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How the wheels came off at Standard Life

By Ian Fraser

Sunday Herald

April 4th, 2004

SANDY Crombie looked haggard, his face tired and drawn as he prepared for his last meeting on Wednesday. It was the worst day of his less than three months as chief executive of Standard Life as he announced the business is to end its 79-year-old mutual status.

But the mauling Crombie received that day should pale into insignificance beside the flak he and his fellow directors expect from policyholders when they step on to the platform at the life assurer’s annual general meeting at the Edinburgh International Conference Centre this Tuesday afternoon

Crombie will know that such treatment comes with the territory. After all, he learned the hardSandy Crombie way two months ago when John McFall MP, the convener of the Treasury select committee, compared him to the infamous former Iraqi information minister “Comical Ali”.

The harshest questioning at the meeting will doubtless revolve around the spectacular volte face unveiled by Standard Life last week and the small matter of executive pay.

Not only did Europe’s largest mutual insurer say it would go ahead with the scrapping of its once cherished mutual status – something it had earlier fought tooth and nail to defend – some time after 2006; it also made an implicit admission of failure in the UK life and pensions market, saying it now needs to spruce itself up to make itself more attractive to future stock market investors.

This will include axing more than 1,000 of its 14,000 global workforce, 880 of them in Edinburgh. The company has huge volumes of low-margin and unprofitable business on its books, particularly in the pensions area, which is why such radical surgery is needed now.

Overall, Crombie told the Sunday Herald, a total of 1600 jobs will have to go from its core life and pensions business this financial year – including no replacements for departing staff since November 15, 2003 – with a view to making cost savings of 20%. The life assurer also said it could not rule out compulsory redundancies and that it would close its final salary pension scheme to new recruits from November.

Staff – who for years have been encouraged to support the mutual line and to view Standard Life as a benevolent employer – have good reason to feel badly let down.

All this came from a group whose recently departed chief executive Iain Lumsden received a salary and bonus of nearly £1 million last year and where a clutch of top executives received a collective £2.6m injection into their pension pots, over and above their already generous 2003 remuneration packages.

The surge in executive pay at the life assurer came despite the drip, drip, drip of cuts in policyholder bonuses (four in two years) as well as shortfalls on most of the company’s endowment-linked mortgages.

Standard Life said it was embarking on a review of its ownership status after a well documented spat with the Financial Services Authority over the “realistic reporting regime” in January. The ultimate destination of that review – conducted by Standard Life’s board together with consultants McKinsey, investment banks UBS and Lazards, law firm Clifford Chance and actuarial consultants Watson Wyatt – was meant to be uncertain and the findings were not expected until June.

But last Wednesday, interim findings were made public much earlier than expected, in what some perceived as an attempt to get all the bad news out at once.

“It was inevitable that if they wanted to expand, it would be too difficult to do as a mutual,” said Alan Steel, chairman of Linlithgow-based Alan Steel Asset Management. “They underestimated the severity of the stock market downturn and were caught with their pants down. They held on to equities for too long.”

Aside from the job losses and the decision to convert to a plc, Standard Life said the “most likely outcome” for its business structure is that it will “retain and develop” its major associated companies – which include Standard Life Bank, Standard Life Healthcare and Standard Life Investments – together with the bulk of its international businesses. But plans to open for business in France have been scrapped.

Speaking to the Sunday Herald last week, Crombie admitted Standard Life’s remuneration and reward structure is partly to blame for its predicament. He said this is too skewed towards motivating executives and staff to sell financial products at all costs – irrespective of whether or not the resultant business would be profitable.

He said: “We’re going to have to bring in a lot of high-margin products and make sure our whole remuneration and reward structure doesn’t encourage people to sell those products which are less profitable.”

In as many words, Crombie was conceding that the pursuit of market share at all costs – the strategy under predecessors Scott Bell and Lumsden – was to tilt at windmills.

Ronnie Sloan, a former principal of actuaries Punter Southall & Co, put it more bluntly. He said: “The trouble is they didn’t realise they were driving a classic Rolls-Royce which was beautifully engineered and with a very smooth-running engine, not some Aviva Turbo. Their response to changing road conditions should have been to slow down, not to put their foot on the accelerator. It’s little wonder the wheels have come off.”

Crombie, who took over as chief executive from Lumsden in January, and who has sought to disassociate himself from the mistakes of the past (even though he joined the company in 1966 and its board in January 2000) said: “We had an infrastructure for a business that had all those higher-charge products and, as you know, we led a movement to introduce lower charges across the whole product range.

“We tried to grow the business to fit that infrastructure but that growth [turned out] not to be sufficiently profitable. We tried to address the issue of these costs by growing the business. Now, we’ve been required to meet our unit costs by cutting the infrastructure.

“The 1 per cent world, the price-capped world, has become more pervasive in the last two years and there are really two ways to respond to that. Now we need to cut cost. Rather than do that in a series of moves, we decided to design the business that we needed to have to hit our target levels of profitability and announce it in one go – that’s what this is about.”

Sloan’s analysis is much harsher: “They rushed headlong to take the hot money from Equitable Life from 2000 on. They previously said they weren’t going to do single premium bonds – but then appeared to throw caution to the wind, taking in hundreds of millions off Equitable Life at the top of the market. But they failed to apply the ‘market value adjuster’ to that business.

“The overall picture is that the board no longer seems in control. Perhaps that’s because they’ve appointed consultants. But everything they do nowadays seems to be dictated by events. Should the people who led us into this pretty pass really still be in charge? ”

Now Standard Life says it will reposition its UK life and pensions business to achieve profitable growth – meaning the group will seek to exit from market segments where margins are thin and put more emphasis on more profitable segments. Critics including Sloan wonder why this wasn’t done before.

David Nisbet, an analyst at Merrill Lynch, said: “I was surprised that Standard Life felt it necessary to take such radical steps to improve the profitability of its UK business.

“My impression is that Standard Life’s expense ratio compares reasonably well with those of most major competitors, although the recent slowdown in new business will have exerted some upward pressure on expense ratios. Also in terms of its business mix, Standard Life’s orientation towards pensions will have had a disproportionate effect [on its expense ratio].

“Since Stakeholder came in, it has been hard to generate particularly attractive returns if a significant proportion of business has been in pensions.”

It has been estimated that Standard Life’s decision to reduce the charges on all existing pension policies (to match Stakeholder) cost it a loss of revenues of at least £750m.

Nisbet believes the insurer will be seeking to reduce its dependence on pensions and step up its presence in areas such as term assurance and investments.

But Crombie disputes Nisbet’s views. “The pensions market is not universally unprofitable. At the upper end of the pensions market there certainly are profitable segments and we can do more business there.”

He suggested Standard Life will refocus on higher margin market segments including defined contribution pension schemes, investments (it launches an “open architecture platform” for a selection of third-party mutual funds later this month), term assurance, income drawdown and Sipps. There is also likely to be an increase in charges and a rebasing of commission structures.

But Crombie would not be drawn on what parts of the business will be given less emphasis, other than saying: “It’s well known that areas of the smaller premium pensions market are totally uneconomic to service.”

Standard Life last week also said it would widen its distribution network by developing relationships with other intermediaries and business partners, at the same time as retaining its traditional independent financial adviser channel.

Commerzbank analyst Roman Cizdyn believes it may forge a bancassurance link with HSBC, the only leading bank without one. Insurers such as Legal & General and Aviva already have tie-ups with, respectively, Barclays and Royal Bank of Scotland.

But Crombie suggested “single tie” deals are ancient history. He said: “We’ll not be going back to single tie, because in that environment the producer takes responsibility for the sale – and we’re not going there.

“In the multiple tie environment [proposed under the governments depolarisation proposals] the intermediary takes responsibility for the sale but does not trawl the whole of the market. So the expectation is that the banks, for example, will go there.”

He said Standard Life was in touch with a range of possible distributors – including chains of IFAs and banks – to establish which route to go down once depolarisation kicks in. “But it won’t interfere with our relationship with the IFA market.”

Crombie highlighted the wider problem of consumer mistrust of the industry, and even had a dig at the media for exaggerating the problems of certain financial products. “People have less trust in providers of long-term financial services than they had. Unfortunately they are often driven to that view by commentary which is often not necessarily good analysis.

“It makes better headlines if you yell from the pages that bonuses have been slashed – but [that coverage] doesn’t actually begin to examine whether the payouts are a good deal, if you look at real long- term returns over and above inflation.”

Crombie is adamant that the launch of subsidiaries such as Standard Life Bank and Standard Life Healthcare does not lie behind the group’s current predicament.

“The subsidiaries are self-sufficient in capital. The problem we are addressing through demutualisation is that the with-profits business is shrinking as a proportion of the whole life and pensions business.

“Last month it was 13% of new business. Four years ago it represented one half of the total business. Now it’s one third and it will soon be one quarter.

“The source of capital is shrinking as a proportion of the life and pensions business and selling a subsidiary – let’s say Standard Life Bank – wouldn’t change that. It may give a temporary respite, but it doesn’t alter the whole inevitability of demutualisation.”

But why is it going to take two whole years before Scottish members will get the chance to vote on whether they wish Standard to convert to plc status?

Crombie suggested one reason for the delay is that the company will be worth more by that time. A combination of the current sprucing up of the business and a rising market might just make the valuation more promising once it eventually floats.

He said: “We could possibly accelerate that but we want to maximise the value of the business. We want to get the repositioning of the business done this year and then demonstrate next year what the business can produce by way of profitability, then when we take the business to market it will be valued on the basis of what we’ve demonstrated rather than what we’ve promised.”

All current Standard Life policyholders are set to get at least some shares, with an additional tranche of shares being placed with institutional buyers.

Windfalls are currently expected to average in the £1500-£2000 range, considerably lower than might have been achieved had the company floated following Fred Woollard’s demutualisation challenge in 2000.

The analysts’ prediction is based on a £4 billion estimate of the company’s market value. That may well be conservative and compares to a current market value of £12.1bn for Aviva (formerly CGNU), £8.9bn for Prudential and £6bn for Legal & General.

Crombie said: “I’m not going to drawn into putting a valuation on the company. The market will value the company at the time.”

But what of the danger that Standard Life will be taken over by a rival financial-services player before it gets to market – as happened when Prudential snapped up Scottish Amicable in 1997?

Roman Cizdyn doubts whether many insurers would have the appetite for such a deal, partly because of the unprofitability, competitiveness and over-regulation of the UK market. He said: “Trade buyers will be few and far between. The big UK banks have had their fingers burnt with buying life insurers, the Europeans have pulled back and the Americans are too insular.”

But Crombie told the Sunday Herald the board would consider an approach from a trade buyer should one make itself known. The once-proud mutual has effectively hung out a for-sale sign.

Copyright SMG Sunday Newspapers Ltd. 2004

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