New Market Demands New Strategy.

In a changing financial-services landscape, life insurers will have to choose a new road to success.

With the convergence of financial services, the capabilities required to win in the new marketplace are evolving. Findings from Tillinghast-Towers Perrin's recently published survey of life insurance chief executive officers paint a clear picture of what the life insurance industry faces: more frequent restructuring and consolidation within and across financial-services sectors, continued focus on the savings and accumulation business (and direct competition with investment-management companies) and the quest for more productive distribution approaches.

The survey findings also suggest that a surprising number of CEOs maintain an optimistic view of current and prospective new-business profitability, despite evidence of companies failing to achieve their profit targets, which in many cases are not particularly ambitious.

Tillinghast-Towers Perrin sent the survey to 270 CEOs of the largest life insurers in the United States and Canada. Sixty-five CEOs responded, a 24% response rate. The respondents have individual life and annuity reserves ranging from less than $500 million to well over $20 billion. On this basis, the firm estimates that 50% to 60% of the life insurance industry is captured by the sample.

Most CEOs expect the competitive structure of the business to change, given the pace of demutualizations and merger-and-acquisition activity within the life business. As a result, many companies will rationalize their businesses: sellers will exit marginal or noncore businesses, and buyers will amass capabilities and capacity in their chosen core businesses. This has certainly been true for group health and disability businesses and could happen in some of the variable-product lines if a significant correction in the equity market occurs.

Continued business restructuring and market concentration are likely to result in:

* increased attention and higher performance expectations from securities analysts and investors, particularly with the completion of major demutualizations/initial public offerings and ongoing consolidation of publicly traded financial institutions competing to serve consumers' long-term savings needs;

* growing pressure to reduce expenses and realize productivity gains to justify acquisition prices and meet rising performance expectations; and

* heightened tension between the desire to grow quickly through acquisition and the need to ensure a solid foundation on which to realize more profitable growth from current operations.

Some relative optimism about current and expected new-business profitability is puzzling. About two-thirds of survey respondents expressed satisfaction with current new-business profitability and nearly three-quarters expected future new-business profitability to stay the same or improve, which is surprising in light of the expected increase in competitive restructuring and the elimination of most barriers to cross-financial-service sector competition.

In Tillinghast's 1995 and 1998 surveys on product pricing methodology companies reported targeting from 7% to 16% internal rates of return for new-business profitability. Perhaps some of the optimism stemmed from the lower profit targets. On the other hand, in the 1998 Product Pricing Methodology Survey, roughly one-quarter of stock companies and nearly half of mutual companies said they were "not likely to meet profit targets." Thus, regardless of the level targeted, many companies are more pessimistic about their expected profitability. Our experience in merger-and-acquisition appraisals suggests that actual new-business profit levels tend to be lower than targets.

For another viewpoint, our analysis of market-to-book ratios for publicly traded life insurers indicates that the market ascribes little premium over book value for single-digit returns. Our conclusion: The challenge of achieving and sustaining attractive levels of profitable growth will increase, adding pressure to reduce expenses and boost productivity, especially in distribution and marketing.

We see four characteristics of successful insurers:

* aligned business strategies and organizational approaches to foster competitive advantage;

* aligned target market, product/service offerings and distribution approach to acquire and develop profitable customer relationships;

* sufficient scale to achieve competitive advantage; and

* ability to compete in the labor market for producers.

We believe focus, a well-leveraged brand, consistency of marketing approach, superior channel management and compelling customer relationships must be combined with vision and strong leadership to guarantee future success.

Richard K. Berry, a Best's Review columnist, is a principal in the New York office of Tillinghast-Towers Perrin.