Typical Life Insurance Cash Flows
This first bit is as interesting as watching paint dry, but it’s important context to understand the good stuff.
If you ever wanted to dissect the expected cash flows that a life insurer might expect for a single life insurance policy they have sold, it would look something like this.
Essentially, Life Insurers normally have a BIG negative cash flow at the beginning of a policy, followed by expected small positive cash flows over time.
Taken together, the small positive cash flows should exceed the big early negative cash flow to make the entire thing profitable, and therefore a worthwhile enterprise.
Typical Life Insurance Persistency
Another concept which is important to understand is that of persistency. Depending on the exact business model, life insurers make specific assumptions around how many people they expect to keep their policies every year.
In direct, or over the phone type business models, the proportion of lapses is relatively high, and generally lower with intermediated business (i.e. when there’s a broker involved).
For the sake of this argument, let’s assume that 10% of the people will lapse their policies every year in an intermediated business model. This is a simplifying assumption, since we know that the number of years a person has had a policy also influences the lapse rate.
How do lapse rates and cash flows work together?
Remember that there is a BIG negative cash flow upfront. This normally happens on day 1, and the bulk of this money is normally a commission or distribution payment which is paid to the broker, or distribution channel.
Now, because it happens on day 1, that expense is incurred for each and every policy which gets sold. (Let’s ignore the fact that early policy cancellations can sometimes mean the commission is taken back, because while this is true, it doesn’t influence the conclusions of this argument.)
So, an insurer spends a ton of money for each policy they sell, at the point at which it is sold. For those keen on jargon, this is normally referred to as New Business Strain. They need to recover positive cash flows in the future, to make up for this spend. BUT, after day 1, people have started to lapse their policies. In fact, assuming a 10% lapse rate, after 5 years, there are only about 60% of the original policies still active and paying premiums.
Think about what this means.
40% of the people have left and don’t have policies anymore. However, the big expense was still incurred for those 40%. For the enterprise to be profitable, the other 60% have to contribute positive cash flows to not only cover their own upfront costs, but also the costs of the people who have left early.
That’s right - a decent part of your premium with most insurers is there to pay for the expenses incurred when a stranger’s policy is sold. Kak, right? And taking the conclusions further, IF you plan to keep your policy for decades, you not only paid off your day one expenses, but you are continuing to subsidise the dropouts every year i.e. you’re getting a raw deal.
So how is this related to the Indie investment, and why is it possible?
There are a number of positive aspects at play which make your investment possible, and believable.
Are no commissions the answer?
Yes, and No.
Because we have cut out the middle man, the expenses we incur on day 1 are a fraction of what is normally paid in a typical intermediated life insurer.
A typical direct insurer still needs to pay for marketing, paid search, referral fees etc; so the expense is not zero, but has potential to be lower. I say potential, because it is still possible that direct marketing lands up costing more than commission-based models.
This can happen when you are trying to sell a very vanilla, low quality, or uninspiring product. When your product does not offer apparent and genuine value or utility, you tend to have to use a big hammer (i.e. spend a ton) to get people to buy.
In addition, we know that direct insurers normally have worse lapse rates than intermediated ones. So, although their day one expenses can be lower than a traditional insurer, there are far fewer policies around over time to cover that expense. And the effect of those two forces generally cancels out any possible premium benefit.
But with Indie's investment, do things change?
Yes! (we hope)
The concept of investing in our clients to create wealth is a truly compelling and desirable value proposition. And as we get better and better at landing our value proposition through marketing interventions, the amount of money we will spend to sell each individual policy will be lower than a typical direct player who has a vanilla or low-quality offering.
And it will cost us significantly less than with a traditional intermediated business model.
Coupled with that, we can reasonably expect that our investment offering will mean that our clients will be more likely to retain their policies over time (i.e. fewer people will cancel a policy with bounty, than without).
These two forces pulling in the same direction are truly powerful. Lower upfront expenses and better client retention mean that premiums can be lowered significantly.
We can then use that significantly lowered premium to fund the cost of the investment, and this essentially cancels out the cost of it.
In other words, introducing the investment lowers our day 1 expenses, and also increases our retention, which lowers our premiums, which pays for the investment.
Are there any other factors?
Yes, there are some other things which help us.
Better risk selection.
Our state-of-the-art, data-driven, fully-digital underwriting and rating model means we can select better risks more often, and price more accurately when we do. This means that our premiums are lower, “all else being equal”.
Our cost base is much lower.
Because we use technology to do so much of the heavy lifting, we can run a fully-functional life insurer at a fraction of the typical cost. This reflects in what we need to charge people.
Indie's investment means we have created a business model whereby we can give so much MORE to our clients, while still maintaining a profitable enterprise.
The bottom line is that more of your spend goes back to you with Indie, and regardless of when you leave or don’t, the amount you are subsidising others is negligible.