This report sets out Oliver Wyman’s market projections for the UK life insurance industry1 over the next five years, and our view on the key issues and opportunities that insurers will need to get right in order to win. In summary there are two stand-out strategic opportunities; firstly the UK’s new flexible retirement system, and secondly the bulk annuity market which will help unwind the legacy defined benefit (DB) pension system.

We expect that five years from now these new strategic lines of business will be extremely valuable and cash generative, attracting a much better rating than the life sector does today. These opportunities will both require substantial capital investment, but will not generate significant cash over the next five years. Insurers will, therefore, need to push in-force management activities to generate the cash required and to cover shareholder expectations of increasing dividends.

The next five years will require a complete reinvention of the industry, and the challenges and degrees of change needed are probably even greater than those we have seen over the past 15 years. Throughout this report our projections are based on the average position across the industry. There is plenty of opportunity for any individual business to perform much better than this, and we set out our views on how this can be achieved.

The life industry has a huge opportunity to become the retail interface between the UK’s workforce and pensioners, and their retirement savings. We forecast that in 10 years’ time the industry will have £1,200 BN on insurance platforms, and will be paying pensions of around £35 BN per annum (p.a.). Insurers who share this growth will be hugely valuable businesses, with long-term dividend growth prospects around 4% p.a. higher than today.

Even if just half of this additional growth became factored into equity valuations, then average share prices across the industry would be more than 50% higher than today. Those companies that best capture these opportunities will significantly outperform this.

Becoming one of these winning businesses will require significant and radical investment in client propositions. However, average cash generation across the industry will be flat over the next five years. At the same time shareholders are becoming strongly focused on dividend growth as the main measure of long term value. Therefore whilst investing for the future, insurers will also need to work their legacy assets harder, providing the additional cash needed to support their transformation. This will require a strong focus on back-book management2, particularly on cost control and on building investment spread through higher yielding alternative asset strategies (e.g. illiquid investments).

The bulk annuity market will become a big industry in its own right. Margins will fall slightly from their current level, due to competitive pressures, and the market will remain capital intensive. However, within a few years the model will be sufficiently successful (in terms of profit and cash generation) to attract new capital. Longer-term we expect significant synergies between the management of bulk annuities and newer, more flexible Retirement Account propositions. There will be many pensioners with both types of policy, and the “payment” nature of the relationship with the annuity end clients will enable insurers to broaden their relationship and to build new direct-to-consumer (D2C) sales opportunities.

Insurance management teams are now radically unlike those that built the back-books over previous decades. They do not see a return to the broader product ranges of the past as feasible, and view the in-force book as an asset whose value should be maximised

The relationship between capital and strategy

Improved cash flow generation is key for future investment and dividend growth. However, we expect that these will also be supported by reduced capital requirements across the business, and successful in-force management will be a strong source of one-off savings here. In addition, the capital intensity of the open businesses will reduce due to the lower capital requirements for protection and unitised business under Solvency II, and the reduction in sales volumes for new individual annuities.

We expect that the reduction in individual annuity volumes in-force across the industry will release around £3 BN of capital over the next five years. The big strategic capital issue for all life insurers will be whether or not to participate in the capital intensive bulk annuity market. Those which do not, will be on a path to a future as a mass market retirement asset platform provider, with smaller protection and individual annuity businesses attached.

These will be cash generative businesses with very little need for new capital other than for acquisitions, and will be assessed by shareholders on the basis of assets under management (AUM), growth in assets, and bps margin generation. As they transition they may also be more likely to sell their in-force books.