DISTRIBUTION STRATEGIES IN BANCASSURANCE

Colm Fagan, Managing Director, Life Strategies Presented to the Cologne Re International Seminar, 15 November 1995

Introduction
Good afternoon ladies and gentlemen. At the outset, I feel that an apology is in order for my inability to speak to you in the language of our host nation for this conference. Rest assured however that I do not propose to make my presentation in Irish, the native language of my own country! Let us agree on English as a reasonable compromise. Lothar Butz tells me that I am the only consultant who has been invited to speak at this seminar. In deciding to limit consultant participation, Lothar must believe in the adage that a consultant is someone who can tell you a thousand ways to make love but knows no women. I shall refrain from commenting on my knowledge either of women or of ways to make love! I suspect that the real reason Lothar asked me to speak here today is because of my seven years' experience at Director level in a leading bancassurer and my 25 plus years' experience in this industry, as a technical actuary, a pension consultant, and as a life company executive. I hope to share with you some of the lessons I have learned in that time. Because of my actuarial background (we all have our crosses to bear in life!), you may be expecting a technical, numerical presentation. You will be relieved to hear that I intend to keep statistics to a minimum. I propose instead to focus on some of the key strategic issues facing the bancassurance industry at this critical stage in its development.

Structure of presentation
My presentation is in two parts. The first part provides an overview of the standard bancassurance distribution model and analyses its strengths and weaknesses. The second part examines bancassurers' attempts to diversify their distribution channels and comments briefly on the factors that will separate winners from losers in future. Winners make it happen; losers let it happen. In the time available it will only be possible to touch on some of the key issues. I hope however to leave you with something of value, something that you can take back with you and that will help to improve your own organisation's performance.

PART I - THE STANDARD DISTRIBUTION MODEL

In summary, the conclusion from the first part of my presentation is that the standard distribution model for bancassurance in the UK and Ireland proved very successful in the early stages. It enabled banks and building societies to generate early profits. Much of that early success lacked durability, however, and most companies are now reassessing their entire strategies for this business. Success sprang initially from unlocking the distribution potential of bank branches. It came from the realisation that two very distinct activities are involved in the sale of a life assurance or pensions policy. One is the initial identification of potential clients. The second is actually sitting down in front of the client and completing the sale. Typically in the life assurance industry, one person is asked to do both jobs. One of the industry's axioms is that a salesman spends 80% of his time prospecting and only 20% selling.

Bancassurers' initial success rested primarily on giving branch employees of the bank responsibility for generating quality referrals. This allowed the insurance and pensions consultant to concentrate on selling. Bankers were not expected to understand the life assurance industry: they simply had to identify customers with potential needs for the industry's products. This separation of prospecting and sales roles led to productivity levels for bancassurance consultants up to four or five times the norm for the life assurance industry. Needless to say, the bank felt that it rather than the individual sales person was entitled to the rewards from the superior productivity. Salespersons' earnings in bancassurance are above the industry average - but not that much above it! Those additional margins to the bank can be significant. I estimate that up to 60% of total expense margins in the first 10 years for a block of business sold through traditional channels are earmarked for distribution costs. A distributor capable of achieving the levels of efficiency described above can make serious money.

Formula for early success

The initial success formula was almost embarrassingly simple. Bancassurers sold much the same products as everyone else. The products were primarily unit-linked under which the customer rather than the insurer bears the investment risk. The bancassurers did not try to offer better value products than others available on the market - for the simple reason that, because of the complexity of life insurance product designs in Britain and Ireland, people would not recognise a better value product even if it stood up and danced a jig for them! So, industry-standard products, involving low risk (to the insurer), combined with average prices and efficient distribution, led inevitably to low entry costs and early profits. Simple, isn't it?

So the theory goes, anyway.

And the theory proved true in practice - for a time at least. NatWest Life, started only in 1993, reached number 14 in the list of the UK's top 20 insurers (as measured by new business) within 12 months of its launch, capturing 1.9% of the market. By way of comparison, the top two players, Standard Life and Prudential, had market shares of 9.4% and 8.2% respectively. Bank of Ireland's Lifetime Assurance, the company of which I was Finance and Corporate Development Director, generated pre-tax profits of &163;17 million on share capital of just £7 million in 1989, two years after its launch. Lifetime's main bancassurance competitor in the Irish market, AIB's Ark Life, was only formed in 1991. It published embedded value profits of &163;10.5 million in 1993. Even more impressive was the fact that, in the same year, the company generated statutory surplus of &163;4 million. It is unheard of for life assurance companies to spew out capital so soon after their launch. Ark Life's ability to generate a statutory surplus so soon illustrates the capital efficiency of the product design.

Storm clouds gather

But behind the success stories, all was not well. Some branch staff and customers became disenchanted with the front-end charges and investment volatility of unitlinked products. It is easy to understand bank employees' disillusionment when we remember that some of them spent half of their working lives defending paltry interest rates on the grounds that "But your money is safe with us". Now, they had to face the unpalatable fact that customers' capital was not sacrosanct. Their money was not safe. Another portend of difficult times ahead was the occasional outbreak of hostilities between salaried bankers and their insurance colleagues who depended on sales bonuses for a high proportion of their total income.

A third problem lurking beneath the seemingly smooth surface of bancassurance - and of the life assurance industry in general - was the legacy of past mis-selling. The UK debacle on pension opt-outs and transfers affected bancassurers less than it affected mainstream insurers. The same cannot be said of mortgage endowments which can rarely be justified on the grounds of best advice. Yet, in their heyday, more than 80% of UK mortgages were written on a endowment basis. I believe that the critical illness (also known as dread disease) market has similar potential to explode in future, for reasons that I am happy to explore in discussion. Bancassurers write an inordinately high proportion of this business. The last item on my list of issues threatening the heady rise of the bancassurers is the collapse of the mortgage market. Most UK bancassurers rely (or more correctly, used to rely) on this market for the bulk of their business. The collapse in the mortgage market caused a triple whammy: first was the volume reduction, second was the reduction in average case size and third was a reduction in the proportion of new mortgages written on an endowment basis: the endowment proportion of new mortgages fell from 84% in 1988 to circa 50% at the present time. Parenthetically, Irish bancassurers have been spared the worst of these problems. Thankfully, the Irish Government did not make the same mistakes as its UK counterpart in opening up the personal pensions market. Also, the two main Irish bancassurers have been to the fore in advising caution in the use of endowment policies to repay mortgages. As a consequence, they are selling only tiny volumes of this product.

The storm breaks

The negative influences I have just outlined are now starting to manifest themselves in companies' published results. In the six months to June 1995, NatWest Life's sales fell by 29%, its profits fell by 48% and its sales force was cut by 20%. In the six months to April 1995, TSB admitted that its life and pensions operation was "in freefall" as sales plummeted 60%. A host of UK bancassurers and "buildsocieturers" suffered the indignity of being fined and/or being publicly reprimanded by industry regulators for poor sales practices. Many were also obliged to take their sales forces off the road for retraining.

Back to the drawing board

All in all, these are difficult times for bancassurers. It's a case of back to the drawing board as banks and building societies reassess their strategies for the life and pensions business. Around this time last year TSB started implementing a radical plan to bring its retail businesses closer together. Lloyds, meanwhile, moved in the opposite direction, creating a clear distinction between retail banking services on the one hand and life and pensions on the other hand. As I'm sure you know, Lloyds and TSB have now agreed to merge. It will be fascinating to see what direction the merged organisation takes in respect of its life assurance and pensions operations. The root-and-branch review now under way in many organisations involves a reassessment of reward systems for sales people. There is a general recognition that over-reliance on commission has sent the wrong signals in the past - namely, that volume counts for more than quality. Companies are now trying to send different messages - about the need for quality and the need to create long-term relationships with customers. Remuneration systems are an important medium for communicating these new messages. Two other items on my list of issues being covered by strategic reviews are product strategy and - surprise, surprise - re-engineering of internal processes. Unfortunately,

re-engineering is too often a euphemism for crude cost-cutting. Talking of reengineering, what's the difference between an optimist, a pessimist, and a reengineering consultant? The optimist says the glass is half-full, the pessimist says it's half-empty while the re-engineering consultant says you have half a glass too much. We are now at the end of the first part of my presentation which provided an overview of the standard bancassurance distribution model - warts and all.

PART II - EXPERIMENTS WITH OTHER DISTRIBUTION CHANNELS

In the second part of my talk, I propose to look briefly at the results of bancassurers' experiments with other distribution channels.

Distributing through brokers

Independent financial advisors - brokers - are (and will remain) major distributors of life assurance and pension products in both Britain and Ireland. Bancassurers simply cannot ignore them when planning strategy. Brokers are a diverse group. Many senior people in business and the professions seek advice from high quality brokers in relation to their pension and insurance needs. At the other end of the spectrum, some down-market brokers do not add value to the customer relationship and are little more than providers of referrals to consultants employed by the life assurance companies. The main argument in favour of bancassurers doing business with brokers is that, while the life assurance company loses the distribution margins on such business, it still captures the manufacturing margins. Half a loaf is better than no bread. The countervailing argument is that the bank and the broker are both in the retail financial services business, competing for the same pound - or Deutsch Mark - of consumers' savings. This applies even more forcibly as the barriers between different sectors of the financial services industry start to crumble. It seems incongruous therefore for a bank-owned life assurance company to, as it were, consort with the enemy. The most coherent strategy for a bancassurer is to fight with might and main to capture both distribution and manufacturing margins. At the same time, over-reliance on a single captive distribution channel creates a certain insularity, a remoteness from the real market-place that is unhealthy for an organisation. Competition is the very life-blood of capitalism. I must admit, though, that I keep telling my colleagues in Life Strategies that our objective is to find market niches that we can dominate, where we enjoy an effective monopoly despite our small size. Yet we always recognise that we do face competition, even in our most specialist consulting areas. That helps to keep us sharp. Bancassurers too need to keep their competitive skills honed. A major strategic difficulty facing a life assurance company distributing through brokers is that the obligation to pay standard industry commission rates acts as a constraint on product development. Bancassurers which ignore the broker channel completely are freed from this constraint.

Contrasting experiences with brokers

I know a small bancassurance operation where the Directors (not acting on my advice, I hasten to add!) decided to expand the range of distribution channels in order to achieve manufacturing economies. They found, unfortunately, that the hoped-for savings never materialised because of the high cost of trying to satisfy the varied support requirements of the different distributors. Also, channel conflict meant that it was difficult to get the full support of any of their distribution channels - including the captive distribution arm. The result was an overall decline in sales volumes without a corresponding reduction in costs.

One of my fellow speakers here today is Ian Gilmour of Abbey National Group. Abbey National seems to have succeeded where the other company failed. An important contributor to their apparent success has been the creation of two very distinct retail brands - Abbey National for bancassurance and Scottish Mutual for broker-distributed products. In passing, I believe that branding is an area of great potential in the financial services business. There is evidence, for example, that Lloyds will retain the TSB brand for certain customer groups and products following the merger of the two organisations.

Direct distribution by branch staff

Having looked at broker distribution, we now turn our attention to the vexed question of distribution of life assurance products by branch banking employees, without the intervention of a specialist life and pensions consultant. One bancassurer's stated objective is to use branch staff to distribute straightforward products and to confine life and pensions specialists to sales requiring high-level technical input. The attractions of this strategy are obvious: it reduces the bancassurer's distribution costs still further.

Implementation issues
The interim verdict is that the strategy has achieved some successes but it needs careful ongoing implementation. Examples of some implementation issues are as follows: a) Allocation of responsibility for sales management is of vital importance. In fact, the question of who manages the sales function permeates all discussions on bancassurance. We could spend the rest of the day discussing this single issue. b) One problem which definitely exists but which is difficult to quantify in practice is the risk of missing value-adding sales opportunities by excluding specialist insurance consultants from apparently simple sales transactions. It is often only in the course of conversation with a customer that more in-depth needs emerge. Branch staff must be trained to identify those needs and, where appropriate, to refer customers to the life and pensions specialist. c) Logic dictates that the branch reward (almost invariably notional rather than in hard cash) for a direct sale should be higher than for one involving a life and pensions consultant. Once again, we could spend the rest of today - and all of tomorrow discussing how to structure profit incentive schemes at branch level. The simple point I want to make is that it is devilishly difficult to get the right answer on some issues of reward allocation. This is one such issue. d) Compliance issues also loom large in respect of sales by branch staff. There is a higher risk that the consumer will misunderstand the product. This reinforces the need to limit sales through this channel to simple products. e) Increasingly, regulators are demanding that consumers receive appropriate advice when buying long-term financial products. The resulting training requirements for branch staff could prove expensive. If you think knowledge is expensive, though, try finding out the cost of ignorance! The solution to the cost problem is often to nominate one or two people in each branch who receive the necessary training to enable them to deal with relatively straightforward insurance products. f) Finally under this heading, the strategy of confining the life and pensions specialist to higher value-added sales implies fewer and more highly trained consultants. In effect, it will mean shedding a high proportion of existing sales staff, many of whom do not have the basic skills needed to progress to the new roles envisaged for them.

Other distribution options

Looking at other distribution options, including all forms of direct distribution, the key strategic challenge is to convert data to information; information to knowledge; knowledge to empathy; and empathy to profit. The quality of the initial data is of crucial importance. In this regard, clearing banks start off with a clear edge over building societies in their ownership of the primary checking account relationship. That enables them to glean much more information so much so in fact that regulators and other players in the financial services industry are constantly on the lookout for abuses of that information. Obviously, it is no good having information if you do not use it to increase your knowledge and your understanding of customers' needs. Here I see enormous strides being made in recent years in the quality of Customer Information Files. Also, the faster processing power of computers is now allowing medium-sized institutions to access the technology needed to link information on checking accounts, business accounts, credit cards, loan accounts, etc. in a value-adding manner. Up to very recently, only the very largest institutions had access to that technology. It would be wrong however to get too carried away with the belief that advances in technology will solve all bancassurers' problems. They will not. Equally though, it would be a mistake to claim - as many do - that selling life insurance and pensions is an "eyeball to eyeball" business, that sales techniques which dispense with face-toface contact are doomed to failure. As in all such situations, no single answer will suffice in all circumstances. It was a fellow Irishman, George Bernard Shaw, who once remarked that every complex problem has a simple solution - which is invariably wrong!

Factors affecting ability to sell remotely

The critical factors affecting a company's ability to sell its goods and services without the involvement of an intermediary are the complexity of the product and the strength and attractiveness of the customer proposition. This applies to life assurance as much as it does to washing machines or bars of soap. Product complexity in life assurance is a major obstacle to direct sales techniques. This is particularly true in Britain and Ireland which have traditionally been subject to a normative supervisory regime. The normative regime favours product innovation. Unfortunately, it also means that products can become ridiculously complicated. The bad news for our continental colleagues is that the EU Commission's decision to opt for the normative regime when setting the rules for the Single Market means that similarly complicated products are now becoming available in countries which traditionally operated under the material supervisory regime. My advice to Directors and senior management of companies in such countries is to be very careful of the extent to which you embrace these socalled "sophisticated" products.

Concluding comments
I am now coming to the end of my talk. It covered two main areas under the overall heading of distribution strategies in bancassurance. I looked first at the strengths and weaknesses of the standard distribution model. My conclusion was that the standard model was effective initially in capturing distribution margins but that it is now badly in need of renewal. The second part of my talk looked at experiments with other distribution channels. In relation to broker distribution, I concluded that separate branding was desirable and may even be essential. I also looked briefly at how bancassurers can meet the challenge of harnessing information sources in a profitable manner. I concluded that ownership of the primary checking account relationship will be one factor (among many) that will separate the winners from the losers in this exciting - and dangerous new world.