Regulation  

‘Disruptive innovation’ will cull big businesses

Half or more of major insurance ‘manufacturers’ are likely to disappear over the next five years as a result of the RDR and the changes underfoot are likely to see new business models created that may force many large players out of business.

Similarly, new business models will emerge that are capable of operating profitably where embedded value, or the lifetime value of an investment policy, for new business will fall to just £150 to £200 for each policy in the UK and sophisticated advice will be provided for below 0.25 per cent of the value of funds being invested. Key elements of the new business models can already be seen and the question is whether existing incumbents or new players will seize the opportunity to dominate in the new world.

While respected observers, such as Ernst & Young, are forecasting that a third of advisers will leave the profession over the next five years as a result of RDR, some large insurance companies do not appear to be too concerned about the potential impact on their own business. But given the impact of disruptive innovation across a wide range of other industries, such as retailing, newspapers and mobile phones, causing many of the leading incumbent businesses to go bust, it may lead you to ask: Is this outlook by the large insurance companies realistic?

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Disruptive innovation is a phenomenon first observed by Professor Clay Christiansen of Harvard University whereby a new business model leads to most of the major incumbents in an industry going out of business.

The new business model introduces a new customer proposition that offers customers an appealing product or service with a significantly higher price performance than those offered by the existing major players. It can be the same service for dramatically lower cost, such as Ryanair and EasyJet, a much better service, such as Google advertising versus traditional advertising, or a combination of both, such as the Apple iPhone compared to Nokia phones.

Classic disruptive innovation arises when someone decides to release a new product or service with a dramatically lower price, typically aimed at the low-end of the market to begin with. Initially, the market appeal is small in terms of potential customer volumes and the pricing is way below the level that the existing dominant incumbents can afford to do business.

The product or service may appear to be inferior in many ways to those offered by the major players (think Ryanair service compared to BA service), however the price performance tempts a small but growing number of customers to switch to the new offering. Over time the new offering starts appealing to more and more customers causing prices, margins and sales volumes to be squeezed leading to many of the once dominant incumbents to go bust or be taken over.

While many insurance product providers see that RDR will lead to huge numbers of IFAs and tied advisers leaving the industry, their underlying assumption is that this will have very little impact on their own business. The insurers seem to be assuming that, one way or another, those consumers with investment assets will find their way to get their assets to the insurers’ business. Indeed some feel that the disappearance of commission payments and the reduced number of IFAs will increase their profitability by reducing distribution costs.