Emerging from the financial crisis: Life insurers focus on quality of business and growth

Victor Muguto

Victor Muguto

Victor Muguto, PwC’s South African Insurance Practice Leader and Francois Kruger, Partner in the Insurance Practice

Former White House Chief of Staff, Rahm Emanuel, once said, “You don’t ever want a crisis to go to waste; it’s an opportunity to do important things that you would otherwise avoid.”

Over the current reporting season, life insurers continued to build on their strategic objectives, which include: improving the quality of business, retaining customers, tightening expenditure, reviewing their investment strategies to operate within risk appetite and focusing on growth strategies. Generally, life insurers reported improved performance, which is encouraging in these challenging times. Improvement in markets over the six months up to December 2010 also had a positive impact on results.


Francois Kruger

Francois Kruger

The reported earnings extracted from the group results of South Africa’s five major listed life insurance groups have been analysed below. A summary of the financial information of these groups is set out in Annexure 1.

Liberty Holdings Ltd (Liberty) reported a significant improvement in headline earnings per share (>100%), mainly as a result of de-risking their balance sheet during 2009 coupled with improved investment performance in 2010. In addition, returns from insurance operations returned to normalised levels due to progress made on policyholder retention levels.

Old Mutual South Africa (OMSA) accounts for 95,5% of Old Mutual plc’s Emerging Markets segment (determined on 2010 new business). Earnings (profit after tax on an IFRS basis) increased in excess of 100% for the Emerging Markets segment. The 2009 earnings included losses on disposal of group undertakings as well as a significant impact of eliminating investment returns relating to treasury shares. Ignoring the impact of these items and the impact of the Rand, appreciating by approximately 14% during 2010, earnings increased by 22,6% year-on-year. The recovery of equity markets, increases in regular life insurance premiums and unit trusts sales were the main drivers for OMSA’s performance.

Sanlam Ltd (Sanlam) reported an increase of 15,9% in headline earnings per share and attributed their performance to the firm execution of their group strategy and financial discipline, supported by improved market conditions and an increase in new business volumes.

MMI Holdings Ltd (MMI) posted headline earnings of 105 cents per share for the six months ended December 2010 compared to 86 cents per share for the six months ended December 2009. MMI was formed with effect from 1 December 2010, through the merger of Metropolitan Holdings Limited (Metropolitan) and Momentum Group Ltd (Momentum). Momentum is considered to be the acquirer for accounting purposes hence the MMI results comprise of six months Momentum’s results and one month of Metropolitan’s results. Given the recent formation of MMI and the different historical year-ends of these companies, Metropolitan’s and Momentum’s results have been analysed separately in this article.

Metropolitan’s headline earnings per share for the financial year ended December 2010 decreased by 12,6%. Difficult economic conditions were experienced in the low to middle-income market, contributing to increased surrender benefits paid to policyholders. Focus, however, remains on the quality of new business and the retention of existing business to ensure satisfactory levels of persistency.

Momentum reported a 9,8% increase in headline earnings per share for its financial year ended June 2010. The results were characterised by a recovery in equity markets, good expense management, strong performance by FNB Life (the bancassurance business conducted through FNB) and growth in retail single premiums offset by lower institutional business. Headline earnings per share for the six months to December decreased by 6,3% compared to the previous six month period ended December 2009. Excluding merger costs and profits from the FNB Life business – which have been 90% reinsured effective 1 December 2010 as part of the merger agreement – earnings were slightly down by 1,1%.

Discovery Holdings Ltd (Discovery) reported an increase of 24,1% in headline earnings per share for the year ended June 2010, mainly due to new business growth as well as positive lapse and mortality experience. Headline earnings per share decreased by 15,9% for the six months ended December 2010 mainly as a result of accounting for the acquisition of Standard Life Healthcare, which increases Discovery’s interests in their joint venture with Prudential (PruHealth and PruProtect) from 50% to 75%. Excluding the impact of this transaction, earnings were up by 24,3%.

Performance of life operations

Premiums from contracts classified as insurance on an IFRS basis increased year on year for all the life insurers, which contributed to improved operating performance compared to the previous reporting period.

· Liberty’s main priority of improving policyholder retention over the past 18 months resulted in better persistency levels. Premiums have increased by 0,8% mainly driven by their Corporate business segment. Focusing on quality led to a decrease in entry level mark (ELM) risk products in their Retail segment. In addition, unprofitable broker contracts were terminated, unprofitable ELM call centres were closed and a number of new business policies were turned away as part of Liberty’s drive to write sustainable quality business, contributing to lower growth in its Retail segment.

· OMSA saw premiums increasing by 3,8%, mainly as a result of growth in its Retail Affluent and Mass Foundation segments. Regular premiums sales increased as a result of lower lapses, higher average premiums, improved adviser productivity and direct channel sales performance. Regular premium business in Corporate risk sales grew strongly, due to new innovative products introduced since 2008.

· Sanlam’s premiums increased by 9,5%, mainly due to growth in recurring risk premiums from its Personal Finance segment. Employee benefits business was reported to be challenging relative to the strong performance in the second half of 2009, which resulted in a year-on-year decrease. Developing markets, aimed at the entry level South African market, and other developing markets showed strong growth, although slower growth was experienced in South Africa due to the focus on writing high quality business.

· Metropolitan had an increase in its Retail new business, driven by good production in its traditional agency sales channels, removing of previously underperforming products and focusing on better quality business. New business decreased in respect of Employee benefits business; however, there was an increase in new business margin in this period. Premiums in total increased by 0,6%.

· Momentum experienced strong sales in its Retail businesses, for the financial year to June 2010, resulting in premiums increasing by 14,5%. During the six months ended December 2010, Momentum benefitted from the economic recovery and has seen premiums increasing by 5,9%. New business volumes increased in the Employee benefits segment, due to new risk business.

· Discovery’s focus on product innovation, competitive pricing points, lower lapse rates and added death benefits to investment products resulted in premiums increasing by more than 100% during the financial year to June 2010. Since December 2009, a death benefit was added to certain contracts that were previously accounted for as investment contracts. This resulted in recognition of insurance premiums amounting to R1,9 billion on the reclassification of these existing investment contracts to insurance contracts. Premiums increased by 41,6% at the end of December 2010, if the impact of the once-off reclassification of investment products to insurance products of R1,9billion is excluded, mainly as a result of re-pricing areas that generated historically high levels of lapses, as well as added death benefits to their investment products.

Acquisition and management expenses

Aggregating premiums for the life insurers analysed, there was an increase of 10% year-on-year compared to an increase in aggregated acquisition expenses of 6,3%. This indicates that life insurers are reviewing their distribution channels, for example, Liberty, who indicated that unprofitable brokers’ contracts are being closed and OMSA reporting increased direct channel sales.

Using these life insurers’ aggregated information, management expenses increased by 8,7% year-on-year, which was above the current inflation levels. The ratio of aggregated expenses to aggregated premiums (on an IFRS basis) has decreased from 36,2% to 35,7% suggesting that life insurers are achieving some cost and operational efficiencies.

New business and value of new business margin

Except for Momentum and Discovery showing annual increases of 9,5% and 32,8% respectively, the present value of new business premiums (PVNBP), which includes insurance and investment contracts, has remained fairly flat, despite growth being one of the strategic objectives of life insurers. Life insurers indicated that focus on quality and persistency, also part of their strategic objectives, resulted in improved lapse experience. Although life insurers have seen better than expected lapse rates, they remained cautious in the current uncertain economic climate and have generally not revised the lapse assumptions downwards. Metropolitan has, however, strengthened lapse assumptions on its Retail business. Discovery increased lapse assumptions in areas where the improvement in experience was slower than expected, although the overall lapse experience was better than expected.

Most companies reported better than expected mortality and morbidity experience, as a result of the focus on quality of business. Metropolitan weakened mortality assumptions on its Retail business, following positive experience. Liberty has, however, strengthened reserves on certain blocks of business given its experience of older ages on these blocks of business.

Life insurers have indicated that cost control will remain a key focus for 2011, although it has proven to be challenging. Liberty has increased expense assumptions to allow for future shareholders’ expenses and an increase in the allocation of maintenance expenses for their Corporate business.

The value of new business (VNB) margin, which is an indicator of expected profitability of new business, ranged from 1,2% to 5,9%.

· Liberty’s VNB margin decreased from 1,3% to 1,2%. Despite improved lapse experience no benefit in withdrawal assumptions has been taken. Fixed costs were reported to cause margin strain.

· OMSA’s VNB margin was up from 2,1% to 2,4%, due to focussing on higher margin products.

· Sanlam’s VNB margin increased from 2,4% to 2,6%, which was in line with the group’s strategy to achieve profitable earnings growth.

· Metropolitan showed the best improvement in the VNB margin, up from 1,4% to 3,1% (mainly from its Retail business) by “doing the basics better”. This included production, persistency, expense management and claims processing.

· Momentum’s VNB margin decreased from 2% to 1,8% for the year ended June 2010, due to more conservative actuarial assumptions and a change in new business mix. Momentum reported a VNB margin of 1,1% for the six months ended December 2010. Momentum has, however, restated its VNB for comparative purposes to treat the FNB Life business as if the reinsurance had been in place for those periods, showing a restated VNB margin of 1,0% as at June 2010.

· MMI reported a VNB of 1,6% for the period ended December 2010 on pro-forma financial information, which assumed the merger was effective from 1 July 2010.

· Discovery’s VNB margin was down from 7,7% in the previous year to 5,9% in June 2010, but increased to 6,4% as at December 2010 and remains the highest of the life insurers considered.

Embedded value

Embedded value (EV), using life insurers’ annual results, has increased by between 10% and 16%, with Return on EV (RoEV) ranging between 12% and 18%, an indicator used by most life insurers to measure performance on shareholders’ capital.

Using the annual results, the impact of experience variances ranged from reducing EV of covered business by 1,1% (Momentum) to increasing EV on covered business by 3,5% (Discovery). Assumption changes ranged from reducing EV of covered business by 4,6% (Discovery) to increasing EV of covered business by 1,1% (OMSA).

Life insurers’ EV risk discount rates varied between 10,5% and 11,1% compared to the ten year South African zero coupon bond rate of 8,6% as at December 2010, indicating that shareholders place a risk premium of approximately 2% on life insurers.

Over the past number of years, life insurers’ share prices have traded at significant discounts to their EVs, as confirmed by most analysts. Sanlam and Liberty have traded significantly closer to EV per share ranging from a 2% premium to a 2% discount to EV as at December 2010. Discovery traded at a discount of 8% to EV per share as at December 2010. MMI which listed in November 2010, was trading at a discount of 14%. Old Mutual plc traded at a discount to Market Consistent Embedded Value (MCEV) per share of 38%.

Capital management

Life insurers indicated that capital is actively managed to balance the need to meet shareholders’ return on capital expectations, as well as preserving capital in view of the forthcoming regulatory changes. Capital Adequacy Requirements (CAR) cover ranged from 2,1 times to 4,1 times as at the end of their financial year-ends, with the exception of Discovery having a CAR cover of 8 times.

· Liberty’s current CAR cover is 2,7 times, above its target CAR cover of 1,7 times.

· OMSA’s car cover remained consistent with the previous year at 4,1 times.

· Sanlam’s CAR cover increased from 3,1 times to 3,4 times. Sanlam reported it has R4 billion discretionary capital and has identified a number of strategic investment opportunities, which are being pursued.

· Metropolitan’s CAR cover remained consistent with the previous year, at 2,8 times. Momentum’s CAR cover increased to 2,3 times as at the end of December 2010. MMI reported a CAR cover of 2,5 times.

· Discovery’s CAR reduced to from 8 times at the end of June to 3,9 times as at the end of December 2010, mainly due to a dividend distribution to fund the group’s acquisition of Standard Life Healthcare. Discovery indicated that its capital may reduce by R3 billion in future.

Although optimal capital levels are targeted, life insurers have retained prudent levels of capital until such time they have a better understanding of the full impact of the new Solvency Assessment and Management (SAM) regime, expected to become effective in 2014. Life insurers have indicated that they expect SAM to have an impact on current capital levels and are in the process of assessing this. In addition, SAM will have an impact on systems requirements, the demand for skilled resources and the way life insurers are managing their business.

Old Mutual plc reported that good progress has been made towards the implementation of Solvency II and SAM. The group expects that decision-making in respect of investments and market risk exposures will benefit from Solvency II/SAM, together with its own Economic Capital model.


Economic indicators, such as improved consumer spending, increased disposable income levels, stabilisation of employment levels and strong JSE performance, suggest that the economy is recovering, albeit slowly. Volatile investment markets in the short term, inflation (including rising food prices) as well as the potential withdrawal of funds from emerging markets, fuelled by political instability in North Africa and the Middle East, are challenges that will have an impact on the operating environment.

Despite these uncertainties and challenges, life insurers are cautiously optimistic:

· Following the steady progress made on operational performance in 2010, Liberty indicated that it will focus on increasing new business sales and margins on insurance business, customer retention, increasing brand awareness and lowering costs.

· OMSA plans to leverage off the experience in its South African Mass Foundation segment to increase profitability and grow business in Africa, using existing distribution channels such as tied-agents, bancassurance and exploring new channels such as distribution through mobile phones for example in Kenya. Driving product development, including adapting product design to customers, easier access to financial services and promoting a savings culture, are also focus areas.

· Sanlam’s strategy includes firstly driving increased return through optimising capital, cutting costs and maximising efficiencies. Secondly, growing profitability through diversification which includes providing the full spectrum of financial services and expansion into new markets such as Africa, India and the United Kingdom (UK).

· MMI expects merger synergies to start flowing through in the second half of the 2011 calendar year. Growth in new business will depend on economic recovery, including improvement in unemployment and disposable income levels. Africa, although a complex market, provides a number of opportunities for the group. MMI believes it has started to implement strategies that will unlock value and generate satisfactory return on capital to its shareholders over time.

· Discovery reported that work done in the past financial year puts the group in a strong position to focus on growth and profitability into the future. The key strategic areas are: quality and innovation in the South African business; achieving scale, profitability and relevance in its international business; and building new businesses on its unique business model, including in China, the UK and the United States.


Whilst life insurers have reported solid results in the aftermath of the financial crisis and have focused on doing the basics right, new and existing challenges in the insurance industry will remain. Some of these include:

· Proposed changes to regulation, solvency, and the accounting for insurance contracts, will have a significant impact on all aspects of life insurers’ business. The International Accounting Standards Board (IASB) will replace IFRS 4: Insurance Contracts with a comprehensive standard that better meets the needs of users of financial statements. As accounting practices vary for different types of insurance contracts and between insurers, the impact of the proposals will differ from insurer to insurer. The final standard is expected to be released by the second half of 2011. Proposals, such as no recognition of day one gains and excluding certain costs in the projection of cash flows in the measurement of insurance contracts, are some of the key areas that will impact the way South African life insurers account for insurance contracts and recognise profits.

· As the industry faces pressures from more demanding customers, increased new regulations, skills shortage and ever-changing systems requirements, life insurers are continuing to invest in improving operational efficiency, increasing revenue and reducing costs. Given that more effective integration and the use of information can improve all aspects of their business, life insurers are also paying closer attention to how they generate, maintain and apply information.

· In an attempt to grow and maintain profitability, many life insurers have strategies in place to transform their business and operating models to expand into new markets. In the process, they are taking a closer look at their products and services, including how they approach customers and distribution.

Summary of financial information for the life insurers analysed Annexure 1

The tables below summarise the results for life insurers for their respective financial year-ends.


The table below summarises the interim results as at December for the life insurers with June year ends.


a OMSA is not listed on JSE Securities Exchange Ltd. The information has been derived from the Old Mutual plc’s Emerging Markets segment information in its preliminary results presentation. Dividends per share represents Old Mutual plc’s dividend per share. The year-end exchange rates used were R10.28, R11.92 and R13.72 to the British Pound for 2010, 2009 and 2008 respectively.

b Group in this context refers to consolidated Discovery Holdings Ltd, consolidated Liberty Holdings Ltd, consolidated Metropolitan Holdings Ltd, consolidated Momentum Group Ltd, MMI Holdings Ltd and consolidated Sanlam Ltd, unless otherwise stated.

c Combined segment results for the South African Life and Investment segments of Discovery, except for HEPS, dividend per share, EV, RoEV and EV discount rates, which are Group information. PVNBP was calculated using the VNB margin applied to the VNB of the Life and Investment segments.

d Consistent with MCEV principles, OMSA used the risk free rate to discount future cash flows in its MCEV calculation, which is not comparable to the risk discount rate applied by the other life insurers.

e MMI provided this information for the period ended December 2010. It has been provided as pro forma financial information, which assumed the merger was effective 1 July 2010. No comparative information has been provided.

f Net premiums were used as only net premiums were reported in the current year. Reinsurance was not significant in previous years and is expected to remain insignificant for the current year.

Where the information could not be obtained from public information and was not considered necessary for our analysis, cells were left empty.

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