#344 | Zurich North America Exits Indexed UL

Quick Take

Zurich North America has decided to shut off new sales for its Indexed UL and Term, the latest twist in the longer-than-you-think and stranger-than-you-think story of Zurich’s forays into the US life insurance market. For the past 12 years, Zurich has executed on a Life strategy focused on offering permanent insurance, primarily Indexed UL, to the ultra-affluent segment of the life insurance market by wielding its hefty $20M of internal retention. The company became a low-volume seller of Indexed UL that never seemed to be able to break out of its niche in the ultra-affluent part of the market, as evidenced by its astronomical average face amount. Now, Zurich has decided to change course to focus on middle-market consumers where there are cross-selling opportunities with its other Accident & Health products. The strategy makes sense. But why couldn’t Zurich get more traction using Indexed UL in the independent channel? In my view, part of the reason is because Zurich focused on fundamentals and eschewed illustration gimmicks. They never won the illustration game. And in Indexed UL as in Squid Game, if you don’t win, you die.

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Last week, Zurich North America announced that it is closing its current suite of Indexed UL and Term products to new sales effective on February 1st, 2023. Instead, Zurich will be focusing on “a combination of individual supplemental health and guaranteed/simplified underwriting term life products, with the first tranche of new products expected to launch in the second half of 2023,” although it will continue with sales of its private placement life insurance and annuity products. This change marks the latest chapter in the evolving story of Zurich’s various forays into the North American life insurance market – a story that became increasingly longer and stranger the more I dug into it for this article.

The story begins in 1991, when Rolf Hueppi took the helm of Zurich Insurance Group in 1991. In the style of many 1990s CEOs, Hueppi wanted to transform the staid insurance giant into something of a global finance powerhouse. One of the keystones of that transformation was the 1995 acquisition of Kemper Corporation, its two life insurance subsidiaries – Federal Kemper Life Assurance (KFLA) and Kemper Investors Life Insurance Company (KILICO) – and its asset management arm, Zurich Kemper Investments with $42 billion in assets. To that, Hueppi soon added powerhouse asset manager Scudder, Stevens & Clark to form Scudder Kemper Investments.

However, all of that paled in comparison to Zurich’s 1998 $38 billion merger with the financial services unit of British-American Tobacco. The merger brought with it Threadneedle Asset Management and numerous insurance operations, including US-based Farmers Insurance, its 14,000 agents and a laundry list of insurance subsidiaries, including life insurance-focused Farmers New World Life Insurance Company. By the end of these acquisitions, Zurich was the world’s 5th largest insurer and was a substantial player in life insurance, investments and reinsurance in the United States. A new Zurich was born – Zurich Financial Services.

The strategy began to fall apart almost as soon as it came together. Zurich’s stock took a beating, losses began to mount and Hueppi came under pressure in early 2001, facing a vote of no-confidence from investors in which he ultimately prevailed. But the damage was done. In late 2001, Zurich spun off US-focused Zurich Re into Converium, which subsequently received numerous ratings downgrades and acquired by SCOR in 2007 in a hostile takeover. Not long afterwards, the SEC fined Converium for a litany of alleged accounting abuses that “artificially inflate[d] their performance figures…[which] allowed Zurich to receive a significant windfall when it spun off Converium.” It’s an odd little sidebar to the Zurich story.

Around that same time, Zurich also sold Zurich Scudder Investments to Deutsche Bank in exchange for cash and some of Deutsche Bank’s insurance operations. In early 2002, Hueppi’s resignation was “demanded by several large shareholders and institutional investors, dissatisfied with the company’s results” and he was replaced. In early 2003, Zurich began to systematically divest of much of what Hueppi had built, particularly its non-insurance assets. It sold Threadneedle to American Express and Swiss private bank Rued Blass to Deutsche Bank, marking the end of Zurich’s asset management empire. Later that year, Zurich also exited one its key UK life insurance subsidiaries and numerous global insurance operations. Call it the new, new Zurich. Slimmer, leaner, and as the company website says – “refocused.”

In the US, Zurich retained Farmers and, if you read the business press from the time, it sounds like Zurich successfully sold off its Kemper life insurance holdings to Bank One, which later became part of Chase Insurance Group and ultimately was purchased in 2006 by Protective. But that’s not quite what happened. Zurich only sold one of the two life insurance companies that it got from Kemper – Federal Kemper Life Assurance (FKLA), which was renamed Chase Insurance and Annuity Company before being sold to Protective. From what I can tell, FKLA housed Kemper’s traditional individual life insurance business.

However, Zurich did not sell Kemper Investors Life Insurance Company (KILICO). From what I can tell, KILICO was primarily focused on two business lines – BOLI and Variable Annuities. In mid-1998, during the heyday of Hueppi’s growth spree, Zurich released a Variable Annuity called Scudder Destinations. It was one of the very first VAs in the market with a guaranteed minimum income benefit, which Zurich called the Guaranteed Retirement Income Benefit (GRIB). To say that the GRIB was exceedingly rich would be an understatement. It offered a guaranteed 5% roll-up in the benefit base until age 80, annual benefit base step-ups if the account value exceeded the benefit base, the ability to take a 5% income without reducing the benefit base (“dollar-for-dollar” withdrawals) and had no investment restrictions. What was the cost of the GRIB? A paltry 25bps. Yes, you read that correctly – 25bps.

Hence, the reason why one advisor quoted by an article called this VA “legendary.” That’s an understatement. Zurich quickly course corrected, shutting the rider off just three years after the product was launched. The irony is that as Zurich was realizing the gravity of their mistake, other life insurers began to pile in the VA with Living Benefits market, igniting an arms race in that segment of the market with repercussions that are still being felt today. Zurich might have thrown the first match, but they didn’t stick around to watch the blaze.

I’ve seen a lot of these riders. Few are more egregiously priced than Scudder Destinations. Since then, Zurich has cut down on the ability to add large premiums to the policy and attempted to buy back the contracts from policyholders. They’ve executed a reinsurance deal with Transamerica to take the most toxic Destinations business off of their books and reinsured the remaining slug of the product to the Zurich Insurance Company mothership. The saving grace for Zurich was that they were early to the market. If they’d released that product a few years later, they would have sold a lot more and the situation would have been a lot worse.

KILICO lay dormant for almost a decade, renamed as Zurich American Life Insurance Company and sitting quietly under the Farmers Insurance umbrella. But in late 2010, Zurich decided to “re-enter” the US life insurance market with a strategy that it branded as Affluent Markets. Zurich hired a crack team from AIG/American General, then struggling under the weight of financial crisis. Coming to market, Zurich had a very quirky advantage that you might not fully appreciate if you’re not familiar with the inner workings of the ultra-high end part of the market – $20 million of internal retention.

For most life insurance cases, the concept of internal retention doesn’t factor into the underwriting and carrier selection process. But as the case size grows, it becomes paramount. If you were to ask a random person how much life insurance Elon Musk can buy (forgetting, for a moment, the question of insurability), they’d probably guess over a billion dollars. But that isn’t the case. Mortality risk capacity is not unlimited. There are finite constraints.

Internal retention is one of them. Retention generally ranges from $250,000 to $30 million. Bigger companies usually have higher internal retention limits. For policies bigger than what the life insurer can retain internally, they use reinsurance – but that only goes to what’s called the Jumbo Limit, the maximum death benefit that a life insurer can write using their own underwriting. For most life insurers, the Jumbo Limit ranges from $30 million to $75 million, although some life insurers have periodically assembled so-called “super pools” of reinsurance that allow for even large policies.

Once you’ve hit the Jumbo Limit with the total amount of coverage on a particular client, then you’re tapped out of the reinsurance market. Why? Because life insurers generally use the same crop of reinsurers. There are situations where a client can be directly underwritten at the reinsurer, but those are rare. In general, the first step to assembling a huge slug of life insurance is to find a lead life insurer with relatively low internal retention and a very high Jumbo Limit. That way, you’re hitting the reinsurance market for the largest possible amount.

From there, to fill up the rest of the mandate, agents canvas the market to underwrite the client at life insurers with high internal retention. I’ve seen situations where a client has policies with 30+ life insurers, each one set at the maximum internal retention, in order to maximize coverage. There are a handful of very large companies with $20-30 million of internal retention and several between $10 and $20 million, but then it drops off very quickly. I’ve never seen a total line of life insurance higher than $300 million. There just aren’t that many life insurers with large enough internal retention to make it happen.

That’s why Zurich’s ability to offer $20 million of internal retention was a huge deal. Zurich gave producers the ability to go to the one or two clients in their book that tapped out the life insurance market for coverage for an extra $20 million from a brand-name firm. Zurich paired the strategy with a Guaranteed UL, then the preferred product for large-case estate planning cases. It was a very, very clever and well executed. And it fit their Affluent Markets moniker perfectly.

The problem, though, is that it is exclusively an Affluents Market strategy and Zurich was quickly pigeonholed as something of a high-end specialist, even after they raised the price on their Guaranteed UL to the point where it was completely uncompetitive and pivoted to Indexed UL. As a result, Zurich was an anomaly in the industry in terms of its business mix. Take a look at the policy count and average premium per policy for Zurich since 2017, the earliest I could get data:

2022 figures are through Q2 and annualized for the full year

To put this into perspective, the average premium per policy in the IUL space in 2021 excluding Zurich was around $16,000. No other company is even close to Zurich’s average premium size. But even more interesting is the fact that Zurich sold so few policies. Zurich’s total premium made up about 1% of the total market for IUL. But in terms of policy count, Zurich accounted for 0.05% of the total. Like I said, they were an anomaly.

Over time, my sense is that Zurich began to reflect the changing trends at the ultra-high end of the market. In 2010, when Zurich burst back on to the scene, the estate planning market was alive, well and completely dominated by Guaranteed UL. Over time, though, the traditional estate planning market has shrunk as the estate tax exemption has increased. Now, the ultra-high end of the market (on the independent side of the business) seems to be dominated by premium financed Indexed UL.

Zurich acknowledged that premium financing was a meaningful portion of their business and that they had recently cut back on their flows of premium financing, which is a contributor to their slowdown in total sales in 2022. As an outsider, Zurich’s business never really looked sustainable too me. The flows were too low, the total premium too small and the strategy too niche to make it work. I’m surprised they stuck around for as long as they did.

From what I understand, the strategic review of Zurich’s US life business began about 18 months ago when Zurich North America combined its Accident, Health and Life businesses under a single business unit. The first two lines are decidedly middle-market. An Affluent Market approach to life insurance didn’t fit. Instead, Zurich is reframing their approach to focus on their ideal customer – mass market consumers with needs that Zurich can address with a range of products. In other words, the opposite of the specialized, $20 million retention approach. As a result, it was time to jettison the Indexed UL suite and switch strategies. It makes sense.

What still doesn’t make sense to me, though, is why Zurich couldn’t seem to find a sustainable toehold in the individual life insurance space. Their Indexed UL products were reasonably competitive overall and, in some cases, offered industry-leading rates and features. They had a brand name with Zurich. They had $20 million of internal retention. They were on the platform of virtually every major distributor in the market. They had a well-known and reputable executive team with deep relationships. For goodness sake, if anyone could have made it work, surely Zurich could.

What was the fatal flaw? From my vantage point, Zurich neglected to pursue one strategy that most other companies have pursued with abandon in Indexed UL – illustration gimmicks. Zurich never built products to cater to the regulatory loophole de jour. They generally played it straight, instead focusing on simple but attractive crediting strategies. As a result, Zurich didn’t exactly fly off the page in terms of illustrated competitiveness. In my book, that’s the right way to play the Indexed UL space. But my book doesn’t count for much. Indexed UL sales follow illustrated performance. That’s the bizarre and unfortunate reality of the hyper-competitive and hyper-saturated independent brokerage market. Win the illustration game or die. It’s the Squid Game of Indexed UL. And it’s hard to blame Zurich for no longer wanting to play.