Interest rate risk, market consolidation and the implementation of enterprise risk management (ERM) are key concerns for North American life insurance company CFOs heading into 2005, according to the latest CFO survey from the Tillinghast business of Towers Perrin.

The survey — the ninth in a Tillinghast series — found that 69% of CFOs identified the competitive and economic environments as the top two challenges for achieving their companies’ growth, profit and risk management objectives in 2005. Regulatory issues are driving nearly two-thirds (63%) of CFO respondents to enhance ERM practices; yet, nearly all companies (90%) feel at least somewhat unprepared to address these challenges.

“Most insurers are just not doing enough to address ERM, but there are encouraging signs that indicate many are moving in the right direction,” said Jack Gibson, Managing Principal for the North American Life Insurance Practice. “We see a growing number of companies aggressively pursuing ways to expand their financial modeling capabilities, enhance controls and develop better analytical tools for a deeper understanding of risk and volatility.”

Interest Rate Risk Top of Mind for CFOs

Nearly all respondents (93%) indicated interest rate risk as their top concern about the economic environment, although the nature of specific interest rate concerns varied. CFOs were almost equally split at to whether their most significant interest rate concern was about falling rates (32%), rising rates (29%), no rate movement (21%) or rate volatility (18%).

“Life insurers are very worried about almost any movement in interest rates. A slow and steady upward movement of rates is probably the only ideal scenario for the near future,” said Hubert Mueller, Principal and Survey Leader. “To prepare for this uncertainty, leading-edge companies are stepping up their stochastic asset/liability modeling (ALM) efforts for interest-sensitive products.”

Is the Market Ripe for Consolidation?

Consolidation is expected to expand at a fairly brisk pace over the next three years, according to survey results. In fact, 93% of CFOs surveyed expect the top 10 life insurance fleets to increase their market share from 40% of total assets (at year-end 2003) to at least 45% by year-end 2007; nearly 20% of those respondents expect the top 10 fleets to seize over 50% market share during that time.

“This finding is more consistent with our long-term view on the U.S. life insurance market,” said John Nigh, North America M&A Practice Leader. “While we don’t believe that the top 10 fleets will increase their market share by more than 50% in 2004 or 2005, we do believe that more than 60% of the market will be controlled by the top 10 fleets within the next four to six years.”

CFO Confidence Down from Two Years Ago

CFO confidence is down significantly from the CFO survey in 2003 with respect to preparedness to address distribution and expense issues. Respondents cited inadequate control over distribution channels (41%), technology limitations (38%), resistant culture (35%) and inadequate scale (31%) as obstacles to dealing with the top industry challenges.

“The prolonged downturn in the economy has taken its toll on CFO confidence,” said Gibson. “Following a period of slow growth and heightened volatility, many companies have found it difficult to move forward with strategic objectives that will differentiate them from the competition and position their business for the future.”

However, companies now seem more ready to take steps toward overcoming these industry challenges, including expanding distribution (59%) and improving financial discipline (41%). This is a departure from 2003, when the focus was more heavily centered on improving financial discipline (60%) and reducing operating expenses (57%). Today, just 28% of respondents are focused on reducing operating expenses.

Distribution Plagues CFOs

While CFOs continue to view distribution effectiveness and efficiency as their third biggest challenge (45% cited it for 2005; 47% cited in 2003), respondents express considerably less confidence in their companies’ preparedness to respond. Just 15% of respondents stated that their companies are prepared to address distribution challenges, down significantly from 50% in 2003.

“The survey findings suggest that insurers have shifted their focus from cost-cutting to managing profitable growth,” said Richard Berry, North America Distribution Practice Leader. “Major issues are tightly wound around distribution, including how insurers can recruit, support and retain profitable producers in a highly competitive environment; and how to manage the costs and risks of sales compliance in a tougher regulatory environment. The trade-offs necessary to grow business profitably are tough — so it is not surprising that CFOs feel less prepared. However, CFOs have a critical role to play in helping the management team understand the fundamental economics of its business, thus enabling better decisions.”

Positive Outlook for Third Quarter 2004 and 2005 Results

Nearly 60% of respondents predicted growth of at least 4% in new life and annuity premiums in the third quarter 2004, over the same period last year, while 19% believed the increase would be more than 10%. Nearly three-quarters (70%) of the respondents expected revenues to increase by at least 4% versus the same quarter last year. Over 60% also predicted quarterly net income to increase at least 4%.

Looking to 2005, nearly 75% of the respondents are expecting significant growth in year-over-year annuity sales, while life sales are expected to remain flat.

These results reflect the CFOs’ broad industry outlook at the time they completed the survey and may or may not reflect company performance that actually emerges. CFOs’ views on future financial results for the industry will be a regular feature of the Tillinghast Life Insurance CFO Survey to track the direction of the industry over time.

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