Insurance Pricing Best Practices and Trends: An Interview with José Moreno Codina, Principal, Towers Perrin

José Moreno Codina is a Principal with Towers Perrin and market manager in Madrid. He has 33 years of experience in the property and liability and life insurance businesses, and his areas of expertise include market entry, company management and bancassurance distribution. Mr. Moreno has a degree in Economics and an M.B.A. from IESE (the business school of Universidad de Navarra).

Q: We want to talk about pricing, but we cannot start without touching on the current economic situation.  How do you see the insurance industry, and particularly in Europe, dealing with the effects of the financial meltdown?

JOSÉ MORENO CODINA: I think the property and casualty side of the business has been less affected by the crisis than the life side.  Apart from AIG which is a unique case, the exposure of property and casualty insurers to the so-called “toxic assets” has been somewhat limited.  I think these insurers were initially undervalued by the stock market because the analysts thought there was greater exposure to these assets, but that also explain why these stock prices have recovered quicker than others.  So all in all, the damage to the insurance segment was not as severe as it was to the rest of the financial sector.

At the same time, P&C companies did suffer larger than expected catastrophe losses, particularly in the US and Caribbean.  Europe also suffered from natural catastrophes, including severe storms in southern England, Belgium, and Germany, and we had the Klaus case in Spain, which are not a common occurrence.

Q: How are these losses affecting the behavior of these insurers?

JOSÉ MORENO CODINA: The P&C market rates are hardening, but they are at a still relatively soft level.  I think the next year is probably going to see harder rate renewals.  Many insurers are reviewing their rates and models to account for these very rare catastrophic events.  They realize that even if an event has a 0.5% probability, it is still something you need to build into your insurance model. The volatility of the other 95.5% is equally very important, because could mean the difference between a good year and a very bad year.

Q: What do you see as some of the things that separate the more successful companies in the business today from those that are less successful in your mind?

JOSÉ MORENO CODINA: Some still believe that it is the size which determines the success.  I think the most important thing is a good management team that looks at things in a very critical way and has created an environment in which opinions are expressed openly.  It is important that management looks beyond the one year horizon and takes into consideration the medium and long-term implications of their decisions.  In addition, it is crucial that the company has the tools, the methodologies, and the procedures to ensure that decisions and expectations are backed by sound quantitative analysis.

Without getting into names, there is a company here in Spain that I use as a case study.  They have a very good management team that was brought up from the rank and file within the company. They communicate very well among the team members and with all the stakeholders.  They also use best-in-class quantitative tools, methods, and procedures that you can find in the insurance industry.  This combination has put them in a position to be a major international player not just in the near future, but also for the long run.

Q: That’s very impressive.  What are some of the metrics they use to measure their success?

JOSÉ MORENO CODINA:  By the end of the day, the measurement of success is sustainable profitability.  What has really attracted my attention is that the company has delivered continuous performance over a very long time.  I am talking decades, not two or three years.  This profitability has enabled them to raise more capital and fuel additional growth.

Q: When you look at their operations, do you see anything that they do particularly better than others?

JOSÉ MORENO CODINA: One thing they do very well is cultivating an internal pool of talent that grows into management positions.  As a result, they continue to have a management team that understands the company’s culture, shares its vision, and keeps improving it.

The other key element is the use of advanced quantitative tools, both for risk and pricing.  It’s this combination that makes them very successful.

Q: Implementing this type of advanced quantitative approach to risk and pricing is also something you help many insurance companies do.  Is there a typical profile of the companies you work with?

JOSÉ MORENO CODINA:  No two companies are alike.  Each company has different objectives, different strategies, and different ideas how to accomplish them.  Probably the one thing in common to the companies we work with is that they all want to quantitatively validate what their intuition tells them.  They want to quantify what it means to go after a segment of the market with a particular rate; what it means in terms of profitability, conversion of new policies, and renewals.  What will that do not only to this product, but also to other products sold to that customer or offered through this channel?  What will be the impact not only for this year but also for the next two-three years and beyond?

Q: Obviously increasing profitability is a goal for many pricing initiatives. What trends are you seeing in terms of other objectives for the companies that you work with?

JOSÉ MORENO CODINA:  One of the clear objectives we are seeing these days, particularly in Europe, is preserving market share.  Some companies are willing to sacrifice some profitability in order to maintain market share which, at the end of the day, means that they value their clients for the longer term more than the profitability that they may see in the short term.

Q: Is this something that you see happening across geographies, or do you see any specific countries that are leading the charge in this direction?

JOSÉ MORENO CODINA: We see it across countries but there are some types of companies that are naturally taking the lead in this direction.  Bancassurers, for example, have broader relationships with the customer and therefore have more at stake.  Companies that have their own agent network, especially in the US, are better equipped to take a customer-centric approach, and some of the direct insurers are going this way as well.  Conversely, companies that sell through brokers have less control over customer relationships so they tend to be more product-focused.

Q: Can you give examples of some of the best practices you help companies implement in the area of pricing?

JOSÉ MORENO CODINA:  We consider customer value optimization as a best practice that should be part of the pricing policy.  One aspect of it is evolving from looking at profitability just for the short-term and a specific product into how that short-term profitability is balanced with the longer term value of the customer across business lines.  More and more insurers are willing to give up profitability on one policy in order to optimize the long-term value of the customer across products.

Another aspect is applying these optimization techniques to marketing campaigns.  The goal here is to optimize the marketing spend across the business mix in order to optimize long-term customer value.

Q: How do you see these best practices evolving in the future?  What are some of the next important things companies are going to look at?

JOSÉ MORENO CODINA:  One of the trends we have seen now for a number of years in the US is the incorporation of credit scores into the loss cost pricing model.  We are now seeing more and more companies starting to consider the customer acquisition and administration costs as part of the pricing model.  In Europe, the trend is towards more individualized pricing.  I think that over the next 3-5 years we are going to see some convergence of these trends.  European companies will be adopting some of the credit experience practices from the US, and the US will become more flexible in terms of individualized pricing.  This convergence will require companies on both sides of the ocean to develop better quantitative analysis capabilities.

Next, I think that insurance companies are going to start addressing more strategic issues related to pricing.  Insurers are realizing that the biggest risk they are facing is not being able to meet their strategic business objectives.  Solvency II is already giving a push in this direction in Europe.  Pricing has a very significant influence on achieving these goals so that is something that I see as an important trend in the next ten years.

Q: How do the issues of privacy, fairness, and compliance come into play in the context of pricing?

JOSÉ MORENO CODINA:  In some countries, you can apply the concept of customer value optimization and that’s perfectly equitable and inline with regulations.  Even in places like the US, if you apply a more sophisticated cost model that allocates the right costs of acquiring and maintaining different customer profiles, in addition to the risk cost, you can produce a much better pricing model.  In most places in the US this is completely in compliance with regulations.  The key is having the methodology and tools to demonstrate what you are doing and how it is fair to the consumer.

Q: Are there any pre-requisites that they should have in place before they can actually implement better pricing practices?

JOSÉ MORENO CODINA:  Not really.  One thing that is often missing is historical data, but you can use whatever data you have.  Probably the worst course of action is doing nothing because you don’t have enough data.  You need to use whatever is available to quantify your decisions ahead of time, not just after the fact.  If you only do it in retrospect you may have lots of explanations why things happened, but you are not going to get back the lost accounts or profits.

Q: What about organizational requirements?  How important is it to get senior management onboard with any type of changes to pricing?

JOSÉ MORENO CODINA:  I think it would be counterproductive for management to go into details.  Instead, I think management needs to communicate clearly what the goals and objectives are for the business and let the technical people come up with the calculations and different alternatives and enhancements.

Management does need to understand what it is getting back from the technical side and be able to ask the right questions, especially related to the assumptions and restrictions taken in making the calculations.  For example, using the  no-claim discount in the UK, a  bonus-malus system in Continental Europe or a specific rate structure in the US, management should question these assumptions implied in those models and encourage the technical people to think outside the box.

For more in-depth discussion on the business impact of pricing, see Price Optimization for Profit and Growth, written by José Moreno Codina and Francisco Gomez-Alvado in Emphasis (April 2008).

Carriers that Get to Know Their Customers Have a Huge Advantage

The recent issue of Insurance & Technology features a number of very well-written and insightful articles about customer retention and acquisition.  As Anthony O’Donnell rightly states, “carriers that get to know their customers well — by effectively leveraging collected data and by simply listening to what they say — have a huge advantage in a tough insurance market.”

The cover of the print edition features Lloyds TSB’s chief actuary Martyn Green, who says, among other things “The lifetime value model of a customer translates into massive amounts of value… From the analytical piece alone, the benefits are probably in excess of £15 [US$23.8] million a year…”

Sounds pretty compelling, doesn’t it?

You can read more about the Lloyds implementation of customer value optimization as well as other cases of leveraging customer insight on the I&T site.

The Five C’s of Insurance Customer Value Optimization

This article was originally published in Insurance & Technology.

If there is a silver lining in the financial meltdown we are experiencing, it is the reestablishment of basic business principles that seem to have been relinquished in recent years, or in the case of some insurance carriers may never have been established properly in the first place.

The current economic shakeout presents an opportunity for insurance carriers that are looking to position themselves for long-term success. With limited options for making money on their investments, insurers should seize the opportunity to create sustainable profitability from their insurance operations by delivering greater value to customers.

To become more customer-centric and optimize customer lifetime value, insurers need to consider the following five variables that create mutual value to the customer and the insurance provider:

1. Coverage: what coverage should we offer to each customer?

Customers have varying degrees of tolerance to risk, and therefore different requirements for insurance coverage. Coverage needs and preferences also change over time. Insurers can do a better job recognizing lifetime events that influence these needs, such as starting a family, a child that is reaching driving age, etc., and proactively offer the appropriate coverage options to each customer at the appropriate time.

2. Cost: at what price?

Traditional risk-based insurance pricing is based on the cost of insurance from the point of view of the insurer, failing to take into consideration the customer view. Insurers can do a better job recognizing other important parameters that influence price sensitivities for different customers and incorporating these into the product–service–price combinations they offer to each customer.

3. Convenience: how important is convenience and time savings to the customer?

Customers have different preferences when it comes to convenience. While some prefer to work through an agent, others prefer doing business online. Some customers are willing to trade cost for convenience, preferring a bundled solution with the convenience of one-stop shopping, while others prefer shopping for each coverage separately to get the best price. Understanding these preferences for each customer and how they change over time can help the insurer better match customer needs and increase customer value.

4. Care: what is the level of service and care that should be offered to each customer?

While a claim is first and foremost a cost item to the insurer, it is also an opportunity to increase customer satisfaction, create greater customer loyalty, and boost retention. The customer lifetime value framework provides the insurer with the ability to optimize the claim process in order to balance these cost and retention considerations and maximize lifetime value for each customer.

5. Compliance: how can all this be done while maintaining compliance with regulations?

To serve as a practical tool for managing customer relationships, the lifetime value optimization framework must incorporate local regulations, which are different from state to state and from one country to the other.

The results of customer value optimization can be highly rewarding. Insurers that have adopted this approach have been able to achieve business growth and profitability in competitive insurance markets, generating Combined Operating Ratio improvements of 1-4 points.

What practical steps can insurers take to get started on the path to optimizing customer value?

• Define profitability goals and time horizon: For example, a carrier that is looking to grow market share and willing to breakeven or incur a loss in the short-term may be able to attract customers that will turn highly profitable in the long run.
• Establish a customer-centric analytics platform: Operating in product-related silos makes it impossible to optimize customer value across products. To maximize customer lifetime value, insurers must implement a platform that provides an integrated view of the customer and enables decisions at different parts of the organization to be optimized based on cross-product profitability.
• Apply a quantitative approach to optimization: Historically, a judgmental process has been applied by insurers to balance marketing goals with the underlying loss characteristics of the risk. Insurers would be better served by applying a quantitative model that can optimize customer offers to best match corporate goals such as improving profitability, increasing market share, or a combination of factors.
• Incorporate regulations: Working in a highly regulated environment undoubtedly puts constraints on the freedom that insurers can exercise in selecting their customers, offering new products, and formulating rates. At the same time, regulations should not be used as an excuse for neglecting to do more on all of these fronts. Rather, regulation restrictions should be integrated into the operational model of optimization decisions utilized by carriers.

To optimize customer value, insurers need to adopt a new way of thinking. They also need processes and technologies that can help them model customer lifetime value and apply it to day-to-day customer interactions, ranging from new customer acquisition to policy renewals and claim processing. None of this is going to happen overnight. Recognizing this is the direction insurance must go, especially in light of the current financial meltdown, many of the leading insurers are already taking steps in this direction. With a growing body of evidence to the success of the customer value optimization model, we can only expect others to follow.

Pricing Optimization in Commercial Insurance: An Interview with John Lucker, Deloitte Consulting LLP

John Lucker leads Deloitte’s Actuarial and Insurance Solutions data mining and predictive modeling practice known as Advanced Quantitative Solutions (AQS). He provides leading insurance carriers with end-to-end business, operational, and technical consulting services. Mr. Lucker has helped numerous commercial and personal insurance carriers develop innovative methods and solutions, and is a co-inventor of three predictive modeling patents which are pending.

Mr. Lucker is a frequent speaker at national insurance and risk management trade association conferences and has been published and quoted in numerous trade journals and professional publications. He holds a BA and an MBA from the University of Rochester.

In a recent conversation, John was kind enough to share with us his observations and insight into the challenges and opportunities related to pricing optimization in commercial insurance.

Price Optimization in the New Age of Insurance

There is an interesting article published last week in FST – Financial Sector Technology about price optimization.

It provides great insight about price optimization in financial services and its relevance given the current financial crisis. Datamonitor’s Jonathan Steiman is an excellent analyst whose opinion I highly respect. However, in this particular case I believe Insurers should put price optimisation at a very high priority.

I hope you enjoy the article and join the discussion.

Customer Differentiation Is Needed to Insure Profitably

Here is an opinion piece of ours that was published last month in National Underwriter P&C – a weekly magazine serving the entire insurance industry.

Customer Differentiation Needed To Insure Profitably

I hope you find it interesting and would be glad to get your comments.

Transforming the Claims Process: An Interview with Brian Cohen

Brian Cohen has long been recognized as one of the most dynamic thought leaders in the insurance industry.  As a senior executive with Farmers insurance, Brian led several highly successful business units.  As the company’s Chief Marketing Officer and Head of Sales, he was instrumental in driving fundamental changes in the company’s sales process.  He also was involved with Farmer’s efforts to improve their claims operations.  After Farmers, Mr. Cohen became President and CEO of Clear Technology, a global software provider to the insurance industry, which was acquired in 2008 by Versata Enterprises.

You can find articles authored by Brian in numerous insurance publications.  He is also a frequent speaker at various insurance industry conferences.  Most recently, he spoke on the topic of insurance claims management at the ISOTECH 2008 conference held in Las Vegas this past November.

Brian is not shy to voice his opinion about things that insurance companies should do differently.  We had the opportunity to catch up with Brian at the end of 2008 and get his take on the opportunities that lie ahead for insurance companies. Following are excerpts from our conversation. 

Lloyd’s weathers the storm – The Boston Globe

Lloyd’s weathers the storm – The Boston Globe

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IT Innovation in Financial Services During Tough Times

(Posted by David Schapiro)

I am on a flight to visit with customers and analysts, something I do every month. With the recent pace of events in the financial sector, the few weeks between one trip and the next seem to last an eternity.

As I mentioned in previous posts, I have done my assessment on how the credit crisis has and will affect our customers in the financial services industry. In the course of this analysis I spoke in depth with our customers and market analysts in order to understand what is going on so we could build a model and take the appropriate action if and when required.

Now, I am going back on the road and telling the world – customers, analysts, the media – what we are doing to address the concerns of our customers given the situation.

Customer Analytics in the Insurance Industry

There is a good discussion on the Insurance & Technology blog about customer analytics in the insurance industry, specifically around its use at Farmers Insurance.  It brings up some interesting questions related to the quality and validity of the underlying data.  I recommend joining the conversation.