The intensified oversight could significantly impact the profitability and operational strategies of insurers, particularly affecting unit-linked and hybrid products.
Since 2018, the European Insurance and Occupational Pensions Authority (EIOPA) has identified substantial disparities in the cost and performance of life savings policies across the EU, often attributed to high cost loadings. Unit-linked and hybrid products typically incur higher costs than traditional savings policies, prompting regulatory concerns that inadequate value for money might deter consumers and disrupt the functionality of the life insurance sector.
Retail Investment Strategy (RIS) in Focus
The Retail Investment Strategy (RIS), a legislative package currently under discussion in the EU, seeks to tighten regulations on life insurance product design and fees. This strategy includes benchmarks to measure value for money, with EIOPA and national regulators enhancing their supervision of products, building on recent improvements in transparency regarding returns and fees.
While these regulations aim to bolster consumer confidence by ensuring better value for policyholders, Moody’s warns they could adversely affect insurers’ earnings and margins. Restrictions on distribution spending may also dampen new business sales.
EIOPA’s December 2023 Report
EIOPA’s latest report from December 2023 underscores ongoing regulatory concerns over whether life insurance savings products offer sufficient value for money. High costs and fees in some instances undermine the likelihood of positive returns for customers, potentially eroding trust in life insurers and the overall life savings market.
EIOPA’s analysis reveals that unit-linked products exhibit more volatile returns compared to other types, while traditional savings products offer relatively stable returns and hybrid products fall in between. Inflation further diminishes real net returns across all products, particularly evident in 2021 and 2022. Costs, measured as reduction in yield, are highest for unit-linked products and lowest for traditional savings products, with significant variation within the unit-linked category, including outliers with high single-digit reductions in yield.
Stricter Regulation on the Horizon
The EU’s proposed RIS aims to enforce stricter regulation on product fees and design. Insurers would need to rigorously assess and benchmark costs against industry standards set by EIOPA. The RIS also proposes tighter criteria for commissions to mitigate conflicts of interest.
EIOPA continues developing benchmarks to evaluate product costs and returns, aiding local regulators in identifying outliers and guiding insurers toward delivering value for money. National regulators are also heightening scrutiny, with some mandating fee reductions and annual fee analyses for insurers.
Stricter regulation aims to enhance value for policyholders and bolster consumer confidence in life insurance products. However, these measures could negatively impact insurers’ earnings and margins, particularly affecting unit-linked and hybrid products, which have gained popularity due to their lower sensitivity to interest rates.
Variable Impact Across Insurers
Not all insurers face identical impacts. Risk assessments vary by insurer type and product category. Expense margins are critical, particularly for unit-linked and hybrid policies, reliant on market performance with minimal investment margins. In contrast, traditional savings products derive profitability primarily from investment returns.
Questions arise regarding whether value for money testing should apply universally, including to closed books and active sales. Extending testing to the entire in-force book, especially older policies with higher costs, could immediately impact earnings. Traditional savings products, benefiting from higher guaranteed returns on older policies, may face less pressure to reduce charges.
Many life insurance savings products offer additional protection riders, such as term life components during accumulation or annuity options in decumulation phases. These features often include a risk margin, where costs exceed actual risk costs due to conservative underwriting. Both expense and risk margins are pivotal profit drivers for insurers, providing stability amid financial market fluctuations.
Navigating Low Yield Periods
During periods of low yields, insurers have relied on stable earnings from expense and risk margins, supporting their credit profiles. Higher investment returns in the current financial environment could partially offset lower expense and risk margins. However, many insurers have shifted focus away from traditional savings products reliant on general account-related investment returns.
Distribution costs pose persistent challenges. While insurers aim to reduce customer charges, cutting underlying expenses related to acquisition, administration, and investment management proves arduous, particularly where distribution channels are limited. Banning commission payments, as observed in markets like the UK and Netherlands, often results in reduced sales of complex insurance products requiring advisory services.
In response to reduced remuneration, distribution channels may pivot toward simpler, lower-margin policies or shift focus away from insurance products altogether. This trend highlights the delicate balance insurers must strike between regulatory compliance, profitability, and maintaining effective distribution networks.
