The costs of sale for many insurance products are significantly out of line with the value provided to consumers, according to new research by Deloitte. 

The research, a result of a six month review of the UK insurance industry’s sales and distribution channels, looks at the root cause of emerging problems in insurance distribution cost structures, particularly around face-to-face sales and examines the likely impact these challenges will have on future profitability. (View this press release with graphs PDF).

It shows that the industry as a whole is to be congratulated for becoming more competitive, cutting operating expenses in half across the past decade.  However, distribution costs are moving in the wrong direction and now account for 38% of total operating costs, an increase from 29% 20 years ago. Coupled with low persistency (poor customer loyalty), current face to face sales models, which are primarily IFAs, are running counter to underlying economics and value. This may account for some of the apparent pressures on Independent Financial Advisors as product providers consider their strategies around their own direct sales forces and telephone and internet channels become more popular.

The underlying economics can be illustrated by a simplified example. The relatively high commission costs paid on the sale of certain insurance products, such as pensions, are based on the assumption that an insurer will have the business on the books in some cases for an expected period of at least 10 years. However, research shows that this assumption is often unrealistic – in some cases 50% of such policies lapse after four years, meaning that many policies come nowhere near to making money. 

Commenting Mark FitzPatrick, head of insurance at Deloitte said: “For the past few years, the insurance industry has focused intently on improving efficiency and reducing administration and investment management costs.  In spite of this effort, an examination of operating costs reveals that while total expenses are going down, sales costs account for an ever larger share of the industries expenses. This, coupled with patchy growth, has forced industry leaders to re-examine their sales strategies, pushing distribution firmly into the spotlight, together with efforts to expand overseas”

Traditional face to face sales currently account for 72% of retail insurance sales in the UK, and in some product groups such as pensions they account for almost 90% of sales. However, this dominant position is not uniform across different product classes. In personal lines insurance, just 39% of sales are face to face – down from 84% 15 years ago. Although a straight read across is clearly simplistic, this trend appears to be replicating across more complex life insurance products and pensions. In 1994 96% of life insurance sales were made face to face, today it is 62%.

“The decline of face to face distribution has been seen across personal lines insurance as direct channels such as telephone and internet have emerged. It is now possible that personal pensions and annuities distribution will follow suit to some extent. The question is not if this will change, but when it will happen and to what extent.”

Reasons behind the symptoms
Insufficient customer segmentation and targeting together with some continued operational inefficiencies means the cost of face to face advice is out of line with industry revenues and growth, driving up sales costs as a percentage of overall operating costs. The question is whether current face to face distribution models cost more than the value they provide. Whilst higher net worth individuals may value the advice they receive for longer term insurance products, certain consumers may be paying for a service they don’t want or can’t really afford. Deloitte’s research shows IFAs believe customers pay the IFAs for advice on helping them to set priorities, yet, customers believe IFAs are paid to provide detailed information on product features and to find the best value products. Furthermore, for this, consumers are prepared to pay 30% less than the IFA’s average required revenue per hour to cover costs1. With such a value mismatch, an increasing number of customers will turn to other channels (phone, branch, internet) to make their insurance purchases.

Without the underlying economics being addressed, structural changes, such as depolarisation, are likely to prove disappointing and scenarios that maintain the status quo will prove unsustainable.

What the industry has to do
“Face to face distribution is becoming a strategy for certain customer segments. Looking across the insurance industry to identify the appropriate distribution strategy we see an over concentration of business in the bundled advice segment. Face to face insurance sales do have their place – there are products that require advice but the present economic structure does not support providing fully-bundled advice to all customers.

 “Insurers have to adopt a multi-channel strategy that develops new alternative channel formats and drives out efficiencies in traditional channels. These channels must be supported by simplified products and unbundled advice. Allied to these changes will be a greater understanding of both the true costs of serving customers via various channels, so the cost of sales can be aligned to their value, and the real needs of consumers.”

Scott Winslow, who led the research, commented: “The retail insurance industry is a major sector which we estimate is worth £183 billion a year, but the current business model is ultimately unsustainable in its current form.

“In spite of a remarkable reduction in operating expenses over the last decade, partly due to outsourcing and offshoring, in their current form, the business economics of distribution and product threaten the future profitability of the industry.

“Going forward, a significant shift in mindset and business practice is mandatory for survival. A successful future strategy in life and pensions markets is likely to be achieved by a shift away from distribution towards customer propositions orientated strategy.”

Ends

Note to editors:
1 ABI Report – February 2006

Deloitte’s research is the result of a six-month review of the insurance industry in the UK. It involved a review of all marketplace data and statistics and included face to face interviews with the heads of distribution of the UK’s leading insurers. The researchers also undertook discussions with equity analysts and utilised research by Deloitte’s insurance advisory board – including the actuarial research on motor and household insurance surveys and the annual offshoring report.

About Deloitte
In this press release references to Deloitte are references to Deloitte & Touche LLP which is among the country’s leading professional services firms, providing audit, tax, consulting and corporate finance services. Known as an employer of choice for innovative human resources programmes, it is dedicated to helping its clients and people excel. Deloitte & Touche LLP is the United Kingdom member firm of Deloitte Touche Tohmatsu (‘DTT’), a Swiss Verein whose member firms are separate and independent legal entities.  Neither DTT nor any of its member firms has any liability for each other’s omissions.  Services are provided by member firms or their subsidiaries and not by DTT. 

Deloitte & Touche LLP is authorised and regulated by the Financial Services Authority. 

The information contained in this press release is correct at the time of going to press.