Capital strength is vital in protection and should determine which insurer advisers choose, argues Stuart Lawson. Yet the market may be heading for a period of instability
Why is a protection insurer like a teabag? Because it's only when they get into hot water that you find out how strong they are.
The joke may be stolen but the sentiment is worth considering.
For an adviser, placing protection policies is much riskier than most insurance; it relies on the longevity and stability of the insurer. Selecting the wrong one could leave clients with future problems in relation to claims and servicing of their policy.
The high-profile issues with Northern Rock in the early part of this year were headline news and the stability of financial institutions is now at the forefront of consumer minds. Confidence was knocked, highlighting the importance of financial strength to the public. As a result, it is increasingly important for consumers to be able to trust the strength of the financial institutions they are dealing deal with.
Long-term relationships
Protection covers are usually taken out over a long term, often to cover a mortgage for 25 years or more. This means the customer needs to be confident that the insurer is going to be around when they come to make a claim, even if it is a couple of decades down the road.
This puts protection in a different class than products such as car or house cover. With these policies, renewed every year, the customer can simply take out a policy with a different provider if the insurer withdraws from the market.
With a protection product the consequences can be far more serious. If the customer's insurance company leaves the protection arena, their policies will probably be transferred to a closed book specialist or run as a closed book.
A closed book business is not trying to attract new business so, as a result, it may not have the same emphasis on customer satisfaction and servicing offered by a provider continuing to sell new business.
A key aspect of running a closed book business will be to extract the maximum value from the policies in force. The provider no longer has to worry about maintaining a long-term adviser brand, and may not have the same concerns around maintaining a consumer brand with its current policyholders.
As a result, it could boost profits by choosing to pay claims by the letter of the law rather than by a claims philosophy focused on promoting a good brand image. This could mean that fewer claims get paid, more are paid on a proportionate basis or the amounts of the proportionate payment go down. All of this is bad news for policyholders. Consumers give providers their money for peace of mind that, should the worst happen, their financial circumstances will be protected. Consumers do not want an increased likelihood that a claim could be contested.
Reinsurance is also a key driver in claims payments. Reinsurers can be liable for as much as 90% of a claim amount. As a result, they will influence product providers with regard to how claims are settled and may put pressure on providers to decline claims. Once again, capital strength has an influence over this.
A strong provider may not need to reinsure as much as a weaker provider, so they have more autonomy over claims decisions. If a provider is able to build international relationships with insurers rather than national, they have access to better deals and a stronger negotiating position for how claims are settled.
If a provider is strong enough to remain selling new business, the reinsurer is more likely to be working hard to keep them happy as the reinsurer will be interested in winning the rights to reinsure future new business. Again, this helps the provider to negotiate how claims are settled.
If an insurer offloads its policies there is no ongoing ability to invest in and continue to develop the proposition, meaning it can become difficult and expensive to amend the client's policy. Consumer protection needs can change over time, so the ability to amend cover is an important one.
A similar situation applies if the insurer is bought out by another one. The current claims philosophy, servicing and so forth, is exchanged for that of the new provider. This could be significantly worse for the client.
The worst-case scenario of an insurance company moving out of the protection market 10 years down the line is that the client is unable to amend their cover and needs a new policy. Over this period, the client will have got older, so purchasing new cover is likely to be more expensive.
In addition, it is likely that during that decade the customer will have had various visits to their doctor, some of which could lead to them having to pay higher premiums or even being declined cover. This could leave the client in the position where they cannot amend their existing cover get a new policy.
There is also a risk that they will forget to disclose important information on their application, because they have many more years of medical detail to remember, possibly affecting any subsequent claim.
Finally, even if a closed book provider allows cover to be amended, the price of the new cover may well be inflated in relation to market leaders. The provider is no longer under economic pressure to offer competitive premium rates. Many providers market guaranteed insurability options. These options may become near worthless if the premium required to effect new cover is greatly inflated.
A pretty penny
Protection is a capital intense business to write. For every £1m of business written, the firm needs around £2.5m to fund it. The high costs are driven by a number of factors including distribution costs and the high underwriting costs associated with protection. Examining medical information and processing general practitioner reports requires time and expertise, and significantly bumps up overheads.
Providers also need to hold extra capital to meet the solvency requirements of the FSA.
In addition, staying in the market can be expensive. The market is not stationary but is constantly evolving. An example is the huge amount spent on developing e-commerce systems over the past few years. As a result, providers need to have sufficient strength to be able to afford the development funding. To run out of development funding almost certainly means that the provider would need to withdraw from the market in the long term.
Therefore capital strength is required to remain in the protection market. A key measure of financial strength is the credit rating issued by agencies such as Moody's, Fitch and Standard & Poor's.
Equitable Life is a perfect example - it was in the top two of the market, but its downfall was a lack of capital strength that would have allowed them to weather harder times.
In the UK, the market may well be heading into a period of consolidation, with smaller and weaker providers being bought out by the larger and stronger ones. New business volumes are likely to come under pressure during the current housing market downturn. Some providers will be hit hard by the fall in profits and may decide it best for their shareholders to withdraw or merge with another provider.
Foreign shores
As the UK economy continues to slow down, it is vital to look at a provider's global strength. If the worst does happen and a recession takes hold here, a provider that is internationally strong should remain stable in many other countries and therefore be able to endure a slump in one country. On the other hand, a provider that is only linked to one country bears the full brunt of its economic conditions, and may be more likely to pull out of the market during a decline.
While price may be an immediate indication of the suitability of a policy for a customer, this is no help if the provider is not around when the client needs to make a claim in a decade or two.
Advisers need to take account of capital strength to ensure their clients can have confidence and peace of mind over the level of service and claims paying philosophy of their protection provider for the entirety of the product term, not just at the point of purchase.
Stuart Lawson is protection marketing manager at Axa.
