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WHY YOU SHOULD READ THIS REPORT
With around EUR1.5 trillion in funds under management, French life insurance is a large and mature market. However structural issues including poor profi tability, risk of lapses, and market conditions suggest the potential demise of the traditional life product in its current form.
All is not lost, though. In the short term, insurance companies should consider pulling a number of levers to enhance the value of their business. Longer term, the inevitable cut in pay-as-you-go pensions could lead to the emergence of a proper private pension market in France.
This report discusses actions that insurers could take now to improve current profi tability and to seize future growth opportunities.
8 JULY 2013
François BoissinLouis CarbonnierFady Khayatt
FRENCH LIFE INSUR ANCE
One life ends; another begins
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Exane BNP Paribas
François Boissin, CFA(+33) 1 42 99 25 12
Oliver Wyman
Louis Carbonnier(+33) 1 73 04 44 08
Fady Khayatt(+33) 1 73 04 44 04
Oliver Wyman is an international management consulting firm. For more information, visit www.oliverwyman.com. For disclosures specifically pertaining to Oliver Wyman please see the
Disclosure Section, located at the end of this report.
Please refer to important disclosures at the end of this report.
FRENCH LIFE INSURANCE
One life ends; another begins
Contents8 JULY 2013
Executive summary 2
Introduction 5
Savings products have fuelled life insurance growth for the past 30 years 6
French Life: A super-saving product 8
“Fonds en euros” product creates little value 10
Beware of lapse risk 14
Protecting the value of the current book of business 16
Private pensions are the long term prize 21
Conclusion 29
Appendix 30
Exane BNP Paribas Research & Oliver Wyman FRENCH LIFE INSURANCE 8 July 2013 page 2
Executive summary
French Life: What is wrong? After 30 years of impressive growth, French life insurance has become a large market with c.EUR1.5 trillion in funds under management. The bulk of this growth has been fuelled by the savings business. France has opted for a pay-as-you-go pension system and as a result, contrary to some other OECD countries, a proper private pensions market has not emerged.
Figure 1: French life insurance sales are heavily geared towards savings Breakdown of annual life insurance premiums (2011)
76%
55%
30%20%
8%
20%
15%
30%
19%
7%
4%
30%39%
61%
85%
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
France Germany US Switzerland UK
Savings & investment Protection Pensions
Source: Swiss Re Sigma, FFSA, Exane BNP Paribas, Oliver Wyman
As it stands, the French life insurance business is unappealing to investors. The main product “fonds en euros” offers generous guarantees to policyholders and is therefore capital intensive. We estimate that this product generates a poor c.4% return on capital for insurers. Unit-linked products are much more profitable but much less popular with consumers because typically they offer no guarantees.
In addition, lapse risk should not be under-estimated: the only penalty that policyholders face in case of early withdrawal is a loss of tax benefit. And even these penalties apply only when the product has been held for less than 8 years. Today, more than 65% of contracts are more than 8 years old, meaning that French insurers face significant withdrawal risk, especially in case of sharply rising interest rates, or renewed sovereign stress. Life insurers in most other countries are much more protected against this risk, thanks to more stringent product features.
What’s more, with low interest rates and on-going de-leveraging, net new lending is declining and with it, the creation of bank deposits. This should slow demand for life insurance products and weigh on future growth prospects.
Exane BNP Paribas Research & Oliver Wyman FRENCH LIFE INSURANCE 8 July 2013 page 3
How to protect the back book of business? Despite poor returns on capital, we believe there is value in the large back books of French life insurers. In our view, insurers could selectively cut credited rates on fonds en euros products with minimal loss of volumes and significant uplift in investment spread margin. Products should be re-designed: Euro-croissance with at-maturity guarantees or unit-linked products with guarantees look promising. However these products would not be liquid for private investors and are therefore unlikely to replace fully the current fonds de euros. We also see scope to re-risk investment portfolios namely by capturing long term illiquid premiums. Lastly, we believe that operating costs can be managed down further.
We believe that these recommended actions are worthwhile. Insurers who take them should get an edge over those that do not. Yet they will not transform the generally forlorn position of the French life insurance industry. For that, we see only one serious possibility: the emergence of a large private pensions market in France
The private pension opportunity The greater hope for a significant turnaround in the fortunes of French life insurers arises from the problems facing the French compulsory pay-as-you-go pension system. The viability of such schemes depends on the ratio of contributors to retirees. This ratio has declined sharply over recent years as life expectancy has increased, baby-boomers have retired, and unemployment in people of working age has risen. The system now has an annual deficit of EUR14bn, which is expected to rise to EUR63bn by 2060 according to public sources but which, using more realistic economic forecasts, we expect to rise to EUR135bn.
The French government will eventually be forced to reduce the value of retirement incomes provided by its pay-as-you-go scheme. This will result in a dramatic increase in the number of French households that make private provisions for their retirement. By 2040, we estimate that pension funds under management could range from EUR400bn to EUR1.0 trillion vs. c.EUR140bn currently.
Figure 2: The private pension potential, total AuM forecasts 2015E-2040E (Base, Bull, Bear case scenarios) in EURbn
0
200
400
600
800
1,000
1,200
2015
2017
2019
2021
2023
2025
2027
2029
2031
2033
2035
2037
2039
2041
BASE BEAR BULL
Source: Oliver Wyman, Exane BNP Paribas
Exane BNP Paribas Research & Oliver Wyman FRENCH LIFE INSURANCE 8 July 2013 page 4
We believe that – depending on policy developments – insurers are likely to provide the mix of risk, return and liquidity features most attractive to people saving for retirement. To take advantage of this opportunity, French life insurers must make sure that they are ready with the right pension products and that they have suitable distribution capacity, both in Group and Individual Life. They must also continue to engage actively with the government as it develops policies in response to the growing crisis in the pay-as-you-go system.
Exane BNP Paribas Research & Oliver Wyman FRENCH LIFE INSURANCE 8 July 2013 page 5
Introduction
Insurers have been ‘crowded out’ by government Governments provide many of the same products that insurers do, such as health insurance, unemployment insurance and pensions. This makes insurers vulnerable to “crowding out” by governments. Unemployment insurance is the most obvious example: in countries where governments provide unemployment benefits, there is little demand for private unemployment insurance, especially among low-income earners.
The same holds true for private pensions, and nowhere is this more obvious than in France. The French government’s “generous”, tax-funded, pay-as-you-go pension approach means that French life insurers have been crowded out of this market. Demand for private long-term savings in France is restricted to affluent households, and the industry has satisfied this demand, not with the illiquid pension products that dominate markets such as the UK and Switzerland, but with more liquid investment and savings products, usually sold through banks.
Demand for savings products has flat-lined This has left French life insurers in a difficult position. After enjoying strong growth from the late 1980s through to 2006, demand for their savings products has flat-lined. This is partly a result of the natural maturation of the market, with the currently distressed economic environment exacerbating the problem. The unusual combination of low interest rates and slow growth in the money supply restricts households’ willingness and ability to save.
Shareholder returns in French insurers’ main business are close to zero What’s worse, shareholder returns on the new business in French insurers’ main fonds en euros product are now close to zero. Life insurance products, such as pensions, are characteristically illiquid, with severe penalties for early exits by policyholders. Such products are not widespread in France, where the bulk of life insurance reserves (fonds en euros) can now be considered liquid given that most policyholders can withdraw their funds without incurring much penalty. This makes insurers who have been writing business in a low interest rate environment particularly vulnerable to a “run” should interest rates increase. As we explain below, such risks can be managed, but the fundamental problem remains: French life insurers are offering products for which demand has stopped growing and for which lapse risk is real.
We see short and long term solutions to French life problems The long-term solution is to be found in the roots of the immediate problems. At best, the French economy could grow slowly over the next decade. At the same time, the ratio of taxpayers to state pensioners will decline rapidly as the “baby boomers” retire. We believe that the French government will become increasingly unable to provide citizens with pensions that are sufficient to meet their needs in retirement, even after implementing planned reforms. The gap created by the government could be filled by insurers.
This report examines the current predicament of French life insurers and assesses a number of short-term actions that can be undertaken to protect the value of the current books of business. Finally, we look at the opportunity created by demographic and fiscal pressures on the state pension system in France. In the last section we consider just how insurers might set about capitalising on that opportunity.
Exane BNP Paribas Research & Oliver Wyman FRENCH LIFE INSURANCE 8 July 2013 page 6
Savings products have fuelled life insurance growth for the past 30 years
Governments typically, if unintentionally, discourage private savings for retirement in two ways. They provide tax-funded pensions, either for everyone, or for those with insufficient savings of their own. And they “double tax” income from savings, that is to say, they tax earnings from investments made with post-tax savings.
The governments of Singapore, Chile and Australia have countered these disincentives by compelling citizens to set aside private savings for retirement. For example, the Australian government requires employees to direct at least 9% of their income to a defined contribution pension scheme. Most other governments provide tax-breaks for contributions to such schemes, while holding state-funded pensions at uncomfortably low levels for retirees. Both approaches encourage private, capitalised or “funded” pensions, usually supplied by life insurance firms.
The French government has taken a different approach. Besides the non-contributory minimum pension established in 1956, employees and employers are required to contribute a portion (in the range of 6% to 9%) of the employees’ salaries to a mandatory state pension. This money is not invested but is simply transferred to current retirees. In other words, France relies mainly on a ‘pay-as-you-go’ pension system.
Employees and employers are also required to contribute to mandatory occupational pension schemes. Although the surpluses of these schemes are invested, like the governmental scheme, they mainly work by transferring the contributions of current employees and employers to retired employees.
This system of compulsory contributions, transfers (rather than investment) and high state-mandated retirement incomes has resulted in little demand for the kind of private pension products popular in countries such as the UK and Switzerland. Life insurers have effectively been “crowded out” of the French pensions industry by the French government. As a result, French life insurers sell a very different mix of products to that from insurers in most developed economies.
Figure 3: French life insurance sales are heavily geared towards savings Breakdown of annual life insurance premiums (2011)
76%
55%
30%20%
8%
20%
15%
30%
19%
7%
4%
30%39%
61%
85%
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
France Germany US Switzerland UK
Savings & investment Protection Pensions
Source: Swiss Re Sigma, FFSA, Exane BNP Paribas, Oliver Wyman
Exane BNP Paribas Research & Oliver Wyman FRENCH LIFE INSURANCE 8 July 2013 page 7
Until the mid-1970s French insurers sold protection products only: death cover through term-life or whole-life products and annuities that covered the risks of outliving one’s assets. This changed in 1976 when the Association Française pour l’Epargne et la Retraite (AFER) was established. Its aim was to create individual savings products that could help to cover the predicted shortfall in retirement income under the pay-as-you-go system, especially for more affluent households. However, these were not the illiquid pension products that are now ubiquitous in other markets. Rather, they were liquid savings products, similar to the now familiar fonds en euros product, but with a higher loading and higher yields (interest rates were then about 15%).
The market for these products did not take off until 1986, when Credit Agricole founded Predica and launched products similar to the AFER products. Other banks soon started their own life insurance companies and the French bancassurance model was born.
Figure 4: The savings business has driven life sales growth over the past 30 years Gross protection and savings sales since 1978 (EURbn)
0
20
40
60
80
100
120
140
160
180
1978 1981 1984 1987 1990 1993 1996 1999 2002 2005 2008 2011
Gross protection sales Gross savings sales
Source: FFSA, Exane BNP Paribas, Oliver Wyman
Figure 5: Life and savings market dominated by Bancassurers Market shares: French life & savings market (2011)
Insurer Market share of life and
savings (%)
CNP Assurances (Bancassurance with Banque Postale & Caisses d’Epargne) 17.2%Crédit Agricole (Bancassurer) 14.0%BNP Paribas (Bancassurer) 8.3%Axa France Assurance 7.6%Crédit Mutuel (Bancassurer) 7.3%Société Générale (Bancassurer) 6.7%Generali 6.3%Allianz 4.5%Covéa 3.4%La Mondiale 3.3%Aviva 3.2%Groupama 3.2%Natixis (Bancassurer) 2.6%HSBC (Bancassurer) 1.9%Macif 1.7%Swiss Life 1.5%Others 7.4%
Source: FFSA, Exane BNP Paribas, Oliver Wyman
Exane BNP Paribas Research & Oliver Wyman FRENCH LIFE INSURANCE 8 July 2013 page 8
French Life: A super-saving product
Premium flows from genuine pension products tend to be very stable in the face of shifting interest rates and changing economic conditions. In contrast, the flow of funds into and out of the AFER or fonds en euros-type products that dominate the French life market has shown them to be substitutes for bank savings products.
The figure below shows the flow of funds into and out of French life products and the popular, tax-exempt Livret A bank saving account, along with the interest rate on the Livret A product. Savers are clearly switching funds between the two products in response to changes in the Livret A interest rate and, hence, their relative returns. The 2009 spike in Livret A, uncorrelated to an increase in interest rates, is due to the fact that all banks, and not only Caisse d’Epargne, Banque Postale and Crédit Mutuel, were then allowed to distribute the product.
Figure 6: Life insurance and Livret A are substitutes 12-month rolling average of net flows life insurance and Livret A (lhs - EURm); Livret A credited rate (rhs)
(2,000)
(1,000)
0
1,000
2,000
3,000
4,000
5,000
6,000
Jan 03 Jan 04 Jan 05 Jan 06 Jan 07 Jan 08 Jan 09 Jan 10 Jan 11 Jan 120.0%
0.5%
1.0%
1.5%
2.0%
2.5%
3.0%
3.5%
4.0%
4.5%
Life net flows Livret A net flows Livret A rate
Source: Banque de France, Exane BNP Paribas, Oliver Wyman
More directly, responses to an FFSA (French association of insurers) survey conducted in 2011 show that savers use withdrawals from their life products in the same way that they use withdrawals from bank savings accounts: 48% on consumption, 22% on real estate, 13% on investments and 17% on “other”.
By 2006, life insurance net inflows (excluding pensions and protection) had reached EUR60bn a year, and total life reserves now stand at c.EUR1,350bn. As shown below, however, net inflows have stopped growing since the start of the financial crisis, and had turned negative in 2012 amid growing concerns over exposure to potentially insolvent European sovereign bonds and fears of potential fiscal tightening following the election of François Hollande as President.
Exane BNP Paribas Research & Oliver Wyman FRENCH LIFE INSURANCE 8 July 2013 page 9
Figure 7: Sharp slowdown in 2011-2012 Gross sales, claims and net flows – French life and savings (EURbn)
-20
0
20
40
60
80
100
120
140
160
2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012Net flow Gross inflows Withdrawals
Source: FFSA, Exane BNP Paribas, Oliver Wyman
Explicit capital and liquidity guarantees protected French life insurance providers from the worst of the crisis, making them “safe havens” for savers. In the first quarter of 2013, net flows increased to EUR9bn on the back of a cut in the Livret A rate from 2.25% to 1.75%. Nevertheless, the prospects for current life insurance products are poor, in our view. Low real interest rates are generally anathema to saving. And rates seem set to remain low for the foreseeable future as central bankers seek to encourage investment and consumption by inflating asset prices and holding down borrowing costs.
What’s more, low real interests rates are now, uncharacteristically, being accompanied by slow or no growth in the money supply. Because businesses and households are deleveraging, net new lending is declining and, with it, the creation of bank deposits. Despite central banks having dramatically increased the supply of base money, the “money multiplier” has contracted and the aggregate money supply has remained flat. There is, quite literally, less new money available to go into French life insurance products.
Figure 8: Life flows driven by new loan production Monthly net flows life insurance + banking deposits and new loan production
0
1,000
2,000
3,000
4,000
5,000
6,000
7,000
8,000
9,000
Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12
New loan production Life insurance + deposits net flows
Source: Banque de France, Exane BNP Paribas, Oliver Wyman
Exane BNP Paribas Research & Oliver Wyman FRENCH LIFE INSURANCE 8 July 2013 page 10
“Fonds en euros” product creates little value
French life insurance is dominated by two products: the fonds en euros, where the insurer takes on the investment risk, and the unit-linked product, where the policyholder bears the investment risk. Both products benefit from favourable tax treatment eight years after the first premium is paid. The fonds en euros accounts for 85% of total savings reserves (excluding pensions) and the unit-linked product for the remaining 15%.
Figure 9: French life insurance products: main features Product 2011 Reserves
(EURbn) 2011 gross
sales (EURbn) Key features Fiscal treatment
Traditional savings ("Euro")
1,153 100 Premiums + accumulated interest available at any time Interest credited annually Insurer bears investment risk and has to allocate 85% of investment revenues to policyholders
15.5% social contributions deducted from interest credited annually Tax rate depends on time of withdrawal since opening of contract < 4 years: 35%; between 4y and 8y: 15% > 8 years: Deduction from gains: EUR4,600 for single individual, EUR9,200 for a married couple. 7.5% tax rate on gains beyond
Unit-linked 204 12 Funds available at any time Policyholder chooses underlying investment funds and bears investment risk In some cases insurer can offer "at maturity" capital guarantee
15.5% social contribution on gains paid when funds withdrawn Tax rate similar to traditional savings "Euro"
Pensions 137 9 Includes group pensions (65% of reserves) and individual pensions (35%)
Typically premiums deducted from taxable revenues. Tax paid when pension revenues are received
Source: FFSA, Exane BNP Paribas, Oliver Wyman
The fonds en euros product is attractive to savers: it is both liquid and offers guarantees that consumers regard as risk-free (not an annual guarantee, rather premiums and accumulated interests are guaranteed at all times). Insurers typically invest funds in sovereign debt (45%), corporate debt (35%), direct loans (5%), equities (5%), real estate (6%) and cash (4%). The average duration of fixed income investments is in the range of 5 to 8 years and is aimed at matching the duration of liabilities, thereby minimising interest rate risk.
Returns to fonds en euros policyholders (“credited” interest rates) have fallen in recent years along with base rates and the tightening of corporate spreads. Nevertheless, in a declining interest rate environment, credited rates still structurally exceed spot market rates and rates paid on savings accounts because of the higher yield earned on the legacy book of assets. In 2012, for example, the average credited rate stood at about 3%, or 2.5% after “social contributions” (that is, after tax), which is still higher than the Livret A rate of 1.75%.
Exane BNP Paribas Research & Oliver Wyman FRENCH LIFE INSURANCE 8 July 2013 page 11
Figure 10: Falling credited rate on traditional life product (Euro) – still attractive 10-year French sovereign rate (OAT 10Y), average credited rate Euro and Livret A
0%
1%
2%
3%
4%
5%
6%
Jan00
Jan01
Jan02
Jan03
Jan04
Jan05
Jan06
Jan07
Jan08
Jan09
Jan10
Jan11
Jan12
OAT 10Y Livret A rate Avg credited rate life euro
Source: Banque de France, Datastream, Argus, Exane BNP Paribas, Oliver Wyman
The fonds en euros product is, however, less attractive to its providers. The guarantees that appeal so strongly to savers make it a capital intensive and, hence, expensive product to supply. Insurers must hold about 4% of total reserves as capital, with 65% of this burden arising from investment risk.
Figure 11: Market risk typically represents 65% of economic capital Typical breakdown of economic capital (market risk in dark colour)
Spread20%
Equity15%
Non listed & other20%
Interest rate5%
FX and volatility5%
Insurance risk25%
Operational risk10%
Source: Exane BNP Paribas, Oliver Wyman
About 80% of insurers’ revenues from the fonds en euros product are derived from the investment spread margin: that is, from the investment returns over and above interest credited to policyholders. We estimate that investment spread margins are currently about 80bps of fonds en euros life reserves, with there being some variance across companies. Insurers can increase this revenue by taking on more investment risk and thus generating higher excess returns, but this also consumes more economic capital. They can also reduce the credited rates offered to policyholders, but this approach carries the risk that policyholders will switch their funds to higher-yielding alternatives.
Exane BNP Paribas Research & Oliver Wyman FRENCH LIFE INSURANCE 8 July 2013 page 12
It is difficult for life insurers to increase entry fees. These fees have always been unpopular with customers, and the emerging direct sales model being adopted by new players, such as Boursorama and Fortuneo, is making it even more difficult for insurers who distribute though face-to-face channels (such as IFAs) to impose such fees.
Figure 12: “Euro” & Unit-linked: Spread business vs. fee business Margin breakdown for EUR10bn “Euro” savings AuM (EURm) Margin breakdown for EUR10bn unit-linked AuM (EURm)
18(8)25
(77)18
84
0
20
40
60
80
100
120
140
Investmentspread
Fees onpremiums
Operatingexpenses
PT profit Tax Net profit
18(8)25
(77)18
84
0
20
40
60
80
100
120
140
Investmentspread
Fees onpremiums
Operatingexpenses
PT profit Tax Net profit
42
(18)60
(100)40
120
0
20
40
60
80
100
120
140
160
180
200
Fees onAuM
Fees onpremiums
Operatingexpenses
PT profit Tax Net profit
42
(18)60
(100)40
120
0
20
40
60
80
100
120
140
160
180
200
Fees onAuM
Fees onpremiums
Operatingexpenses
PT profit Tax Net profit
Source: Exane BNP Paribas, Oliver Wyman
High distribution and administration costs (77bps of fonds en euros reserves on average) mean that pre-tax profits are a mere 25bps of AuM and 18bps post-tax. Given an economic capital requirement of 4% (400bps), this product is returning c.4% on capital after tax.
The appeal of unit-linked products The unit-linked story is the exact opposite of the fonds en euros story. In light of the financial crisis, the sovereign crisis and the “lost decade” on stock markets, savers have little appetite for a product that leaves them with the investment risk. This explains its small share of the life market (15%) and its greater appeal to affluent customers, who generally have a higher risk tolerance for long-term investments.
Yet this demand-stifling feature makes the unit-linked product profitable for life insurers. Because it is the policyholder rather than the insurer who carries the investment risk, the amount of capital that the insurer needs to set aside is relatively small: about 1% of the unit-linked reserves, mainly covering operating risk. Most insurers now offer “at-maturity” (as opposed to “anytime”) capital or return guarantees on their unit-linked product, which consumes additional economic capital. But even then, the total capital remains in the 1–2% range.
Entry fees for the unit-linked product are typically allocated to distributors. The majority of insurers’ revenues (about 75%) comes from commissions charged on assets under management, as with other asset management businesses, with the rest coming from fees on premiums. Revenues therefore vary with the market value of assets under management, which are mainly in equities and corporate bonds. Despite the higher operating costs of this product, the combination of higher revenues and lower capital means that insurers’ return on capital from the unit-linked product is currently 10 times that of the fonds en euros product: 40% versus c.4%.
Exane BNP Paribas Research & Oliver Wyman FRENCH LIFE INSURANCE 8 July 2013 page 13
Given the disparity in returns, insurers now treat the fonds en euros product almost as a loss leader (produit d’appel) with the aim of boosting unit-linked sales. Insurers pay a higher rate on their fonds en euros product if policyholders invest more than, say, 30% of their funds in unit-linked. With a product mix of 85% fonds en euros and 15% unit-linked, we estimate that insurers would generate an overall return on economic capital of c.10%, close to their typical 10–11% cost of capital. Should the product mix move towards 80% fonds en euros and 20% unit-linked, returns could reach 12%.
Figure 13: “Euro” & Unit-linked: Capital intensive vs. capital light business “Euro” vs. unit-linked: Capital consumption and return on capital
400
100
1842
42%
4%
0
50
100
150
200
250
300
350
400
450
Traditional savings Unit-linked0%
5%
10%
15%
20%
25%
30%
35%
40%
45%
Allocated capital Net profit Return on capital
Source: Exane BNP Paribas, Oliver Wyman
Exane BNP Paribas Research & Oliver Wyman FRENCH LIFE INSURANCE 8 July 2013 page 14
Beware of lapse risk
In most markets, life insurance policies are illiquid because early withdrawal attracts heavy contractual penalties, usually in the form of surrender charges or the elimination of capital guarantees: that is, policyholders who withdraw their funds early must accept the current market value of the investments made under their policy.
Not so in France, where the only penalty for early withdrawal is the loss of tax benefits. And even these penalties apply only when the product has been held for less than 8 years. (This explains the spike in lapses that occur when contracts are 8-years old: see figure below.) Today, more than 65% of contracts are more than 8 years old and hence beyond “fiscal maturity”.
This means that French life insurers face far greater lapse risk than life insurers in most other countries. In its most acute form, this risk could take the form of a “run” on these products, with a large percentage of policyholders simultaneously withdrawing their funds. This would force insurers to sell assets below par at “fire sale” prices, thereby suffering significant losses.
Figure 14: Lapse experience shows spike after 8 years Typical lapse experience on French life (x-axis: # of years; y-axis: lapse in % of reserves)
0
2
4
6
8
10
12
14
0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24
Source: Exane BNP Paribas, Oliver Wyman
No “run” on French life insurance products has occurred since their inception in the mid-1980s. Yet this is a relatively short period of time, and one characterised by economic conditions that no longer exist. Interest rates in the mid-1980s were high and have steadily fallen to the point where they are now near zero. On the basis that nominal interest rates cannot fall far below zero, this trend cannot continue. If interest rates begin to rise again, life insurers’ predominantly fixed income assets would devalue and insurers could incur significant losses.
Policyholders may respond to a loss of confidence in life insurers by withdrawing their funds and switching to products based on shorter re-pricing schedules, such as the Livret A or spot-priced products. Or doubts about the quality of insurers’ assets, perhaps caused by a sovereign crisis, could lead to large scale withdrawals.
Exane BNP Paribas Research & Oliver Wyman FRENCH LIFE INSURANCE 8 July 2013 page 15
Even if such events do not occur, life insurers bear a cost of increased lapse risk. Specifically, to be able to honour the increased (probability of) early withdrawals, they must allocate a greater portion of their investments to short-term or liquid assets. French life insurers thus forgo the “illiquidity premium” (the higher yield on illiquid assets) from which life insurers normally benefit.
If rising interest rates threaten French insurers with significant funds outflows, declining investment yields also present them with a serious threat. The credited rate on new fonds en euros sales can be reduced in response to falling yields (with the effect of reducing demand), but the spread on in-force policies with return guarantees (on parts of the back book linked to old products) would be severely compressed, potentially becoming negative. This could require French life insurers to reduce credited rates, to “run off” their books or even force them into insolvency. A protracted low investment yield environment has caused many Japanese life insurers to fail.
Figure 15: c. 130 bps decline in investment yield in base case Projected evolution of yield on invested assets (Base, bull and bear cases)
0.0%
1.0%
2.0%
3.0%
4.0%
5.0%
6.0%
2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022
Base case Bull case Bear case
Source: Exane BNP Paribas, Oliver Wyman
Exane BNP Paribas Research & Oliver Wyman FRENCH LIFE INSURANCE 8 July 2013 page 16
Protecting the value of the current book of business
In this section, we argue that French life insurers are effectively making a trade-off between the unit value of product sales and growth when pushing the fonds en euros product – and that this trade-off should be made more rigorously and more transparently to avoid destroying shareholder value. We also investigate a number of avenues for protecting the value of the current book of business, including selectively cutting credited rates, redesigning products, increasing portfolio risk on the asset side and managing costs down.
Time to clarify the growth vs. value trade-off As noted in the previous two sections, the fonds en euros product creates almost no value for life insurers while consuming substantial capital. Insurers continue to promote it for the sake of maintaining relationships with savers, hoping to cross-sell more profitable products.
But are they making the optimal trade-off: that is, the one that will maximise long-run return on capital? This is what potential investors need to be convinced of. To date, French insurers have failed to tell a convincing story – potentially because they have not evaluated the trade-off properly.
The financial crisis has forced banks to revisit their financial resource management (FRM): that is, the way they take account of risk, liquidity and capital consumption when making strategic plans. They have developed more robust ways of calculating the financial resource implications of any strategy, most notably by estimating the P&L and balance sheet implications of various scenarios, rather than relying on historical statistics to formulate a single set of projections (see figure below).
Figure 16: Integrated FRM has become the norm in the banking world Risk strategy● Risk tolerance● Target-risk profile
Risk effects● Review the risk on the
group level and the risk of diversification effects
● Stress scenarios
Approving risk● Final check of plans with respect to
risk tolerance and limits
Capital and financing strategy● Efficiency of capital and
financing● Consideration of capital
market circumstances
Capital and financing effects
● Coupling of asset and liability plans
● Assessing requirements with available resources
Approval of capital and financing● Approval of capital and
financing● Derivation of capital and
financing plans
Business segment contract● Profit objectives, limits,
resource allocation● Responsibility of
management (e.g. product/market)
● Management initiatives● Value drivers/KPIs● Personal goals and
compensation● Agenda for performance
evaluation
Vision of the group● Clearly formulated vision of
the future of the business segments, defined through consensus
● Clarity about the expected contribution of the business segments to the accomplishment of the vision of the future
● Strategic balance sheet
Business guidelines Business planning Questioning, debating and resource allocation
Strategy GuidelinesBusiness segment strategy
Planning detailing
Aggregation, questioning,
debating
Resource allocation
Budgeting, action
planning
^ ^ ^
^ ^ ^
^
Risk strategy● Risk tolerance● Target-risk profile
Risk effects● Review the risk on the
group level and the risk of diversification effects
● Stress scenarios
Approving risk● Final check of plans with respect to
risk tolerance and limits
Capital and financing strategy● Efficiency of capital and
financing● Consideration of capital
market circumstances
Capital and financing effects
● Coupling of asset and liability plans
● Assessing requirements with available resources
Approval of capital and financing● Approval of capital and
financing● Derivation of capital and
financing plans
Business segment contract● Profit objectives, limits,
resource allocation● Responsibility of
management (e.g. product/market)
● Management initiatives● Value drivers/KPIs● Personal goals and
compensation● Agenda for performance
evaluation
Vision of the group● Clearly formulated vision of
the future of the business segments, defined through consensus
● Clarity about the expected contribution of the business segments to the accomplishment of the vision of the future
● Strategic balance sheet
Business guidelines Business planning Questioning, debating and resource allocation
Strategy GuidelinesBusiness segment strategy
Planning detailing
Aggregation, questioning,
debating
Resource allocation
Budgeting, action
planning
^ ^ ^
^ ^ ^
^
Source: Oliver Wyman, Exane BNP Paribas
No such advances in FRM have been made in the strategic planning of many French life insurers. Even though most of them now have the tools in place to measure value creation, be it under Solvency II or using a market-consistent value framework, many are still falling short of using those tools in an integrated fashion for day-to-day decision-making. This is evident in the persistence of poorly designed products, with guarantees that are too generous, creating liquidity risk or pressure on investment margin.
Exane BNP Paribas Research & Oliver Wyman FRENCH LIFE INSURANCE 8 July 2013 page 17
Such practices are a problem not only for those insurers that undertake them. When some suppliers under-price, others that wish to maintain market share are obliged to follow suit. The small mutual life insurers and Institutions de Prévoyance that have not embedded risk-adjusted value frameworks to the same extent thereby may exacerbate the level of competition on the French Life market.
A lot of the scepticism regarding value creation has come from the fact that insurers have neither been good at articulating the growth vs. value trade-off nor at communicating it to the market, along with the implications for capital and liquidity consumption. The political environment is stabilizing (see box below) and we believe that there is a timely opportunity for insurers to reset their strategies and reaffirm the shareholder promise.
Rapport Berger-Lefebvre
The “Berger-Lefebvre” report was released on 2nd April 2013. Its authors (two members of Parliament) presented a number of measures aimed at improving the long term financing of the French economy:
– Maintain the current favourable tax treatment. A stable fiscal framework is critical for individuals making long term savings. Insurers need stable long-term liabilities to make long-term investments
– Modify the fiscal treatment of contracts over EUR500k (1% of contracts, yet representing 25% of total AuM), with current fiscal rules maintained for fonds en euros only for contracts below EUR500k. Above that level, funds would benefit from the current tax treatment only if they are invested in unit-linked or Euro-croissance products, with a minimum share of investments in SME financing.
– Promote a new Euro-croissance product similar to the existing Euro-diversifié. Insurers would only offer “at-maturity” guarantees. This will allow them to take more investment risk and offer higher expected rates of return to policyholders. It would also create real long term liabilities and help solve the liquidity issue. Switching from fonds en euros to Euro-croissance should be made easy within an existing contract (maintien de l’antériorité fiscale)
– Over 4 years these measures are expected to generate about EUR100bn in new equity financing of which c.EUR25bn for SMEs, matching the long term funding requirement of SMEs over the period.
Not only is the policy environment moving in the right direction but insurers can take immediate actions that will boost shareholder value. Specifically, they can cut their credited rates, redesign their products, increase the risk and yield on their investment portfolios and cut their operating costs.
Exane BNP Paribas Research & Oliver Wyman FRENCH LIFE INSURANCE 8 July 2013 page 18
Cut credited rates Life insurers’ spread income is the difference between their investment returns and the credited rate for policyholders. A simple way to increase spread income is thus to cut credited rates. This may seem to risk a significant loss of market share. But our analysis suggests that clients are generally not as sensitive to credited rates as they are to entry fees and that their price sensitivity varies substantially by customer segment. A well-designed 50bps reduction in average credited rates could enhance the spread margin of many French life insures without causing a material increase in lapse rates.
Figure 17: Credited rates have little effect on next year’s market share Analysis of the correlation between credited rates (y-axis) and market share gains (x-axis), for the top 10 French insurers and for time period 2006 – 2011, showing that there is only a 1.7% correlation between credited rate and next year’s market share
R2 = 0.017
2.5%
2.8%
3.1%
3.4%
3.7%
4.0%
4.3%
4.6%
4.9%
(20%) (15%) (10%) (5%) 0% 5% 10% 15% 20%
Market share year N+1 compared to year N
Cre
dite
d R
ate
year
N
Source: Oliver Wyman, Exane BNP Paribas
Ideally, increases in credited rates should be targeted on the most price elastic customers. Similarly, changes in service levels entailed by cost-reduction programmes should be designed to avoid losing the most valuable customers. Both require insurers to identify value skews in the portfolio by combining cost and actuarial data with information about customers’ preferences and behaviours. This will allow them to develop action plans tailored to portfolio clusters, where a cluster is defined as a type of product sold to a client segment through a specific distribution channel. We believe that most insurers are leaving money on the table because they do not mine data and take action at the cluster level.
Redesign products As with suppliers of any goods, the challenge for French life insurers is to design products that customers value higher than their cost of production. Capital is the cost most sensitive to the way life insurance products are structured – especially to the features of any guarantee included in them. The fonds en euros product which now dominates the French market is often very costly from this point of view (see the second section of this note).
New products, such as the fonds euros diversifiés, are better designed, maintaining the long-term guarantees that matter to savers but without the liquidity and high capital costs of the fonds en euros product (see earlier box). Firms that are quick to identify and promote such improved products could capture leading positions in those new areas. However, so long as insurers continue to sell the fonds en euros product, new products with terminal guarantees are unlikely to take-off significantly. We believe that most savers will continue to prefer liquidity to slightly higher expected returns. The trade-off would favour these new products only if insurers materially cut credited rates on fonds en euros.
Exane BNP Paribas Research & Oliver Wyman FRENCH LIFE INSURANCE 8 July 2013 page 19
Increase portfolio risk French insurers have a tradition of very conservative asset allocation and meagre yields. The majority of their assets are government or high-rated corporate bonds. And, as shown below, they have recently increased their allocation to such assets. Even well managed insurers now earn less than 4% on their asset portfolios.
Figure 18: Insurers have been investing increasingly in bonds Investment of French insurers split by bonds vs. others, 2000 and 2011
68% 72%
32% 28%
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
2000 2011
Others
Bonds
Total EUR1,526bnincl. bonds EUR1,099bn
Total EUR691bnincl. bonds EUR470bn
Source: Oliver Wyman, Exane BNP Paribas
This situation has been aggravated by insurers’ cleaning their portfolio of GIIPS debts following the 2011 sovereign crisis as this contributed to lower recurring yield on investments.
Having restored their provisions to healthy levels, it is now time for French life insurers to re-risk their portfolios. The obvious way to do this is to re-weight their portfolios away from fixed income and towards higher-yielding alternative assets classes, such as those listed in the table below. The spread available varies by country but, after allowing for expected losses and cost of credit capital, a risk-adjusted uplift of around 150-200 bps above gilts is achievable in our view.
Figure 19: Alternative assets yield higher returns
Spread on medium term, investment grade asset (bps) Assets Description UK France Germany Comments
Commercial mortgages Mortgage loans made using commercial real estate as collateral
300-500 300-500 150-200 High barriers to entry created by requirements for specialist skills
Infrastructure financing Loans to fund infrastructure, energy and project finance
200-350 Similar to UK Similar to UK Secondary market for assets limited and segregated to specialised buyers
Social housing Government-guaranteed loans to housing associations
150-300 Not applicable Not applicable
Residential mortgages Mortgages loans made to individuals using real estate as collateral
Not applicable Not applicable 60-140
SME lending Direct loans made to SMEs Not applicable 100-300 10-20
Not applicable in countries where a banking licence is required or there is significant pre-payment risk
Asset-backed securities Mortgage and other asset backed securities that are secured by the loan on asset
250-350 50-100 100-200 Non-transparent nature of risk reduces investor appetite and confidence and liquidity shown to disappear under stress
Covered bonds Securities backed by cash flows from mortgages or public sector loans and wrapped by the issuing bank
100-300 50-100 0-20 In some countries, e.g. some Nordic countries, markets are extremely liquid hence spread has been bid down making these less appropriate assets
Liquidity swaps Trade in which one party lends a pool of liquid assets to another in exchange for a pool of collateral/illiquid assets, plus a fee
50-100 50-100 50-100 Banks will typically pass on some of the write-down of assets to insurer thus compression spreads versus direct investment in the underlying illiquid asset
Source: Oliver Wyman, Exane BNP Paribas
Exane BNP Paribas Research & Oliver Wyman FRENCH LIFE INSURANCE 8 July 2013 page 20
About 25% of French life insurers’ EUR1,350bn of assets are matched with very sticky liabilities, which are still far from the 8-year threshold. If the life insurers switched these to less liquid alternative assets, the additional “illiquidity premiums” would amount to about EUR5bn on a risk-adjusted basis (before profit sharing with policyholders).
To capture this opportunity, we think that insurers must extend the skill and reach of their asset management functions. They will need staff who are specialists in illiquid and alternative products, especially in evaluating their risk and proper pricing. Potentially, life insurers should establish business units dedicated to acquiring these assets or “originating” them in the case of direct lending.
Cut costs Many insurers have undertaken cost-cutting exercises in recent years. However, we believe that they have achieved less than they could because they have approached the matter in a “subtractive” manner. That is, they have looked at their existing operations and cost base with a view that they can cut 5% here, 10% there and so on.
To materially improve operating margins, however, they need to take a “zero-based” approach. That is, they need to forget where they find themselves and re-think their operations from scratch. For example, if Amazon or Google were to sell insurance tomorrow, they would not manage distribution channels in silos, there would be no paper exchange and they would not have multiple functions and systems carrying out similar analyses on different data and different systems.
We see lots of room for improvement in the operations of French life insurers. Even within the boundaries of the intermediated distribution model, acquisition costs could be slashed by “digitizing” much of what is now done manually by front line staff. Some consumers will always seek face-to-face advice. But consumers’ increased ease and even preference for conducting business online provides an opportunity for cost-cutting that French life insurers have hardly begun to exploit.
Another major cost-cutting opportunity is business process outsourcing. Unlike their British counterparts, who outsource many of their administrative processes, we believe that many French insurers continue to think that they should do everything in-house, even when they are sub-scale. Over the past 10 years some have attempted to “mutualise” platforms and processes across business units: that is, to create “shared services” internally. But even this does not lead to the scale or concentration of expertise enjoyed by large third-party providers, neither does it lead to lower potential unit costs.
We believe that the actions recommended in this section are worthwhile. Insurers who take them will get an edge over those that do not. Yet they will not transform the generally forlorn position of the French life insurance industry. For that, we see only one serious possibility: the emergence of a large private pensions market in France.
Exane BNP Paribas Research & Oliver Wyman FRENCH LIFE INSURANCE 8 July 2013 page 21
Private pensions are the long term prize
Pay-as-you-go pensions will be cut As noted above, France has a pay-as-you-go (PAYGO) pensions system. Contributions from current earners are not invested to provide them with a pension on retirement. Rather, their contributions are transferred directly to current pensioners. When current earners retire, their pensions will be funded by transfers from those who are then earning.
At least, that is the idea. In fact, things are unlikely to work out this way. The viability of a PAYGO pension scheme depends on the ratio of current earners to current pensioners. As the ratio declines, the government can pull a combination of three levers: a) pushing back the retirement age, which simultaneously increases the number of contributors and reduces the number pensioners, b) reducing the amounts paid to pensioners, and c) increasing the amount taken from current earners. In the short term the government could borrow to fund contribution short-falls but we see this as unsustainable since government borrowing is simply deferred taxation.
France currently finds itself at a dead-end: Increasing longevity and a high unemployment rate mean that the ratio of working age people to retirees is declining sharply. By 2060, each pensioner would be supported by just 1.3 workers. The contributions of current earners cannot be materially increased; the burden on the productive part of the population would be both politically impossible and economically calamitous. Nor is economic growth likely to come to the rescue. The French economy is currently contracting, and the IMF forecasts zero growth over the next five years, with unemployment still above 10% in 2017.
Figure 20: Demographic ratio forecasts Nb of contributors / nb of public pensioners, 2006 – 2060E
120%
130%
140%
150%
160%
170%
180%
190%
2006
2009
2012
2015
2018
2021
2024
2027
2030
2033
2036
2039
2042
2045
2048
2051
2054
2057
2060
Source: COR forecasts, projections excluding impacts from future reforms
Exane BNP Paribas Research & Oliver Wyman FRENCH LIFE INSURANCE 8 July 2013 page 22
The French PAYGO system now has a yearly deficit of EUR14bn, which, without reform, is expected to reach EUR63bn a year by 2060 in a “pessimistic” scenario developed by the Conseil d'Orientation des Retraites (COR) based on GDP growth of ~1.5% p.a. and an average unemployment rate of 7%. Given that unemployment is now 11%, it is difficult for us to see how 7% can be a pessimistic scenario. Our own projections, based on more conservative growth and unemployment projections (on average 1% GDP growth and 10% unemployment rate), show that the deficit will probably grow even faster and could reach EUR135bn p.a. by 2060 without reform.
The French population is, understandably, becoming increasingly concerned about its income in retirement. A 2013 survey by Le Cercle des Epargants asked a representative sample of more than 1,000 French consumers “How do you feel with regards to your retirement?” 67% of interviewees responded that they were worried, up from 57% in 2011.
Figure 21: Yearly deficit for the French public pension system
Deficit p.a. in EURbn and as a % of GDP (inflation adjusted), 2012-2060E
0
20
40
60
80
100
120
140
160
2012 2020 2030 2040 2050 20600.0%
0.5%
1.0%
1.5%
2.0%
2.5%
3.0%
Deficit p.a. Deficit/GDP
Source: Oliver Wyman central case forecasts, based on COR and IMF data
As baby-boomers reach retirement, and despite a planned increase in the retirement age, the public PAYGO system will end up delivering substantially lower income replacement rates for pensioners. To maintain pensioners’ standard of living, the PAYGO system will, in our view, need to be supplemented by genuine long-term savings: that is, by private, capitalised pensions. It is not clear what form private pensions will take in France. They could be either group or individual pensions and the level of State incentivisation could, in theory, be anything from nothing to generous tax-breaks, or even out-and-out compulsion, as in Australia.
The “Australian option”, whereby earners are legally obliged to contribute to a private pension scheme, would be politically difficult in France and, hence, unlikely to occur, despite its numerous advantages in terms of transparency and fairness. Previous attempts, such as the plan Juppé legislation on pensions in 1995 or the loi Fillon in 2003, prompted uproars against the système par capitalisation. However, the seriousness of the current situation may create an opportunity for the government to strike a deal with trade-unions and push for the creation of a true second pillar for pensions.
Exane BNP Paribas Research & Oliver Wyman FRENCH LIFE INSURANCE 8 July 2013 page 23
The more likely evolution of the system will be one caused by political inertia. To avoid conflict with vociferous interests, the various régimes spéciaux will be preserved while the value of state pensions slowly erodes. Affluent French householders may increase their contributions to voluntary private pensions but most of the population would find itself with no incentive to make private savings and becoming progressively worse off in retirement.
On an even worse scenario, uncertainty about economy growth, tax rules and monetary stability could cause affluent households to keep their savings in liquid assets and real estate, allowing for no growth in private pensions.
Provided this last scenario does not unfold, the eroding value of state pensions should cause increasing quantities of money to flow into private pensions in France. And, given the extraordinarily low starting point, these inflows could be very significant.
Figure 22: Total investment of pension funds in OECD countries % of GDP, 2011
0.00.21.92.22.93.84.24.54.94.95.35.56.57.47.77.88.4
12.915.015.8
25.133.9
46.249.449.7
58.563.7
70.575.0
88.292.8
110.8128.7
138.2
0 20 40 60 80 100 120 140 160
GreeceFrance
LuxembourgTurkey
SloveniaHungaryBelgium
KoreaItaly
AustriaEstonia
GermanyCzech Republic
NorwayPortugal
SpainSlovakia
MexicoPoland
New ZealandJapan
AVERAGEIreland
IsraelDenmark
ChileCanada
USAFinland
UKAustralia
SwitzerlandIceland
Netherlands
Source: OECD Global Pension Statistics
Exane BNP Paribas Research & Oliver Wyman FRENCH LIFE INSURANCE 8 July 2013 page 24
What is the opportunity for life insurers? Pensions are not the only vehicles for long-term saving. People could make private provision for their retirement by investing in real estate or bank savings products. However, these alternatives do not protect retirees from the risk of outliving their assets and could be more penalising from a fiscal standpoint. A dramatic growth of private pensions in France, though not a matter of certainty, is very likely. And Life insurers are best positioned to capture most of this growth.
Figure 23: Competitive positioning of financial services providers by customer needs
Customer needsRetail
banking Private banking Life & Wealth Asset Manager Pension funds
1. Income & liquidity
2. Asset protection
3. Wealth accumulation
4. Longevity protection
5. Advice
6. Tax efficiency
7. Long term care
8. Services / affinity
Customer needsRetail
banking Private banking Life & Wealth Asset Manager Pension funds
1. Income & liquidity
2. Asset protection
3. Wealth accumulation
4. Longevity protection
5. Advice
6. Tax efficiency
7. Long term care
8. Services / affinity
Source: “Pension Markets in focus” September 2012, OECD Global Pension Statistics
We estimate that flows into private pensions by 2020 could range between EUR16bn and EUR39bn per annum. If so, total private pension funds under management in 2020 would stand at between EUR182bn and EUR359bn. By 2040, we expect the inflows to be between EUR19bn and EUR45bn per annum and total funds under management to be between EUR377bn and EUR1,042bn. Compared to traditional fonds en euros, currently with annual inflows of c.EUR100bn and EUR1,153bn under management, private pensions should remain relatively small. However, because we expect traditional products to stagnate, private pensions could be the main source of growth in life insurance over the coming years.
Exane BNP Paribas Research & Oliver Wyman FRENCH LIFE INSURANCE 8 July 2013 page 25
Figure 24: The private pension potential, annual inflow forecasts assuming enforcement in 2014 EURbn, 2013 – 2041E (3 scenarios: Base, Bear, Bull)
0
5
10
15
20
25
30
35
40
45
50
2015
2017
2019
2021
2023
2025
2027
2029
2031
2033
2035
2037
2039
2041
BASE BEAR BULL
Source: Oliver Wyman, Exane BNP Paribas
Figure 25: The private pension potential, total stock forecasts EURbn, 2013 – 2041E (3 scenarios: Base, Bear, Bull)
0
200
400
600
800
1,000
1,200
2015
2017
2019
2021
2023
2025
2027
2029
2031
2033
2035
2037
2039
2041
BASE BEAR BULL
Source: Oliver Wyman, Exane BNP Paribas
Our projections are based on data from the COR (for deficit projections) and INSEE for demographics. We have developed three scenarios based on the following factors: – assumptions about the current deficit in the state PAYGO based on different sets of reforms, and resulting “replacement ratios” of the state pension
– the percentage of pension shortfall that individuals will want to bridge to reach their desired standard of living during retirement (differentiated by wealth band), and thus required annual savings by cohort during working life and
– the percentage of required savings allocated to life insurance as opposed to other vehicles, such as real estate and banking products.
Exane BNP Paribas Research & Oliver Wyman FRENCH LIFE INSURANCE 8 July 2013 page 26
The assumptions behind each of the three scenarios are summarised in the table below.
Figure 26: Hypotheses for the private pension potential forecasts 3 scenarios: Base, Bear, Bull
Scenario Deficit Sets of reforms Replacement level (of State pension diminution)
% of savings allocated to life insurance
Annual inflow in 2040 Total stock in 2040
BASE Realistic Reform 1 (2013): +6 months, +5bps contrib. deduction, -EUR1500 /pensioner/year on average
Reform 2 (2018): +6 months, +5bps contrib. deduction, -EUR900 /pensioner/year on average
Reform 3 (2023): +6 months, +5bps contrib. deduction, -EUR900 /pensioner/year on average
75% From current 20% up to 75% in 20 years, exponential growth
EUR21bn additional yearly inflows +EUR9bn current yearly inflows = EUR30bn
EUR554bn additional stock +EUR136bn current stock = EUR690bn
BEAR Optimistic (COR scenario C’)
Reform 1 (2013): +6 months, +5bps contrib. deduction, -EUR1000 /pensioner/year on average
Reform 2 (2020): +6 months, +5bps contrib. deduction, -EUR600 /pensioner/year on average
Reform 3 (2030): +6 months, +5bps contrib. deduction, -EUR600 /pensioner/year on average
66% From current 20% up to 60% in 20 years, linear growth
EUR10bn additional yearly inflows +EUR9bn current yearly inflows = EUR19bn
EUR241bn additional stock +EUR136bn current stock = EUR377bn
BULL Realistic Reform 1 (2013): +6 months, +5bps contrib. deduction, -EUR2200 /pensioner/year on average
Reform 2 (2018): +6 months, +5bps contrib. deduction, -EUR1200 /pensioner/year on average
Reform 3 (2023): +6 months, +5bps contrib. deduction, -EUR1200 /pensioner/year on average
90% From current 20% up to 80% in 20 years, exponential growth
EUR36bn additional yearly inflows +EUR9bn current yearly inflows =EUR45bn
EUR906bn additional stock +EUR136bn current stock = EUR1,042bn
Source: Oliver Wyman, Exane BNP Paribas
Figure 27: Illustration of expectation of growth in life insurance: savings vs. pension
Funds under management for French insurers in EURbn, 2000 – 2020E
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
2019
2020
1400
1200
1000
800
600
400
200
0
Expected trends for traditional life insurance
Expected trends for additional private pension
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
2019
2020
1400
1200
1000
800
600
400
200
0
Expected trends for traditional life insurance
Expected trends for additional private pension
Expected trends for traditional life insurance
Expected trends for additional private pension Source: Oliver Wyman, Exane BNP Paribas
Exane BNP Paribas Research & Oliver Wyman FRENCH LIFE INSURANCE 8 July 2013 page 27
Individual pensions taking-off; Group pensions uncertain The tax treatment of individual pension products (Madelin, PERP) is very favourable (see table below). Those products are now even more attractive from a fiscal standpoint after the recent tax hikes on banking savings and capital gains.
Figure 28: Individual pension products are attractive from a fiscal standpoint Overview of retirement products in France
Product 2011 Reserves (EURbn)
2011 gross sales (EURbn)
Key features Fiscal treatment
Individual pensions (PERP, Madelin…)
48 4.2 Individual savings for retirement: funds cannot be withdrawn ahead of retirement. Funds only accessible as annuity. Capital accessible in specific situations (long term unemployment, over-indebtedness…)
Premiums deducted from taxable income (max 10% of taxable income p.a. with a cap of c. EUR30k) Financial income not taxed during accumulation phase Annuity taxed as an income when paid
Group pensions 89 4.8 Pensions contracts subscribed at the initiative of employers. Premiums paid by employers. Funds paid to employee as annuity upon retirement
For employers premiums not subject to social charges and can be deducted from taxable income For employees annuity taxed as income when paid
ow defined contribution (Art. 83)
40 2.7 No guarantee on annuity payment to employee (annuity will depend on account value at retirement)
ow defined benefits (Art. 39)
49 2.1 Guaranteed annuity payment upon retirement
Total 137 9.0
Source: Oliver Wyman, Exane BNP Paribas
Solid growth in individual pensions is already visible: assets under management for Madelin contracts (dedicated to the self-employed) have grown from EUR15bn in 2007 to EUR24bn in 2011. 58% of the self-employed population is now covered by this product. Similarly AuM in the PERP (available to everyone) have increased from EUR3.4bn in 2007 to EUR7.5bn in 2011.
Figure 29: Some retirement products are starting to grow – Madelin contracts Number of contracts in thousands, 2002 – 2011
0
200
400
600
800
1,000
1,200
2002 2003 2004 2005 2006 2007 2008 2009 2010 2011
Source: FFSA
Exane BNP Paribas Research & Oliver Wyman FRENCH LIFE INSURANCE 8 July 2013 page 28
The question for French life insurers is how to position themselves to capture most of the supplier surplus in a growing private pensions market. Private insurers currently dominate the small individual pensions market. But, if the French government takes measures that favour group policies, the majority of funds may flow not to insurers but to institutions de prévoyance (non-profit workplace-based insurance providers). This is especially likely if the government institutes accords de branche arrangements which give specified suppliers “preferred status”, as nearly occurred in health insurance.
Figure 30: Insurers are well positioned on individual and group pension products Top 10 insurers in individual pensions, 2012 premiums
Market share pensions (%)
Top 10 insurers in group pensions, 2012 premiums
Market share pensions (%)
AG2R La Mondiale 16% AG2R La Mondiale 19%CNP assurances 13% Axa France 18%Generali 13% CNP assurances 17%Crédit agricole assurance 11% BNP Paribas Cardif 15%Swiss Life 10% Generali 5%Axa France 9% Crédit agricole assurance 5%Union mutualiste retraite 4% Groupe Agrica 2%Aviva vie 3% Swiss Life 2%BNP Paribas Cardif 3% Humanis 1%Allianz 3% Suravenir 1%
Source: L’Argus de l’Assurance
In the event that the government does nothing significant in this area, affluent households are likely to direct their saving to individual policies and insurers should be able to maintain their market dominance. Nevertheless, given policy uncertainty and the “size of the prize”, French life insurers need to position themselves to thrive in either scenario.
Distribution will be the key. For group contracts, insurers should expand their distribution capacity, especially those who are starting from a low base. This means developing their own group policy sales-forces, that differ greatly from the agents and banking tellers used for individual contracts, as well as structuring a distinct employee benefits proposition for the broker channel.
For individual contracts sold to affluent clients, life insurers already distribute effectively through IFAs. However, the really big opportunity comes from the mass and mass-affluent segments, which in most private pension markets account for more than 50% of total inflows. However the “high touch” IFA and bancassurance distribution models are too costly for mass customers, whose relatively small savings cannot generate much income for financial institutions. In France, as elsewhere, the evolution of a mass-segment private pensions market will require a more varied distribution model.
The challenge is to find low-cost ways of providing advice to mass market customers. To date, this has been difficult to achieve, even in countries with well-developed private pensions industries. However, advances in online financial services, and in consumers’ ability to use them, provide new hope to solve this difficult problem.
Exane BNP Paribas Research & Oliver Wyman FRENCH LIFE INSURANCE 8 July 2013 page 29
Conclusion
Our recommendations for clarifying strategic positioning and improving returns in the current French life insurance business, made in section six, can, in our view, be achieved in the current regulatory environment. But the big prize – the emergence of a large-scale private pensions market in France where life insurers suffer no structural disadvantage – depends crucially on government policy.
One way or the other, we believe that the government will have to get out of the woods and reform the current system, which will put an end to the prevailing uncertainty. Hopefully this will be done by adopting policies designed to promote a competitive market in private pensions. This would benefit future retirees, by encouraging them to supplement the diminishing retirement incomes from the PAYGO system with their own savings; it would help to curb government deficits; and it would provide a pool of savings available for investment in the real economy of France.
In the meantime, French life insurers should recognise what the different macroeconomic scenarios have in common and start building up their distribution capabilities in individual and group pensions. At the same time, they should retain enough flexibility to reallocate their financial and other resources as the situation evolves. And they would be well advised to influence that evolution by engaging even more actively with the government as it develops policies in response to the growing crisis in the PAYGO system.
Exane BNP Paribas Research & Oliver Wyman FRENCH LIFE INSURANCE 8 July 2013 page 30
Appendix
Figure 31: Future investment returns – detailed scenarios BASE CASE 2013e 2014e 2015e 2016e 2017e 2018e 2019e 2020e 2021e 2022e
Cash 0.1% 0.1% 0.1% 0.1% 0.1% 0.1% 0.1% 0.1% 0.1% 0.1%Government debt 2.0% 2.0% 2.0% 2.0% 2.0% 2.0% 2.0% 2.0% 2.0% 2.0%Corporate bonds 2.1% 2.1% 2.1% 2.1% 2.1% 2.1% 2.1% 2.1% 2.1% 2.1%Loans 4.0% 4.0% 4.0% 4.0% 4.0% 4.0% 4.0% 4.0% 4.0% 4.0%Equity 9.0% 9.0% 9.0% 9.0% 9.0% 9.0% 9.0% 9.0% 9.0% 9.0%Real estate 5.0% 5.0% 5.0% 5.0% 5.0% 5.0% 5.0% 5.0% 5.0% 5.0%BULL CASE Cash 0.8% 1.4% 2.0% 2.0% 2.0% 2.0% 2.0% 2.0% 2.0% 2.0%Government debt 2.0% 2.5% 3.0% 3.5% 4.0% 4.5% 4.5% 4.5% 4.5% 4.5%Corporate bonds 2.1% 2.7% 3.5% 4.0% 4.5% 5.0% 5.5% 5.5% 5.5% 5.5%Loans 4.0% 4.5% 5.0% 5.5% 6.0% 6.5% 6.5% 6.5% 6.5% 6.5%Equity 9.0% 10.0% 11.0% 12.0% 13.0% 13.0% 13.0% 13.0% 13.0% 13.0%Real estate 7.0% 7.5% 8.0% 8.5% 8.5% 8.5% 8.5% 8.5% 8.5% 8.5%BEAR CASE Cash 0.1% 0.1% 0.1% 0.1% 0.1% 0.1% 0.1% 0.1% 0.1% 0.1%Government debt 2.0% 1.5% 1.0% 0.5% 0.5% 0.5% 0.5% 0.5% 0.5% 0.5%Corporate bonds 2.1% 1.7% 1.2% 0.7% 0.7% 0.7% 0.7% 0.7% 0.7% 0.7%Loans 4.0% 3.5% 3.0% 2.5% 2.0% 2.0% 2.0% 2.0% 2.0% 2.0%Equity 9.0% 8.0% 7.0% 6.0% 5.0% 5.0% 5.0% 5.0% 5.0% 5.0%Real estate 5.0% 4.5% 4.0% 3.5% 3.0% 3.0% 3.0% 3.0% 3.0% 3.0%
Source: Exane BNP Paribas estimates
Exane BNP Paribas Research & Oliver Wyman FRENCH LIFE INSURANCE 8 July 2013 page 31
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WHY YOU SHOULD READ THIS REPORT
With around EUR1.5 trillion in funds under management, French life insurance is a large and mature market. However structural issues including poor profi tability, risk of lapses, and market conditions suggest the potential demise of the traditional life product in its current form.
All is not lost, though. In the short term, insurance companies should consider pulling a number of levers to enhance the value of their business. Longer term, the inevitable cut in pay-as-you-go pensions could lead to the emergence of a proper private pension market in France.
This report discusses actions that insurers could take now to improve current profi tability and to seize future growth opportunities.
8 JULY 2013
François BoissinLouis CarbonnierFady Khayatt
FRENCH LIFE INSUR ANCE
One life ends; another begins