Life Insurance to See Material Shifts
The life insurance industry, both on the distribution side as well as on the underwriting side, is expected to go through some material shifts in the next 10 years, according to Ramnath Balasubramanian, a senior partner at McKinsey.
We asked Balasubramanian and his colleague, Mckinsey partner Matthew Scally to dive further into what those shifts may be as part of our discussion with them on private equity’s role in insurance industry M&A.
Balasubramanian: With interest rates at the level they are, with business models being significantly pressured, with profit pools shifting from more traditional life insurance products to more fee based—just given the pressure on the economics and emergence of new types of players bringing more digitally oriented models—the industry is going through a lot of change.
There are a few areas which we think are ripe in terms of digitization and leveraging analytics across the value chain. Distribution is clearly one. We think that for certain categories of products like simple term life or critical illness type of accident and health products, there is merit in some part of the purchasing journey shifting online, and you’ve seen that happen over the last few years. But even there, we think there’s going to be an evolution between a pure end-to-end digital journey. Even if you go into some of these digital platforms, you still have the option of calling up someone on the phone. So we think digital hybrid is actually going to be a model which a lot of these digital disruptors will need to put in place.
I think the bigger opportunity we see is in terms of digitally enabling your physical distribution. We believe very strongly in the value of face-to-face physical distribution, but the physical distribution of the future will look very different. It will be a lot more digitally enabled. It will be a lot more analytically driven in terms of how agents are supported when it comes to lead generation, prospect identification, and financial planning, so that we can have holistic conversations with the client.
Balasubramanian: The underwriting space is ripe for disruption. There’s been a lot which has been happening over the last decade. People have experimented around the edges in terms of substituting fluid data for underwriting with external data sources. People have used, for example, electronic medical records, they’ve used driving records, prescription information which is de-identified. What we’re now seeing is the next evolution of that.
How are we going beyond what we would call the standard non-traditional data sources to some of the non-standard, non-traditional data? For example, there’s a bunch of data out there in terms of your behavior patterns, in terms of a shopping pattern, in terms of your lifestyle. How do you bring all that together to create artificial intelligence-driven underwriting approaches, which are able to identify and segregate out risks, but do that in an ethical manner, and then use it to augment your underwriting decisions? We think that’s the game. And you know, we’re probably in the first or second inning of the journey in terms of really shifting the arc of these non-traditional data sources.
Balasubramanian: We think that’s a very significant trend. And we will see an acceleration of that trend in the coming years. To put it in context, life insurance as a category is already a fairly significant pool of capital, when it comes to a lot of these alternative asset managers. Even though a small fraction of life insurance general account assets is actually invested in alternative investment at this point in time, just given their sheer size, it’s still an important source of funds. Today, in the U.S. alone, there’s close to $2 trillion of liabilities in reserves of life insurance products, as well as what we would call spread-based annuities, which are all sitting in the general accounts of insurers. The proportion of that which is invested in alternatives is extremely low single digits. A lot of assets continue to be invested in common securities and corporate bonds. On the other hand, on the asset side, there’s been a kind of continuous decline in terms of yield, and therefore, how do you continue to generate the yield to be able to meet the obligations on your liability? So a lot of this has been driven by mismatch in terms of assets and liabilities in the industry. So that’s a little bit of the size of the opportunity.
We’re seeing a lot of private equity firms move toward life insurance. They call it a permanent capital source because life insurance offers the ability to actually originate assets. Because of the business model, where they are essentially selling life insurance and annuities to their clients, and then doing that on a daily basis, there is almost a high degree of confidence and certainty in terms of every year, the amount of assets is actually originating. This is not just about the stock of assets, but this is actually around the flow, in terms of what you’re actually originating. And the reason private equity firms find that attractive is because this is one of the few pools of capital which has the characteristics of being “permanent capital” because it’s a pool, which continuously replenishes every year.
And so you’ve seen the trend now—look at the top 10 private equity firms—where a majority of them have what we would call fairly significant permanent capital vehicles, through insurance. The one you mentioned, obviously, is the most prominent of them, but if you look at the remaining top five or six players, each of them has an insurance vehicle. Depending on the firm, anywhere between 10% to up to 40% of the overall AUM [assets under management] of the private equity firm is contributed through this permanent capital vehicle through insurance. And, you know, for the folks who are at the lower end of the range, they have significant aspirations in some ways.
Balasubramanian: In addition to being a source of capital, on a standalone basis, investing in life insurance balance sheets is now starting to be a fairly attractive investment opportunity. For people who do it well, it can generate anywhere between 12% to 15% IRR, through a combination of levers. One is, you have the opportunity to actually reorient your assets investing strategy, so you’re acquiring some of these books of business, you’re changing over the asset model from being more traditional plain vanilla to actually taking on more alternatives, so you’re getting an investment spread, a significant expense efficiency, which you can drive.
We’ve seen situations where you can try probably 30% to 40% expenses efficiencies, actually acquiring these books by just managing them better, leveraging technology and AI. And then there are also efficiencies you can drive when it comes to the capital side.
Scally: The investment ownership of these permanent capital sources is going to drive additional investment at scale in the insurance industry. The dollars that are coming into the permanent capital sources are AUM that could be distributed across financial services, healthcare, AI, renewables, energy, whatever it may be. These are attractive pools of capital for the PE fund. And the reason is, if you look at how a private equity fund operates, they’re in the business of raising and deploying capital, and when they deploy it, [they] build the businesses around it and then exit it. And if you look at where something could go wrong, in any of that chain, raising is one, right?
Private equity firms continue to grow and they’re out in the market every two or three years trying to acquire, raise that capital from limited partners they eventually deploy. The more of that you can source from a renewable or permanent vehicle like life insurance and other insurance policies provide, the less you need to raise and the less variability in that raise on an annual basis. And that’s a very important point that Ramnath mentioned. There’s a reason why a lot of the listed PE firms have done this. It’s because when you evaluate them, you can have lumpy returns at times between their investments, but you also have less certainty in the ability to continue to raise. And if you can take some of the uncertainty away from the street and point to the fact that you have permanent AUM or at least long-standing AUM to invest, it increases the value of you as an investor and a business builder.