A Strategic Shift
The U.S. Department of Labor's new fiduciary rule is challenging insurers to revise their approach to product development.
The final version of the U.S. Department of Labor's new fiduciary rule aims to raise investment-advice standards for retirement accounts. After months of speculation, this streamlined version of the regulation addresses a number of the concerns raised by earlier drafts.
For insurance companies, this softer ruling will no doubt feel like a reprieve; however, they should not be lulled into a sense of security. True, the final rule offers relief, and on two fronts. First, the deadline for implementation now allows insurers 12 to 20 months for implementation rather than eight. Second, the fiduciary standards for the sale of variable annuities have been lowered.
While traditional commission-based variable annuity products will still require a best-interest contract exemption (BICE) for clients with individual retirement accounts, the requirements for such exemptions are much lower than initially proposed. Instead of an upfront contract between a financial adviser and a prospective customer, it will suffice for the customer to acknowledge the exemption at the time of sale.
Additionally, the new rule clarifies that appropriate fees are not the only standard for determining the best interest of the customer, and gives more leeway to the sale of proprietary products-- a change that is especially relevant for insurers with captive agents. In addition, earlier proposed disclosure requirements related to expenses and the projected performances of the underlying products have been greatly relaxed.
Overall then, the ruling has two broad implications for insurers: While they still have to implement the reporting and process requirements related to BICEs, the administrative burden has been eased significantly and insurers will not have to scramble to be compliant within eight months. More importantly, fewer advisers than predicted will find their compensation models are no longer economically viable, and thus few will leave the industry. This situation, in particular, will mean that new sales in variable annuities will not drop precipitously and harm insurers' existing go-to-market approach in the near term.
Yet even the more lenient final rule will still accelerate the industry's continuing structural shift away from complex, commission-based products and toward simpler, more customer-friendly, fee-based advisory-- a shift that has been gaining momentum for more than 10 years within the wealth management world, especially for wealthier clients. For nearly all advisers, commission-based products such as traditional variable annuities-- once the bread and butter of the retirement-income world-- will sooner or later become the exception to the rule. In fact, most investment products competing for the attention of customers and advisers these days are already fee-based, with annuities being one of the few products trailing behind the trend.
So, yes, the ruling means insurers can breathe a sigh of relief-- but only as long as they use their newfound breathing room to begin a strategic shift to next generation retirement-income products. To keep up with distribution and avoid being left behind, insurers should begin to double down on product innovation, both for high net worth customers and for the middle market.
Steps to Take
On the high end, successful insurers will lead the way by developing retirement-income products that are significantly simpler and easier for consumers to understand. In the past, insurance companies have sometimes struggled to be truly innovative in their product development, often simply tweaking existing product features and refiling. In fact, one natural inclination of insurance companies in response to the ruling may be simply to adjust the commission schedule for existing products, as the ruling does not attack the product itself, but the way in which advisers are compensated for it.
Instead, they should start over and approach their new-product development with a defined customer need, designing a product around that need, getting customer feedback early on, testing their ideas, and circling back with their customers-- doing a great deal of homework on the front end before heading into the product development process. This more deliberate, rigorous process will be more beneficial than simply making changes to existing products, which could result in products even more complex than before.
New, simpler products will be easier, not just for end-consumers to understand, but for advisers as well. The easier annuities are to understand, the more they can move away from being sold only by annuities specialists who are comfortable with the complexity, and toward a broader base of advisers who will embrace them as part of their retirement-income solutions-- and, by extension, sell more of the product, rather than less. Note that any new product's compensation scheme should be developed in line with the way advisers are being compensated for many of their other products, that is, through asset-based fees. Offering fee-based compensation for variable annuities will bring its own challenges; in particular, common fee levels will be insufficient to meet the economics of products with a number of guarantee riders attached. However, moving to simpler, more modular product structures that build seamlessly on common fee arrangements-- with "premium" modules that are more intuitively defined than today's benefit riders-- could be one solution.
Marketing to the Middle
On the other end of the market, insurers should work toward inexpensive, no-frills versions of retirement-income products that allow the growing segment of consumers who don't have a personal financial adviser to identify their retirement-income goals and help them purchase with confidence. The middle market of America's retirees is vastly underserved today. By virtue of being unattractive to financial advisers, many in this market already use automated online or fairly standardized advice-- and many more will do so in the near future. The product this market needs is therefore low-cost, affordable, straightforward and accessible through multiple channels-- not only so consumers can be comfortable with it, but so they can compare it across different offerings and ultimately make the most appropriate choices.
To succeed in these efforts, insurers will need to redefine the entire operating model for their product-development, product-management and customer-experience processes. Today, a majority of insurers' product teams are focused heavily on product management, enhancement or re-pricing. Looking to best-in-class product development companies outside of insurance, however, insurers should begin to dedicate a meaningful share of product development resources to new, "breakthrough" product development instead of product evolution.
For such innovative product development to occur, it will be essential to bring in the customer's voice early on, building the product on genuine customer needs and interfacing frequently with customers in spiral loops along the entire process. Cross-functional product development teams-- that represent all interests from start to finish-- can facilitate this shift, as well as making it easier to avoid back-end headaches as finished products are sent to operations and IT for implementation. Insurers today often develop their products in silos, sending them first to one department and then another. Operations, IT, and marketing are often brought in only at a late stage, making product adjustments costly and time-consuming.
In addition, insurers should put in place an effective stage-gate process, as is standard in the consumer goods and technology worlds. While many have already established such a process, the gates are often ineffective at filtering out weak value propositions or products that are very difficult operationally. In fact, the shape of the product pipeline can sometimes resemble a tunnel rather than a funnel, with not enough new-product ideas being fed in at the front and too many ideas eliminated late, tying up scarce resources. Some products even proceed to launch despite limited commercial prospects. Insurers can better understand this phenomenon by rigorously measuring their product performance through post product-launch reviews based on clearly defined metrics, then linking the results back to the development process.
One aspect of the next generation of retirement-income products is that they will need to fit seamlessly into an omnichannel approach involving digital, direct and in-person interactions between consumers, distributors and carriers. While the acquisition process for many consumer segments will likely continue to be centered on in-person interactions with financial advisers, that process will often start with online product research (or even research on advisers) before the interaction takes place. Similarly, it will be more cost-efficient-- and preferable from a customer-experience perspective-- to be offered an online "self-service" option for many aspects of customer service, likely on a mobile app, rather than going through a call center.
In short, success will require a step-change advance in product development capabilities and go-to-market approaches. Insurance products might look very different if Apple or P&G were driving the innovation process. For many insurers, a new approach to product development will also require a significant change in the underlying culture, moving toward greater customer-centricity, increased technology and more agile forms of organization. The final DOL rule does not make all these strategic changes mandatory. However, it does provide a significant impetus toward taking the offensive and getting ahead of the immediate competition from other insurance companies. Simultaneously, it also highlights the imperative to catch up with the providers of competing products, such as mutual funds, that have been leading the structural change in wealth management.
By Achim Schwetlick and Lucy Pilko
(Best's Review contributors Achim Schwetlick and Lucy Pilko are partners in the insurance practice at The Boston Consulting Group. They can be reached at pilko.lucy@bcg.com and schwetlick.achim@bcg.com.)
