While life insurance has outperformed the overall market, both domestically and regionally, for a decade, heavy reliance on investment-linked products reveals the sector’s bias towards savings rather than outright protection. A sustained inflow of foreign underwriters, who now dominate the sector, has highlighted the segment’s strong growth prospects.

BULL RIDE: New accounting standards and a growing realisation of the benefits of traditional life protection is spurring a shift in the segment’s product mix, just as alternative distribution channels such as banks continue to drive strong growth in the sector. With GDP per capita expected to nearly double to $6000 by 2017, according to the World Bank, higher disposable incomes and the growing middle class will likely vindicate foreign underwriters’ strong growth forecasts.

The value of life premiums has sustained average annual growth rates of over 25% over the past five years, rising from Rp27.5trn ($2.6bn) in 2006 to Rp93.6trn ($9.4bn) in 2011, according to the Indonesian Life Insurance Association (AAJI). With y-o-y growth of 17% to Rp49.7trn ($4.97bn) in the first half of 2012 and projected premiums of Rp117trn ($11.7bn) for the year as a whole, according to the association, growth shows no sign of slowing. Indeed the AAJI estimates that new premium income tends to peak in the year’s final quarter as new project launches accelerate.

MIDDLE CLASS GROWTH: Strong growth in the middle class, measured as those with over $4 of disposable income a day, to some 45m in 2011, according to McKinsey Global Institute, has driven growing interest in life insurance. Yet with life insurance penetration of a mere 1.3% of GDP in 2011 – far lower than the 2.6% in Thailand and near 4% in Malaysia – premiums still have significant room for growth. While an estimated 52.76m Indonesians hold a life policy as of the first quarter of 2012, up 15.1% y-o-y according to AAJI, the majority of these are extended as part of group coverage. The number of policies is split between 43.03m group policies taken out by corporates and 9.73m individual ones. “In such a vast untapped market, efforts are primarily focused on growing the premium base by means of reaching first time buyers,” Bert Paterson, the president director of Sun Life Financial Indonesia, told OBG.

The country’s large population, low penetration and strong recent growth have attracted the attention of a number of foreign underwriters. Of the top 10 life underwriters, who accounted for a total of 61.9% of life gross written premiums and 66.3% of life assets in 2010, according to local rating agency Pefindo, only three are wholly Indonesian-owned. Foreign players such as Prudential, AXA, Allianz, Avrist, Manulife, AIA and MSIG hold the segment’s commanding heights.

TIES THAT BIND: While brokers have a small share of the group life policy segment, agents and banks have accounted for the lion’s share of premium income over the past decade. Yet bancassurance sales have outperformed the market as a whole since first being introduced in the late 1990s. This channel has had a more profound effect on life policies than on non-life, given their bundling with credit – banks usually insist on borrowers holding life and personal accident cover in order to extend financing. By the first half of 2012, bancassurance accounted for more life premium income than agency for the first time, generating some 40.6% of life premium (Rp20.1trn [$2bn]) compared to agencies’ 39.2% (Rp19.5trn [$1.95bn]) according to AAJI.

The segment’s agency sales force has continued to grow, however, with 274,000 licensed life agents by March 2012, up from 220,000 in 2011 according to the association, which expects agent numbers to reach 500,000 by 2014. Under new rules issued by the central bank in late 2010, however, costs associated with this channel have been growing. The new rules require each employee selling insurance to be a certified agent – one of the factors driving growth in agent numbers. Yet ratings agencies expect bancassurance to continue to outperform. “Bancassurance has been successful due to the banks’ existing customer base, the trust clients have already placed in their respective banks and the fact that banks know how much money their customers have to spend on insurance products,” Oemin Handajanto, the chief executive and president director of Zurich Topas Life, told OBG.

Lenders like Bank Sinar Mas, Bank Mandiri and Bank Mega have exclusive arrangements with affiliated underwriters on certain products, and the market remains open to new deals. AXA Mandiri’s exclusive bancassurance partnership with its affiliated bank is lauded as an example of a successful such tie-up, generating 90% of the underwriter’s premium revenue. A number of new exclusive deals involving major players have been signed in the past year. HSBC signed an eight-country deal over 10 years with Allianz Life in October 2012, while Manulife concluded a 10-year deal with the larger Bank Danamon in October 2011.

SHIFTING PRODUCT MIX: Policies linked to investment returns – so-called unit-linked policies, associated with units in mutual funds – have grown quickly in popularity since 2006, rising from 19.17% of total life premiums that year to 62% by 2010, when 26 underwriters were offering unit-linked policies. Prudential popularised a unit-linked policy in 1999 and the British insurer remains a leader in the segment.

For individual policyholders such covers offer the prospect of higher returns in a bullish capital markets environment. For underwriters, meanwhile, such policies have the benefit of shifting most investment risk off their books and onto policyholders. In a market with relatively shallow capital markets, where investment instrument maturities rarely match the longer-term liabilities (of 30 years and more) of life policies, this has proved a significant draw and underwriters have eagerly encouraged the shift towards unit-link.

UNIT-LINKED: Higher reliance on unit-linked policies runs the danger of higher premium volatility for insurers, however, as was evident in 2008 when life policyholders terminated their unit-linked policies in higher numbers given the slowdown in equity markets. Reliance on unit-linked is also symptomatic of the eagerness to save rather than use insurance as a risk hedge.

Yet over the past year new unit-linked sales have slumped relative to traditional life policies. Unit-link’s share of new premiums in 2011 already fell from 60.27% to 52.56% in a year, according to AAJI, while traditional policy premium’s share grew from 39.73% to 47.44% in the same period. In the first half of 2012 new unit-linked premiums dropped a further 7% y-o-y.

One reason for the decline stems from the underwriters themselves as they anticipate new accounting rules in line with IFRS, which separate protection premium income from investment-linked premium. The association also sees in the slowdown a sign of growing awareness on the part of Indonesian policyholders about the need for stable protection in the face of more volatile markets worldwide.

YIELD CHASING: In a slowing inflation environment – Indonesia’s inflation rate has dropped below 5% over the past year for the first time in a decade – life insurance coverage has become more attractive. While most Indonesians are still likely to view life insurance more as a savings instrument than as a hedge against risk, the recent changes in the product mix may be a sign of a more balanced approach.

Underwriters, however, have benefitted from high yields on their investments in the economy’s financial markets, a factor that has further padded impressive profits for the segment. Life insurers’ investments have expanded from Rp199.12trn ($19.9bn) in 2011 to Rp219.26trn ($21.9bn) by the third quarter of 2012, according to AAJI, which expects total investment to reach Rp251.27trn ($25.1bn) for the year as a whole.

Whether pushed to purchase life insurance by bundling it with bank credit, or enticed by the prospect of higher savings, the life segment holds clear prospects for sustaining the rapid growth of recent years. With this potential widely recognised by foreign insurers, the market is only set to become more competitive in coming years. Despite a high chance of pressure on operating margins, investment returns will likely more than compensate and deliver a strong performance in one of the world’s most dynamic life insurance markets.