#14 | Carrier Overhead
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To state the obvious, life insurance companies don’t operate without cost. Employees have salaries and benefits, buildings cost rent and office furniture depreciates. Life insurance company overhead isn’t something that agents or clients readily discuss. I’ve eaten more than my fair share of dinners paid with a carrier expense account (as I’m sure you have, too) and I’ve never asked where the money came from. Well, I take that back. I was at a very nice restaurant last year during AALU when a group of about 50 folks from MassMutual showed up. I jokingly asked the person sitting next to me whether or not she thought Mass got approval from its policyholders before it picked up the tab. It’s not really a joke, though. Policyholders pay for every dinner we eat. The question is whether or not, in the aggregate, overhead expenses impact a policyholder’s returns.
Overhead expenses aren’t a mystery. All statutory filings include Exhibit 2, a breakout of all company expenses by category. As expected, salaries dominate the list but there are some interesting expenditures like medical examination fees ($6.9 million at John Hancock), books/periodicals ($1.9 million at Hartford), agency conferences ($13.2 million at Lincoln) and printing and stationary ($11.6 million at MetLife Investors). Expenses specifically allocated to the Life Insurance division is specified under the Summary of Operations by Lines of Business.
As with anything, context is key to understanding. I’ve struggled with putting context on expenses. Looking at raw numbers like $1.08 billion for Lincoln Financial in total and $408 million for Life Insurance don’t tell me what I need to know – is Lincoln’s overhead bigger or smaller than its peers in a way that might impact policyholders? The expense context measurement in the statutory filing located in the 5 Year Historical Analysis is based on premiums before reinsurance and, for Lincoln, stands at 14.7% and includes commissions. But is comparing expenses plus commissions to premium the right method? I’m not necessarily sold. Premiums change dramatically year to year, particularly on the annuity side of the house. A carrier selling Variable Annuities might post low expense ratios when sales are hot (like Hartford’s 5.4% in 2007) and high expense ratios when sales are off (Hartford’s 17.8% in 2011). My first inclination was to look at only expenses (no commissions) as a percentage of assets but that gets messy. Companies who use lots of reinsurance or have lots of separate account business have terrible expense ratios and companies who retain risk or use modified coinsurance look better. The chart below compares the three ways across several companies.
Even though we can’t get a complete picture from any one statistic, looking at all three can be helpful. For example, it’s relatively obvious that Nationwide is most likely of the bunch to have an issue with expenses. MetLife is in second place because we know that its expense ratio is temporarily lowered by heavy annuity sales in 2011 that are rapidly declining in 2012. Third and fourth might be Lincoln and Principal. Hancock’s high ratio but low percentage of assets is an indication of slow sales now but a very large asset base – evidence of high sales in the past.
So what? I think there are a couple of implications for producers. We don’t normally think of scale in the insurance business beyond qualifying for the law of large numbers when it comes to mortality and policyholder behavior. But I’d argue that overhead expenses constitute another angle on scale. Running an insurance company, any insurance company, is expensive. Growing one is really expensive. You can’t just magically start promoting, underwriting, administering and pricing new products that will sell like gangbusters. Carriers have to invest in expansion before the driver of profitability, the asset base, can pay for itself. Carriers with big overhead and slowing sales are red flags for abandoning new business acquisition, especially if the operation in question is a subsidiary of a much larger, publicly traded company. The mothership decided to throw some money into growing the business and, when sales don’t turn out but the costs are high, might decide to take that money away just as fast. SunLife fit that category perfectly.
The trick about getting to scale in this silly business is that you have to sell lots of something. Selling lots of something usually means making concessions on price. Making concessions on price will get you to scale, but not profitability. The SunLife mantra might have been “scale now, profitability later.” But what if the switch to profitability never happens because profitable products don’t sell well enough to recoup the overhead and pricing losses from selling the unprofitable stuff? One guaranteed way to make it work is to stop the hemorrhaging by shutting down the business and running off the unprofitable block in hopes that it turns profitable. Again, this is what SunLife did and what others might. Scale issues, I think, are a red flag. Scale is the hurdle that every business must profitably clear in order to justify its existence.
The second implication is that companies are going to be much more judicious going forward about size and sales. The idea of becoming a dominant company is dying, I think. The biggest companies in both the life and annuity markets have fallen from sales grace the moment their pricing became profitable. Tempting a company with growth isn’t going to work except maybe on your wholesaler – companies are going to be much more tempted by profitability. I think that’s going to lead to smaller companies looking for niches in markets that are more captive. I think it’s going to mean proprietary relationships with banks, wirehouses, independent BDs, Wal-Mart, you name it. I think it’s going to mean quasi-career relationships with agents where the agent gets three direct contracts, maybe, instead of having access to 20 through a BGA. And above all, I think it’s the death knell of the commoditized product. Differentiated product offerings require direct access and the ability to tell the story to an audience that will actually listen. Right now, every carrier is standing in the BGA bullpen yelling over each other as loudly as possible. Differentiated, profitable product requires a quiet conference room. That’s where things are going.
I’ll end with a quick story. I clearly remember two large dinners that made an impression on me. One was at Nick and Sam’s in Dallas, paid for by Phoenix, and the other at The Palm in Chicago and SunLife got the tab. Both occurred right before the respective carriers essentially exited the market and in both cases I knew prior to the dinner that the end was nigh. So who paid for my steak? I’m not sure exactly, but I know it wasn’t the carrier.
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