Sector analysis: Life insurance

Imagine an industry where customers hand over sums of money each year, but potentially don’t ask for anything in exchange for decades. Sounds like a scam, yet this is how the life insurance sector works.

These regular premiums known as the insurance float, married with what is often a steady industry, are what makes life insurance companies one of the more compelling timeless investment options.

Not convinced then look at some of the most well-known millionaires it has produced. Shelby Davis, for example, started investing in 1947 when he was 37 and amassed a fortune of $900m. This was through a lifetime of investing exclusively in insurance stocks adopting the ‘buy and hold’ strategy still favoured by many today.

Investors have long been drawn to the attractive yields on offer from the sector and according to business advisory firm Deloitte, profits from life insurance companies are estimated to grow by £1.5bn from £6.6bn in 2016 to £8.1bn by 2025.

Types of life insurance policy

There are three major types of life insurance: term, universal and whole life insurance.

Term insurance is the most popular kind of cover and this pays out a lump sum or a monthly income if the policyholder dies within a set period of time. If they don’t die during the term, the policy doesn't pay out and the premiums paid are not returned.

Whole life assurance offers protection for an insured’s lifetime until death occurs, and therefore premiums are much higher.

Universal life insurance is a  policy that combines features of term life and whole life insurance by adding a cash component. Instead of just selecting a specific term and putting 100%  towards the policy, there is a cash value account that may be invested.

What affects the sector’s share prices?

Earnings are directly tied in with insurance risk and both have a big impact on share prices in this sector.

Yet, it is interest rates that provide the largest blow to a company’s stock. When they are low, companies find it is harder to produce products that are attractive to both shareholders and customers. 

Richard Baddon, head of insurance insight and partner at Deloitte

New entrants into the market are also affecting life insurers’ profits by offering simpler and more engaging ways to save for retirement.

Richard Baddon, head of insurance insight and partner at Deloitte, said: “The challenge for life insurers will be to provide customers with low-cost advice, guidance and financial education.

"For example, robo-advice, or automated advice models, can generate low-cost, yet well researched personal product recommendations for a saver with typical needs.”

Moody's life insurance outlook

The growing pressures on profits from low interest rates, coupled with shifts in their regulatory and business environments, led Moody's Investors Service late last year to change the outlook of the US life insurance industry from stable to negative.

The outlook reflects business conditions over the next 12 to 18 months and in the UK, the outlook was changed to stable from negative. This was largely due to the expectation of a moderate and manageable impact from Brexit.

UK life insurers are less vulnerable to low rates than some of their European counterparts because the majority of their reserves are unit-linked with no interest guarantees.

The report said: “UK life insurers' business model has allowed them to maintain resilient performance in the face of increased competition and positions them strongly for the long-term shifts in the sector.” 

What can make one company buck the trend?

Moody’s say it will be technology that will increasingly differentiate the life insurance industry winners from losers. There is widespread pressure for companies to offer better digital services to help them connect more efficiently with customers.

Baddon added: “Insurers that are digitally focused will be more effective in protecting their market share and profitability. Those that use social media, wearables and the cloud will be best placed to develop new savings products that have the customer in mind.

"M&A opportunities are also one to watch, as selling off non-core assets could help insurers raise much needed capital for new innovative projects. Success is dependent on acting now. Those that fail to act with sufficient speed will be disrupted and face long-term decline.”

Baby boomers are changing their portfolio of investments in preparation for retirement: Shutterstock.com

Wearable devices, such as Fitbit, Pebble or Apple Watch, play a role in the life insurance sector. Data collected could lead to lower premiums, or even higher premiums if a consumer gets poor health behaviour ratings from their device.

Andrew Grill, global partner at IBM Interactive Experience, in a report from The Economist Intelligence Unit, said: “Consumers are itching to have their digital social life integrated with these insurance products— but they will only do that if there is a benefit to them.”

What can make a company's share price fall?

Regulatory change can affect share prices. For example, Prudential saw its shares slump in early 2016 when China's financial regulator announced a crack-down on leverage in the financial industry and the sale of insurance products sold by overseas companies.

This was expected to hit the company hard as Asia was at the heart of Prudential’s plans for growth with the demand for insurance products rising due to a growing middle class.

Its stock fell more than 8% in minutes after reports that insurance sales in Hong Kong from mainland China would be capped at $5,000 per transaction for those using certain payment methods.

In May, though, the company announced that profits increased by 25% in the first quarter of the year from its Asian business, with favourable exchange rate movements playing a factor.

What should I look out for in company accounts?

The real income generator for insurance companies is their large investment portfolios that they get for free if they write policies that are profitable. It stands to reason those companies with intelligent capital allocation policies will fare the best.

The insurance float usually sits on a life insurer’s balance sheet as a liability, but it is actually an asset as this is what generates the investment income.

Three main things to look at are leverage, liquidity and profitability. Although important, leverage is a bigger issue for general insurance companies as a highly leveraged company might not be able to pay out to claimants if a large catastrophic event occurs.

What else is there to watch out for?

The ageing population will have an impact on the sector as baby boomers change their portfolio of investments in preparation for retirement. It is less about leaving money for the next generation and more focus on providing safety and security while living.

Life insurance is no longer just a matter of the risk of dying too soon, but also living too long and now many insurance policies include chronic illness and long-term care riders.

Paul Coulthard, head of life insurance at Deloitte, said: “Life insurers are facing a prolonged period of unprecedented market dislocation. We are seeing a ‘two-speed’ market, as a result of huge pension changes such as auto-enrolment, the retail distribution review and pension freedoms.

"New rules combined with an ageing population and consumer preference for leaving pensions invested, rather than buying an annuity, mean that insurers’ profits will be dramatically reshaped over the next 10 years.

“While some market commentators have argued insurers could lose out, we think insurers have important advantages. These include close ties to employers and strong actuarial and risk management, which position them well to grow in the decade ahead.”