
4. More flexibility in product design, pricing and strategy to improve risk and
contingency management
5. Innovation to generate improved risk-adjusted return opportunities.
Delivering on these five dimensions requires several critical enablers: clear roles
and responsibilities, analytic horsepower, and information systems that allow
companies to track performance against pricing models.
Institute financial and capital management discipline to build a

culture of value over volume generation
Many life insurers need to overcome the cultural norm of allowing the needs of
distribution to trump profitability, capital management and risk. This norm was
understandable when margins were healthy, capital was readily available and
risk predictable. Those days are gone.
Creating a culture of value over volume requires more than talk. Top
management needs to reinforce its message with carefully crafted
incentives that reward effective capital deployment and a governance
structure that enables a thorough vetting of new products and, most
important, pricing and feature changes that adequately reward shareholder
and institutional risk-taking.
Profitability and capital management will be even more critical in the face of the
challenging economic environment. Recent senior management appointments
at a number of major life companies, including MetLife, Prudential,
Northwestern Mutual and Pacific Life have emphasized the importance of
financial skills.
Further, investor communications increasingly focus on ROE expansion and

capital reallocation, with less emphasis on growth. And carriers have begun to
make tough decisions about their product portfolio.
Create a more compelling capital management framework to help

senior management make better decisions
Effective capital management begins when senior management, including the
board, aligns around the firm’s risk appetite. Setting capital targets and floors,
a measure of annual earnings at risk
or even a rating target and floor can The challenge is defining
guide decisions about businesses
and segments down to the product
what metrics to use. A balanced
and investment class level. Without approach that establishes
these parameters, senior some measurements of capital
management often struggles to
redefine the capital plan and strategy
as constraints and others
at every key decision juncture. as objectives tends to lead
Companies should also establish to more informed decisions
guidelines or tolerances for how and fewer surprises.
much capital they want to expose to
equity, credit and interest rate risk. These should be consistent with business
plans and strategies for the most capital-market-sensitive products such as
variable annuities.
Use better metrics to manage capital and govern risk

The challenge is defining which metrics to use. A balanced approach that
establishes some measurements of capital as constraints and others as
objectives tends to lead to more informed decisions and fewer surprises. We
outline below four types of metrics and analyses that support strong capital
and risk management:
• Understanding the distribution and tail outcomes

While senior managers understand differences in mean predictions and
potential outcomes, they don’t always seem to grasp the potential for
deviation. They should rely on statistical distributions around potential
returns—rather than means—in the decision-making process.
• Applying different costs of equity by line of business

Virtually all companies put capital loads on new business. They generally use
economic or statutory capital and charge for the capital employed. But fewer
companies then set specific hurdle rates for that capital based on cost of
equity of those businesses (Exhibit 12). Doing so can greatly improve
decision-making and reduce cross-subsidies in the product portfolio.
Exhibit 12
The long-term cost of equity varies significantly by line
U.S. long-term cost of equity
Variable annuities 17.8%
Long-term care 14.2%
GIC/Institutional
14.1%
spread
Retirement plans 11.2%
Fixed annuities 10.4%
International 9.7%
Individual life 9.5%
Investment
9.3%
management
Property and
9.3%
casualty insurance
Group benefits 8.7%
Source: Bloomberg; McKinsey Corporate Performance Center analysis
• Monitoring the in-force books closely

Virtually all companies focus on new product pricing, but fewer closely
monitor the in-force books. This is a missed learning opportunity that
could sharpen new business pricing skills. The most fundamental analysis
requires tracking individual assumptions that were baked into the pricing
models. Further, monitoring different issue-year vintages will reveal the
impact of changes in underwriting and terms and conditions over time.

Aggregating overall results may mask key changes in profitability by issue
year that could lead to poor forecasts and decision-making.
• Establishing product and distribution P&Ls

This tool, when fully established, reveals product design and pricing
issues that can materially improve capital and risk management.
Distribution, when informed of the cost of support services, will become
more discriminating and focus more closely on what really improves
producer productivity and expands the market. Likewise, product
managers will learn what services, commissions, product features and
prices will clear their cost of capital hurdles and be saleable in the market.
The net result should be a much more collaborative relationship between
product management and distribution.
Build flexibility into product design, pricing and strategy to improve

risk-adjusted return opportunities
P&C companies have an enormous advantage over life companies with their
ability to change prices, re-underwrite and modify terms and conditions
annually. The life industry, in contrast, locks itself into long-term guarantees and
pricing that leave it vulnerable to changes in mortality, morbidity and interest
rates and capital markets gyrations.
But life companies also have many opportunities to share risks with
customers. For example, within annuities life insurers can use several
approaches to share risk:
• Widening the minimum-to-maximum range of account charges on

annuity products
• Widening the range of living and death benefit guarantees
• Using the step-up as a trigger for increased charges and reduced

guarantees
• Linking fees and charges to the benefit base as opposed to the

account value
• Explicitly linking guarantees to capital market variables.
The spirit of these changes should be to modify the product to introduce risk-
sharing with the customer. When the risk is shifted, the product price can be
lowered to generate the same returns.
Innovate to improve risk adjusted returns

We expect that life insurers will reorient their product portfolios to achieve
greater capital efficiency and reduce the emphasis on financial
guarantees. Sophisticated finance and risk skills will be required to stress-
test new products.
As exhibit 13 illustrates, many companies are moving aggressively on this front

and discovering that material changes to historic norms can get traction with
distributors and consumers.
Exhibit 13
Recent product enhancements and innovations

Company Product Innovation type Description
Secure Target fund Target date fund with Guaranteed Lifetime

Retirement structure Withdrawal Benefit to which assets are
Alliance Strategies automatically funneled when participants reach midlife
Bernstein reduces risk Matures in 5-year increments; guarantee
covers passively managed asset classes;
carries 100 bps mortality and expense charge
Long-Term Long-term Offers LTC benefits up to monthly maximum

Care care benefit for at least 4 years
Lincoln Advantage (LTC)
Finan- Owner can increase tax-free LTC benefits
cial if investments gain
VAROOM — Offers access Offers individual ETFs from iShares and

VA for Rollover to exchange- Vanguard as subaccounts
W&S Only Money traded funds Until now, ETFs were available in variable
(ETFs) annuities only through a fund-of-funds
structure
Retirement Dual accounts Guaranteed benefit floats with Treasury rate,

Cornerstone with alternative recalculated yearly
AXA risk profiles and Tax-free transfers among portfolios
tax-free capital
transfers
Guaranteed Circumstantial Allows withdrawal of up to 30% of present

Retirement liquidity value after 3 years for a qualifying emergency
USAA Income Plan such as uncovered medical expense
Guaranteed Flexible way to Deferred immediate annuity with optional

Future generate income start date
New Income guaranteed
York Life Option to make premium payments in smaller
Annuity income in the increments between the initial premium date
future and the income start date
Source: Web search; press search; Ignites; McKinsey

In the variable annuity market, we have already seen innovations in

sub-accounts that lessen volatility or allow carriers to trade between asset
classes. We expect to see further innovation in lightened guarantees with
fee-based annuities, or modest guarantees such as stand-alone living
benefits. We also expect further innovations that protect against poolable
risks such as mortality, longevity, health and morbidity. These are likely to
include accident and health policies, revised long-term care policies and
riders and bundled products that offer protection against a number of
these risks.
Using analytics to build a competitive advantage in distribution

Life insurance distribution has always been regarded as an “art” led,
understandably, by leaders who have grown up in distribution. This has led to
management models and decisions based on personal experience and
intuition—experience that has been critically important in building credibility
with the front line and in selecting and developing talent, but rarely for
leveraging analytics to drive profitable growth.
Today, distribution is not only the single biggest constraint on growth for life
insurance carriers but also its biggest source of cost. As carriers struggle to
grow distribution capacity, agents have continued to increase their
bargaining power and extract a greater share of economic rent. Given the
industry’s consistent underperformance since 2007 and continued pressure
from low interest rates, it has become critical for carriers to improve their
performance in distribution. To create competitive advantage across both
career and third-party distribution channels, carriers could explore a series
of opportunities that have substantially improved performance in insurance
and adjacent industries:
1. Using deep analytics to identify opportunities. Life insurance sales

present carriers with the inherent economic tension between growth and
current earnings. We believe carriers can better manage this tradeoff by
building deep analytic capabilities to identify opportunities and set robust
sales targets at a granular agent and product level. By identifying these
opportunities at the more granular level, carriers can also allocate home
office and field resources, set incentives and manage accountability
more effectively.
2. Aligning services offered to behavioral agent segments. Carriers can

drive agent productivity and profitability by aligning services and
support more closely to agent attitudes and needs rather than

production volume. Our 2012 survey with LIMRA of 2,000 experienced
advisors shows that most agents do not value almost 40 percent of the
services they receive. Segmenting agents by need (Exhibit 14) and
aligning services accordingly can improve agent performance and
satisfaction and lower unit cost.
Exhibit 14
Segmenting advisors based on needs and attitudes can reveal the

best ways to influence them
Needs and SATISFIED DRIVEN CAPABLE COLLABORATIVE
attitudes SERVICERS MARKETERS INNOVATORS LEARNERS
Maintain the Drive growth Willing to try new Value personal

Summary status quo with through aggres- technology and relationships
minimum sive marketing invest for and team-based
disruption and client long-term growth sales
Satisfied with Focused on new Most likely to Most frequent

current client acquisition, specialize in client use of
Productivity production need help finding segments partnering and
clients Early adopters of teaming, driving
technology and tools productivity
Want services to Focused on Value technology Value practice

Value make doing maximizing support and development,
proposition business easier compensation practice develop- coaching and
(compen- ment and coaching in-person sales
sation and Will trade Highly value leads,
compensation for orphans and support
services)
stability and marketing support
Recruitment Willing to move Most likely to Attracted and Personal

and but require large change firms to get retained by useful relationships and
retention1 payout best support tool offerings culture are keys
to retention
1
From advisor interviews
Source: 2012 McKinsey – LIMRA Survey of Financial Advisors
3. Building a lean service model that cuts across channels. A lean service
operating model can help carriers align home office and field resources
across channels, agencies and agent segments to allow high-touch
service at significantly lower unit cost. Functions where carriers have done
this effectively are training, marketing, sales support and wholesaling.
Often this requires creating a shared backbone of dedicated resources
across channels with modularized capacity that can be moved across
segments and channels to meet peak load needs.
4. Increasing the adoption of financial planning. Carriers need to spur

career and third-party agents alike to adopt financial planning with
education and training, sales support and incentives. Data from the
McKinsey-LIMRA 2012 survey shows that agents who have developed a
formal written retirement plan for at least 30 percent of their clients are on
average 5 percent more productive than others. Carriers that understand
this have begun to build capabilities to support financial planning,
including introducing centralized groups to run simple financial plans at no
cost to agents. This improves sales processes at the front line and
becomes a great repository for customer data to drive HO-led sales
triggers and cross-sell and upsell. Ameriprise is well known for having
leveraged this capability to create a competitive advantage.
5. Developing training customized to agent practice models. Carriers need

to develop and coordinate training curriculum across products and
financial planning customized to agent career stages and practice models.
For example, the 2012 McKinsey-LIMRA survey shows that agents who
target well-defined customer segments are on average 12 percent more
productive. Carriers who support agents in building specialized practices
can significantly boost agent productivity and create a strong value
proposition that helps capture profitable shelf space with third-party
distributors, such as broker general agents and wirehouses.
6. Teaming. In analyzing the performance of thousands of agents across

networks, we’ve found that the single biggest driver of agent
performance is the operating model of their practice. An agent recruited
into a team-based practice is 2.5 times more likely to become a top-
quartile producer over a four-year period than an equally talented agent
recruited into a solo practice. This difference translates to hundreds of
thousands of dollars in incremental lifetime value from the agent.
Although most carriers now intuitively recognize the importance of
teaming, they have struggled to implement it successfully. We believe the
answer lies in applying deep analytics not just to understand which
producers to migrate into teams and with whom, but also which type of
team is suitable and is likely to create more value. For example, revenue-
sharing teams require a much greater level of trust and create 50 to 80
percent more value than pure cost-sharing teams, but not all producers
are suited for them. Similarly, teams designed to prioritize the
development of new producers—even at the expense of marginally
offsetting the productivity of veteran producers—are the true engines of
value creation. Such teams significantly outperform those focused

primarily on growing producer productivity within two to three years, and
can achieve a lift in sales of 50 to 100 percent over a five-year period.
Building capabilities to support team-based practices in both career and
third-party distribution can help build significant competitive advantage.
7. Creating capability for lead generation and marketing through deep

analytics. Carriers are finding that they can improve results by creating a
centralized group to help agents mine their books of business for repeat
sales and cross-sell by focusing on client life events. The McKinsey-LIMRA
2012 survey indicates that life agents who have timely information about
10 to 15 life events—such as births, divorces, job changes, deaths in
family and retirement—and reach out to clients, tend to be 15 to 20
percent more productive. Most life insurers find it difficult to track life
events, given infrequent interactions with customers and agent turnover.
Building capabilities to mine consumer insights and leverage new data
sources, such as consumer credit bureaus and online behavior tracking
firms, offer opportunities to stay abreast of key life events.
8. Building product expert, wholesaler and sales teams to drive agent

performance. Wholesalers are having success using data-driven tools to
help select which agents to reach out to, determine how to help them mine
their books of business and support them in serving clients through next-
product-to-buy tools. Similarly, carriers are strengthening their value
proposition to distribution partners by building consultative sales desks
with attorneys, CPAs, tax specialists (on a retainer and on a more variable
cost model), many of whom can also provide point-of-sale support through
technology-enabled solutions.
The common theme underpinning these capabilities is the ability to access

and mine data that helps inform strategic decision-making. Building this
capability requires adding analytical talent as well as systems and
processes that can gather and analyze data from marketing, distribution,
products, actuarial and finance. Together, these capabilities could help
build significant competitive advantages, strengthening the agent value
proposition and driving performance across career and independent
distribution channels. In addition, these capabilities can also help build
alternative distribution channels such as salary-plus-bonus models and
other one-to-many direct distribution channels capable of delivering step-
changes in profitable growth.
Unlocking value in the in-force book

The in-force book accounts for the lion’s share of profits, revenues and
operating costs. Yet life insurers focus the bulk of their management attention
on new business.
An excellent case example of the value embedded in in-force business is

provided by Protective Life Insurance Company. Protective, one of the
companies in the top quintile in
value creation, has designed its Protective was able to
business model to acquire and raise ROE by 125 to 150 basis
extract economic value from in-
force books of business.
points over two years by acquiring
(Resolution Trust has had a similar and improving the performance of
and successful model in the UK.) mature life blocks.
For instance, according to
Protective’s investor relations presentation, it was able to raise ROE by 125
to 150 basis points over two years by acquiring and improving the
performance of mature life blocks. A major source of these improvements is
greater efficiency: Protective is significantly more efficient than first quartile
industry performance.
Several distinctive levers, well-known in the industry and outlined below, can
help unlock the hidden value of the in-force book. The key to capturing value is
the focus and intensity of management attention brought to bear on the in-
force. The carriers that create the most value in in-force have formed integrated
units with senior leadership to drive the critical levers. Those who leave the
critical levers scattered across a number of organizational units are clearly
leaving money on the table.
Capitalizing on pricing, fee and asset allocation flexibility

Few companies have made full use of available pricing levers for the in-force
book. Within variable annuity contracts, for example, fees can be adjusted and
increased. Crediting rates on existing fixed books, such as UL, also have flexibility
and are only partially at the guaranteed level, offering room to lower crediting rates
and improve returns. Other financial service providers have used this approach to
boost revenue by 2 to 5 percent, with almost all going to the bottom line.
Reducing “pricing leakage” also drives significant benefit. Fee collection and
billing calculation often leave money on the table, for instance by indefinitely
waiving fees that were supposed to be waived for only a limited period.
Optimizing asset allocation and cost—moving more assets toward passive—can

also significantly increase account value, thereby reducing the cost of guarantees.
Giving cross-sell and customer behavior management a second chance

New data-driven techniques can identify key life events. For instance, we estimate
that roughly a third of incoming service calls relate to life events—most frequently
identified by change of address or beneficiary. These calls are prime opportunities
to educate customers and increase product penetration when relevant.
Segmenting customers based on their lifetime value and propensity to buy

allows companies to deploy their resources more profitably. The more advanced
insurers also leverage customer touch points, including service and billing calls.
Group is an especially fertile ground for cross-sell and upsell.
Managing customer behavior—and using behavioral techniques to “nudge”

clients into making the most effective insurance decisions—can have meaningful
impact on penetration and ticket size.
Improving operational efficiency

One important lever that has been utilized extensively in the UK is outsourcing.
As exhibit 15 shows, through 2009, 19 legacy outsourcing book deals have
been done in the UK while very few have been done in the U.S.
Exhibit 15
In a growing insurance O&O market, nearly all legacy book

outsourcing has been in the UK
Number of outsourcing deals in insurance (life and non-life, 1998 through September 2009)
Location Traditional outsourcing Legacy book

of carrier outsourcing
BPO deals IT deals1
UK 63 49 19
Rest of Europe 14 66 0
U.S. 98 128 2
Asia 4 53 0
Rest of world 18 51 0
1
ADM/infrastructure
Source: IDC deal database; McKinsey
Insurers in the UK who outsourced their books have realized efficiency

gains averaging more than 20 percent. Obviously, in the U.S., life insurers
have been preoccupied with the fallout of the financial meltdown, but given
the ongoing profit pressures they face, many are now giving outsourcing a
fresh look.
Another major opportunity is the application of lean techniques. Insurers who

have rolled out a lean program have typically experienced double-digit
increases in productivity, customer satisfaction and quality of service, while
benefiting from reductions in operational risk. Lean’s focus on removing
“waste”–eliminating non-value-added activities as opposed to just reorganizing
the work—and on transparency of metrics, performance and capacity has
driven meaningful and sustained improvement for insurance carriers. A number
of mid-size insurers, for example, have achieved best-in-class cost efficiency
through lean techniques.
Finding growth in retirement, the middle market and developing

country markets
To achieve real, profitable growth, carriers need to succeed in their traditional
core affluent markets and simultaneously look beyond this core to the less
conventional sources of growth. We believe that thoughtful analysis of where
and how to compete along with targeted investments in the growing and
underpenetrated retirement, middle market and developing country markets
will be critical to achieving attractive growth rates over time.
Building share in the retirement market

The life insurance industry has been a major player in the retirement space
both as a manufacturer of individual retirement products and as an
administrator and asset manager of defined contribution and defined benefit
retirement plans. But asset managers such as Fidelity, Vanguard and
Blackrock, and securities firms such as Merrill Lynch and Morgan Stanley
Smith Barney, have been the big winners in the DC and DB markets as well
as the wealth management space, fueled by the introduction of qualified
plans in the 1980s.
To strengthen their position in this enormous and growing market, life insurers
will need to determine their strategic footprint, increase their penetration of the
retirement risk market, revamp their advisory capabilities and capitalize on the
pension buyout opportunity.
Determine the strategy footprint in the retirement market
The life insurance industry captures approximately $11 billion of the $33 billion
retirement profit pool, with slightly more than half generated by manufacturing
individual retirement products (Exhibit 16).
The market becomes far more complex when we break these retirement
businesses down by distribution channel and segment customers by wealth,
age, family status and affinities. And given the massive influx of funds into
retirement over the next two decades, companies will need to take a more
Exhibit 16
Taxonomy of the retirement businesses

Retirement Profit Life Top 3 life Market
business pools players’ players dynamics
Billions share in category3
Defined contribu- $4.5 45%1 TIAA-CREF Commoditization is pressuring

tion (DC) and ING already thin margins for record-
defined benefit (DB) Prudential keepers
plan administration
DC/DB asset $7.4 22%2 TIAA-CREF Solution products key to growth in DC

management ING Large opportunities in DB for insurers
Prudential in buyouts and derisking
Wealth manage- $8.6 7% Ameriprise Retirement advice correlated with

ment brokerage MetLife advisor productivity, but no one has
and advice TIAA-CREF cracked the code to deliver it credibly
IRA asset $6.8 5% Ameriprise Rollover activity key to growth in IRA,

management MetLife so the biggest record-keepers stand
TIAA-CREF to gain the most assets
Life insurance $1.3 85% New York Life Recovering. Focus on new products
manufacturing MetLife and distribution to reach younger
Prudential customers
Annuities $4.0 85% TIAA-CREF Growth returns, but operating income

manufacturing MetLife suffers due to reserve strengthening
AIG
Health risk $0.4 100% Genworth Market concentrated among few

protection John Hancock large players
provision Unum
Pension risk $0.3 100% Prudential High growth potential with declining
outsourcing funding ratios, but capital require-
ments create supply-side gap
Total profit pool $33.3 $10.8

billion billion
1
Market share reflects share of DC only
2
DC, IRA and VA assets as percent of total assets in brokers and RIAs
3
Market share in top 15
Source: P&I; Cerulli; Conning & Co.; McKinsey Retirement Practice
forward-looking approach to building a footprint in that market. Designing

strategy in this space will differ from traditional strategic decision-making in
several dimensions:
• It will take longer to monetize investments, creating tensions with short-
term earnings pressures. As in international markets, the winners will need
to make bets with a long-term view on payoff. Those focused on shorter-
term payoffs will see opportunities pass them by.
• Companies will need to leverage their strengths within the context of
emerging advice models and a much richer set of competitors, many in
the asset management space.
• They will need to invest capital and talent ahead of the curve to jump start
new market positions. Incremental investments with a mindset of waiting
for scale are unlikely to be successful.
• A portfolio of initiatives with various time frames and levels of risk will
create more options over time than a handful of traditional bets. Accurate
predictions will be difficult in a diverse and dynamic market.
Help retirees understand products that meet their risk-protection needs
Consumers face three critical risks that life insurers are uniquely
positioned to address: death during peak earning years, end-of-life illness
and outliving assets.
The industry offers a wide variety of products to protect families from the
untimely death of a breadwinner, but the industry could do a better job of
communicating the role these products can play in protecting the retirement
of survivors, especially in the middle market. This will likely require more
low-cost, one-to-many, user-friendly channels and less of the traditional
one-on-one selling.
Virtually every retiree faces the risk of losing his or her life savings to an end-of-
life illness, but a low proportion of retirees with the means to purchase long-
term care insurance have done so. Although any retirement plan should
account for this risk, consumers often don’t understand the LTC product and
see it as expensive, and salespeople find it complex. A broader array of long-
term care products would appeal to a wider range of consumers.
Longer lives, low investment returns and erosion in Social Security, Medicare
and Medicaid benefits will mean that more retirees will outlive their assets.
Annuities can protect against this risk, but their penetration remains small. The
industry can take advantage of this opportunity if it can find new ways to
educate consumers about longevity exposure and how to manage it (e.g., hold
annuities rather than cash them in to invest the proceeds).
Revamp advisory capabilities
Millions of older Americans feel unprepared for retirement, and fewer than
half say they have a “trusted financial advisor.” Life insurers could connect
with this market better by focusing more on advice than sales, looking to
fee income rather than commissions, and
looking beyond insurance to offer a more Uneducated consumers
holistic approach to financial planning.
have trouble choosing the right
Individuals approaching or in retirement face financial products, and they tend
tough decisions about family obligations,
health care, housing, investments and
to be skeptical of advice
employment. Until a consumer has a holistic from agents on commission.
understanding of these issues and their
financial consequences, he or she is not prepared to make decisions about
specific insurance products. Companies that provide effective education
through retirement teachers or coaches will make sales to educated
consumers. Some will convert agents to play this broader role, while others
will recruit people, possibly including those in their 50s and 60s with
teaching or financial backgrounds, who are interested in launching new
careers helping other seniors.
Uneducated consumers have trouble choosing the right financial products, and
they tend to be skeptical of advice from agents on commission. Recognizing
this challenge and seeking to build long-term relationships with customers, the
securities brokerage industry shifted from commission-driven to asset-driven
compensation many years ago. Life insurers looking to expand their position in
the retirement space need to consider comparable shifts.
A service model based on longer-term relationships will include periodic

discussions and advice beyond insurance issues. The latent demand is huge
but can be met only by changing the advice model.
Companies with strong balance sheets should consider pension buyout

opportunities
The Prudential/GM deal highlighted an important opportunity for major life

insurers with strong balance sheets. The $29 billion pension closeout deal
demonstrated the appeal to major corporations of reducing balance sheet

volatility inflicted by mark-to-market accounting of pension valuations.
Transactions like these are attractive to corporations with pension liabilities
that are particularly large in relation to their market valuation. For Prudential,
the bet is that the 10 percent premium GM paid over the current valuation will
more than cover the interest rate and longevity exposure they took on.
Although only a handful of deals may be done, and few life companies have
the balance sheets to participate, the sheer size of the deals suggest this
could be an important growth opportunity for some carriers.
Capturing the untapped middle-market opportunity

The life insurance industry’s record of serving the middle market in the
U.S. is a curious case of failure. Today, the middle market, which we
define as the 63 million households with incomes between $25,000 and
$100,000, is underinsured at historic levels: only 43 percent, or 38 million,
of these households have life insurance, far below the 59 percent of
households with incomes greater than $125,000. Penetration has been
declining since the 1960s, when 70 percent of Americans had some form
of life insurance.
This market could be much more profitable for the industry, especially if the
product arena is broadened to include supplemental products, such as vision,
dental, disability and critical illness. In 2010, these products, which often enjoy
margins in the range of 6 to 10 percent, garnered over $90 billion in total
premium for a profit pool of $6 to $7 billion across group and individual
underwriting platforms. With the onset of health reform and shifting middle-
market consumer preferences, demand for these products will outpace
demand for life insurance.
Not everyone can seize this opportunity, however. Regardless of whether

they lead with simple term, supplemental, or other product solutions,
successful carriers will need new distribution and technology capabilities to
overcome the challenges associated with serving this segment with an
agency-based model. For some carriers, this may mean moving explicitly to
a one-to-many model, such as at the worksite, while others may need to
move online. In fact, the operational and organizational barriers are so
significant that some carriers may choose not to enter the market or do so
only through a stand-alone subsidiary. For those that do enter, winning will
require a full value-chain alignment with the unique needs and economic
structure of the middle market.
While cracking the code can be challenging, the equities markets are rewarding
carriers who are operating in the space. Today’s market outperformers—those
with high revenue-growth forecasts and high returns—are building unique
advantages. Primerica, for example, is using non-traditional distribution channels,
and Aflac and Torchmark have supplemental product capabilities that have been
very profitable.
Drivers of the declining middle-market position

To understand why the industry is failing to serve the middle market, we need to
look at supply and demand. Demand has been falling for several reasons:
• Middle-market consumers are more concerned with living benefits. Research

shows that consumers are more interested in purchasing living benefit products
such as vision, dental and disability insurance than life insurance.
• Middle-market family formation is slowing. From 2008-2010, middle-

market household formation has virtually ground to a halt. This continues a
longer-term trend: from 2000 to 2011, the
share of people ages 25-34 who are married The last decade has not been
has declined from 55 to 46 percent.
Although these statistics have been fueled by kind to middle-market
the recession, they also mark the consumers: real median
continuation of a multi-decade shift in the
household incomes fell
U.S. population that began in the 1960s,
when the same cohort had marriage rates in 8.1 percent from 2007 to 2011,
excess of 80 percent. while personal balance sheets
• Middle-market discretionary income is are still recovering from the twin
getting further compressed. The last decade
evils of the housing crisis and
has not been kind to middle-market
consumers: real median household incomes stubbornly high unemployment.
fell 8.1 percent from 2007 to 2011, while
personal balance sheets are still recovering from the twin evils of the housing
crisis and stubbornly high unemployment. Middle-market consumers are
therefore less likely to value life insurance and less able to afford it.
• Alternative savings vehicles have emerged. Before the deregulation of the

securities industry in the 1970s, life insurance was one of the few ways for
retail consumers to accumulate and transfer wealth. Since then, the mutual
fund industry, self-funded retirement vehicles and low-cost brokerages have
emerged to serve this need.
A demand failure is only part of the equation. On the supply side, the industry
has failed to adjust for reasons we touched on earlier. Producers have
migrated up-market for larger commissions, and carriers have gone along to
realize economies of scale in wholesaling and administration. Many
employers have reduced group life
coverage as health and retirement To profit from the middle-market
costs have risen, and fewer people
are employed. As a result, from
opportunity, life insurers will need
1997 to 2009, employers held to innovate in product
nominal group life expense development and shift
constant, even in the face of an
inflation rate of 2.4 percent.
from agency-based distribution
towards technology-enabled,
Alternative channels with lower
distribution costs, such as direct one-to-many capabilities.
and worksite, are still in their
infancy, representing 8 percent and 5 percent of the industry, respectively.
The industry has yet to develop and apply the more sophisticated mass
market marketing and consumer insights found in consumer credit and
other adjacent sectors.
THE PATH FORWARD THROUGH BETTER DISTRIBUTION AND PRODUCT

To profit from the middle-market opportunity, life insurers will need to innovate
in product development and shift from agency-based distribution toward
technology-enabled, one-to-many capabilities. Given that these approaches
upend industry traditions, some carriers will choose not to compete in the
middle market. For those who do want to drive growth in the space, we see
six basic routes:
• Worksite: Middle-market consumers see the workplace as a natural place

to buy life insurance, since it’s where they get many other benefits. While
carriers like Aflac have had good results in worksite marketing, the
channel as a whole remains sub-scale. Winning in this channel will require
new capabilities such as simplified/guaranteed issue and other simplified
products, face-to-face channels for sub-segments, such as executives,
and robust multichannel capabilities that may include online enrollment
and call centers.
• Direct: Despite success in personal lines in the U.S. and in life in

Europe, direct life insurance sales in the U.S. are in their infancy. They
are still confined mostly to term products, though some smaller

insurers, such as Gerber Life, are capturing consumers at trigger
points, such as births. Carriers that can get around channel conflicts
can find direct sales to be cost-effective. Required capabilities
include branding, underwriting in a matter of minutes, product
development agility and social media prowess. Direct sales forces
working in call centers, data mining to identify potential leads, broad
marketing, online quotes and low-premium products will also help
carriers profit in this channel.
• Sponsored: Despite success in other markets, co-branded or white

label insurance has not taken off in the U.S. Other businesses with
established distribution networks are looking for additional products.
Wal-Mart, for example, entered financial
services distribution with Western Union To excel in bancassurance,
and Green Dot. Insurers can leverage
existing fixed-cost distribution networks if
insurers will need to co-market
they can co-brand with retailers or other with banks by teaming
marketing partners, launch broad marketing at branches, for example,
efforts and offer low-premium products.
or gathering referrals from call
• Banks: In many developed economies with
centers, and align on branch
high life insurance penetration,
bancassurance is a primary distribution distribution mechanics.
channel. The tide might be turning in the
U.S. as banks struggle to profit from their retail networks and look for
new fee income. Retail banks may have a special advantage, since they
have primary financial relationships with many middle-market
consumers. To excel in this channel, insurers will need to co-market
with banks by teaming at branches, for example, or gathering referrals
from call centers, and align on branch distribution mechanics.
• Affinity: Several carriers have partnered with affinity networks to reach

specific demographic groups, such as New York Life with AARP, or
professional networks, such as Prudential with the AICPA. These
networks permit distribution to groups with specific needs, and
successful carriers tailor their products to fill those needs, such as
USAA’s Military Term. To excel in this channel, carriers need marketing
agility and business-to-business and business-to-consumer
capabilities like those required in worksite.
• Ethnocentric: Carriers may develop sustainable competitive positions by

tailoring products and marketing to serve specific ethnic segments,
especially those with population growth, family formation trends and a strong
sense of familial responsibilities.
In addition, health care reform is likely to create challenges and opportunities for
life insurers as employers reduce or completely eliminate coverage and a
growing share look to shift to a more DC-like benefit offering. Building product
and distribution capabilities to establish a presence on both public and private
exchanges will be critical to group carriers’ efforts to maintain share, and will be
a significant growth opportunity for individual-only carriers.
Market-specific distribution models are only half the equation. Carriers will need
to develop new products that appeal to today’s middle market. Since these
consumers are not seeking intergenerational wealth transfer, they will not be
drawn to simple term. They want protection solutions that meet a more
comprehensive set of needs, including liquidity reserves, life, auto, home,
disability and long-term care. Winning carriers will develop simple, easy-to-
understand products that bundle these features.
Winners may also go beyond the idea of death benefits to explain life insurance
in new ways. Research indicates that “ensuring a college education” or
“protecting my family’s home” may be more appealing.
Tapping international opportunities—while sidestepping the risks

The core arguments for addressing the developing markets are relatively simple.
Few U.S.-only life insurers can expect to achieve strong or even moderate
growth and cover their cost of capital for the foreseeable future. The exceptions
will be companies with distinctive product and/or distribution strengths that
have been validated by past results. For the majority, fully exploring developing
market opportunities makes sense, given the higher returns and growth rates
that are being fueled by low penetration and high GDP growth. Further, many
U.S.-based and foreign insurers have demonstrated the ability to penetrate
developing markets. But to be clear, the bar is high, and success requires a
well-defined and -executed strategy.
Obviously, each company needs to explore developing market opportunities from

its own perspective, but other companies’ success offers some useful lessons:2
2 For a more complete discussion on successfully entering Asian markets, see Life Insurance in Asia: Sustaining Growth in the Next
Decade, 2nd Edition, by our colleagues Stephan Binder and Joseph Luc Ngai, 2012, John Wiley & Sons.
1. Adopt a long time horizon

Winners in developing markets have evolved their position not over years but
over decades. Companies looking for near-term payback and quickly accretive
acquisitions will be disappointed.
AIG, for example, was founded by CV Starr in Shanghai in 1919 and spent 90
years building a juggernaut in Asia (Exhibit 17). Hank Greenberg drove their
greatest growth periods over the past three decades. Their ultimate position
was shaped by a wide range of initiatives characterized by a broader and
deeper strategic footprint.
Exhibit 17
AIG’s growth in Asia has been largely organic over close to a century
1919 1931 1931 1933 1938 1947 1951
Cornelius Establishes Opens Enters Establishes Moves AIA founded

Vander Starr branch branch Malaysia office in home office in Indonesia
opens offices in office in Thailand to to Hong as it
agency in Hong Kong Singapore write life Kong becomes
Shanghai and general independent
1957 1970 1981 1981 1983 1987 2008 2010
Registered Incorpo- Enters Begins PT AIG Life Life First IPO: stock
in Brunei rated in Macau operations estab- operations interna- begins
Australia in New lished in launched tional trading in
Zealand Indonesia in Korea operator Hong
license in Kong
Malaysia
Source: Press search; company Web sites; McKinsey
Similarly, Prudential Plc achieved its success in Asia over a long period
(Exhibit 18). Today, Pru’s Asian operations account for the lion’s share of
its market cap.
In both cases, management invested for years before the capital markets
fully recognized the value of their franchises. Before the financial
meltdown, Prudential Plc and AIG traded at market-to-book ratios well in
excess of their global peers.
2. Build on strengths but be prepared to tailor

Building local strengths, whether product or distribution or systems, and
tailoring to local markets requires a delicate balance. Some companies that
tried to replicate their distribution at home by focusing on the mass affluent in
Exhibit 18
After steady growth until 1964, Prudential Plc expanded into Asian
insurance markets
Steady growth Big bang: First wave Big bang: Second wave
1923 1924 1931 1964 1994 1995 1996
First Prudential Prudential Prudential Regional HQ Life Life

overseas Assurance Assurance Assurance of Prudential operations operations
operations launched in launched in launched in Corp Asia launched in launched in
launched in Malaysia Singapore Hong Kong established Indonesia Philippines
Kolkata, in Hong and
India Kong Thailand
1999 1999 2000 2000 2001 2001 2006
Life Life Life joint Life joint Life Life Malaysian

operations operations venture with venture in operations operations TAKAFUL
launched in launched in CITIC in India launched in launched in industry
Taiwan Vietnam mainland Korea Japan
China
Source: Press search; company Web sites; McKinsey
developing markets found that their highly trained agents were poached. Some
built models from scratch and found them copied quickly, since they did not
incorporate difficult-to-replicate sources of competitive advantage.
Understanding the lasting sources of competitive advantage is critical.
3. Lead with local talent

Seasoned local talent is in scarce supply simply because domestic companies
are relatively young and have not yet built the technical skills that are well
established in their Western peers. Meanwhile, attracting strong talent to work
in a developing market is difficult and expensive. Waiting until your company is
large enough to afford “A” players is natural, but winners in foreign markets
have consistently invested in attracting the best local talent.
4. Acquisitions can play a critical role in entering a market or accelerating

development
Acquiring a strong operating company in a developing market is invariably
expensive and turns on a bet that the acquirer will be able to add sufficient
value to earn back the premium or that the acquired will do it on its own.
MetLife took another approach in its acquisition of ALICO. The core

business is in the mature Japanese market, but ALICO has a significant
number of strong positions in developing markets to provide a strong
jumping-off position there.
In either targeted acquisitions in a single developing market or broadly

based acquisitions as in the case of ALICO, the clear advantage of
acquisitions is the accelerated timetable it offers and the direct control
that is not available through JVs. That said, history has shown that a
minority of acquisitions across all markets are accretive to the acquirer
and that attractive acquisition candidates in developing countries are
relatively scarce. In other words, M&A is not a certain recipe for success,
but for those who get it right, the upside is substantial.
5. Joint ventures can work but significant homework is required

The critical determinant of success in a JV is the alignment of interests. If one
partner is looking for short-term earnings and the other seeks longer-term
value creation, the JV is highly unlikely to be successful. Where both sides
agree on the long-term strategic model and on the role played by each partner,
the results can be outstanding. If the foreign player brings distinctive
intellectual property but does not protect itself, it may see the local partner
capture the value added once the IP has been transferred. Finally, most JVs
have a modest shelf life, with each party often choosing to go its own way
once the JV matures.
6. Invest boldly behind success and cut losses quickly

Winners abroad have been willing to invest boldly once a model has been
proven. AIA in Southeast Asia, Aflac in Japan and the Spanish insurer Mapfre
in Latin America each invested aggressively when its business model was
validated. Less well known are the companies that stayed with losing bets well
after the likely outcome was clear.
7. Build relationships with government institutions and regulatory bodies

Extrapolating from domestic experience, we know that governments and
regulators in developing markets play a critical role. AIG built its dominant
position throughout Asia by overinvesting in governmental relationships, which
helped it get a broad and unique license in China in 1992. This enabled AIG to
build a share in China that is now more than twice as large as the combined
share of the rest of the foreign players.
Understanding the overall context within a developing market is also

critical. China’s heavy reliance on exports meant becoming a full member
of the WTO was a top priority for the government, and its ability to open
the insurance market is one of its trump cards. Understanding how that
may affect CIRC, the Chinese insurance regulator, is critically important.

Likewise, the Indian government has a history of changing its position with
respect to foreign companies. Understanding that risk is essential before
making big bets in that country.
8. Get ahead of the curve for key global trends

While there is always uncertainty in developing markets about the speed and
direction of changes in product, channels and industry structure, getting ahead
of the curve creates first-mover advantages. In China, for example, the friends-
and-family distribution model and simple products geared to the mass market
will not appeal to the rapidly growing mass affluent market. Foreign players that
anticipate market developments are able to leverage their experience in
developed markets to leapfrog many of the large but less experienced
domestic players. Third-party advisory, worksite, internal-based and affinity
channels will all take hold in developing markets and create significantly longer-
term growth opportunities for companies that know how to get to market.
Similarly, variable, long-term care, health and disability products will build share
in the rapidly growing mass affluent markets. Finding the right entry vehicle and
getting the timing right will be critical, but as Prudential demonstrated in Japan,
the rewards can be huge.
* * *
In penetrating developing markets, each player’s path and time horizon will be
different, but many will find profitable growth there.
Conclusion: The Way Forward
The first four chapters lay out the case for the “what”
with a focus on taking risk and distribution skills to a
new level and staking out positions in the high-
potential segments: retirement, developing countries
and the middle market. Answering the “how” question
is a critical challenge that we would like to explore in
our concluding section.
In our experience working with companies that outperform the average, not
just in life insurance but across sectors, we have found three institutional skills
that help them navigate their journey to success: alignment, execution and
renewal (Exhibit 19).
Exhibit 19
Organizational health consists of 9 elements that can be grouped

in 3 clusters, all centered around leadership
Nine elements Three clusters
of organizational Alignment
health Are people at all levels
Direction
aligned around the
organization’s vision,
Coordina- strategy, culture and values?
Accoun- tion &
tability Control
Execution
How does the organization
External Leadership Innovation execute in accordance with its
orientation & Learning strategy? Can the organiza-
tion perform essential tasks
with its current capabilities
and motivation level?
Capabilities Motivation
Renewal
How does the organization
Culture
& Climate understand, interact, respond
and adapt to its situation and
external environment?
Source: McKinsey Organization Practice

Alignment
Given the magnitude of the changes many companies need to make, they should
begin with alignment at every level. Setting the direction and getting the board,
CEO and top management aligned is the easy part. What’s harder is achieving
alignment all the way down to front-line staff, with everyone understanding the
rationale for the new direction and their role in making it happen. Change is hard;
leaders need to set a tone of opportunity and excitement, not simply create
awareness and gain consent.
Execution
As the exhibit shows, execution is driven by a combination of strong capabilities,
clear accountability, coordination and control and, perhaps most important,
motivation. Capabilities are difficult to build. They require not only highly talented
people in critical roles but also capability-building programs that embrace adult
learning techniques and change mindsets and behaviors. Traditional training
programs can impart best practices intellectually, but they fall far short of what’s
required to capture hearts and minds and bring about the required changes at
multiple levels of the organization.
Renewal
Life would be far simpler if we could choose a destination, plot the course and
execute in a logical, sequential manner. But the economic environment,
competitors, consumers and regulators change in unpredictable ways. A successful
organization has to learn by constantly comparing what happened to what was
expected, and it must understand root causes and take corrective action. The more
change taking place, the more critical these renewal skills become.
* * *
In our analytical journey, we were surprised by several findings. The first was the
extent to which industry results have deteriorated in recent years—“the good old
days” of stable, attractive returns are gone. The second was the magnitude of the
differences in company performance and the fact that risk skills, broadly defined
to include product and investment, were the critical drivers of those performance
differences. Finally, we were struck by the magnitude of the market opportunities
in retirement, developing countries and the middle market.
Charting the course and setting the sails will be the easy part. Weathering the
storms while remaining committed to execution and continuing toward the
ultimate goals will separate the winners from the rest of the pack.
Contact
For more information about this report,
please contact:
Pete Walker
Director
(212) 446-8580
peter_walker@mckinsey.com
Vivek Agrawal
Principal
(212) 446-7159
vivek_agrawal@mckinsey.com
Guillaume de Gantès
Principal
(212) 446-8536
guillaume_de_gantes@mckinsey.com
Authors: Vivek Agrawal, Alex D’Amico, Guillaume de Gantès,

Prashant Gandhi, Chandresh Kothari, Hasan Malik, Aser Rodriguez,
Chad Slawner, Giambattista Taglioni and Pete Walker
Financial Services Practice
March 2013
Designed by Hudspith Design
Copyright © McKinsey & Company
www.mckinsey.com/clientservice/financial_services

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Financial Services Practice

The Life Journey:

A Changing World Is Challenging the U.S. Life 3

Risk Skills Drive Major Differences in Company 9

Powerful Forces at Work: A Challenging 19

Strategic Implications for Life Insurers 25

Conclusion: The Way Forward 51

A Changing World Is Challenging

The U.S. life insurance industry, in aggregate, has

The life insurance industry barely covers its cost of capital1

-2.1 -1.9 -1.9

What has changed? How did we get here?

Before 1985, the industry took a long-term economic view, focusing on

Meanwhile, more companies turned to third-party channels as they

Rising volatility has increased beta and the cost of equity

Average cost of equity

A challenged industry model

• The high cost of agent-based distribution. The cost of distribution has

The life industry has lost ground in financial services

Life insurers 40%

• The slow development of alternative distribution. Alternative channels,

• Employers’ reduction in group benefits. Group life, the traditional

• The absence of products that respond to changing consumer needs.

Risk Skills Drive Major Differences

Despite lackluster returns in the life industry as a whole,

Performance varies widely among the top 30 companies

Top quintile 10.1

2nd quintile 7.8

3rd quintile 6.4

4th quintile 4.4

-2.9 Bottom quintile

Note: Does not include AIG

Risk skills drive performance differences

Performance within lines drives differentiation

Source: A.M. Best; McKinsey

Looking at performance from this perspective, we see patterns emerge. Results

While investment performance was the second-largest driver of differences, the

Risk skills drive performance differences

Top quintile 10.1 3.2 0.4 0.9

2nd quintile 7.8 1.4 -0.9 2.0

3rd quintile 6.4 3.2 -0.5 -1.6

4th quintile 4.4 -1.7 0.8 0.3

-2.9 Bottom quintile -6.1 0.1 -1.7

The primary conclusion of this analysis—that performance in life insurance

Senior property and casualty (P&C) executives, in contrast, have always

Apples-to-apples performance metric

The mathematics of decomposing life insurer performance

Poolable risks have created the most value

Carriers have made most of their profits by managing poolable risks

Poolable Equity/fee Spread 2 Investment 3 Total

$108 $36 $28 $58 $230

$143 billion—while consuming less than half of the industry’s capital, or

Both fixed annuities/spread and variable annuities/equity have been

Career distribution has created more value

Career distribution creates more value than third party

Average growth 7.1%

Product returns for companies with career distribution are consistently

Group lines have delivered more than individual lines

Traditional individual life and health businesses have performed

The poor performance of annuities is even starker when compared with

Group lines have delivered more profit with less capital

Average capital and cumulative net income,

Capital allocation Contribution