Midlife Crisis For Insurers

The pace of change in the life-insurance industry, where product cycles sometimes seem to span decades, has tended to range from slow to glacial. Life insurers have been relatively small players in the gale-force merger activity that has buffeted most of Corporate America for the past couple of years.

Nowadays, however, the chief executive of an underperforming life insurance company is well advised to watch his back as well as his 401(k). Merger mania has been hitting life insurers hard. Already this year, the volume of deals, at $7.5 billion, far surpasses the talley for all of 1994 (chart, page 138). Among the biggest: Metropolitan Life and New England Life, Jefferson-Pilot and Alexander Hamilton, Humana and Emphesys Financial Group. "If we now have 100 to 200 significant life insurers," says Michael W. Blumstein, an insurance analyst at Morgan Stanley & Co., "five years from now it could be down by a third."

Like the wave of banking mergers, the insurance consolidation has the potential to make a lumbering, fragmented industry vastly more efficient by forcing companies to squeeze out costs and modernize operating systems. Even mutual insurers, many of which have been particularly slow to modernize, are getting in on the action. But the consolidation could be disruptive for consumers and disastrous for the 200,000 or so agents who today represent the primary--and very costly--means of selling policies. Says David S. Kimmel, a vice-president in the insurance advisory group at J.P. Morgan & Co.: "Insurance companies are going to have to dramatically reduce distribution costs, and I think the real losers are the agents."

HIGH COSTS. Several forces are coming together to force the consolidation. For starters, with the population growing only slowly and the competition for consumer savings increasingly fierce, "life insurance in the U.S. is a very mature market," says James R. Tuerrf, president of American General Corp. That means the best way for companies to grab market share is to grab each other, as even such mutuals as Massachusetts Mutual Life Insurance Co. and Connecticut Mutual Life Insurance Co. are now contemplating. "The product's essentially a commodity," says Ron W. Frank, senior insurance analyst at Smith Barney Inc. "The competitive edge comes from [lower] expenses and distribution. Those point you in the direction of consolidation."

Cost pressures are a factor as well, thanks in large part to life insurers' reliance on agents. Moody's Investors Service says new business production costs can actually exceed insurers' expected revenues. Larry G. Mayewski, a senior vice-president at A.M. Best Co., says that although costs have dropped, commissions and other compensation still account for some 54% of life insurers' first-year direct premiums.

Insurers also face intensifying competition in the rapidly growing markets for such products as annuities and mutual funds. The annuity business is expanding rapidly, but close to 18% of annuities are sold through banks, which are gaining market share. Fidelity Investments and other brokerage houses also are pushing annuities, and insurers face just as many rivals selling mutual funds.

RAPID CHANGE. Then there are regulatory pressures. Many insurers, particularly mutuals, are somewhat low on capital under the new risk-based standards. That's hurting them with rating agencies, and that in turn makes it harder for them to deal with agents and consumers wary of low-rated insurance companies. For their part, health insurers, whether independent or affiliated with life companies, are contending with rapid change on both the competitive and the regulatory fronts. Many among them are merging simply to build competitive clout.

As if these pressures weren't enough, changing technology is adding to the drive for consolidation. Consumers are getting more of their financial needs met electronically, and life-insurance companies have begun to realize that they may have to follow suit with some products. Growing numbers also realize that they need to bulk up to be able to afford to modernize their back offices and get their costs more in line with nonbank competitors'. "A lot of these companies are small," says Gary C. Wendt, chief executive of GE Capital Services Inc., which has spent more than $1.5 billion in the past two years snapping up life and health insurers. "They don't have enough scale to power into these [new] markets."

The drive for clout and technnological prowess were key factors for Harry P. Kamen, chairman and CEO of Metropolitan Life Insurance Co., when he agreed to a $2 billion deal with New England Mutual Life Insurance Co., whose presence with affluent customers complements MetLife's prowess with middle-income consumers. "The market we were not comfortable in was the market New England was strong in," he says. "We would have [had] to spend more in computers and so on, and we still wanted to put money in our core middle-market [business]. This comes with ready-built systems."

Kamen says that agents will benefit from all the mergers taking place. "Industrywide, every transaction that strengthens a company helps the agent," he says, because agents have an easier time selling the products of a strong company. But others beg to differ. The average agent today sells just one policy per week. That is a grossly inefficient sales process for mass marketing when the average life-insurance policy sells for just $750, according to Robert S. Morette, a vice-president at Boston Consulting Group Inc. Robert W. Fiondella, president and chairman of Phoenix Home Life Mutual Insurance Co., charging that the agency system "is doing a lousy job" for the industry, is reducing the proportion of his business that depends on agents by expanding his company's presence in the mutual-fund market through a deal with Duff & Phelps.

Some believe the cost pressures driving consolidation will lead to a fundamental shift away from the agency system altogether. Richard K. Berry, managing principal at the consulting firm Towers Perrin, predicts that the insurance industry will go through the same changes the brokerage business did in the 1970s, when commissions were deregulated. Today, he says, only a third of all brokerage customers deal with full-service registered representatives--not exactly a rosy prospect for full-service agents.

FRUSTRATION. Consumers, though, could ultimately benefit from the mergers. Robert Hunter, director of insurance for the Consumer Federation of America, says that as high-cost, high-price players are forced into the arms of more efficient companies, consumers will be better served. Another plus: Consumers holding policies from weak companies could have them taken over by stronger insurers. But as their policies change hands and the inevitable mishaps crop up, consumers could be frustrated.

Who's the next merger bait? Potentially, almost anyone. Gary W. Parr, head of the insurance group at Morgan Stanley & Co., sees intense merger activity for the foreseeable future. "We've got a lot of business in the backlog, and we're working on a lot of strategic assignments" involving insurers, Parr says.

That's good news for Morgan Stanley, and for farsighted insurers. But woe to the companies that are simply trying to be big. Banks that have grown too large and diffuse have come under attack from shareholders. And insurers that embrace size for its own sake run the same risk. Industry experts say big, faltering multiline insurers, such as Aetna Life & Casualty Co., are warnings to insurers that are trying to expand too fast. "By the year 2000, the multiline insurance company as we know it in the U.S. will not exist," says David W. Nelson, managing director and global insurance executive at Chase Manhattan Corp. "The expense bases of these companies are too large, and the businesses have been unfocused for too long." Size counts for a lot in insurance. But it's not a cure-all. All the consolidation in the world will not make life insurance a growth product again.

Why the Urge to Merge?

COMPETITION With banks and mutual-fund companies grabbing share in the market for annuities, insurance companies have to get their costs down to stay in the game. Mergers allow insurers to achieve greater economies of scale.

SLOW GROWTH Life insurance is a mature industry. Acquisitions are the easiest route to expanding market share.

RATINGS Insurance rating agencies are coming down harder on mutual companies low in capital. Mergers offer an easy route to higher ratings, important to winning agents' and consumers' confidence.

TECHNOLOGY Technology is fast becoming a key competitive edge. Mergers permit greater investment to modernize back-office and distribution systems.


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