The global life insurance industry is facing an inflection point. A fundamental reimagination will usher in significant change.
Over the past decade, our publications have chronicled the increased instability the life insurance and retirement industry has experienced. They’ve also reckoned with the trends that have been causing industry players to rethink their operating models, such as digital transformations; the rise of environmental, social, and governance (ESG) concerns; and the shifting economic environment. More important, they’ve worked to inspire insurers to consider new avenues for value creation.
About the authorsThis life insurance chapter of the Global Insurance Report 2023 is a collaborative effort by Vivek Agrawal, Ramnath Balasubramanian, Pierre-Ignace Bernard, Kristin Cummings Cook, Henri de Combles de Nayves, Alex Gestal, and Bernhard Kotanko, representing views from McKinsey’s Insurance Practice.
This chapter covers life and retirement, including the major forces at play in the current life insurance industry, several ways insurers have adapted, and opportunities that life insurers and stakeholders can consider going forward—as well as the fundamental implications for their business models as a result.
Over the past decade, the life and retirement industry has experienced increasing instability. Four paramount forces will continue to shape the industry globally over the coming decade.
More citizens are realizing that they are personally responsible for their future health and retirement costs: advanced economies’ governments have become more indebted, and government health and retirement programs—such as the United States’ Social Security program and Japan’s National Pension System—are experiencing funding gaps, resulting in a nearly $41 trillion global pension gap. 2 “The pension gap epidemic,” The Geneva Association, October 2016. This realization, however, is creating opportunity for insurers in the industry.
Nominal interest rates will remain elevated in the foreseeable future as central banks look to get inflation under control. This is in sharp contrast to what we have seen over the past two decades, which have largely consisted of quantitative easing and ultralow nominal rates. In the near-term, life insurers may use these tailwinds to passively capture growth opportunities, especially as asset rotations on the investment side happen quicker than adjustments on the liability side, which results in higher spread.
Customer expectations are increasing when it comes to level of service, including the desire to integrate digital technology with conventional products. As such, many companies have shifted their business models to increase their adoption of disruptive technologies such as cloud computing and applied AI and have used more agile ways of working, as well as new talent attraction strategies.
A new middle class has begun to emerge in Asia and other developing economies. In China, India, and Southeast Asia, the middle-class population is projected to grow to 1.2 billion people by 2030 and make up nearly 14 percent of the total global population. 3 Augusto de la Torre and Jamele Rigolini, “MIC Forum: The rise of the middle class,” The World Bank, 2011. However, seizing the full potential of these opportunities won’t be easy given renewed geopolitical risks and concerns.
These forces have been affecting industry performance, shifting the sources of value creation and accelerating structural changes. A look at the current dynamics in the industry offers a compelling case for action.
A confluence of factors, some in direct control of life insurers and others exogenous, has deeply affected the industry’s performance in recent years.
Nominal GDP growth has far outpaced premium growth. Life insurers have faced several challenges delivering growth and returns. In the past two decades, economies grew faster than insurance premiums, indicating insurers haven’t been growing at the same rate as the economies in which they operate. In the United States and Europe, nominal GDP grew at a CAGR of 4 percent over the past 20 years, but premium growth grew at a CAGR of 2 percent. In Asia (excluding Japan), economies grew at a CAGR of 10 percent while premiums grew just 3 percent.
The industry has struggled to generate returns in excess of cost of capital. Over the same period, the industry struggled to generate profitable returns after the cost of capital. Insurers have also struggled to change their performance relative to peers: of insurers that were in the bottom quintile of performance, nearly two-thirds remained in the bottom quintile ten years later.
Carriers have still not structurally addressed their cost base. Compared to other industries, life insurers have still not structurally addressed their cost base. Since 2003, costs as a share of revenues have increased by 23 percent for life insurers—compared to a 5 percent increase for P&C insurers—while other industries, including asset management, have been able to address costs. While these structural costs have been rising for two decades, the imperative to address them may have arrived.
Life insurers’ relevance in capital markets has declined. The lack of returns after cost of capital, muted growth, high volatility in earnings, opacity of risks and sources of earnings and value, and lack of individual insurer performance mobility have caused the global life insurance industry to gradually lose its relevance with investors, particularly in the public markets. This trend is most apparent in the United States, where the largest US life insurers’ share of market capitalization relative to other financial-services peers has decreased over the past 35 years—from 40 percent in 1985 to 17 percent in 2005 to only 9 percent in 2020. This is according to McKinsey analysis of data of the top 20 publicly traded life insurers, banks, and asset management and securities brokers in the United States.
The value pools and sources of creation across the life insurance industry are not homogenous. Carriers face choices in products, components of the value chain, and geographies.
Huge dispersion in growth hot spots. While overall industry performance has been disappointing, across the globe there are some notable pockets of growth and opportunity. In the United States, products that provide principal protection with some upside based on market performance (fixed and fixed-indexed annuities and variable universal life, for instance)—as well as simple, protection-oriented products (such as accident and health products distributed through worksite channels)—are expected to grow more than 5 percent between 2021 and 2026. Over the same period, market-oriented annuity products where the customer bears most or all of the risk are expected to decline by more than 5 percent.
Value creation shifting to investment alpha. As interest rates have declined over the past two decades, the importance of investment alpha as a source of competitive advantage has increased. Despite near-term nominal tailwinds, low-for-long real rates will continue this shift toward investment alpha. Returns on conservative investment allocations have plummeted below the cost of holding traditional insurance liabilities, and in an environment in which it is cheap to raise capital, life insurers gain competitive advantage from growing high-yield assets.
Carriers are now weighing the risks and fiscal costs to operate in developing economies. Companies have started to rethink what it means to be a “global insurer.” Historically, life insurers looked toward markets that were similar to theirs—which also tend to be closer geographically—to expand market share and drive top-line growth. As technological advancements accelerated the globalization process, insurers began to expand globally, particularly into Asia, to diversify their portfolios and increase valuations. As the economics of the world have changed, insurers are weighing the risks and fiscal costs to operate in several regions.
Entrants and new sources of capital are disrupting and pushing the structural evolution of the sector.
Private capital–backed platforms gaining relevance. The past decade has seen a continuous rise of private capital–backed platforms—typically fully or partially owned by alternative asset managers, which find the life insurance industry attractive for several reasons. Primarily, they’re enticed by the opportunity to drive improvement in performance and by the potential to access “permanent” capital in form of a stable pool of liabilities, which can be deployed into various asset strategies, from traditional fixed income to more structured products or alternatives. 4 For more, see Ramnath Balasubramanian, Alex D’Amico, Rajiv Dattani, and Diego Mattone, “Why private equity sees life and annuities as an enticing form of permanent capital,” McKinsey, February 2, 2022. In turn, they can generate more predictable fee-based earnings streams while reducing the overall fundraising burden. In the United States alone, private capital–backed platforms account for almost $292 billion in general account reserves, making up about 9 percent of the industry stock, according to our analysis. These platforms also have significant market share in some categories of new business generation: among the leaders within each product line, private capital–backed platforms accounted for 40 percent of fixed-indexed annuities sales in 2021, up from 7 percent in 2011, and 19 percent of fixed-rate deferred annuities sales in 2021, up from zero a decade prior.
Structural shift toward more independent, third-party distribution. In recognition of the power of earning streams from distribution, investors have tended to reward the capital-light earnings generation of pure-play distributors, such as brokerages, independent marketing organizations, and field marketing organizations. Those players have generated 2.6 times the TSR of life insurance companies since 2010 and currently trade at nearly 2.8 times the price-to-earnings multiple of their life insurance counterparts.
Beyond continued innovation and the shift in value toward distribution, the industry is also experiencing a structural shift toward more independent distribution. Many companies have moved away from captive or affiliated distribution because of the increased commoditization of many insurance and annuity products and the increasingly open technology architecture and choice offered by insurance distributors. In the United States, third-party distributors are increasingly becoming more dominant, expanding their share of the market from 49 percent in 2010 to a forecasted 55 percent in 2021; conversely, proprietary distribution networks are declining in prevalence, from 30 percent to 26 percent during the same time period. In Europe and Asia, we can see a similar—although smaller—increase in third-party distributors. In the same timeframe, Europe increased its market share from 17 percent to 18 percent, and Asia increased its share from 8 percent to 11 percent. Within Asia, the share of third-party distribution is still low overall, and select insurers with high-quality, proprietary distribution will continue to see high value creation from this model.
Insurers will have a dizzying number of options available to them in the coming years—as will investors. In the balance of this report, we detail how insurance companies will shift their priorities in the near future and how different types of insurance models can help determine how best to meet the objectives of their investors. The question is clear: what strategic strengths can insurers depend on to generate growth in the coming turbulence?
Traditionally, insurers have achieved profit and growth by identifying attractive products and markets, such as individual protection and annuities, and structuring their end-to-end value chain to support these products and markets. Ownership of most of the value chain was important to simplify operations and maintain control over the end-customer experience. Today, the industry is reconsidering this approach to the value chain in two notable ways: product bundling and functional unbundling.
Four insurance functions will take center stage during this change: product design and underwriting, balance sheet management, distribution, and technology and administration. Insurers can start by determining how the strengths of their business model map to these four functions (exhibit). Balance sheet specialists, for example, might consider finding a distribution partner, while distribution specialists tend to be best served by partners in product design and underwriting or balance sheet management. Those insurers can then use those strengths to differentiate themselves, achieve profitable growth, and appeal to investors.