The Robo Invasion

• Angelo Lewis
• February 2016
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Not that long ago, the view of many in the financial industry was that the robo-adviser phenomenon was mostly a fad.

At one conference in 2014, for instance, organizers reportedly had fun with the concept, bringing in a robo-adviser dressed in a robot costume, answering questions with a robotic voice modulator.

These days, people are entrusting an increasing amount of money to these algorithmically-based financial solutions. Though the segment still accounts for only a fraction of what the Boston Consulting Group estimates at $74 trillion in global assets under management, the category's growth has nonetheless been impressive.

Total assets under management grew more than 13% to $218 billion in 2015 from $192.4 billion in 2014, based on the estimated 44 firms that offer automated, online advice--including defined contribution plan focused companies, business-to-consumer platforms and white-label rebranded solutions.

The business-to-consumer segment, which includes those owned by large financial firms and stand-alone firms such as Betterment and Wealthfront, grew to $30.6 billion in 2015 from $7.8 billion in 2012, according to Tiburon Strategic Advisors.

This kind of growth has caused the entire financial services industry, including insurers and intermediaries that sell insurance products, to stand up and take notice. The consensus seems to be that the new advisory platforms will deeply influence, if not totally disrupt, the financial advisory industry.

However, many advisers are ho-hum about these upstarts.

"I think financial advisers have their heads in the sand on this trend a little bit," said Tiburon Managing Partner Chip Roame on a recent online advisory call to his clients. "Journalists play into this by saying its robo versus human advice. I think that's a relatively naïve view of the future. I tend to think any successful, large, institutionally minded financial advisory firm will have a robo-advisory offering, that the robo-channel and the advisory channel will meld together over time, and that technologically driven advice will just be table stakes: You'll have to offer it to be a successful financial adviser firm."

Almost half of all financial sales professionals said that robo-advisers would have no real impact on the insurance and financial services industry, according to a recent Limra survey concerning robo-advisers, "For insurance, there are many variables that need to be identified in order to determine what [the right thing to do is]," said one survey participant. "Robos do not have that intelligence."

There are a number of reasons why that view might be shortsighted, starting with the contrast between the average age of advisers and those of their future customers, many of whom are dramatically more technologically literate than their older siblings and parents, which plays right into the use of robo-advisers, said Robert McIsaac, senior vice president, research and consulting at Novarica.

"The key statistic is that the average age of an agent today in the U.S. is 59 and that's both interesting and a challenge in and of itself. Fifty-nine isn't old, but as an average number, that suggests some pretty interesting challenges for carriers in the future as they try and demonstrate relevance to a younger demographic," McIsaac said.

"Most insurance companies still have not figured out how they're going to tap into what is now the largest generational cohort and there's a tendency to still think of millennials as being the kids living in the basement or the kids that are off at college, but the reality is that the leading edge of the millennial generation, depending on how you do the math, is either 33 or 35 years old. These people are forming families, having babies and buying houses. For insurance companies, if they don't figure out a way to make themselves more attractive in that space, they may well find that somebody else takes that on for them," he said.

The financial services industry, he continued, is fixated on the outmoded conception that face-to-face is the only workable advisory model.

"The idea that meaningful advice is somehow locked away from younger people because they've got to have a relationship with a human being is not particularly attractive," McIsaac said. "That gets you to the idea of omnichannel capabilities, or the notion that maybe someday I might want to talk to somebody, but I would like to start the relationship on my own. That's something that I think you see banks have somewhat perfected and I think is going to be a leading model for the kinds of things that we will see emerge in insurance and other aspects of the financial services world."

A Question of Age

Although younger people are currently the primary users of robo-advisers, the category has a broader, cross-generation appeal than what might intuitively seem the case.

"When we have done focus groups or surveys, I've been surprised by the demographic breadth of these products' appeal," said Andrew Edwards, a Bain & Company partner.

"The stereotype is that the user-base is going to skew young, and as a consequence, it's going to skew lower wealth. That's the hypothesis I came in with when I first started working in this space. But it's amazing the degree to which older consumers are receptive to robo-solutions," Edwards said.

In addition to millennials, who tend to be comfortable with online services, robo-advisers also appeal to another demographic, according to Scott Hawkins, vice president, insurance research at Conning Inc.

"At first glance you would think robo-advisers are going to appeal to millennials who are comfortable with online services, are confident about online shopping, and getting online advice," Hawkins said. "That's true, but there's also this group of individuals who are, I would refer to it as, do-it-yourself investors or planners who are perhaps building wealth. They might be older, but they feel confident in their own ability and expertise in managing their own portfolios," he said.

Individuals in 401(k) plans also may gravitate toward robo-advisers, Hawkins said.

"When you look at 401(k) plan sponsor surveys, a recurring theme is that their members want more help in understanding how to save for retirement, more help with planning their retirement and that's creating a nice little market for certain types of robo-advisers," he said.

Research conducted by Limra suggests that the majority of current users of robo-advisory services are members of Generation X or Generation Y. According to the company's 2015 survey of 1,000 consumers, 11% of Generation Y versus 7% of Generation X and 1% of baby boomers are current users. At the same time, some higher net worth individuals are avid users of these products. Some 33% of robo-advisory consumers are those with a half-million dollars or more, far exceeding other financial categories, according to Limra.

"My interpretation is we're seeing a barbell effect," said Scott Kallenbach, research director for Limra's strategic research program. "On one side you have 7% of households with $25,000 to $49,000 who are more likely to use a robo-adviser to make at least some of their financial decisions. These are people who are just starting out, just building wealth, and they're really not a good fit right now for a fee-based adviser."

"On the other side, you have people with a half million dollars or more who are also more likely to be using robo-advisers. Most likely, they already work with a financial adviser and have some investment knowledge, so they're taking the robo-adviser out for a test drive," he said.

The types of financial firms that will feel the most immediate impact from the advent of robo-advisers are those that focus on self-directed investors. This is a category that includes individual advisers and discount brokerages.

"I think these more transaction-based firms may be challenged by the robo-advisory model, as those types of clients might migrate to those types of services," Hawkins said.

"The discount brokerages are trying to get ahead of this, which is why we see firms like Vanguard and Fidelity getting into the robo-advisory business," Kallenbach added.

Vanguard last March launched its Personal Advisor Services, an automated investment platform that offers users who invest $50,000 or more the option of consulting with an adviser. After severing its yearlong partnership with Betterment, the leading business-to-consumer robo-adviser as measured by assets under management, Fidelity in November announced plans to launch both a platform for its advisers and one for consumers. The direct-to-consumer Fidelity-Go automated investment platform requires a minimum investment of $5,000 and is currently free, but will eventually charge a fee based on assets, which won't include the cost of the funds and ETFs in the portfolio, according to a filing the firm made with the Securities and Exchange Commission.

"As we begin to see generational shifts in assets, financial advisers of all types will eventually need to come to terms with the robo-advisory phenomenon," Kallenbach said.

"The clients of traditional financial advisers are typically older. As the clients age and leave wealth to their children, these children may be dependent on technology and already using a robo-adviser. We need to remember that today's younger, more sophisticated investor who is attracted to the adviser alternative is tomorrow's client. The traditional adviser business model is going to have to evolve to include some sort of technology driven alternative," Kallenbach said.

Cost is the main disrupting influence on current advisory practice, said Anand Rao, a partner at PwC Analytics who leads the firm's insurance analytics practice.

"Disruption comes in very much at the level of the fees that are being charged by the two sides. Let's say I've got $50,000 cash to invest. If I go to a life insurance provider, I get slapped not only with a huge commission fee, but I'm also told I have to keep my money there for a fixed term of five, 10 or 20 years. If I withdraw earlier than that, at least for the next six years, I'll get slapped with a surrender charge.

"Compare this with what some of these robo-advisers are now offering. They say, 'Give us that $50,000, we'll charge you only 30 basis or 50 basis points. We'll take care of all of the investing, and we'll keep reporting to you; you can come and look at it any time you want and you can change your mind any time you want. If the market goes up or down, you can change it. If you want to just park it there, that's fine, we'll just keep it,'" Rao said.

"For advisers who are insurance-based as well as financial advisers in general, the big disrupter is going to be in investment management pricing. Robo-advisers are redefining investment management pricing and they're going to continue to influence how consumers view fees. What we'll see is that financial advisers may need to adjust their business models," he said.

Department of Labor Rule

The issue of fees is front and center in the Department of Labor's implementation of its "best-interest-of-the-consumer" fiduciary rule, which most observers believe will be announced sometime this year. (See A New Rule Battle in the December 2015 issue of Best's Review.)

The DOL's rule is based on the premise that there are inherent conflicts of interest in how broker-dealers and advisers are compensated for the retirement products they sell. Because how these financial professionals are paid is not transparent to consumers, the agency appears to believe some consumers are paying higher than necessary fees.

Although it's unclear what the final DOL rule will look like, the agency in its analysis of the legislation's impact appeared to look favorably on the robo-advisory business model as a way of providing consumers unbiased financial advice.

"So-called robo-advisers and products (such as target date funds) that minimize the need for complex advice are already rapidly gaining market share. They promise to make advice far more affordable for small investors, especially young investors who generally are more accustomed to technology-based tools. … The new proposal will help ensure that these new approaches evolve toward less conflicted and more innately impartial business models, rather than succumbing to the competitive pressures that have led more conflicted models to dominate today's highly imperfect marketplace," the DOL's regulatory analysis stated.

What's Ahead

No matter what the fate of the DOL's proposed fiduciary rule, it seems certain that the capabilities of robo-advisory platforms will evolve in their capacity to help consumers make more complex financial decisions.

"What I see happening five to 10 years down the road is that robo-adviser firms will become more sophisticated, handle more complex needs and provide an increasing breadth of solutions. I can see a time when a robo-advisory firm partners with an insurance company to build products specific for the robo-adviser platform. They'll be able to pull in the predictive analytics to help improve and streamline the underwriting. We're not quite there yet, but I can see that happening," said Kallenbach.

Rao believes that the next generation of these platforms will incorporate advances in machine learning and artificial intelligence.

"If you look at the current robo-advisers, what they're basically doing is taking a pot of money and based on the individual characteristics, coming up with a portfolio and asset allocation. Then, if the client wants, they'll go further and choose specific index funds or mutual funds to get the return that the projection promises.

"In the future, what is very likely to be coming is, these robo-advisers would have machine learning and A.I. embedded in them so that they'll be looking at the historical stream of data and then saying things like, 'At your lifestyle, based on all the expenses that you have, we believe that you would need, let's say $100,000 for retirement per year. Given your current expenses and your current savings, you will not be able to match it and here is a way in which you can cut down your expenses and change your lifestyle to be able to meet it,'" Rao said.

He believes insurance companies will need to more aggressively embrace robo-solutions or lose market share to other financial companies."The main reason that insurance companies say that we really need insurance agents is, 'It's a very complex product and we need people to explain it,'" Rao said.

Now the challenge is figuring out how to use technology and embed all that complexity in the software and make it simpler for the end customer. Whoever is able to exploit this technology to make the life insurance and life insurance investment simpler, can reduce the cost of selling life insurance.

"I'm pretty sure some insurance companies will start doing that, but if they don't do that, then I think more of these assets will go into mutual funds and these robo-advisers and all these types of investments as opposed to the life insurance," Rao said.

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Old School Meets New School: An Insurer Purchases a Robo-Adviser

When Northwestern Mutual purchased the financial planning-oriented LearnVest last March, it was the first insurer to purchase a robo-adviser. Relatively unique among other algorithmically oriented online firms, the acquired company focuses on one-on-one personalized financial planning that's facilitated by technology. It brought to Northwestern Mutual 1.5 million users, 25,000 clients through LearnVest at Work (a program in which the company works directly with employers to provide financial planning services to employees), and 10,000 premium clients. Tim Schaefer, executive vice president of operations and technology at Northwestern Mutual, explained to Best's Review his company's logic for making the acquisition and its plans going forward.

Why did Northwestern Mutual invest in and ultimately purchase LearnVest?

We initially wanted to learn more about the impact of a digital model and how it could best support the interactions clients have with organizations. We ultimately decided to purchase LearnVest because we saw the potential of aligning their technology with the human touch of our trusted advisers. Both companies also have a shared vision of helping people deal with the financial stresses in their lives and find better paths to financial security through comprehensive planning. We're now working closely with them to drive our strategy forward.

How do you think Northwestern Mutual's approach to financial planning might evolve as you integrate LearnVest technology?

We're evolving our approach to create a more dynamic client experience. Clients today are dealing with lots of complexity in their financial lives and we're trying to bring some order and sense to it all by creating a road map to financial security.

Essentially we're moving from a paper map to a dynamic GPS that's real-time and adjusts to the financial decisions you're making in your daily life. We've always had a robust planning approach, and now we're adding the dynamic piece.

How will the integration of this technology affect your existing financial adviser model?

Enhanced technology will strengthen the relationship that clients have with their trusted adviser. Many of our advisers are looking to enhance their digital engagement with their clients as they recognize that doing so will help them partner to create better financial plans, stay on the same page over time, and more easily provide everyday relevance in their clients' lives. Enhanced digital tools will help clients more easily see progress in implementing their financial plans, know what their next steps and to-do's are, and be notified of positive changes in progress toward their plan.

A number of large financial companies have either purchased or created their own robo-advisory platforms. Do you see your approach as fundamentally different from what your competitors are doing?

Northwestern's approach is certainly different. We fundamentally believe in the importance of a trusted adviser who helps clients deal with their financial life beyond just the numbers and the facts. There's a whole emotional component to financial planning, and having someone you trust, who can help you work through the planning process and how you're feeling about your financial life is critically important. Many robo-adviser type solutions focus solely on building wealth and investing into the future. Northwestern brings together both insurance and investments, helping people protect what they have and manage against risk, while at the same time helping them grow and build toward their future goals.

What do you think may be the resistance on the part of other insurers to get involved in the robo-advisory space?

I can't speak for other insurers, but I can tell you how we've approached it.

When bringing digital into your business model, it's possible to take an either/or perspective and start to view it as 'we're going to do some things digital over here, we're going to do other things, say, through our distribution system, over there.' Our approach emphasizes the end result for the client and looking at how we seamlessly integrate these two pieces together. I think it's more challenging to do that, but I also think it creates a much more engaging and richer experience for the client.

So, we see the opportunity with LearnVest to take a bigger step forward with technology to accelerate our strategy to transform the client experience.

What do you see as the potential for technological solutions like LearnVest to expand insurers' demographic customer base for financial services?

I think digital is an important and in many ways a necessary component to connect with people today, certainly in the millennial or younger generations. But I'd broaden that to say it's important across all generations. In the financial services industry, people are increasingly looking for digital engagement to supplement the relationship they have with their adviser.

What do you think is important for insurers to keep in mind when integrating a digital solution?

The whole process needs to be put into the context of creating a robust client experience that's both engaging and compelling. When we think of digital or robo-advice, one of the challenges is the risk that it becomes too generic or cookie-cutter. Northwestern's focus is entirely about understanding the individual, their family, and their unique needs to ensure that the solutions provided are specific to what they're trying to accomplish in life.

Do you have a timeline on the full range of your technology integration with LearnVest and when it will be available to your clients?

It's difficult to focus on a specific timeline because we believe digital is an ongoing investment that we make over time. However, we will start sharing improvements to our digital experience with our clients and advisers in 2016, continually enhancing capabilities and being responsive to our clients' needs by innovating over time.

by Angelo Lewis, Senior Associate Editor, Best's Review.