Expense management with respect to Life insurance industry

Expense management means all charges incurred whether directly or indirectly and include commission payment of all kinds, operating expenses and amount of expenditure capitalized. A major expense head for life insurers is commission paid to the intermediaries. Expense management is one of few areas within the control of insurers to improve performances; yet as they review expenses, insurers must consider associated risks. There are many levels of risk associated with seeking expense efficiency for insurer, particularly in loss control and in meeting ever-changing customer expectations. In the current underwriting and investment environment, it is critical for insurer to develop and work within a set of guiding principles. To be successful in expense control, ongoing expense measurement against both competitors and customer value considerations are crucial, as both are moving target. Underwriting and claims expenses must be managed with an eye to the impact on losses and loss ratios to ensure adequate loss controls. Claims management is critical process in the insurance life cycle. Quick and efficient claims processing increases customer satisfaction optimizes settlements and minimizes expenses. Analyzing and proactively managing the end-to-end process across regions, loss types, product companies to better understand their most critical components in operational effectiveness and customer retention. Further, insurance companies only collect fund and management and policy administration charges from the policy holder as per the design, which is the income stream of life insurance companies.

Limits on Management Expenses for Life Insurers:

The Insurance Act, 1938, prescribes a ceiling on management expenses. These include administration expenses such as commissions, fund management fees, fund management fees, custodial fees, and expenses on marketing and advertising. The percentage varies from insurer to insurer and primarily depends on the new business premium generated in a year and the age of company. According to recent amendment, this rule is applicable only to companies that have been in operations for more than five years. The limit on expenses is set to protect long term interest of the policy holder and ensure that reckless expenditure by insurance companies might not hurt their profitability and long term sustainability. Higher expense ratio would result into delay in break- even.Companies valuation and break-even are depend on the way they manage their expenses. Higher expenses may push break-even further and lower valuation. Various measures like cost cutting and focus on proper productmix may be conducted as solution. And improvement in renewal premium collection will help the insurance company to reduce their expense accordingly. The expense ratio of an insurance company can be calculated by dividing underwriting expenses (i.e. operating expenses related to insurance business+ commission) by net premium earned. Underwriting expenses are the cost of obtaining new policies from insurance carriers. The lower the expense ratio the better, as it means more profits to the insurance company. Limitation of expenses of management of life insurance business Sec 40B of Insurance Act 1938 Every insurer transacting life insurance business in india shall furnish to the controller, within such time as may be prescribed, statements in the

prescribed from certified by an actuary on the basis of premiums currently used by him in regard to new business in respect of mortality, rate of interest, expenses and bonus loading. After the 31st day of December,1950,no insurer shall, in respect of life insurance business transacted by him in India, spend as expenses of management in any calendar year, an amount in excess of prescribed limits and in prescribing in any such limits regard shall be had to the size and age of insurer and the provision generally made for expenses of management in the premium rates of insurers: Provided that where an insurer has spent as such expenses in any year an amount in excess of the amount permissible under this sub section, he shall not be deemed to have contravened the provisions of this section, if the excess amount so spent in within such limits as may be fixed in respect of the year by the authority after consultation with Executive Committee of the Life Insurance Council constituted under section 64 F, by which the actual expenses incurred may exceed the expenses permissible under this sub-section. In respect of any section mentioned in sub section (1),the authority may require that it shall be submitted to another actuary, appointed by the insurer for the purpose and approved by the authority, for certification by him, whether with or without modifications. Every insurer transacting life insurance business in India shall in corporate in revenue account: (a) A certificate signed by chairman and two director and by the principal officer of the insurer , and an auditors certificate , certifying that all expenses of management in respect of life insurance business transacted by the insurer in India have been fully debited in the revenue account as expenses, and (b) If the insurer in carrying on any other class of insurance business in addition to life insurance business, an auditors certificate certifying that all charges incurred in respect of its his life insurance business and in respect of his business other than life insurance business have been fully debited in the respective revenue accounts.

Stepping stone towards minimizing operational expenses: Life insurers shifting focus on profitable growth Based on research reports of the past two years, top private life insurance companies have stopped their expansion plans and Started to focus on profitable growth. This becomes evident as companies are rationalizing their number of branches and headcounts. However, current economic conditions, combined with market forces that have gained momentum in the insurance industry over past few years, have caused cost reduction to become a top strategic business priority. As per recent survey during last two years ,some of the top private life insurersICICI Prudential Life , Bajaj Allianz Life, Max New York Life, Birla Sun Life, TATA AIG and HDFC Life have reduced their number of branches by 30% (approx) and number of employees by 27%(approx) However, SBI Life is an exception to this trends as it has increased its workforce and branches. This downsizing is the direct fall out of Insurance Regulatory And Authority (IRDA) stringent regulations laid down on Unit Linked Insurance Plan (ULIP) in September 2010. One of the largest private insurer ICICI Prudential Lifes numbers of branches declined from 1950 in FY10 to 1000 in FY12 which is fall of 40.8%. It reduced the number of employees by 34% to 13200 in March 2012 as against 20000 in march 2010. However, SBI Life which is also leading private life insurer, has increased its number of branches to 714 as on 31st march 2012 as against 494 at the end of FY10. Despite expanding in continued tough external conditions, the company maintains the lowest expense to GWP ratio in the industry 7.8%

Bajaj Allianz Life trimmed down its number of branches to 1044 FY12 from 1151 in FY10. Its number of employees declined 30% to13289 in FY12 as against 20000 in FY10. Max New York Lifes number of branches stood at 464 in FY12 as against 705 in FY10 which is fall of 34%. Its headcount declined by 27.5% in FY12 to 7783 as compared to 10454 in FY10. TATA AIG Lifes network of branches declined by 32% to 294 in 2011-2012 as against 433 in 209-2010, while its number of employees declined 41% to 4744 in FY12 as against 8100 in FY10. HDFC Lifes number of branches declined to 474 in FY12 as compared to 568 in FY10, while number of employees declined marginally to 14310 in FY12 as against 14397 in FY10. Birla Sun Lifes number of branches declined to 634 in 2011-2012 as against 652 in 2009-10 This move of insurers has paid off, as during last two years, the profit of these companies has doubled irrespective of decline in new business income. The top six life insurers together reported net profit of Rs.4106crore in FY12 as against loss of Rs.335crore in FY10. Achievement s of SBI Life Insurance by proper governance and the management of the resources SBI Life derives significant synergies from its major shareholder SBI, in the form of steady revenues through Bancassurance channel including extensive distribution reach and low expense structure.

SBI Life one of the best channel productivity, with strong Bancassurance channel and strong agency force , contributing to its low cost structure as compared to its peers and it was the first new age life insurance company to break even register profit for three consecutive years. SBI Life has been reporting profitability since FY10, supported by tight expense management and higher economies of scale . SBI Life is adequately capitalized with solvency ratio of 2.09 as on March 31, 2012( as compare to regulatory minimum of 1.50) SBI Life follows the integrated bancassurance model where the cost of operations is significantly lower than any other distribution channel, barring the online direct selling channel, barring the online direct selling channel, because bank employees themselves sell the life insurance product to the bank customer .Thus commission payable on the sale is paid only to the bank, that in turn internally incentivizes the authorized employees that sell life insurance product. Using the network of state Bank Group (SBG), SBI Life has successfully been able to reach out to the remotest parts of the country in the cost effective manner, particularly since banks staff- Certified Insurance Facilitators (CIFs)- who deals with banking need of customer also sell the life insurance products. It also has a strong cushion in the form of parent support for infusing capital to meet any exigencies to support growth and solvency margins. The company has one of the lowest operating expense ratio, due to lower infrastructure, branding and employee cost, resulting from access to its SBIs nationwide distribution franchise in the industry. The new business premium for the company stood at Rs.6531 crore, down by 13% , as compared to private industrys de-growth of 17% during FY 2011-12. The leading new generation life insurer collected Rs.6602crore of Renewal Premium during FY 2011-12,a growth of 23% over the last financial year 2010-11. The

persistency level, as per the standard 13-monthindusry measure, has moved up to 72%, an increase of 3% points over the corresponding period last year. Consequently, the Gross Written Premium (GWP) collected by company recorded at Rs.13133crore, a growth of 1% over the last financial year. The company has witnessed improvement in persistency of the renewal premium, with the conservation ratio as at march 31, 2010, March 31, 2011 and December 31, 2011 reporting and improving trend of 62.9%, 73.4% and 76.2% respectively. Nonetheless, prolong slowdown in the growth of the insurance industry can have a negative impact on the financial profile of the company. SBI Life has increased its number of branches to 714 as on 31st March 2012 as against 494 at the end of FY10. Despite expanding in continued tough external conditions, the company maintains the lowest Expense to GWP ratio in the industry of 7.8% Expense management system Cut transaction costs, boost management control Expense- management automation is the means by which an organization can significantly reduce transaction costs and improve management control while logging, calculating and processing corporate expenses. Independent research, evaluating the use of automated Expense Management System (EMS) has confirmed that the cost of processing an expense claim significantly reduces as the level of automation increases. EMS application addresses the service industry needs of multilocation controls, paperless processing and tracking/adherence to turnaround times[from requisitioning to ordering to receiving to invoicing to payment] seamlessly and cost-efficiently. It helps in

managing cost judiciously and in the most prudent manner, thereby eliminating time and effort spent on non-core, non-value adding administrative activities such as expense management paperwork. We have observed that our turnaround time has improved and the size of accounts payable team has continually come down leading to significant benefits. Sangramjit Sarangi Head of Finance, SBI Life Insurance Company Ltd., relates their experience after using the EMS application thatExpense management system has helped in tracking our expenses at granular levels (cost centre, location, employee, and item), Providing accurate and qualitative data for decision making and controls. It also acts as repository for financial policies of the company ensuring compliance for all types of expenses with strong financial process workflows. We have been able to effectively execute controlled decentralization of expense payment processing. EMS delivers compliance by design and helps the organization manage their spend by integrating what is not achieved in most casesbottom of the pyramid. SBI Life goes live successfully in channel management system SBI Life has successfully launched Channel Management System (CMS) which caters to end- to- end requirements pertaining to enrollment, hierarchy, compensation and maintenance pertaining to the distribution staff. The solution provides straight through processing and incorporates flexibility using highly configurable business requirements. It is significant achievement tailored to Indian insurance business environment and IRDA regulations for SBI Life.

Channel Management System helps significantly in supporting planned growth and increased demand for automated processes with the flexibility of adapting to changes to meet the market demand. Massive calculations around commission and intensive would help and support SBI Life in successfully executing timely compensation management. This is a leap over current conditions of multiple interdependent heterogeneous systems. The volume speaks in terms of number of new agents being enrolled and support current strength of sales force. It helps both home office team as well as people on the field, to significantly improve their performance in executing their sales efforts. SBI Life extensively leverages the SBI Group as platform for cross- selling insurance products along with its numerous banking product packages such as housing loan and personal loan.SBIs access to over 100 million accounts across the country provides a vibrant base for insurance penetration across every region and economic strata in the country ensuring true financial inclusion .Agency channel , comprising of the most productive force of more than 63000 insurance advisors, offers door to door insurance solutions to customers. CMSs solutions are geared towards automating the distribution, processing and underwriting of insurance product and management of distribution relationships. These solutions are configured on the insurance industry specific, web- services, straight through processing platform. This unique and differentiated platform is data driven, which enables the software vendor to meet its customers requirements through configuration, rather than coding, thereby meeting all business requirements,

expediting time to market and reducing the overall cost of ownership. Challenges/ Problems faced by the insurance industry Pitfalls of insurers Life Insurance industry is struggling to find the right selling channel which can increase their profitability. The industry was privatized about a decade back, but profit returns are still tough for the most of the life insurers. Several insurers are still trying hard to reach the break-even point. According to the life insurance council, as on March31,2011, there were about 32.54 crore in-force insurance policies in India , one of the highest in the world. However if we look at the profit and loss account of industry , the cumulative losses of the top 10 private players in the past decade is in excess of Rs.16000crore, according to the IRDA annual report. The biggest issue of the finding right distribution channel by industry remain unresolved, leading to low productivity. Agency Model The expense ratio for the agency model is high, due to fixed compensation for agency managers. In most of the countries, agency compensation is variable rather than fixed.The high fixed cost of agency management pushes the break-even point of the insurers even higher. Boston Consulting Group(BCG)did a detailed analysis of the life insurance market in the top 1000 towns in india. The report finds that out of 1000 towns, owned branch infrastructure in only top 150-200 towns is economically viable for the life insurers.40 to 45 percent of the life insurance market is beyond these top 150-200 towns, the report says. Most companies are struggling to raise productivity per sales manager beyond Rs.1 lakhof premium collected per month.However,industry experts estimate break even levels of Rs.2-3 lakh per month per sales manager.As per the Life

Insurance Council, it is apparent that companies continue to trim the cost and the number of direct employees has reduced from 2.67lakh to 2.42 lakh Y-o-Y.the number of agents has also reduced from 29.78 lakh to 26.47 lakh Y-o-Y, with aview to professinalise agency force and to ensure informed decisions are taken. Bancassurance model In the early years,bancassurance model excited every other life insureras they had found the success mantraof selling policies through tie-ups with various banks.According to the BCG report india insurance, once bank realized their value and clout, they renegotiated more attractive terms for themselves, making the economics for the insurer less favourable.Several banks are exploring an optimal dealfor themselves. The large corporate agents including banks are known to insist on highpayout which has made the corporate agency model less viable. Although life insurance industry in India is fragmented in its sales practices, the experience of the bancassurance and corporate agency model is no more as exiting as insurarers anticipated few years back. Small and Medium sized Life Insurance Companies The major threat to Mid-Cap life Insurance as well as to small-cap Life insurance business is achieving economical of scales, when compare to blue chip well established, large size insurance business. The large size entities are flourished with large pool of policy holders and policies to manage their services. This would insure that there risks are spread more evenly and their losses are relatively more predictable. The large volume evenly distributes their labor, information technology and facilities, envolved over large number of polices, thereby reducing the overhead allocated to each policy serviced, the inherently enjoying this scale benefit over their midsized rivals.

For most SME life companies, challenges related to the scale are further exacerbated by paper intensive and inefficient processes and low bargaining power with requirement vendors, channel partners and customers. All this result in additional cost being added to the cost structure of SME cos. Profitability in the industry today depend on much more on the issuance ability to control cost and offer products at competitive prices. Increased completion and the commoditized nature of a insurance product have made cost control all the more important and difficult. In order to generate new business, the SME life has to go through a series of a complex processes which is time consuming and cumbersome. A life underwriter receives a vast amount of information from multiple internal and external sources. Most of this information being received in a paper format. A significant degree of a manual effort and supervision is therefore required to mange intermittent receipt, assignment of work, and monitoring case progress. This increase policy issuance cycle times, affect employee moral and fails to meet agent and customer expectation. On the other hand, working with a paper includes considerable stoarage cost and increased efforts in retrieval of information. Underwriting the application is higher in SME life as compare to the large size life, thus requiring additional staff to process those applications, which is not made by these companies. The priorities of life insurance companies may differ, depending upon the circumstances in which the insurer finds itself. For some the imperative is survival, with short term stability being the primary goal. For others, it is improvement of their cost structure and their operational capability, the aim being to emerge from the downturn as a more formidably positioned competitor. For high performance insurers, the strategy may be to fundamentally

transformed their cost structure, implementing a new business model that enables them to capitalized on the opportunities for the growth that the economic crises present. In short term, if the company goes on increasing distribution cost and product prices, it will affect the profitability of the firm, thereby posing a risk of a financial distress leading to reduce budget for future investments, downgrading by rating agencies that would increase scrutiny by regulatory bodies, customer attrition and overall loss of a competitiveness. In the longer term, the quest for the economies of scale and improved efficiencies could make smaller life insurers aqusition targets, as consolidation increases opportunities to cross sell, improve customer satisfaction and aids in enhancing revenue efficiency. For achieving economies of scale for both small and midcap life companies, it is imperative for these companies to come up with the creative and innovation ways to control new business cost by minimizing scale disadvantages. For that, increased usage of innovative usage of software application of workflow management technology and intelligent process reengineering, can allow these business to achieve their outcomes. Chasing topline Industry experts believe that life insurance industry did not follow the oft used clich that Top line is a vanity; bottom line is sanity M. N. Rao,CEO, SBI Life, quoted the Gold Rush Phenomenon, after the sector opened for private players, with insurance fascination for the topline growth at any cost. This resulted in a large branch offices with high payout to the sales managers which ideally should have been agent servicing locations. The limited attention to the lean staffing and the variable compensation model

further inflated cost. Opex ratio (Operating Expenditure/Total Premium) for the top ten Indian life insurance are in the 15-30% range, compare to the international benchmark of the 10-15% . The smaller companies are even worse, says the BCG report.

Paradigm Shift Life insurance industry is currently going to the process of adopting their business model to suit the new environment created mainly due to change in regulations. The regulatory changes introduce since Septemer 2010 have singnificantly reduced the new business premium for ULIPs. The companies have been forced to reduce commission payout and explore means to reduce operating expeses. According to reported estimates, insures have shut about 1000 branches and realesed about 4 Lakh inactive agents after the regulatory changes. Insurance companies are becoming more comfortable with the profitability issues. Capital has indeed become an issue post regulatory changes. According to the life insurance council, India has moved from 20th place in 1999 to 2000 to 9th position among 156 countires and is expected to grow at a fast pace in the next few years. However, capital remains a big issue for the industry which has long been demanded FDI cap to be raised to 49% from 26%. The step whenever taken, would infuse large amount of long term capital into companies. Allowing bank multi tie ups would increase competition and help improve offering. Currently only one tie up is allowed, which puts banks in a better negotiating positions. Industry experts believe that gradually the individual agent model would come down andbancassurance along with corporate agents would gain prominence. The online and telemarketing channels are also expected to grow fast.However, abot 40% of the sales still comes through the agency model and involves maximum cost for

the insurance companies.The key challenge going forward would be optimize the agency modelalong with the altenative channels. Cost Reduction Techniques Strategic cost reduction creates an efficient organization positioned for growth A strategic approach towards the problem, where the cost cutting is the part of broader agenda, and also not deviating from theparameters set by the business towards profitable growth.There are different approaches that can be adopted to reduce cost.Short term strategies may aim to cut expenses as rapidly as possible. Other seek to optimize current modelinorder to move to the higher levels of efficiency.Application of Strategic Cot Reduction, on the other hand, entails broader ambitions and more far- reaching changes to both current operating model and organizational structureInfact,throughout the value chain.Its aim not only to take out cost but to build capability that supports the business strategy. It defines value not only from an internal perspective, but also in terms of what it means to customer, agents, regulators and shareholders. Benefits of Application It is aligned with business strategy , it includes the entire enterprise, and it is planned and effectively implemented by an experienced team f specialists.The magnitude of saving achieved byStrategic Cost Reduction is attributable to its comprehensive approach and shaping the cost structure of the enterprise, affecting the way the insurer conducts every aspects of its business. Their reliance on four powerful interrelated levers that shape the cost structure of the enterprise are as follows:

Level1:Operating model integration Integration lowers the cost structure expenses as well as less cost through economies of scale and scope and by raising effectiveness across value chain. Betweeen 30 and 50% of the total cost savings potential can be achieved through operating model integration with typical results, including : Consolidated and centralized structures and activities , such as single finance functionsupporting all lines of business. Flatter organizational structure and increased spans of contol. Standardized, simplifies and integrated and automated processes across the value chain especially for underwriting claims and policy owner functions. The elimination of activities that add little or new value , and better alignment of resources with those that do. Better use of business intelligence solutions to enhance decision making Better management of procurement budgets.

Level 2: Optimized sourcing Strategic cost reduction will guide the insurer to select the strategy, the location, the skill sets and prices as wel as the level of sensitivity that best suit its needs by careful evaluation of the options, followed by the aggressive pursuit of business arrangements that offer advantageous, variable cost structures. Some of the more popularsourcing alternatives are: Business Process Outsourcing(BPO), which enhances process effectiveness and efficiency by engaging with the

service providers that offer greater scope, scale and expertisethan can usually be achieved in-house. Application Outsourcing(AO), which is used both for rationalization and process improvement Infrasructure Outsourcing(IO), which enables the ensurer to consolidate and rationalize its infrastructure and server environments.

In addition to these benefits, the typical results of optimized sourcing include: Simpler, standardized processes and platforms Imroved efficiency and quality as result of greater scale and expertise The reduction of labor costs by moving operations to less expensive locations The focus of resources on assets and activities that differenciate the insurer The switch from a fixed to more variable cost structure, which keeps costs more in line with transaction volumes and policy numbers The opportunity of sharing risk and rewrd with a strategic partner.

Level 3:Sales and Service Optimization The sales and service capabilities of an insurance company obviously vital to its comparative differenciation. Cost reduction in these areas has to be undertaken carefully to avoid damaging the growth engine of the business or inadvertently driving up customer attrition.Insight from customer, channel, product and other data can be leveraged to inform strategies such as customer /agent segmentation and tieredservice

levels.This not only can positively shape th customer/ agent experience, but also can ensure that the improvements are cost effectively sustained.

The results typically achieved through sales and service optimization are: Greater reliance on fixed or lower cost channels as sales and service transactions increase, reducing unit costs. The optimal alignment of marketing spend with distribution and sales goals More effective sales management and execution , and a better focused sales force. An increase in cross and up- selling Improved alignment with desired agent service model through, for example, tired levels of focus and service.This is achieved by gaining a better understanding of agent segmentation. Reduced call volumes and other transactions through intuitive sales and service processes on self- service channels like the Web. An increase in first-call resolution and a l0ower cost-percall. Greater customer retentionthrough better, more relevantly segmented service.

Level 4: Operational Excellence Operational excellence is indispensable to establishing a business capability that delivers long term differenciation.It provides discipline that allows insurers to realize benefits , and also to systematically evaluate their business and make improvement on continuous basis .Companies that have this

capability tend to be better positioned when going into downturn, as well as better equipped to deal with it. This lever plays a key role in strategic cost reduction , as it provides the infrastructure, methods and capability to monitor and sustain the cost reduction benefits. Most importantly, it infuses a discipline that views cost management as way of doing business not an event.

The results typically achieved through operational excellence are: Trained internal resources who have the tools and experience to continuously improve performance and reduce costs. The discipline to rationalize projects on the basis of their contribution to overall economic value. The precise measurement of benefits, and the rigorous evaluation and prioritization of opportunities. The infrastructure needed to perpetuate operational excellencefor example deployment leaders,master black belts, kaizen practitioners, etc. Ongoing identification of opportunities, and an increase in activities that reduce costs across the business.

Companys name ICICI pru Life Bajaj Allianz Life Max New York Life TATA AIG Life HDFC Life Birla Sun Life SBI Life

FY10 0.19 0.24 0.40 0.37 0.32 0.33 0.15

FY11 0.15 0.23 0.35 0.33 0.22 0.28 0.12

FY12 0.19 0.27 0.28 0.27 0.18 0.26 0.12