Slowing growth cuts returns
The UK market is looking forward to the opportunities stakeholder pensions may bring but has concerns about the margins involved
The UK insurance industry, which has been riding high during the last year on the back of strong growth and a 'feelgood' factor in bond and equity investment is ex-pected to see a downturn for 1998, with question marks being placed on share valuation and business operation margins.
Andrew Ritchie, insurance analyst at London-based Fox Pitt Kelton predicts an overall slowdown this year for the UK life market after last year's 12% growth. However, re-sults for the first half of the year remained strong, rising by around 15%, boosted by good pensions premiums. This, he says, has been due to a general UK market recovery against a rated downfall on continental margins. Nevertheless, the annual pensions dividend is down 24% on the year and issues such as accounting standards changes and some of the negative aspects in the industry such as the pensions misselling fiasco will keep overall growth down," he adds. Some companies, including Norwich Union and Legal & General, still show good growth.
Over the past two years the mutuals have been particularly present in the regulatory pensions and independent financial adviser (IFA) market. Notably Standard Life introduced products with no 'front-end' charges, squeezing the break-even levels for insurance groups as others followed suit. Ritchie feels this move will push typical pensions policies out of the market within five years, but also significantly lower returns.
Sun Life, which has stuck to its previous margins, even increasing them slightly to between 20% and 24%, has consequently shown slower growth levels.
Legal & General admits that, in becoming more aggressive in the market, it has had to sacrifice margins to gain market share. This is particularly true within the IFA domain, where many companies are keen to access a larger customer base.
Such strategies are leading to fears of a dilution of capital and hence of security for policyholders. Furthermore, lower profit margins will make it more difficult for insurers to raise external capital should the need arise.
Part of this shift by insurance companies is the desire to acquire brand names within the distribution domain, with suggestions, for example, that Prudential, for one, is looking to procure a building society to provide a high street presence for customer access.
Ritchie believes the prospect of a pan-European insurance sector will have little real impact on the UK market. "It is still very difficult to sell life insurance cross-border, with the UK a particularly difficult area to break into. I get the impression that regulation is more extensive here than on the continent and operating, training and compliance costs are very high. Also, the UK has a number of well capitalised and positioned groups to try and take on," he says.
The foreign presence is limited as a result. AXA-Sun Life and Aegon, through Scottish Equitable, are top 10 players, but the re-mainder of the top 20 are still UK-owned. "That is not to say that foreign insurers don't want to enter the UK market, because with substantial growth prospects and full development of funded schemes being actively pushed as the answer to the demographic problem, they certainly do," he notes.
The government's 'stakeholder' pensions plan has been touted, by another leading analyst, as one of the reasons UK life insurers' valuations were stretched at the start of the year, with companies sensing growth possibilities in the reforms being discussed. The lull in the debate has cut valuations back, and in fact analysts are unsure of the real benefits insurance companies will pick up from the much vaunted stakeholder boom.
"Stakeholder pensions may result in substantial volume growth and projections show they could hold the largest section of the market in 10 years, but the business margins are going to be extremely thin because of the government target for cost base reduction in yield of about 50 basis points. It is also unclear how distribution will occur."
Other analysts also believe the government will firmly back mutual insurers in any stakeholder proposals. And the consensus is that companies such as Friends Provident and London & Manchester should be well placed for any eventuality, with home distribution networks, corporate pensions franchises to cover any salary deduction systems, and fund management capabilities.
In terms of more general trends, the erosion of large surplus insurance company funds because of market corrections may mean companies have to price themselves more realistically in the future.
However, competition is still very strong and the larger groups are still very well capitalised. The notion that UK insurers are suffering from guaranteed annuity rates is not being borne out of any significant changes in pricing.
The latter half of this year will see further margin squeezes and a slowdown in unit-linked products, say analysts. But on the up side there is considerable investor interest in profit-distributing bond products, which could keep year-on-year growth in the industry at around 6%. Hugh Wheelan"