The profitability of European life insurers is under pressure. Major challenges involve shrinking investment returns from an ultra-low interest environment, increased capital requirements from Solvency II on traditional (guaranteed) products, and unaddressed structural cost challenges.
Life insurance carriers must consider all levers to address these challenges. Especially for those trapped in a position of idle growth, one promising strategy is to transfer unprofitable closed books to consolidators to free up resources and energy to focus on higher-growth areas. While the United Kingdom and United States have seen many closed-book deals, players in continental Europe have made less use of this option to date. The frequency of closed-book deals is likely to increase throughout Europe in the next few years, and the opportunity is significant.
Three considerations to maximize value with life closed books
As the business needs of life insurers evolve, in-house management of the closed-book business may no longer be aligned with overarching strategy. Owners that want to explore whether a closed-book sale makes sense should first evaluate three factors.
1. Optimal exposure to closed books.Insurers need to calculate the economic value of the in-force business against the potential value creation of innovative products and new ways to engage customers. If they estimate the value added above the cost of capital from new products to be much higher than the capital returns from existing policies, insurers should seriously consider lower exposure.
2. Current skill set of the organization.Insurers should thoroughly assess their existing capabilities to run an effective closed-book operation—especially compared with the skill sets of specialized consolidators. Without the required skills, increasing the strategic focus by transferring the closed books is likely the better option.
3. Relationships with clients and distributorsInsurers need to assess how not operating a closed book would affect the nature of their client and distributor relationships. They should also investigate how they can mitigate potential hurdles—notably, in terms of customer ownership and quality of service.
Consolidators outperforming traditional owners across geographies
First, closed-books consolidators can maximize efficiency by managing closed books at scale. Our analysis shows steady consolidator outperformance of traditional life insurers across markets over the past ten years: US run-off players have performed better on both total shareholder returns (TSR) and return on equity (ROE). In the United Kingdom, run-off players have outperformed by TSR, while ROE is on par with the overall life insurance market. German run-off players have also consistently delivered a higher ROE.1
Second, when looking at consolidators’ operational metrics, the total cost per policy is below market average. In mature markets—such as the United States, where consolidators have achieved more scale than life insurance players—the pure administration-cost ratios of consolidators account for only 50 percent of those of the average market.
European life insurers have been reluctant to sell to consolidators—a reticence reinforced by conventional wisdom that the public views such deals negatively. Yet our research finds such challenges are no more severe throughout continental Europe than in the United Kingdom or United States, both of which have enjoyed a robust closed-book deal market.
The answers to successful closed-book deals
When evaluating the possible sale of closed books, life insurers must understand the ways in which consolidators can create value, as these upsides are split between the buyers and sellers, depending on the transaction structure. Consolidators can implement a set of actions to create value (exhibit). Acquirers that successfully pull off all five can improve TSR by a factor of 1.4 to 1.9 after the deal. The value split between the two parties is then reflected in the transaction price along with deal appetite, negotiation skills, and other factors.
To date, European insurers have avoided selling their closed-book business, justifying this decision by pointing to regulatory, client, or distribution constraints. But as the UK and US markets suggest, the potential benefits are substantial. Carriers should closely review whether they truly are the best owners of their closed-book business. Evaluating their optimal exposure to closed books and their organizational capabilities is a constructive first step to capturing this value.
1. To date, no German consolidator is listed; therefore, it was not possible to analyze or compare TSR performance with the overall German life insurance market.
Contributors: Pierre-Ignace Bernard, Thomas Bossart, Marion Hämmerli, Nils Jean-Mairet, Johannes-Tobias Lorenz, Diego Mattone, and Sirus Ramezani and Thorsten Röttger