Changes Regarding the Client

The most important changes that unit linked brought to clients can be summarized in the following 4 categories.

Compared to traditional insurance – that is fundamentally inflexible, and almost impossible to change during the term – unit linked insurance is flexible, and allows the client a number of options and possibilities to change parameters that the traditional insurance lacked, namely:

‚ The client can choose – within the options provided by the insurer – the ratios by which the reserve of the client’s insurance is divided between the different types of assets. The client can reallocate funds between the different types of assets as many times as he wants, naturally on payment of an extra charge.

‚ The client can – within certain limits but with no penalty – freely deviate from the date of premium payments, and may perform irregular top-up payments. (Besides the regular payment is remaining the default, because if the client does not pays regularly, then after a while he/she would not pay at all.)

‚ The client can freely choose – again, within a wide range – the minimum sum of all benefits payable in the event of death, and this sum can be changed during the term relatively easily.

‚ The term itself is also flexible, it can be adjusted to the changing needs of the client. This also means that the distinction between maturity and surrender will gradually disappear.

On the other hand, flexibility doesn’t only bring the freedom of choice. It also means that the insurer can flexibly adjust to developments since the commencement of the policy, e.g. to changes incurred in mortality. Contrary to traditional insurance, where the invariable premium also meant that during the term the insurer didn’t take into account necessary adjustments of the risk-premium due to changes in mortality, in unit linked insurance the insurer reserves the right to change the death-risk premium during the term. The direction of this change – naturally – is not known beforehand, so the client doesn’t know if the change will be favourable or unfavourable, however since in developed countries mortality rates have decreased for decades, this type of flexibility is bringing rather the former than the latter result.

In exchange of flexibility the client has to pay a certain price. By having the option of selecting the assets of the investment of the reserve, the client takes over the yield-risk from the insurer. This frees the insurer from the responsibility of having to

achieve a certain yield under all circumstances, which makes it possible to invest in instruments with higher risk, but also higher expected yield. Of course, the insurer – for an additional fee – may undertake a guarantee on the yield of individual investment forms (asset funds) offered to the clients, (cf. variable annuity!).

Transferring the greater part of investment responsibilities from the insurer to the client supposes in an implicit way the financial maturity of the client (as the investment practice of traditional insurance hidden from the eyes of the client supposes the financial immaturity of the client), since only a client informed in the capital markets at least on a basic level can make correct decisions, in accordance with his own risk-bearing “capacity”, regarding the allocation of his reserve. This supposition on the maturity of clients is often not yet justified in the Hungarian practice, moreover it is arosing big conflicts from this from time to time.

The expense structure of traditional insurance and the magnitude of expenses is invisible to clients, and insurers consciously aimed at this invisibility. Unit linked insurance has brought a great change in this respect, the expense structure and the magnitude of expenses is fundamentally visible and can be planned by clients. The administration fee, the fund management fee and the bid-offer spread are all openly announced amounts.

On the other hand, insurers would like to hide certain expenses even in case of unit linked insurance – similarly to the traditional insurance. These are primarily acquisition costs and their coverage. The technique of Initial Units has been created to realise this, which hides the fact that the greater part of the premium of the first (two) years is not accumulated and invested for the client, but taken away to cover acquisition expenses.

Since this technique can be applied to mislead clients, its use is forbidden in more and more countries.

The transparency of the expense structure at the same time makes possible a more even expense loading. On even loading we mean that expenses are charged on premiums and on the reserve according to the actual services, and not some other factors. In traditional life insurance expenses are usually charged as a certain percentage of the premium, this way loadings are proportional to the sum assured⁸⁴, while the actual incurring expenses of the insurer depend on a lot of other factors, so in reality it is not proportional to the sum assured. In unit linked insurance naming separately the different types of expenses and defining them as proportional to different factors closely related

84 This is only partly eased by the practice of premium discount for a higher sum assured, that is often applied by traditional life insurance, or the corresponding, but reversed technique, when the premium tariff depends on the sum assured, relatively decreasing.

to their source makes fairness⁸⁵ of a greater degree possible. Maintenance commission and expenses of premium collection are premium income proportional, this way they are covered by the bid-offer spread, fund managing fee is proportional to the reserve, the administration fee is independent from the premium or the sum assured, so it is usually defined as an absolute sum.

Because of all these effects, in unit linked insurance – compared to traditional life insurance – there is much less cross-financing between different groups of clients.

6.5.2. Changes in the Relationship of the Insurer and the Client The transparent construction, the visible magnitude of expenses at the same time puts pressure on insurers to decrease expenses. Visible expenses make it possible for clients to compare also from this point of view – either by themselves, or through an agent arguing beside the product of his company – the offers of individual insurance companies. Insurers automatically take into account this effect, and emphasize more strongly in their pricing that the product should not be much more expensive than competitor products, or that if possible, they should offer the same service cheaper.

Naturally, as we have indicated earlier, greater transparency has its limits (e.g.

initial units), insurers try to resist the pressure of decreasing expenses, that they try to accomplish by hiding certain expenses of unit linked insurance, or by presenting them to clients in a special way.

Reducing the expenses is encouraged also by regulators. One of the most effective tools here internationally is the cost indicator. Its use has been spreading from the end of ‘2000s years and the EU has made it compulsory (see EU [2014]). Hungary has introduced it in the field of Unit Linked insurances as one of the first countries in 2009 (see MABISZ [2009]), and we have gained rich experiances. The products with extremely high cost indicators has disappeared from the market as the effect of this indicator, but the reason was not the unwillingness of the clients to buy very expensive products. Namely the clients are willing to buy – unfortunately – practically anything, if the insurance intermediary persuaded them. Instead of this, the mode of action is the following: the product defelopers themselves have recalled these products, averting the wrong position of their product in a public comparative list. The other important factor was, that the intermediaries have started to argue for the low cost indicator of their insurers’ product, so they have started to urge the reduction of the value of the cost indicator at their own insurer.

85 The term “fairness” are used in Hungary (and probably in many other countries as well) parallel in two often opposite meanings. The meaning of this here: everybody has to pay that cost, what has really arosen connecting to his/her concrete contract. Namely I consider fairness and correctness as synonyms. The often used different meaning of the term is: the cost charged is relatively higher for

“richers” and smaller for “poorers”. In other words: some redistribution has to be realized.

The environmental factors promoting the appearance of unit linked, the – above analysed – product design characteristics of unit linked itself, and the shift in emphasis compared to traditional life insurance have inevitably changed the systems of arguments used by insurers – and their representatives – when selling unit linked.

One of the most emphasized elements in the unit linked design is the choice between different investment options. Correspondingly, this investment characteristic is the most emphasized when selling the product – and in many cases emphasized too strongly by insurance agents – generally on the account of the death coverage. We are witnesses of an interesting phenomenon in relation to this. One reason for the appearance of unit linked insurance throughout the world is the increasing demand for living benefits on the account of the death benefits. In Hungary we see strong under-insurance regarding term assurances – in an international comparison, of historical reasons – but at the same time – similarly to developed countries – unit linked insurance is spreading even on the account of term assurance. Furthermore, the Hungarian mortality rates do not give grounds for Hungarian consumers not to view this risk as important, either. Because of this, some insurance companies see a marketing chance, and incite their agent network through high commission rates to sell high death coverage. In spite of this, there is a certain shift in emphasis in life insurance “rhetoric” from providing for dependants toward self-care.

Because of the above, a number of stock market phrases and connections have been imported into the system of arguments, and agents have to help clients in recognising their own risk-bearing “capacity” and in forming an investment portfolio accordingly.

We have to mark that in Hungary unit linked insurance has been introduced at a very favourable historical moment, in the stock market boom, this way they could become popular, well-known and widespread in a short period of time. This was not the case in every country (Spain is usually mentioned internationally) where due to the bad timing these products were unpopular for long.

Traditional life assurance is traditionally sold by agents having an exclusive contract with the insurer, against payment by results (an acquisition commission depending on the term and annual premium of the insurance, payable at the inception of the policy).

The cover of the commission is the greater part of the premium of the first (sometimes the first two) years, that is not accumulated in the client’s reserve. From the clients point of view this commission of an unknown sum appears (or would appear if the client had precise information about it) as the fee of the guidance and services of the agent, who in a general sense plays the role of a financial advisor. This guidance and service includes a very general survey of needs and the (insurance) solution to these needs. Traditional insurance is largely standardized, so we can say that these are uniform solutions to uniform needs, and the guidance of the agent is quite simple.

This traditional marketing technique faces a lot of challenges – mainly from the new circumstances incorporated by unit linked insurance – to which the insurance industry has not necessarily found the adequate answer yet. The challenges can be characterised by the following contradictions:

‚ Because of the visible expenses (and the competition of alternative investment options) there is pressure to reduce the largest item, acquisition expenses, while the increasing complexity of needs and products increases the demand for quality counselling. On the other hand – due to the habitude reinforced by the foregoing practice of financial service providers – consumers tend to think of counselling as a free service.

‚ The diverging and more-and-more unique needs of clients would make it necessary to separate and make independent the costs of counselling and mediation, but these two expense elements are not separated in the current practice of financial providers.

‚ But the most important contradiction is that although wide classes of society have increasing possibilities and objective needs for long term investments and generally for the formation of long term individual financial strategy, only a minority recognises this fact by himself, the majority has to be persuaded by government instruments (e.g. compulsory pension funds) and through the marketing pressure of financial intermediaries (through agents).

Because of all these, there is a kind of “crisis”, seeking ways and means in the marketing of life assurance throughout the world – in Hungary also –, of which the solution cannot yet be seen, but some factors will probably intensify:

‚ The marketing of very simple unit linked insurance with low expense ratio, not including counselling fee, only the cover of mediation is increasing through alternative intermediary channels such as the Internet, bank agents and direct mail. Mostly the financially well-informed clients can take advantage of this.

‚ The need for the counsel and life-cycle planning service of highly qualified advisors independent from insurance companies is probably increasing, and parallel to this the willingness to pay separately for these services will probably increase, too.