Tag Archives: IFRS

Modernizing Insurance Accounting — Finally!

Modernization of insurance accounting is finally here. The FASB issued its final guidance on enhanced disclosures for short duration contracts in May 2015 and published an exposure draft in September 2016 on targeted improvements to the accounting for long-duration contracts.

After literally decades of deliberations, the IASB has completed its most recent exposure draft and plans to issue a final comprehensive accounting standard in the first half of 2017. Moreover, additional changes in the statutory accounting for most life insurance contracts are coming into effect; a company can elect to have Principles Based Reserving (PBR) effective on new business as early as Jan. 1, 2017. Companies have three years to prepare for PBR, with all new business issued in 2020 required to be valued using PBR.

The impact of these regulatory changes is likely to be significant to financial reporting, operations and the business overall. Instead of approaching accounting modernization as a compliance exercise, companies instead should view the changes holistically, with an understanding that there will be impacts to systems, processes, profit profiles, capital, pricing and risk. Planning effectively and building a case for change can create efficiencies and enhanced capabilities that benefit the business more broadly.

Financial reporting modernization will affect the entire organization, not just the finance and actuarial functions. Operations and systems; risk management; product development, marketing and distribution; and even HR will need to change.

FASB’s Targeted Changes

In May 2015, the FASB issued Accounting Standards Update (ASU) 2015-09, Disclosures about Short-Duration Contracts.

Rather than changing the existing recognition and measurement guidance in U.S. GAAP for short-duration contracts, the FASB responded to views from financial statement users by requiring enhanced disclosures for the liability for unpaid claims and claims adjustment expenses. The disclosures include annual disaggregated incurred and paid claims development tables that need not exceed ten years, claims counts and incurred but not reported claim liabilities for each accident year included within the incurred claim development tables, and interim (as well as year-end) roll forwards of claim liabilities.

The enhanced disclosures will be effective for public business entities for annual reporting periods beginning after Dec. 15, 2015 (i.e., 2016 for calendar year end entities) and interim reporting periods thereafter. The new disclosures may require the accumulation and reporting of new and different groupings of claims data by insurers from what is currently captured for U.S. statutory and other reporting purposes. Public companies are currently preparing now by making changes to existing processes and systems and performing dry runs of their processes to produce these disclosures. Non-public business entities will have a one-year deferral to allow additional time for preparation.

See also: Who Is Innovating in Financial Services?  

In September 2016, the FASB issued a proposed ASU on targeted improvements to the accounting for long-duration contracts. Proposed revisions include requiring the updating of cash flow assumptions and use of a high-quality fixed-income discount rate that maximizes the use of market observable inputs in calculating various insurance liabilities, simplifying the deferred acquisition costs amortization model and requiring certain insurance guarantees with capital market risk to be reported at fair value. The FASB also proposed enhanced disclosures, which include disaggregated roll forwards of certain asset and liability balances, additional information about risk management and significant estimates, input, judgments and assumptions used to measure various liabilities and to amortize deferred acquisition costs (“DAC”). No effective date was proposed, and transition approaches were provided with the recognition that full retrospective application may be impracticable.

IASB to issue a new comprehensive standard

The IASB’s journey to a final, comprehensive insurance contracts standard is nearly complete. After reviewing feedback from field testing by selected companies in targeted areas, the IASB completed its deliberations in November 2016.

The IASB staff is proceeding with drafting IFRS 17 (previously referred to as IFRS 4 Phase II) with a proposed effective date of Jan. 1, 2021. Three measurement models are provided for in the standard: 1) Building Block Approach (“BBA”); 2) Premium Allocation Approach (“PAA”); and 3) the Variable Fee Approach (“VFA”).

The default model for all insurance contracts is the BBA and is based on a discounted cash flow model with a risk adjustment and deferral of up-front profits through the Contractual Service Margin (CSM). This is a current value model in which changes in the initial building blocks are treated in different ways in the P&L. Changes in the cash flows and risk adjustment related to future services are recognized by adjusting the CSM, whereas those related to past and current services flow to the P&L. The CSM amortization pattern is based on the passage of time and drives the profit recognition profile. The effect of changes in discount rates can either be recognized in other comprehensive income (OCI) or P&L.

The IASB has also allowed for the use of the PAA for qualifying short-term contracts, or those typically written by property and casualty insurers. This approach is similar to an unearned premium accounting for unexpired risks with certain differences such as deferred acquisition costs offsetting the liability for remaining coverage rather than being reflected as an asset. The claims liability, or liability for incurred claims, is measured using the BBA without a CSM.

Discounting of this liability for incurred claims would be required, except where a practical expedient applies for contracts in which claims are settled in one year or less from the incurred date. Similar to the BBA model, the effect of changes in discount rates can either be recognized in other comprehensive income (“OCI”) or the P&L.

The VFA is intended to be applied to qualifying participating contracts. This model was subject to extensive deliberations, considering the prevalence of such features in business issued by European insurers. This model recognizes a linkage of the insurer’s liability to underlying items where the policyholders are paid a substantial share of the returns, and a substantial proportion of the cash flows vary with underlying items. The VFA is the BBA model but with notable differences in treatment including the changes in the insurer’s share of assets being recognized in the CSM, accretion of interest on CSM at current rates, and P&L movements in liabilities mirroring the treatment on underlying assets with differences in OCI, if such an option is elected.

The income statement will be transformed significantly. Rather than being based on premium due or received, insurance contract revenue will be derived based on expected benefits and expenses, allocation of DAC and release of the CSM and risk adjustment. The insurance contracts standard also requires substantial disclosures, including disaggregated roll forwards of certain insurance contract assets and liability balances.

Forming a holistic strategy and plan to address accounting changes will promote effective compliance, reduce cost and disruption, and increase operational efficiency, as well as help insurers create more timely, relevant, and reliable management information.

Statutory accounting: The move to principles-based reserving

The recently adopted Principles-Based Reserving (“PBR”) is a major shift in the calculation of statutory life insurance policy reserves and will have far-reaching business implications. The former formulaic approach to determining policy reserves is being replaced by an approach that more closely reflects the risks of products. Adoption is permitted as early as 2017 with a three-year transition window. Management must indicate to their regulator if they plan on adopting PBR before 2020.

PBR’s primary objective is to have reserves that properly reflect the financial risks, benefits and guarantees associated with policies and also reflect a company’s own experience for assumptions such as mortality, lapses and expenses. The reserves would also be determined assessing the impact under a variety of future economic scenarios.

PBR reserves can require as many as three different calculations based on the risk profile of the products and supporting assets. Companies will hold the highest of the reserve using a formula-based net premium reserve and two principle-based reserves – a Stochastic Reserve (SR) based on many scenarios and a Deterministic Reserve (DR) based on a single baseline scenario. The assumptions underlying principles-based reserves will be updated for changes in the economic environment, for changes in company experience and for changes in margins to reflect the changing nature of the risks. A provision called the “Exclusion Tests” allows companies the option of not calculating the stochastic or deterministic reserves if the appropriate exclusion test is passed. Reserves under PBR may increase or decrease depending on the risks inherent in the products.

PBR requirements call for explicit governance over the processes for experience studies, model inputs and outputs and model development, changes and validation. In addition, regulators will be looking to perform a more holistic review of the reserves. Therefore, and as we noted in the 2015 edition of this publication, it is critical that:

  • The PBR reserve process is auditable, including the setting of margins and assumptions, performing exclusion tests, sensitivity testing, computation of the reserves and disclosures;
  • Controls and governance are in place and documented, including assumption oversight, model validation and model risk controls; and
  • Experience studies are conducted with appropriate frequency and a structure for sharing results with regulators is developed.

PBR will introduce volatility to life statutory reserving, causing additional volatility in statutory earnings. Planning functions will be stressed to be able to forecast the impact of PBR over their planning horizons because three different reserve calculations will need to be forecast.

There is no “one size fits all” approach to addressing the FASB’s and IASB’s changes. Each company will likely be starting from a different place and may have different goals for a future state.

Implications

A company’s approach to addressing these changes can vary depending on a variety of factors, such as the current maturity level of its IT architecture and structure, potential impact of proposed changes on earnings emergence and regulatory capital and current and planned IT and actuarial modernization initiatives. In other words, there is no “one size fits all” approach to addressing these changes.

Each company likely will be starting from a different place and may have different goals for a future state. A company should invest the time to develop a strategic plan to address these changes with a solid understanding of the relevant factors, including similarities and differences between the changes. In doing so, companies should keep in mind the following potential implications:

Accounting & Financial Reporting

  • Where accounting options or interpretations exist, companies should thoroughly evaluate the implications of such decisions from a financial, operational and business perspective. Modeling can be particularly useful in making informed decisions, identifying pros and cons and facilitating decisions.
  • Financial statement presentation, particularly in IFRS 17, could change significantly. Proper planning and evaluation of requirements, presentation options, granularity of financial statement line items and industry views will be essential in building a new view of an insurer’s financial statements.
  • Financial statement disclosures could increase significantly. Requirements such as disaggregated roll forwards could result in companies reflecting financial statement disclosures, investor supplements and other external communications at lower levels than previously provided.
  • Change is not limited to insurance accounting. Other areas of accounting change include financial instruments, leasing and revenue recognition. For example, the impact of changes in financial instruments accounting will be important in evaluating decisions made for the liability side of the balance sheet.

See also: The Defining Issue for Financial Markets  

Operational

  • Inherent in each of these accounting changes is a company’s ability to produce cash flow models and use data that is well-controlled. Companies should consider performing a current state assessment of their capabilities and leverage, to the extent possible, infrastructure developed to comply with other regulatory changes such as Solvency II and ORSA and identify where enhancements or new technology is needed.
  • Given the increased demands on technology, computing and data resources that will be required, legacy processes and systems will not likely be sufficient to address pending regulatory and reporting changes. However, this creates an opportunity for these accounting changes to possibly be a catalyst for finance and actuarial modernization initiatives that did not historically have sufficient business cases and appetite internally for support.
  • As these accounting changes are generally based on the use of current assumptions, there will be an increased emphasis on the ability to efficiently and effectively evaluate historical experience on products by establishing new or enhancing existing processes. Strong governance over experience studies, inputs, models, outputs and processes will be essential.
  • As complexity increases with the implementation of these accounting changes, the impact on human resources could be significant. Depending on how many bases of accounting a company is required to produce, separate teams with the requisite skill sets may be necessary to produce, analyze and report the results. Even where separate teams are not needed, the close process will place additional demands on existing staff given the complexity of the new requirements and impact to existing processes. Companies may want to consider a re-design of their close process, depending on the extent of the impacts.

Business

  • Product pricing could be affected as companies consider the financial impacts of these accounting changes on profit emergence, capital and other internal pricing metrics. For instance, the disconnect of asset yields from discounting used in liabilities under U.S. GAAP and IFRS could result in a different profit emergence or potentially create scenarios where losses exist at issuance.
  • Companies may make different decisions on asset and liability matching or choose to hedge risk on products differently. Analysis should be performed to understand changes in the measurement approach with respect to discount rates and financial impacts of guarantees such that an appropriate strategy can be developed.
  • The move to accounting models where both policyholder behavior and market-based assumptions are updated more frequently will likely result in greater volatility in earnings. Management reporting, key performance indicators, non- GAAP measures, financial statement presentation and disclosure and investor materials will need to be revisited such that an appropriate management and financial statement user view can be developed.
  • The impact from a human resources perspective should not be underestimated. Performance-based employee compensation plans that are tied to financial metrics will likely need to change. Employees will also need to receive effective training on the new accounting standards, processes and systems that will be put in place.

Forming a holistic strategy and plan to address these changes will promote effective compliance, reduce cost and disruption and increase operational efficiency, as well as help insurers create more timely, relevant and reliable management information. Given the pervasive impact of these changes, it is important that companies put in place an effective governance structure to help them manage change and set guiding principles for projects. For example, this involves the development of steering committees, work streams and a project management office at the corporate and business group level that can effectively communicate information, navigate difficult decisions, resolve issues and ensure progress is on track.

Each company has a unique culture and structure, therefore governance will need to be developed with that in mind to ensure it works for your organization. Companies that do not plan effectively and establish effective governance structures are likely to struggle with subpar operating models, higher capital costs, compliance challenges and overall lack of competitiveness.

Possibilities for Non-Traditional M&A

2015 was a record year for announced insurance deals, as long-anticipated industry consolidation finally started to occur. Several factors have driven consolidation, notably slow economic growth and persistently low interest rates, both of which have limited opportunities for organic growth and forced insurers to reconsider their long-term competitive strategies. Combined with record levels of corporate capital and private equity funding, these pressures have created the perfect opportunity for both buyers and sellers.

Historically, regulatory or financial pressures have driven insurance carve-outs. [An insurance carve-out is a transaction in which a seller divests part of its business (e.g., a particular customer group, product line or geographic area) rather than an acquirer buying the entire enterprise. The seller typically benefits from exiting sub-scale or unprofitable lines, while the acquirer is able to increase scale or geographic reach.] These pressures typically have included repayment of emergency funding received during the financial crisis, fulfillment of regulatory conditions for receiving state aid, divestment to free up capital and improve solvency ratios in preparation for Solvency II, or the shoring up of capital via asset sales following losses.

In recent years, we have seen the industry move away from complex multi-line business models. Insurers are exiting sub-scale business lines to improve returns and compete in an environment in which technology is disrupting tradition business drivers. There are many insurers considering carve-out transactions or IPOs as sellers, and there are even more looking to build market share by acquiring and consolidating businesses with their existing operations.

See also: Insurance M&A Stays Active in 2016  

However, insurance carve-outs tend to be more complex in both transaction structure and post-merger integration than an acquisition of an entire insurance enterprise, and require careful planning and execution to successfully separate the acquired business (“SpinCo”) from its former parent (“RemainCo”).

What should executives be aware of when they consider these types of transactions?

  • Planning and Organization
    • Confidentiality, maintaining optionality and speed of execution are critical to maximizing deal value.
    • The flexibility to execute deals via alternative structures (described below) helps maintain optionality. In addition, a thorough understanding of the M&A landscape is necessary for sellers to run a competitive sales process and for buyers to understand how to properly position themselves for success.
    • To facilitate speed of execution, executives need to simultaneously focus on multiple priorities, including deal execution, separation planning and negotiation of transitional service agreements (TSAs). Leading practices include having a transaction committee that can rapidly make decisions and a project office that guides the planning effort.
  • Transaction Structures
    • Acquisitions of an entire insurance enterprise typically involve the purchase of all of a holding company’s issued stock. The holding company, its subsidiary legal entities, assets and liabilities, products and licenses, people, technology and infrastructure transfer to the control of the acquirer at close. A carve-out requires a different approach. It is rare that the business being sold is fully contained within a single subsidiary legal entity. More frequently, the business being disposed of is written across numerous legal entities and is mingled with business that is core to, and remains with, the vendor. Therefore, carve-outs typically use a mix of strategies to separate the insurance business of SpinCo from RemainCo:
    • Renewal rights – The acquirer receives an option or obligation to renew the acquired business in its own legal entities.
    • Reinsurance – Renewal rights may be accompanied by reinsurance transferring the economics of the historical book either to the acquirer, to other entities owned by the vendor or to a third party.
    • Fronting – Certain domiciles, such as Japan and the U.S., require regulatory authorization of products or rates prior to their availability to policyholders, and such product approval frequently takes longer than regulatory approval for a change of control. When an acquirer doesn’t have regulatory approval to immediately write the business in its own legal entities, the transaction structure typically allows an acquirer to:
      • Continue to issue and renew policies using the vendor’s legal entities for a defined period of time, and
      • Assume the economics of the business via reinsurance. The acquirer frequently is responsible for administering the business (which is still the legal and regulatory responsibility of the vendor’s legal entities) via a servicing agreement.
    • Stock transactions – These are used when assets and liabilities can be segregated into legal entities (e.g. using the European Economic Area’s (EEA) insurance business transfer mechanisms), or when a legal entity, such as a specialist underwriting agency, specifically supports the business being sold.
      • Transfer of assets and contracts/TSAs – Just as the insurance business being sold may be diffused across the vendor’s legal entities, the same may also apply to the people, facilities, technology and contracts with sellers that support the business. While a certain portion of these will clearly align either to SpinCo (and will transfer at close) or RemainCo, there will be a significant subset (particularly in IT and corporate services) that support both and are not easily divisible. For such functions where SpinCo is heavily reliant on the resources of its former parent and it is not possible for the acquirer to fully replace such services prior to the transaction closing, a TSA provides the acquirer and SpinCo with continuing access to and support from RemainCo’s resources after close.

Negotiating the TSA

TSAs provide access to the resources and infrastructure of the former parent for a defined period. While in certain simpler transactions, TSAs can be for as little as three months and require only that the support provided previously be maintained at the same service levels and at the same cost basis, it is more common that acquirer and vendor during the months prior to close:

  • Understand and define the reliance of the business being sold on its parent (and vice versa);
  • Set the duration post-close for each service required under the TSA;
  • Agree on the charging basis e.g. fixed monthly fee, usage, hourly rates (for tax efficiency, each service is usually priced individually);
  • Establish service levels and post-close governance processes.

The acquirer should set realistic timeframes for exiting from individual services. The complexity of insurance policy administration systems, the frequent integration of certain capabilities (such as billing, commissions, and contact centers) across products and the need to separate networks, migrate data centers and implement replacement mainframes frequently require TSAs of 24 to 36 months.

TSAs also may cover centrally provided non-IT services, including HR/payroll/benefits administration, facilities management, procurement, compliance or financial and management and regulatory reporting. However, the duration of these TSAs tend to be shorter – usually a few months, or sufficient to support regulatory and financial reporting for the period following close.

Ideally, the acquirer should seek as much flexibility as possible with the duration of the TSA. It should have the right to terminate the TSA early, the option to extend it at pre-agreed rates and the inclusion of force majeure clauses (a natural catastrophe can significantly affect exiting from a TSA).

Contract assignment and access to shared reinsurance

An area of often-underestimated complexity in carve-outs is the need to ensure that the separated business can continue to receive the benefit of third-party contracts with suppliers, distributors and reinsurers. In most jurisdictions, contracts cannot simply be novated (the insurance business transfer mechanisms of the EEA provide certain exceptions), but instead each contract must be evaluated to determine if assignment simply requires notification to the counterparty or its express consent.

The challenges that arise in contract transfer are both:

  • Logistical – 85% of counterparties contacted typically respond at first instance. However, a recent carve-out had more than 50,000 contracts that needed to be assessed, prioritized and migrated. In this instance, chasing down the remaining 15% was a real challenge.
  • Commercial – Certain experienced counterparties, knowing the tight timeframe for most transactions, may try to renegotiate better terms either prior to the contract being assigned to the acquirer, or prior to permitting the vendor to use the contract to provide services under the TSA.

Also important in a carve-out is a clear apportionment of access to historic reinsurance programs shared between the vendor’s continuing business and the business being sold, as well as definition of the resolution process for any post-close disputes.

Executing close

Transaction close for virtually all insurance carve-outs is triggered by the receipt of one or more regulatory consents enabling the execution of fronting, reinsurance and stock transfer agreements.

When migrating staff and assets supporting SpinCo to the acquirer, supporting staff and assets are moved into a legal entity, the ownership of which transfers at close in certain cases. However, when the relevant staff are not employed or supporting assets are not owned by legal entities transferring to the acquirer at close, there will need to be arrangements for the valuation and transfer of both tangible and intangible assets (e.g. trademarks) and the offering of employment and enrollment in benefits to selected staff by the acquirer. This is a significant logistical exercise for an HR function.

See also: Group Insurance: On the Path to Maturity  

Insurance carve-outs are also particularly challenging for finance functions:

  • The combination of renewal, reinsurance and legal entity acquisition in the transaction structure complicates accounting immediately post-close.
  • Cross-border acquisitions can include acquirers and sellers with different accounting standards (e.g. IFRS, U.S. GAAP, statutory and JGAAP) that often have very different rules on the treatment of assets and liabilities.
  • The practice of closing at a month or quarter end – which in some ways can simplify the transition – may also introduce a tight and immovable timeframe for external financial and regulatory reporting.

Lastly, although there typically will be several months between the deal being agreed upon and the close, this may not be sufficient time – particularly in larger acquisitions across multiple locations – to roll out the acquirer’s networks and desktop technology prior to close. Therefore, full access to the acquirer’s IT capabilities may need to wait until later in the integration.

Post carve-out integration

While an acquisition of an entire enterprise provides a pre-existing governance structure, an insurance carve-out typically includes fewer members of senior management and requires rapid integration of functional management within the acquirer’s existing structure, the expansion of governance and compliance structures to include the acquired operations and the establishment and communication of delegations of authority and decision-making rights.

Due diligence should have provided the acquirer with initial hypotheses as to the organizational capabilities required by the combined organization, interim and end-state operating models, and opportunities for synergies.

As with any insurance acquisition, synergies in carve outs are typically realized through:

  • Functional consolidation.
  • Platform consolidation and process standardization, which enhances productivity and enables staffing efficiencies.
  • Facilities and infrastructure reduction, and
  • Reduced costs through more efficient third-party vendor selection.

PwC’s research indicates that the most successful acquisitions are those that develop momentum by demonstrating tangible integration benefits in the first 100 days. Accordingly, the acquirer should act fast but should also be prepared to revisit pre-deal assumptions and revise its integration roadmap as the two organizations integrate and new information becomes available.

Conclusion

Based on what we see in the market, notably a recent succession of P&C and reinsurance megadeals, we predict that insurance industry consolidation will continue apace. Multi-line insurers have divested themselves of numerous franchises and this trend seems likely to continue. Because these types of transactions are complex and depend on many internal and external factors, companies that are considering such moves will need to be aware of and address the many challenges and issues we describe above.

This article was written by John Marra, Mark Shepherd, Michael Mariani, and Tucker Matheson.

trends

13 Emerging Trends for Insurance in 2016

Where does the time go?  It seems as if we were just ringing in 2015, and now we’re well into 2016. As time goes by, life changes, and the insurance industry—sometimes at a glacial pace—does, indeed, change, as well. Here’s my outlook for 2016 on various insurance topics:

  1. Increased insurance literacy: Through initiatives like The Insurance Consumer Bill of Rights and increased resources, consumers and agents are both able to know their rights when it comes to insurance and can better manage their insurance portfolios.
  2. Interest rates: The federal funds target rate increase that was announced recently will have a yet-to-be determined impact on long-term interest rates. According to Fitch Ratings, further rate increases’ impact on credit fundamentals and the longer end of the yield curve has yet to be determined. Insurance companies are hoping for higher long-term rates as investment strategies are liability-driven. (Read more on the FitchRatings website here). Here is what this means: There will not necessarily be a positive impact for insurance policy-holders (at least in the near future). Insurance companies have, for a long period, been subsidizing guarantees on certain products or trying to minimize the impact of low interest rates on policy performance. In the interim, many insurance companies have changed their asset allocation strategies by mostly diversifying their portfolios beyond their traditional holdings—cash and investment-grade corporate bonds—by investing in illiquid assets to increase returns. The long-term impact on product pricing and features is unknown, and will depend on further increases in both short- and long-term interest rates and whether they continue to rise in predictable fashion or take an unexpected turn for which insurers are ill-prepared.
  3. Increased cost of insurance (COI) on universal life insurance policies: Several companies—including Voya Financial (formerly ING), AXA and Transamerica—are raising mortality costs on in-force universal life insurance policies. Some of the increases are substantial, but, so far, there has been an impact on a relatively small number of policyholders. That may change if we stay in a relatively low-interest-rate environment and more life insurance companies follow suit. Here is what this means: As companies have been subsidizing guaranteed interest rates (and dividend scales) that are higher than what the companies are currently (and have been) earning over the last few years, it is likely that this trend will continue.
  4. Increasing number of unexpected life insurance policy lapses and premium increases: For the most part, life insurance companies do not readily provide the impact of the two prior factors I listed when it regards cash value life insurance policies (whole life, universal life, indexed life, variable life, etc). In fact, this information is often hidden. And this information will soon be harder to get; Transamerica is moving to only provide in-force illustrations based on guarantees, rather than current projections. Here is what this means: It will become more challenging to see how a policy is performing in a current or projected environment. At some point, regulators or legislators will need to step in, but it may be too late. Monitor your policy, and download a free life insurance annual review guide from the Insurance Literacy Institute (here).
  5. Increased complexity: Insurance policies will continue to become more complex and will continue their movement away from being risk protection/leverage products to being complex financial products with a multitude of variables. This complexity is arising with products that combine long-term care insurance and life insurance (or annuities), with multiple riders on all lines of insurance coverage and with harder-to-define risks — even adding an indexed rider to a whole life policy (Guardian Life). Here is what this means: The more variables that are added to the mix, the greater the chance that there will be unexpected results and that these policies will be even more challenging to analyze.
  6. Pricing incentives: Life insurance and health insurance companies are offering discounts for employees who participate in wellness programs and for individuals who commit to tracking their activity through technology such as Fitbit. In auto insurance, there can be an increase in discounts for safe driving, low mileage, etc. Here is what this means: Insurance companies will continue to implement different technologies to provide more flexible pricing; the challenge will be in comparing policies. The best thing an insurance consumer can do is to increase her insurance literacy. Visit the resources section on our site to learn more.
  7. Health insurance and PPACA/Obamacare: The enrollment of individuals who were uninsured before the passage of Obamacare has been substantial and has resulted in significant changes, especially because everyone has the opportunity to get insurance—whether or not they have current health issues. And who, at some point, has not experienced a health issue? Here is what this means: Overall, PPACA is working, though it is clearly experiencing implementation issues, including the well-publicized technology snafus with enrollment through the federal exchange and the striking number of state insurance exchanges. And there will be continued challenges or efforts to overturn it in the House and the Senate. (The 62nd attempt to overturn PPACA was just rejected by President Obama.) The next election cycle may very well determine the permanency of PPACA. The efforts to overturn it are shameful and are a waste of time and money.
  8. Long-term care insurance: Rates for in-force policies have increased and will almost certainly face future increases—older policies are still priced lower than what a current policy would cost. This is because of many factors, including the prolonged low-interest-rate environment, lower-than-expected lapse ratios, higher-than-expected claims ratios and incredibly poor initial product designs (such as unlimited benefits on a product where there was minimal if any claims history). These are the “visible” rate increases. If you have a long-term care insurance policy with a mutual insurance company where the premium is subsidized by dividends, you may not have noticed or been informed of reduced dividends (a hidden rate increase). Here is what this means: Insurance companies, like any other business, need to be profitable to stay in business and to pay claims. In most states, increases in long-term care insurance premiums have to be approved by that state’s insurance commissioner. When faced with a rate increase, policyholders will need to consider if their benefit mix makes sense and fits within their budget. And, when faced with such a rate increase, there is the option to reduce the benefit period, reduce the benefit and oftentimes change the inflation rider or increase the waiting period. More companies are offering hybrid insurance policies, which I strongly recommend staying away from. If carriers cannot price the stand-alone product correctly, what leads us to believe they can price a combined product better?
  9. Sharing economy and services: These two are going to continue to pose challenges in the homeowners insurance and auto insurance marketplaces for the insurance companies and for policy owners. There is a question of when is there actually coverage in place and which policy it is under. There are some model regulations coming out from a few state insurance companies, however, they’re just getting started. Here is what this means: If you are using Uber, Lyft, Airbnb or a similar service on either side of the transaction, be sure to check your insurance policy to see when you are covered and what you are covered for. There are significant gaps in most current policies. Insurance companies have not caught up to the sharing economy, and it will take them some time to do so.
  10. Loyalty tax: Regulators are looking at banning auto and homeowners insurance companies from raising premiums for clients who maintain coverage with them for long periods. Here is what this means: Depending on your current auto and homeowners policies, you may see a reduction in premiums. It is recommended that, in any circumstance, you should review your coverage to ensure that it is competitive and meets your needs.
  11. Insurance fraud: This will continue, which increases premiums for the rest of us. The Coalition Against Insurance Fraud released its 2015 Hall of Shame (here). Insurance departments, multiple agencies and non-profits are investigating and taking action against those who commit elder financial abuse. Here is what this means: The more knowledgeable that consumers, professional agents and advisers become, the more we can protect our families and ourselves.
  12. Uncertain economic and regulatory conditions: Insurance companies are operating in an environment fraught with potential changes, such as in interest rates (discussed above); proposed tax code revisions; international regulators who are moving ahead with further development of Solvency II; and IFRS, NAIC and state insurance departments that are adjusting risk-based capital charges and will react to the first year of ORSA implementation. And then there is the Department of Labor’s evaluation of fiduciary responsibility rules that are expected to take effect this year. Here is what this means: There will be a myriad of potential outcomes, so be sure to continue to monitor your insurance policy portfolio and stay in touch with the Insurance Literacy Institute. Part of the DOL ruling would result in changes to the definition of “conflict of interest” and possibly compensation disclosure.
  13. Death master settlements: Multiple life insurance companies have reached settlements on this issue. Created by the Social Security Administration, the Death Master File database provides insurers with the names of deceased people with Social Security numbers. It is a useful tool for insurers to identify policyholders whose beneficiaries have not filed claims—most frequently because they were unaware the deceased had a policy naming them as a beneficiary. Until recently, most insurers only used the database to identify deceased annuity holders so they could stop making annuity payments, not to identify deceased policyholders so they can pay life insurance benefits. Life insurers that represent more than 73% of the market have agreed to reform their practices and search for deceased policyholders so they can pay benefits to their beneficiaries. A national investigation by state insurance commissioners led to life insurers returning more than $1 billion to beneficiaries nationwide. The National Association of Insurance Commissioners is currently drafting a model law  that would require all life insurers to use the Death Master File database to facilitate payment of benefits to their beneficiaries. To learn more, visit our resources section here. Here is what this means: Insurance companies will not be able to have their cake and eat it too.

What Can You Do?

The Insurance Consumer Bill of Rights directly addresses the issues discussed in this article.

Increase your insurance literacy by supporting the Insurance Literacy Institute and signing the Insurance Consumer Bill of Rights Petition. An updated and expanded version will be released shortly  that is designed to assist insurance policyholders, agents and third party advisers.

Sign the Insurance Consumer Bill of Rights Petition 

What’s on your mind for 2016? Let me know. And, if you have a tip to add to the coming Top 100 Insurance Tips, please share it with me.

Life-Annuity Insurers: Outlook for 2016

U.S. life-annuity insurers will enter 2016 in relatively good financial condition but facing exponential changes from rapid advances in technology, rising customer expectations and growing competition. These market shifts will require insurers to reinvent their strategies, services and processes, while coping with nagging financial, economic and regulatory uncertainty. Fortunately, after years of bolstering their balance sheets, life-annuity firms are in a strong position to invest in the innovations and technologies needed to fuel future growth.

Growing customer expectations

Digital technology will continue to transform the life-annuity industry in the coming year. From anytime, any-device digital delivery to customized services, today’s diverse insurance customers will demand flexible solutions that go beyond one-size-fits-all product offerings. To take advantage of these trends, insurers will need to adopt a customer-centric approach that relies on deeper relationships, more personalized advice and more rigorous information. At the same time, life-annuity insurers must integrate emerging distribution technologies to reach customers through multiple channels, all without disrupting traditional distribution.

Millennials and mass-affluent consumers, in particular, are seeking the latest digital tools, such as on-demand insurance apps and robo-advisers for automated, algorithm-based financial advice. Meanwhile, insurers are establishing omni-channel platforms to reach and service customers more effectively and exploring the use of wearables and health monitors for usage-based life insurance. Advanced analytics, such as predictive models, combined with cloud and on-demand technologies, will provide insurers with the instruments to re-engineer front and back offices.

To fast-track digital transformation, insurers are turning to partnerships and acquisitions. For example, in 2015, Northwestern Mutual purchased online planner LearnVest to provide more customized support to customers. Other insurance firms, such as Transamerica and Mass Mutual, have set up venture capital firms to invest in digital service providers.

But digital innovation also carries greater risks. Digital technologies make insurers more vulnerable to financial fraud, data theft and political activism. Privacy breaches are becoming a bigger concern as insurers gain wider access to sensitive financial and health data. Even the use of social media is exposing firms to risks from reputational damage.

Competitive pressures are building

As digital technology becomes more pervasive, insurers will face greater competition from new digital start-ups. Although much of the recent innovation in financial services has occurred in the banking and payments sector, insurance is now squarely in the cross-hairs of new digital providers. One example is PolicyGenius, which is offering digital platforms to help consumers shop for insurance. With the recent launch of Google Compare, the rise of InsuranceTech will gain momentum in 2016.

But competition will also come from existing insurers leveraging new digital solutions and business models. For example, John Hancock recently launched Protection UL with Vitality, which rewards life-insurance policyholders for health-related activities monitored through personalized devices. In 2016, more insurance stalwarts will jump on the digital bandwagon through new product development, acquisitions and alliances. At the same time, changing insurance attitudes and practices among Millennials will spread to other age groups. Insurance firms reluctant to embrace innovations for fear of cannibalizing their own market space may be overtaken by more nimble firms able to capitalize on a shifting insurance landscape.

Uncertain economic and regulatory conditions

Life-annuity insurers are operating in a tenuous economic and financial environment with sizable downside risk. In 2016, global economic weakness will continue to be a worry, particularly as emerging market growth decelerates, financial volatility escalates and the U.S. economy muddles through a presidential election year. Regulatory and monetary tinkering will further complicate macro conditions.

The political landscape is likely to remain gridlocked at the federal and state levels as the election cycle concludes. Tax policies are unlikely to change in 2016, but insurers should prepare for new post-election regulatory headwinds in 2017. Insurers should also stay on top of the Department of Labor’s evaluation of fiduciary responsibility rules, which will remain a disruptive force in 2016.

Regulations originally designed for other industries and jurisdictions are being extended into the U.S. insurance market. International regulators are moving ahead with further development of Solvency II and IFRS. The NAIC and state insurance departments are adjusting risk-based capital charges and will react to the first year of ORSA implementation.

Mixed impact on life-annuity insurers

Premiums will grow moderately in 2016. Individual life premium growth will be particularly sluggish, as consumers remain focused on retirement savings. Faced with equity market volatility, consumers will continue to invest in fixed and indexed annuities and avoid variable annuities.

To cope with torpid market conditions, insurers will focus on growing premium and investment income, managing risks and controlling costs. Companies will continue to identify opportunities to improve return on equity through active balance sheet and back-book management. Among the strategies are investments in organic and inorganic growth, seeking reinsurance and capital market capacity and returning excess capital to shareholders. M&A activity will likely accelerate in 2016 as Asian insurers and private equity firms continue their interest in U.S. insurance companies.

Margin compression will dictate sustained emphasis on cost management through centralized control, technology upgrades and better integration of business units. With mission-critical information becoming more accessible, data-driven business decisions are moving to the C-suite. At the same time, regulatory demands and business imperatives are elevating risk management responsibility to the C-suite and board.

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STAYING IN FRONT OF CHANGE: PRIORITIES FOR 2016

In 2016, life-annuity insurers will need to take decisive measures to cope with market upheavals – or risk the consequences. By staying in front of change, insurers can strengthen customer relationships, build market share and gain competitive advantage. Tapping their strong capital positions, insurers will invest in new technologies, systems and people that will allow them to capture their future.

Specifically, leading insurers will focus on the following pathway to change:

1. Pick up the pace of business transformation and innovation

Time to reboot

The life and annuity industry has never been considered highly innovative or nimble. But the convergence of technological, regulatory and customer trends is creating a perfect storm, with the power to upend the industry. EY’s 2015 Retail Life and Annuity Survey of senior executives identified the need to embrace new market realities in 2016, highlighting innovation as a top strategic priority. To cope, industry leaders must act now to rethink their business approach:

Priorities for 2016

Create a company-wide culture of innovation. To foster transformation, insurers will need to break away from their conservative leanings, and create a culture that encourages new thinking. Such a culture should allow for greater experimentation, and even short-term failures, to achieve long-term success. Senior leaders through to middle-managers should champion change and avoid the danger of the status quo.

Drive innovation through cross-functional teams. In 2016, life and annuity insurers will need to cut across organizational silos to drive innovation. Establishing cross-functional teams of sales, underwriting and policy administration can lead to new ideas
that enrich the customer and distributor experience. Similarly, a cross-functional team of actuarial, finance and risk management can help build consensus around new analytical and risk approaches.

Share information openly. Overcoming departmental silos will not be easy. Executives should ensure that information-sharing occurs at the right time and that teams are working from the same set of high-quality data. To avoid time-consuming reconciliations, managers will want to address data discrepancies across business units. Using skilled program managers to track progress against timelines and budgets can help.

2. Reinvent products and services for the new digital consumer

Addressing ever-rising customer expectations

In 2016, life insurance and annuity products will need to come to grips with tectonic shifts in consumer expectations and behaviors. Driven by their experiences in other industries, customers will demand greater digital access, better information and quicker service. Failure to respond will make it difficult for insurers to acquire and retain customers. Fast-moving insurers are redefining their customer relationships and products and services to cope with these new market dynamics.

Priorities for 2016

Offer anytime, anywhere, any-device access. Banks now provide customers with unprecedented 24/7 access and self-service on multiple devices, from PCs to smartphones. In 2016, life insurance customers will expect a similar anytime, any-device experience from insurers from point of sale and throughout the relationship.

Provide greater transparency to customers. In today’s digital world, customers expect clearer product information and pricing transparency. To respond, insurers should reduce the complexity and definitional rigidity of current life insurance products, while providing a more streamlined and transparent issuance process.

Deliver more flexible solutions. Insurers will need to emphasize product flexibility to cost-conscious customers and offer hybrid products that combine income protection, such as long-term care and disability insurance, with life and retirement coverage. For high-net-worth customers, insurers should stress the tax advantages of life insurance and annuities and develop features to compete with alternative investment products.

Build continuing engagement with customers. The life and annuity industry has long suffered from “low engagement” with customers following the initial sale. More customer engagement will minimize the risk of customer indifference and potential disintermediation. Developing an integrated, personalized digital experience that leverages the latest mobile and video technology will be a key to success.

Move toward a service orientation. To differentiate themselves, insurers will want to shift from a product placement to a trusted adviser approach. With established personal relationships in place, and access to more flexible products and services, new sales will occur more naturally in response to customer needs.

3. Adjust distribution strategies for technological and regulatory shifts

The rise of omni-channel distribution

Technological and regulatory changes are prompting life and annuity insurers to think beyond traditional distributors. For example, robo-advisers, growing in popularity in the wealth industry, could offer insurers a way to reach the underserved mass-affluent market. Yet, unlike property and casualty carriers, life and annuity insurers have made little progress in selling through digital channels. Looking ahead to 2016, life and annuity insurers may find themselves losing market share if they fail to adapt to an omni-channel world.

Priorities for 2016

Prepare for new fiduciary standards. In 2016, the Department of Labor’s proposed fiduciary rule could upend existing distribution models. The rule strengthens consumer protection, constrains distributors and alters compensation for advisers providing retirement advice. Similar changes in the UK widened the gap in personal financial guidance between wealthy and mid-market customers – a potential impact in the U.S. The ability to recommend specific products may become more difficult, creating a ripple effect on retirement sales and advice.

Adapt services for new distribution models. Insurance firms, particularly those focusing on retirement services, will find themselves under pressure to transform their distribution platforms. In 2016, insurers should consider developing products for an “adviser-less” distribution model that delivers financial and product information directly to consumers through digital platforms. Insurers will need to adjust compensation systems to meet new fiduciary requirements, while maintaining existing distributor relationships.

Explore the use of robo-advisers. Robo-advisers represent a new self-service channel aimed particularly at younger, tech- focused consumers. In 2016, insurers will need to consider the best way to incorporate robo-advisers into their current distribution platforms-through internal development, partnership or acquisition. To help make that decision, insurers should ask themselves: Would the robo-adviser be a new distribution channel, a supporting tool for current distributors or some combination of the two approaches? Insurers will need to evaluate the costs and potential impact of integrating systems to improve sales and service. And with regulations in flux, firms will want to give compliance and suitability careful attention.

4. Reengineer processes to drive efficiency and market growth

Building operational agility

Changing customer expectations are opening up new opportunities for life-annuity insurers to grow their business through innovative products, solutions and go-to-market strategies that focus on the customer experience. However, existing process silos and legacy systems can restrict operational flexibility, so insurers may need to focus on reengineering processes and systems in the year ahead.

Priorities for 2016

Determine if your systems are ready for rapid market change. Today’s assembly line approach to policy quoting, issuance and administration can slow application turnaround and detract from the customer and distributor experience. Once a policy is issued, legacy administrative systems can limit the ability of customers and distributors to access current account information, especially policy values, and to self-service their accounts. This problem can be exacerbated as customers purchase additional products from the insurer, particularly if those purchases are on different platforms.

Ensure that your systems can stand up to new regulatory rigors. Policy issuance and administration are not the only areas affected by process silos and legacy systems. Regulatory changes and risk management imperatives are putting pressure on finance to improve the quality and speed of reporting, as well as the use of advanced analytics for predicting and stress testing trends. As companies expand into new geographic markets and lines of business, the complexity of reporting and analyzing data is multiplied. A review of your systems through a regulatory lens could be helpful.

Invest in next-generation processes and analytics. Recognizing the importance of operational excellence to future strategies, insurers will continue to invest in straight-through-processing in 2016 to speed application turnaround times. They will also use more advanced analytics to enable underwriters to minimize the amount of required medical data, slash decision- making time and improve accuracy. Data consolidation projects will remain a high priority for many IT departments.

Revamp IT systems built for simpler times. During 2016, insurers will need to improve and replace IT systems that have reached the end of their useful life and are no longer fit for purpose. Unlike past investment cycles in IT systems, when one generation of hardware replaced another, the emergence of cloud technologies and on-demand solutions create new flexible options that can be implemented more quickly.

Consider partnerships that will facilitate transformation. To support critical business data processes, life-annuity insurers should explore creating strategic alliances with outside specialists. Insurers have already worked on consolidating legacy information systems and integrating data from around the firm, which will facilitate their transition to cloud and on-demand platforms. However, management must clearly understand the auditing, control and business risks of taking that leap.

5. Bring in the right talent to lead innovation

A growing talent gap

Life and annuity insurers are finding that driving innovation will take fresh ideas and new talent. As they age, distribution teams are falling out of sync with emerging consumer demographics.

The result: Life insurance and annuity sales to younger generations are declining, a trend that will only build momentum over time. In 2016, insurers will want to meet this challenge head-on by developing initiatives to attract young, diverse workers.

Priorities for 2016

Take concrete actions to compete for talent. The talent shortage affects every layer of the organization, from gaps in senior executive roles to deficiencies in technical skills. At the same time, the industry’s image as staid and risk-averse often does not appeal to the brightest and most promising young people, who view fast-growing technology companies as their employers of choice. Insurers will need to compete fiercely for the talent required to build the next-generation insurance company.

Go beyond image-building to attract fresh blood. Executives recognize that simply burnishing the industry’s image will not be enough to draw in new talent, such as data scientists and digital experience designers. In 2016, insurers need to offer greater flexibility in work locations, find creative ways to motivate and reward employees and fine-tune talent management programs.

Make diversity a strategic imperative. Workforce diversity is more than a compliance exercise; it offers a powerful way to achieve key strategic objectives. An employee base that reflects the customer universe is better-equipped to respond to changing customer needs. Diverse teams make better decisions by avoiding groupthink. In 2016, life and annuity insurers will broaden their efforts to attract a workforce representing a mix of cultural, demographic and psychographic backgrounds.

6. Put cybersecurity high on the corporate agenda

Escalating cyber risks

Leveraging social media, the cloud and other digital technologies will expose life and annuity insurers to greater cyber risks in 2016. These risks can run the gamut from financial fraud and corporate terrorism to privacy breaches and reputational damage. To protect their businesses and their clients, insurers will need to take strong measures to keep their technical platforms air-tight.

Priorities for 2016

Make cybersecurity a priority. Inadequate cybersecurity can cause a serious financial, legal and reputational fallout. In today’s digital age, hacking often involves organized crime looking to steal data and trade secrets for financial gain. Cyber attacks can also be politically motivated to disrupt organizations. Whatever the motive, insurers will want to ensure that growing digital connections between their systems and outside parties are well-protected.

Take a broad view of the potential risks. Cybersecurity is not the only data-related risk for insurers to consider. Privacy issues surrounding consumer and distributor information are a mounting area of concern, especially as insurers use that data in product pricing, underwriting and target marketing. In addition, social media can make insurers vulnerable to reputational risks – in real time.

Safeguard customer data from misuse. Although consumers have grown accustomed to providing personal information to third parties, there is still uneasiness over usage, especially when it involves sensitive consumer medical and financial information. Insurance firms, particularly those with a global client base, need to stay abreast of emerging privacy regulations that could affect the use of digital technology and analytics. Crucially, insurers must invest in internal firewalls that protect personal data from misuse.

Assess your exposure to data sovereignty risks. As insurers move toward cloud computing and on-demand solutions, issues surrounding data sovereignty are becoming more complex. In a hyperconnected world – where a U.S. insurer might partner with a Dutch firm using a data service in India – the concept of data residing in one jurisdiction is difficult to apply. To cope, insurers will want to set up processes to monitor changing data regulations around the world and their impact on their businesses.

This piece was written by Doug French and Mike Hughes. For the full white paper, click here.