Winds Of Change

These are challenging times for the insurance sector. As the ‘Credit Crunch’ tightens its grip and nerves begin to fray, there are likely to be higher numbers of claims and less new business. At the same time, a brace of new regulations challenges the way the industry operates. Even before the global crunch, ‘European Insurers were facing tougher times ahead: growth is slowing, earnings are declining and valuations have fallen.’ [1] Insurers find themselves operating in an increasingly competitive marketplace, with margins significantly narrowing. To remain profitable, insurers must improve efficiency, driving down their cost base at the same time as improving customer relationships. ‘The increasing competition and consolidation in the… industry is continuing to make product differentiation difficult, relegating insurance and other financial products to commodities often chosen on price alone.’ [2]

Technological changes also represent a major challenge- ‘much of the industry is technologically obsolete, even paper-based, which ties its hands when competing with new entrants into the business: better equipped banks and internet-based suppliers.’ [3] The future will almost certainly mean a move online, which requires a large initial investment, but reduces costs in the long run. Across Europe, sales online are growing ‘at a spectacular rate.’ [4] However, insurers have yet to witness a similar enthusiasm for online sales of their products. This must, and surely will, change. Also, as insurance companies interact with their customers relatively infrequently, the challenge is in making the most of these interactions- and as they increasingly move online, insurers will have to provide a personalised and high quality online experience which makes the customer feel valued and keeps them returning. Given the increasingly competitive marketplace and rising costs of acquiring customers, retaining profitable ones has perhaps never been so important.

Another major challenge to the sector at present is posed by significant regulatory changes. The UK already has perhaps the toughest regulations in the world. Indeed, a surfeit of regulation is identified as ‘the greatest risk facing the insurance industry’ [5] by the CSFI’s latest Banana Skins survey. And the FSA is due to reveal its Retail Distribution Review (RDR) before the end of the year, which will lead to some potentially very dramatic changes in the industry. Job losses and teething troubles are likely, as the role of those who sell insurance direct to the consumer is redefined, and the wider industry reacts to the stipulations of the RDR. Indeed, Andrew Strange (Policy Director of the Association of Independent Financial Advisers) has remarked that ‘The RDR is one of the biggest challenges our profession is currently facing.’ [6] The RDR is in part a reaction to the need for more regulation in the face of continuing bad press for PPI (insurance that covers someone in the event of illness, redundancy, etc to help meet their repayment responsibilities). PPI has long been seen as the cash cow of insurers. Will it cease to exist, at least in this profitable form? If so then the industry needs to find something to replace it.

Insurance is an increasingly competitive and complex marketplace. Over the past decade the market has exploded- more underwriters, more competition, more choice for consumers. This has led to increased innovation in service & products. Technology is playing an increasing part in this. Traditional methods of reaching customers and distributing products are changing. Mis-selling scandals, natural disasters and climate change, an ageing population, regulatory changes- all these factors make for challenging times for the insurance industry, which must constantly evolve as a result. And now as the economy slows many will cancel their non-compulsory policies. People are ready to cancel their life insurance before canceling their cable. This will be a big challenge for all providers- retaining, protecting and where needed replacing this income will be key. ‘The era of easy returns is over. Insurers are now competing in a much more challenging marketplace, and their valuations are reflecting that fact.’ [7]

The Retail Distribution Review (RDR)

Partially prompted by the ongoing bad press and mis-selling of PPI insurance, the FSA’s ongoing RDR is now set to publish its recommendations. As far back as 2005, the FSA called on firms to take urgent action to ensure their selling practices for PPI were in line with regulatory requirements, following a series of visits and mystery shops uncovering very poor selling practices and lack of proper compliance amongst a sample of firms. The RDR was launched in June 2006 as a response to recurrent problems in the market for the distribution of retail investment products. The review involves the FSA, industry, and consumer representatives working together. It incorporates the ‘Professionalism Group’, comprised of senior representatives from professional bodies and from the Financial Skills Council. The RDR aims to increase customer confidence in the market, so that customers will be more willing to engage with it more often.

The RDR will lead to new ways of thinking about how financial products are distributed in the UK, and is likely to initiate significant changes in the industry. In its RDR interim report of April 2008, the FSA sought to ‘make a simple distinction between sales and advice but suggested the term ‘Guided Sales’ could be used to cover the sale by firms of restricted financial products.’ [8] The concept of ‘Guided Sales’ is a process of educating the customer to the point where they can make an independent and informed choice of financial product, radically altering the current process. There would be a new distinction between ‘Sales’ and ‘Advice’ to enable this. The interim report set out a simple landscape for mapping retail distribution, based on 3 tenets:

1. Advice- There will be one type of adviser. ‘All advisers will be independent…, operating remuneration determined without product provider input and [the adviser will] recommend… products from across the whole market.’ [9]

2. Sales- These will be ‘strictly non-advised services. These services are intended to encourage higher levels of savings and protection so that the needs of more consumers are met.’ [10]

3. Money guidance- a newly proposed impartial information and guidance service, in partnership with HM Treasury.

The FSA’s interim report also unveiled 3 specific challenges to the industry:

1. A challenge to product providers to change their business models so they do not determine how much advisers are paid.

2. A challenge to the industry to develop and implement an agreed common framework for professional standards (for advisers).

3. A challenge to present propositions to the FSA for new sales services and to make the case for FSA action to help implement these ideas in a way that delivers outcomes for consumers.

This ‘simpler future landscape’ [11] has the ‘potential to deliver greater clarity for consumers and could lead to a material increase in the levels of consumer confidence in the advice sector’ [12], putting in place a clear distinction between ‘Advice’ and ‘Sales’. ‘Advice’ would be restricted to those who can meet a step change in standards and who are ‘acting as an agent of the customer.’ [13] Everything else would be ‘Sales’. ‘The only advice would be independent advice- again, simplifying the consumer’s view of the market, making it more intelligible and enabling customers to make independent but informed choices- a key point of the RDR.

This would also help achieve the stated aim of stopping product providers playing any part in the determination of advisers’ remuneration, ‘removing the potential for provider-led remuneration to result in bias.’ [14] Furthermore, the RDR’s separation of ‘Sales’ and ‘Advice’ means some significant changes in the way the products are distributed, not least for those advisers who currently play a combination Sales/Advice role in this space. Many will need to undergo further training and make a move into the ‘adviser’ space, others will find themselves classified as ‘sales’ or else forced out altogether.

Of course, all this is quite a challenge, and the FSA acknowledges that there will be ‘transitional issues’ [15], specifically around professional standards, remuneration, and business models. Some embrace the changes- a recent report by AT8 shows that many IT vendors have realised the potential opportunities awaiting and are already responding to the review, and ‘investing in enhancing their solutions to meet the needs of the post RDR world.’ [16] The survey showed 47% of IT vendors confirmed investing already in adapting and enhancing their solutions to meet these potential changes. 73% of vendors thought the RDR would positively impact the industry, benefiting the market and consumers.

Mark Thelwell, Director at AT8 Group commented, ‘The RDR proposals not only force existing distribution channels to review their business models and processes but also bring to the foreground new automated sales channels such as direct to consumer websites from existing providers, distributors, and new entrants.’ [17] This obviously presents a wealth of opportunity to IT suppliers, as it will mean large changes to the technology already in place. Focus Solutions CEO, Richard Stevenson, suggests that the ‘advice process is being turned on its head, with an adviser no longer providing an interrogation and analysis method, but instead giving a client the knowledge to make an informed choice.’ [18] The company is currently developing a variation of its Focus:360 software to meet the proposed guided sales model in the RDR. Fidelity is considering providing ‘Guided Sales’ tools for consumers wanting access to products. Opinion seems divided- some believe that ‘Guided Sales’ could help facilitate providers offering more products direct to consumers; some are more critical, suggesting the move will only confuse customers further.

Sacrificing the Cash Cow?

As has been previously noted, a principal reason for this increased regulation is the near-constant bad press and mis-selling of PPI. A spokesman for the Financial Ombudsman Service (FOS) said ‘PPI complaints have risen 10-fold in the past two years, and are now about 25% of all the complaints we get.’ [19] Consumer organisations (such as Which? and Citizens Advice) have criticised the insurance as ‘useless and little more than a profitable protection racket for the banking industry.’ [20] The FSA has already fined 11 financial organisations in the past two years for mis-selling PPI, as well as introducing tougher rules on how PPI could be sold earlier in 2008.

Providers are overcharging borrowers taking out PPI by over £1.4billion each year due to a lack of competition at point of sale and through the practice of selling PPI at the same time as selling a loan. This is likely to be banned as many customers felt that they would be refused their loan if they did not take out the insurance. An FSA mystery shopping exercise found providers still failing to fully explain flaws in the products. ‘According to Which?, the success rate for claims on PPI is a miserable 11% and most PPI holders would be better served spending their money on more comprehensive cover, such as income protection.’ [21] Doug Taylor of Which? has said that ‘Credit Card PPI is a modern day snake oil- it’s a useless product, expensive and poorly designed.’ [22] The FSA’s investigations identified a risk of inappropriate sales- a large proportion of firms surveyed failed to take reasonable steps to ensure customers did not buy policies on which they could not claim or which only provided very limited cover.

The FSA concluded that advice on PPI was likely to be poor, and there were inadequate controls in place for non-advised sales and provision of advice or information amounting to giving advice. They also identified that there was an over-reliance on documentation supplied to customers rather than explaining the product orally, and that the way that sales staff were incentivised encouraged mis-selling. In addition, training and competence of sales staff was not adequate. These findings led to a move to increase intervention into PPI sales.

Possible sanctions include financial penalties, stopping offending firms from selling PPI, and action against individuals. To try and combat the common situation that there is limited opportunity for customers to search for alternatives or switch products and that there is a considerable point of sales advantage for providers, the Competition Commission is also suggesting that PPI is not available at point of sale and distributors may have to wait up to 90 days to sell it on to their customer. It also recommends price caps on PPI and that all policies be renewed annually.

However, there would likely be big repercussions if PPI is stubbed out. David Willcock, heading up the Consumer Banking practice within Firstperson, notes that banks earn considerably more on the PPI than they do on the APR. If the new regulations prevent providers from selling the loan and the protection offer at the same time, ‘this will mean that banks would need to find millions of pounds of income to replace this. Replacing PPI with other GI products isn’t necessarily the answer, as they’d need to sell millions of policies to recoup the income.’ The Association of British Insurers says that the insurance industry has been working hard to improve sales of PPI, and in the current economic climate, it seems consumers will still buy PPI out of fear.

Supermarket banks are likely to be well placed- ‘they have an existing distribution network (stores) and don’t have the back books the banks have, and they aren’t as reliant on the income from PPI. Financial Services is only a suite of products they offer- they can afford to go more competitive on rate and compete with the high street banks’, David notes. In his view, next steps for the banking industry has to be ‘more customer segmentation- [the retail banks will focus on] two key levels. [Firstly]… customers who will buy from the bank because they trust the brand, don’t have time to shop around, and pay a slight premium so they can have peace of mind for when they need to make a claim. Secondly there are established customers who will have banked with them for years, they’ll take the branch manager’s recommendation and take the product (customer advocacy).’

The Road Ahead

To compete and survive, insurers need to reduce costs- and develop or migrate to lower-cost operating models. This would probably include an increase in online activity. Although this requires significant upfront costs and is complicated to implement, it should prove rewarding in the long term and increase efficiency. Whilst internet-based comparison sites such as Moneysupermarket.com are becoming ‘increasingly popular for cross-provider and cross-product research purposes’ [23], they do not appear to have boosted online sales so far. ‘The experience of many providers is that 80-100% of customers will research their products extensively via their websites, including quote generation, but revert to the telephone or an agent at point of sale.’ [24] The reason for this is that ‘advice remains central to the insurance sales process… and has become engrained in customers’ buying behaviour.’ [25] Perhaps this will shortly be forced to change. A key challenge for insurers will be in evolving the internet from ‘a complementary channel for customer communication and distribution’ [26] to a sales channel.

The internet cannot offer the specific and personalised advice that an actual person can- the challenge for providers is in overcoming their own reluctance to take this on, and develop more sophisticated online capabilities. The growth of success in the internet channel would likely further the decline of the role of the intermediary. This is another reason for the slow uptake of the internet as a sales platform, as advisors are reluctant to push customers in this direction. However, the internet has the potential to radically change existing distribution and communication methods, driving down costs and potentially reaching a wider market.

The fact that customers are sceptical about buying online because they feel the need to speak with someone before making their decision reinforces the impression that many lack confidence in their product knowledge and understanding. Customers are reluctant to buy these kinds of products online because they think they need advice.

The RDR’s aim to make the market more intelligible for the customer, and to boost their confidence in their own understanding, might have a knock-on effect of increasing online sales. Meanwhile, the draw to the online realm is inexorable. Consumer banks and general retailers have already made significant moves towards online sales and servicing, putting pressure on the insurance industry to follow. ‘Traditional distribution models are becoming uneconomic, thanks to fierce price competition and the mounting administrative burden of regulation.’ [27] Meanwhile, the benefits of online channels are obvious. Insurers have a clear choice- they can stick with the traditional model (which limits investment costs, but keeps distribution, servicing and cost communication costs high in comparison with online competitors), or they can develop an online model. If this becomes the norm, then the current role of intermediaries will diminish.

The successful firms will make strides into new, higher growth markets. In the ultra competitive environment they operate in, firms are unlikely to win new business market share from their competitors, except at woefully low margins. To survive, many insurers will have to find new markets- increasing their presence in Europe or perhaps even further afield, such as in India or Asia.

The FSA sees that as a result of the recommendations of the RDR there will be big changes within the sector. ‘Product providers may need to change their approach to compete for distribution more on the basis of quality and price of their products than currently, and this could significantly alter the design of their products.’ [28] As we await the final proposals of the RDR, it is clear that ‘whatever the eventual shape of the new regulation,… the relationship between manufacturer, distributor and consumer is about to change.’ [29] Clearly, interesting and challenging times lie ahead.

Gi Lewis

References

McManus, Richard and Helge Fredheim, “The End of the Golden Age: Rising to the Challenge”, in PA Perspective on European Insurance (PA Consulting Group, 2008), p2.
2 Unknown author, Enterprise Personalization for the Insurance Industry, (Exstream Software White Paper, 4/04), p.1 http://research.pcpro.co.uk/viewer/viewDocument.do?accedId=
8312209, accessed 16/10/08.
3 Unknown author, ‘Too Much Regulation’ Tops Insurance Risks, www.ukmediacentre.pwc.com/content/Detail.asp?ReleaseID=
2350&NewsAreaID=2, accessed 16/10/08.
4 Rumsey, Martin and Nina Korfu-Pedersen, “Unleashing the Internet: Follow the Customer”, in PA Perspective on European Insurance (PA Consulting Group, 2008), p.14.
5 ‘Too Much Regulation’ Tops Insurance Risks.
6 Andrew Strange, quoted in Westacott, Gemma, Aifa Hosts Web Chat on RDR, 26/9/08, www.ftadviser.com/FTAdviser/Advisers/Industry/TradeAssociations
/News/Article/20080926&5acfefo-8be5-11dd-649c-00144f2af8e8/Aifa-hosts-web-chat-on-RDR.jsp, accessed 16/10/08.
7 McManus and Fredheim, “The End of the Golden Age”, p.4.
8 Lander, Edward, Old Mutual Attacks FSA on ‘Guided’ Sales as Skandia Sales Fall, 8/5/08, www.citywire.co.uk/adviser/-/news/market-and-shares/content.aspx?ID=302750&page=2, accessed 16/10/08.
9 Unknown author, Retail Distribution Review- Interim Report, (FSA, 2008), p.2.
10 Ibid.
11 Ibid., p.3.
12 Ibid.
13 Ibid., p.8.
14 Ibid., p.17.
15 Ibid., p.26.
16 Unknown author, Technology Vendors Rise to the Retail Distribution Review Challenge (Press Release, 1/10/08), www.bobsguide.com/guide/news/2008/Oct/1/Technology_
vendors_rise_to_the_Retail_Distribution_Review_challenge.html, accessed 16/10/08.
17 Mark Thelwell, quoted in Technology Vendors Rise to the Retail Distribution Review Challenge
18 Unknown author, Focus Develops ‘Guided Sales’ Software, 3/10/08, http://www.ifaonline.co.uk/public/showPage.html?page=ifa2006_
articleimport&tempPageName=818238, accessed 16/10/08.
19 Quoted in Pollock, Ian, PPI Sales Face New Restrictions, 10/09/08, http://news.bbc.co.uk/go/pr/fr/-/1//hi/business/7608056.stm, accessed 16/10/08.
20 Ibid.
21 Montia, Gill, “PPI Successful Claim Rate A Miserable 11%”, Insurance Daily, 22/09/08, www.insurancedaily.co.uk/2008/09/22/ppi-successful-claim-rate-a-miserable-11/, accessed 16/10/08.
22 Unknown author, PPI Still Mis-Sold, Says Which?, 09/09/08, http://news.bbc.co.uk/go/pr/fr/-/1/hi/business/7606249.stm, accessed 16/10/08.
23 Rumsey and Korfu-Pedersen, “Unleashing the Internet”, p.14-15.
24 Ibid., p.14.
25 Ibid., p.15.
26 Ibid.
27 Ibid., p.16.
28 Unknown author, Retail Distribution Review- Interim Report, p.12.
29 Unknown author, www.altus.co.uk/consultancy/themes/rdr, accessed 17/10/08.