That's Life by ps94506

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									BRAVE Partners LLP: Capital and Finance                                                               2009


       Capital and Finance: That’s life.
       As life insurers scrabble for capital globally and reinsurers rush for
       opportunity, BRAVE Partners asks a deeper question: “What next for the
       life insurance industry?”

       Fellow Brits will probably remember That’s Life, a lighthearted consumer watchdog program on British
       TV. At its height That’s Life was a minor British Institution, but in 1994 its twenty one years on the air
       caught up with it. The format began to look dated, other TV programs of different formats catered to its
       audiences and the show gracefully went off the air. BRAVE Partners is beginning to wonder if over the
       next twenty years – it’s going to be That’s Life Insurance.


       A brief history of life insurance
       Life insurance can be traced back to ancient Rome, where “burial clubs” covered the cost of members’
       funeral expenses. Today this business still exists, euphemistically called a “final expenses” or “final
       needs” policy, but given the certainty of the insured event, it is questionable that it is classified as
       insurance. This business is small and is often offered and operated by the relevant service provider.

       More classic life insurance, usually called protection
       business, emerged in the mid eighteenth century. This          Investment based life insurance became main
       was often run to provide for widows.                           stream with the advent of Industrial Branch
                                                                      business in the United Kingdom. In 1854, The
       Investment based life insurance became main stream             Prudential began selling low cost life
       with the advent of Industrial Branch business in the           insurance to the working population.
       United Kingdom. In 1854, The Prudential began selling          Premiums were collected door to door by
       low cost life insurance to the working population.             Agents, which has left the lasting image of life
       Premiums were collected door to door by Agents, which          insurance: “The man from the Pru”.
       has left the lasting image of life insurance: “The man
       from the Pru”.

       The life insurance industry developed a purpose. Industrial Branch business provided a banking and
       savings service to the working population that otherwise would not have had access.


       1854 to today
       The world has changed a lot since 1854. Banks have extended banking services to cover most of the
       population. Bevan introduced the welfare state which still provides something for pensioners and
       widows. Moreover, door to door premium collection would be highly inefficient and costly in the day of
       online insurance.



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BRAVE Partners LLP: Capital and Finance                                                                 2009

       Another major difference between 1854 and the current day is life expectancy. Life expectancies have
       risen dramatically. There are two sides to this. Firstly health is significantly improved and medicine and
       medical techniques are enormously advanced. But, secondly our lives and workplaces are a lot less
       dangerous. In the 1850s a shipyard would almost expect to lose a few lives in the construction of a ship.
       In the UK today, if a person is injured on a construction site it yields an investigation and probably a law
       suit. BRAVE Partners applauds this progress, but it is also not such good news for classic life insurance
       protection business. Less deaths means less awareness and less need for the classic life insurance
       protection product.


       The search for growth
       Searching for growth, life insurance moved to focus on investment products. Increasing life expectancies
       meant an aging population. This demographic trend, together with tax breaks, drove the life insurance
       industry towards savings based products.

       Not a saving grace
       Savings business has been high growth for the life insurance business, but it has been riddled with speed
       bumps.

       Endowments
       First there were endowment pensions and endowment mortgages,
       then there was endowment mis-selling.
                                                                                    Before the variable annuity
       “With profits”                                                               business could take hold in Europe,
       Next, “with profits” pension and savings were the hot product, then
                                                                                    the markets once again taught the
       the industry was shown the value of the embedded guarantees as the
                                                                                    life insurance business the risk of
       stock market ramped up into 2000 and crashed. The complex
                                                                                    selling long dated, complex
       embedded investment guarantees bit. The industry ran out of capital
                                                                                    investment guarantees. In autumn
       and could not meet the investment promises. The regulator fumed
       and private equity moved in. The result is that over 50% of the UK
                                                                                    2008 (I would call it fall but it
       “with profits” assets are now in a run-off business owned by Sun             might      depress      too      many
       Capital and TDR.                                                             Americans) the stock markets slid
                                                                                    rapidly to large losses. The large
       Variable annuities                                                           variable annuity writers in the USA
       After the “with profits” or participating life insurance business lost its   began to feel the pain, reporting
       lustre, the industry in the UK and Europe needed another product.            large losses and fielding analyst
       Pretty soon, the UK subsidiaries of American companies found the             questions on their regulatory
       answer. In the USA, the variable annuity business was booming. Soon,
                                                                                    solvency position if the S&P fell to
       the US subsidiaries were introducing variable annuity (VA) style
                                                                                    700. BRAVE Partners suspects that
       products and their European competitors were quick to follow.
                                                                                    The Hartford has seen its 200 years
       However, before the VA business could take hold in Europe, the               of history flash before its eyes a few
       markets once again taught the life insurance business the risk of            times over the past months.




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BRAVE Partners LLP: Capital and Finance                                                               2009

       selling long dated, complex investment guarantees. In autumn 2008 (I would call it fall but it might
       depress too many Americans) the stock markets slid rapidly to large losses. The large variable annuity
       writers in the USA began to feel the pain, reporting large losses and fielding analyst questions on their
       regulatory solvency position if the S&P fell to 700. BRAVE Partners suspects that The Hartford has seen
       its 200 years of history flash before its eyes a few times over the past months.


       Retirement and savings market
       An excellent life actuary, who is a good friend of BARVE Partners, once explained the savings business to
       us as: “We are an investment company with some bad habits: underwriting”. The problem for the life
       insurance industry is that there are many others who run excellent investment businesses. Pimco and
       Fidelity to name the big brands, but many more. Furthermore, there is general doubt as to the value of
       managed funds against cheaper index tracker products.

       Insurers just can’t give up underwriting
       The insurers continually seek to differentiate themselves from the vanilla asset managers by providing
       some form of insurance or guarantee. However, there is a new competitor in that department.
       Investment banks in search of larger and higher margin markets moved into the structured note
       business. Structured notes look much like life insurance guarantee products and so the only form of
       competition is price and, of course, extent and complexity of the guarantees. The two sides ramp up
       vast, expensive systems and hedging programs and compete head to head – until market volatility
       proves their hedging programs inadequate. The past profits are lost overnight. The future profit
       expectations are slashed in the GAAP accounts – this is DAC write
       downs.

       Guarantees are only good if the provider has the financial resource to     “Hugh Osmond is smart. He saw the
                                                                                  opportunity solely as managing the
       honour them. Equitable Life in the UK is a good case study on this.
                                                                                  run off and moving on with his
       Providing complex, underpriced guarantees in a bull market is a
                                                                                  business ventures. It is only now,
       business that is constantly destined to failure.                           years later where the industry can
                                                                                  see the futility of trying to compete
       Hugh Osmond and his Sun Capital and TDR co-investors never used
                                                                                  on guarantees in the savings
       Pearl Group to write new business. It always seemed like the logical
                                                                                  business.”
       next step for his business. Chris explains: “Hugh Osmond is smart. He
       saw the opportunity solely as managing the run off and moving on           Christopher Cloke-Browne
                                                                                  Managing Partner
       with his business ventures. It is only now, years later where the          BRAVE partners LLP
       industry can see the futility of trying to compete on guarantees in the
       savings business.”


       Back to basics
       Having been harsh on the life insurance industry so far, BRAVE Partners wishes to be clear that we do
       not wish the industry ill. The business keeps many friends gainfully employed, who are far too intelligent
       and mistchievous to be allowed to roam the street.



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BRAVE Partners LLP: Capital and Finance                                                                   2009

        The ambition of this commentary is to highlight that the life insurance industry needs to find a purpose
        once again. “The man from the Pru” fulfilled such a social need at the time that it is an embedded part
        of British heritiage and culture. The very concept is as reassuring to a Brit as a cup of tea and Marmite
        on toast.

        Protection
        Protection business still does well. Those companies that have not been tempted to stray have thrived.
        RGA springs to mind here. In fact, in the opinion of BARVE Partners, RGA’s biggest issue is that it has
        stuck too hard to basics and foregone too many opportunities to develop new businesses from its
        outstanding core skill base of underwriting mortality. A senior industry figure who is well known to
        BRAVE Partners and knows the RGA business intimately, always seeks
        to challenge the firm on each new life insurance idea that we present:   There should be a growth
        “Are you going to compete with RGA on underwriting?”                     opportunity in protection business
                                                                                    even in developed markets. People
        There should be a growth opportunity in protection business even in
                                                                                    in developed markets are possibly
        developed markets. People in developed market are possibly under            under invested in life insurance.
        invested in life insurance. Swine ‘flu, terrorism and other developing      Swine ‘flu, terrorism and other
        risks should act as a marketing opportunity. Furthermore, there has         developing risks should act as a
        been little product development or product innovation in this area.         marketing opportunity.
        The BRAVE Partners always joke that we can tell that we are in the UK       Furthermore, there has been little
        by watching the TV with the sound off. If every other advert is for         product development or product
        auto insurance then we are in the UK. Conversely if every other             innovation in this area.
        advert is for a medication where the rare, but possible side effects
        include a gross and painful death, then we are in America.

                                           Savings
Ultimately a guarantee on equities         BRAVE Partners believes that the savings market is sorely missing an
is implemented by selling equities         integrated asset manager. There is little value to an equity fund
and buying risk free assets as             manager who charges 2% to beat an index by 1.5% and still tells the
equities fall; and selling risk free       clients that he did a good job if the index declines 40%, because his
assets and buying equities as they
                                           fund only fell 39%.
rise. Those of us who have worked
in a French Bank, where the quants         Ultimately a guarantee on equities is implemented by selling equities
learned to prove Black-Scholes             and buying risk free assets as equities fall; and selling risk free assets
from first principles at the age of
                                           and buying equities as they rise. Those of us who have worked in a
three, will have the dynamics of
                                           French Bank, where the quants learned to prove Black-Scholes from
option hedging etched in our minds.
Rather than selling an explicit            first principles at the age of three, will have the dynamics of option
guarantee, what is wrong with              hedging etched in our minds.
providing a suite of funds that the
                                           Rather than selling an explicit guarantee, what is wrong with
fund manager switches between as
they see the markets develop?              providing a suite of funds that the fund manager switches between
                                           as they see the markets develop? After LDI or Liability Driven
                                           Investments are all the rage with asset managers where at last they



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BRAVE Partners LLP: Capital and Finance                                                              2009

       offer an asset management product where the returns look something like a pension fund liabilities.
       Why not the same for personal investments – a personal LDI – where personal liabilities look like
       mortgages and school fees, all of which do not shrink with declines in the stock market.

       The equity fund manager should be an expert on the equity markets. If he believes that the markets are
       going to fall hard, then he should be encouraged and rewarded for moving assets out of his fund. If the
       manager could switch the assets to another fund, say a government bond fund, within the same firm
       and keep the management fee income, then this would provide the template for the right framework.

       There is also value for the client here. The hardest task facing most people saving for retirement is not
       so much which fund to be in, but more when to get into and out of different asset classes. A fund that
       could provide that service so that it is up when the equity markets are down 40% would be worth a
       reasonably sized fee.
                                                                    • BRAVE Partners believes that the life
       The future for life insurance                                  insurance industry has run out of ideas.
       BRAVE Partners believes that there is a great future for     • Variable annuity business, the third attempt
       the life insurance industry. The huge growth markets in        at providing savings products with
       India and China offer new, fertile ground. However, the        guarantees, is not going to be in vogue for a
       industry must define itself and its role. Life insurance       while.
       has tried to grow by selling underpriced investment          • Moreover the large variable annuity writers
       guarantees too many times now. It has always ended in          have just watched their hundreds of years of
       failure.                                                       history flash before their eyes.
                                                                    • BRAVE Partners believes that there are gaps
       BRAVE Partners believes that it is time for the industry       in the protection and savings markets that a
       to go back to basics and innovate from there. The new          life insurer could fill. It just needs a more
       ideas are out there. BRAVE Partners has seen some              basic and innovative approach.
       interesting ones. Now it is for the entrepreneurs and the
                                                                    • BRAVE Partners can advise life insurers on
       industry to identify the winners, nurture them and grow        strategies to mitigate their existing risks.
       them into the next phase for the industry. That’s Life.      • Moreover, the extensive global exposure that
                                                                      the BRAVE partners have to the life
                                                                      insurance industry means that the firm can
       BRAVE Partners services                                        provide strategic advice to a life insurance
       Throughout their careers, the BRAVE partners have              business or an entrepreneur seeking to enter
       finance, advised and traded with a range of life               the market.
       insurance businesses from Korea going east to
       California. This experience gives the firm has a thorough        enquiries@bravepartners.com
       understanding of the life insurance business and its
                                                                        www.bravepartners.com
       dynamics.

       BRAVE Partners can advise life insurance businesses on
       the strategies for coping with existing issues.

       Moreover, BRAVE Partners can assist a life insurance business undertake a strategic review of its
       products and services in order to develop its next phase of growth and success.



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