I find this report enlightening because it covers all aspects that make analytics so valuable to insurance organizations.

• Data: We live in the big data era. Insurers that fail to take advantage of the data available to them to make better business decisions are essentially surrendering a huge advantage to their competitors. They are also forfeiting additional value they could provide to their customers.

• Algorithms: Traditional analytics were all about analyzing past data. Advanced analytics are all about using this data to predict future business outcome and help managers make better decisions to optimize these outcomes.

• Integration: No longer are analytics confined to the back office. Today’s competition is not only about making better decisions, but making them quickly enough to stay ahead of the field.

• Organizational culture: Making use of analytics requires managers to trust the data. This is not always easy. The data and analytics sometimes point in a direction that contradicts intuition and current business practice.

The report also does a good job explaining how seemingly small changes can make a sizeable difference in business performance. In highly competitive markets such as property and casualty insurance, these small changes often end up what separate the winners from losers.

Click here to access the report.

Prior to launching Strategy Meets Action, Deb held a variety of leadership roles as the VP of the TowerGroup Insurance Practice, Chief Transformation Officer at ICW, Partner at KPMG LLC, and Head of Application Development at Liberty Mutual Commercial Lines.

Deb was a guest speaker on our recent webinar on Cloud Pricing Analytics. Following the webinar we sat down with Deb to discuss some of the broader issues facing insurers today.

Q:  Your firm is called “Strategy Meets Action” so we should talk about the strategies and the actions insurers are taking. But before we go there, what are the trends that drive these strategies and actions? What are the challenges insurers are trying to address?

DEB SMALLWOOD:  We have identified a number of major trends that are driving change in the insurance marketplace. These are highlighted in the slide we used in the webinar.

The biggest challenges for insurers stem from a lack of normal growth in the economy. The combination of a down stock market, zero interest, and a soft insurance market is exceptionally dismal. There is very little green-field new business out there, because people aren’t buying new cars and people aren’t buying new houses and aren’t upgrading things. The only way to grow at the top line is to steal business from your competitors.

The only way to grow bottom line is to cut your expenses, which insurers have done over the years. But, this is where pricing precision and matching the right price to the right customer are really key, because that is what enables you to write good business – healthy business that you can make a profit on.

Q:  Changes seem to come at a faster pace these days; do you see insurers responding to challenges in a timely manner, or are they mostly late in responding?

DEB SMALLWOOD:  I’ve been in the insurance industry for a long time. The pace of adoption of new approaches and new technologies in this industry is generally slow, but when you have a leader making moves that start impacting competition and profitability, then all the other insurers want to jump in.

What Progressive has done in personal automobile is a good example. Ten years ago, they changed their distribution strategy from just independent agents to go direct. They really pushed the envelope in terms of pricing precision, self-service, and expanding distribution channels beyond the independent agent. They significantly invested in call centers and enabled them to actually do quoting and sales. They were the first to invest in self-service portals. They turned the 3-5 rate tiers that insurers used to have into hundreds of rate segmentations. They were the first to incorporate straight-through processing in personal auto.

Over the last 10 years, these changes pushed other insurers to make significant investments. There are still insurers that aren’t doing straight-through processing or using predictive analytics. But, their book is probably shrinking and unprofitable.

Q: How does that impact insurers’ attitude towards technology investment?

DEB SMALLWOOD: Technology is now an integral part of the business processes. It is woven into the fabric of the business. After September 11 and the dot-com bust, the industry froze. It wasn’t until about 2003 that they started to open up the purse strings again.

When the 2008 crisis came, they kept spending. They may have delayed some decisions and more closely scrutinized projects, but they kept spending. That tells me they all recognize that those that stopped spending in 2001 and 2002 fell behind. I was just talking to an insurer the other day and they said, “Oh, we made these huge investments three to five years ago and then we sort of stopped and everyone caught up to us.” They all know that they can’t fall behind – that they have to keep pace.

We see this trend continuing. Our preliminary research from our annual EcoSystem survey indicates that 56 percent of the insurers are increasing their budgets for 2012. Another 37 percent say budgets will remain flat, but even some insurers who go into the year with flat budgets will spend more if the business case and value warrant investments.

Q: What do you see as the key areas for these technology investments?

DEB SMALLWOOD: We have identified ten areas that are imperative for insurers in order to compete. You don’t necessarily have to do them all today, but they need to be on your roadmap or you need to acknowledge that you’re not going to do them and clearly understand why.

The number one project last year, this year, and next year is policy admin and rating. These systems have been around for some 30 to 40 years. In today’s flat market and competitive environment, insurers need to connect either to the customer or to their independent agents, make it easy for them to push business so that it flows in, and then make sure they’ve priced it appropriately.

The old policy admin systems are just too old to support new sales and service initiatives. Insurers need to fix these policy admin systems and put modern ones in place so they can hook in predictive analytics models, take rules out of COBOL and assembly code and put them into rule engines, and plug in sophisticated workflows that can connect to different channels to enable straight-through processing – be it through an agent, self-service, or through comparative raters.

The second most common project is around data and analytics. It could be master data management. It could be creating data marts. It could be using analytics in claims, underwriting, pricing, and/or actuarial – but, it’s about data and analytics.

Claims and billing initiatives also rank high on the priority list. There’s also a lot of spending on enterprise content management, customer communication, and customer relationship management.

Q: What, in your mind, are the most exciting opportunities for insurers as they look to leverage new technologies moving forward?

DEB SMALLWOOD: There are five new technologies that we think are the most important for insurers to leverage.

One of them is around data and analytics – using these capabilities and technologies to take underwriting and pricing precision to the next level, using them in claims, using them in marketing.

I think social media is going to have major influence on the way people in interact. We don’t know yet how it’s going to impact insurance, but it will. It’s going to be felt throughout the whole value chain.

The mobile evolution is changing how people are communicating. It’s not going to be sufficient for insurers to just have mobile devices connected to quoting or first notice of loss or billing. They will need to have modern applications in the background.

My new conclusion on the Cloud is that once insurers can get past some of their concerns around security and acknowledge the fact that they already have applications running outside their firewall, once they start getting comfortable with the idea, it will help them bypass the bottleneck in IT. It’s going to offer new options for IT delivery. The IT director or the CIO will become an orchestrator of many options for IT delivery. Their role will shift to managing these options versus actually delivering them. I get pretty excited about all these possibilities – good things will come of them.

For a complete coverage of the presentation, a recording of the webinar is now available.

Q: Do you see more of the insurance business going direct across Europe, and if so what do you see as the impact of such a trend on the importance of price optimization?

Nicolas Michellod: I think the adoption of online insurance is just a matter of time in the European markets where it has not really taken off yet.  If you look at Switzerland, for instance, it is one of the countries where the density of access to the Internet is one of the highest, so I think it is just a matter of time before online insurance becomes widely adopted in this country the same way it has been in the Netherlands and UK.

I want to emphasize that the use of price optimization is not limited to online insurance, and there are many companies that use it as a back-office function. But once they adopt online insurance, price optimization becomes a must, so these companies will be forced to invest in real-time price optimization.

In the more competitive markets, price optimization is essentially a must for survival. If we are talking about an online insurance company that wants to quickly capture market share in a less mature market, implementing price optimization would provide a better understanding the market and a clear advantage over the competition.

Q: You are describing price optimization as a revolution in progress.  Can you explain what you mean?

Nicolas Michellod: For decades, insurers have used a cost-centric approach to define insurance product prices.

The question we have here is can insurers do things differently? Are there better ways to do things that will bring more value to the insurance business and also to the clients?

With price optimization, more elements are taken into consideration. We can describe these using the four key steps of price optimization.

The first step is analysis and segmentation. Customer data allows insurers to analyze and identify segments through modeling of customer behavior, claim propensity, and the market environment.

The second step is defining strategies and scenarios that integrate the models to predict volume and prices, identify the best prices, and measure the impact of price changes to find the optimal tradeoff between supply and demand.

Third step is execution, which includes running simulations and comparing the results with the objectives of the scenarios defined.

Finally, and this is a key aspect, is the closed-loop for monitoring and recalibration of the models. Any pricing strategy that is judged to be optimal at some time will sooner or later lose its validity. Based on data collected from the market, new constraints and parameters can be identified to trigger the necessary recalibration.

I think it’s very important to understand that this is a big change from what insurance companies have been doing in the past, which is why we call it a revolution in progress.

Insurers can actually join this revolution in two steps. The first step is implementing price optimization techniques within the back-office systems, while the second steps is a real-time approach that automatically gathers data from the front-end system and optimizing online prices.

Q: How can companies gain competitive advantage by using price optimization?

Nicolas Michellod: I think it is very important for an insurance company to understand the benefits of price optimization.

The first benefit is shorter time to implement new tariffs.  The closed-loop process of testing and price optimization enables new pricing models to be generated within hours.  There is no need to rework the price scheme as long as the parameters influencing the models do not change.

The use of sophisticated techniques to optimize pricing is a second great benefit.  Price optimization leverages sophisticated methods such as strategy models and scenario simulation to improve underwriting results. Using these methods helps insurers refine their pricing techniques and better comprehend the logic behind parameters and factors influencing price calculation.

Thirdly, with price optimization, insurers can make full use of their data.  The insurance industry is well-known for having a broad set of quantitative data, but sometimes fails to use it efficiently.  Price optimization helps insurers maximize the use of data to refine pricing models and strategies.

Finally, price optimization helps capture the market behavior at no additional cost.  Through live field testing, insurers are able to capture useful information about customers’ behavior directly from the market.  Price optimization tools allow insurance companies to obtain free of charge what in the past they had to pay marketing and research agencies to provide.  And I work for a research firm, so I know that

Q: What are some of the key success factors for companies that implement price optimization?

Nicolas Michellod: I think there are key factors for price optimization success in terms of project and staffing.

The first key to success is the team working on the price optimization project within the insurance firm. Price optimization is new to most insurers. It represents an important business enabler, especially during these times of crisis where insurers have to find growth opportunities in a soft and difficult market. I believe it is essential that insurers build a dedicated team working exclusively on this subject. The goal of such a team would be to review how pricing can be improved and how the company could leverage existing technologies to apply more sophisticated pricing models.

The second aspect is mixing multi-functional and multi-skilled resources. Each function has unique background and interests. Having a multi-disciplinary team helps the insurer avoid outcomes that are biased by such considerations.

A third and very important aspect is IT expertise. Some IT vendors specialize in predictive analytics and price optimization. They have acquired the knowledge and expertise to understand all the factors that can make a price optimization program successful. They combine IT and business capabilities that help support not only the insurer’s IT staff but also its business team and specifically the mathematicians and actuaries.

Last but not least is promoting the spirit of innovation. I see the implementation of price optimization as a matter of innovation within the company, because talking about price optimization is re-thinking the whole business. With the emergence of business and IT tools, insurers have been able to refine their analysis and the enumeration of certain risk elements. But the biggest value these tools have brought to the industry is the democratization of risk evaluation principles. We are now in an era where specific teams are built within insurance companies to ask questions that have never been asked before and then build models that include dynamic parameters to improve pricing. That’s why it’s very important to understand that implementing price optimization should be done with a spirit of innovation and with tight cooperation among different types of people within the organization.

Since we ran out of time to answer all the questions at the end of the webinar, we are posting a few of the remaining questions and the responses from Nicolas Michellod.

Q: Does price optimisation always drive rates down? What evidence is there for increasing rates?

Nicolas Michellod: Price optimization does not always drive rates down. Actually price optimization’s goal is to find the optimal trade off between supply and demand at a given time taking into consideration multiple parameters including market environment and claims information with relation to a segment of clients, a type of products or other elements. Strategies defined by the insurance company in the frame of the price optimization process allows the company to determine models each of them applying certain approaches. For instance, a specific insurer can decide to adopt an aggressive approach to pricing a certain type of product for a specific segment because it thinks that with high volume the overall profit will be positive while preferring to adopt a more careful approach in pricing another segment of customers because of particular market conditions or even recognition of specifc weaknesses in this segment that would require not to enter into a price war in this category of business. Overall, price optimization does not necessarily drive rates down, I would say it gives more granularity and parameters to play with than the historical way of pricing which was essentially based on risk assessment per line of business. In terms of evidence for increasing rates, as already mentioned above, this depends on the strategy of the insurance company. In my example above I mentioned two different pricing approaches based on a clear definition of where the company desires to focus its effort versus being more selective in another line of business and/or segment of customers. In other words what is true for one insurer is not necessarily good for another one but we can assume that an insurer focusing on standard car insurance sold exclusively online will try to do its best to appear in the upper level of ranking on aggregators’ websites. On the other hand if this same online insurer decides to launch a new product, whose market is perceived to be emerging with high future potential and for which the insurance firm does not really have detailed information (let’s say online pet insurance) then the company will prioritize a moderate pricing and even increase its rates progressively if the price elasticity of demand is not that high in comparison to a very mature market where many players are competing.

Q: Does price optimisation assume a totally commodity product?  What is the impact of different product features?

Nicolas Michellod: No, price optimization is not only a technology for commodity product. As mentioned in my presentation there are insurers taking advantage to review their pricing methodology and investing in price optimization in the frame of a more global project consisting in promoting automation. Actually price optimization is also a good opportunity to automate the underwriting process for instance. I know a large insurer who has decided to implement Business Rules Management System (BRMS) and SOA in order to increase the Straight-Through-Process proportion of its underwriting process even in lines of businesses where automation has always been difficult to achieve (e.g. car fleet or working compensation insurance for small corporations). Doing so implies an investment in back office price optimization technology. In terms of impact of different product features it is important to say that defining rate models and pricing strategies is easier when dealing with commodity products. However a product remains an addition of covers, which are themselves an addition of benefits an insurer proposes to underwrite. Here again what is key is to get to the optimal granularity to be able to apply different rating models and then simulate strategies at the different levels of the insurance product (cover, list of benefits and then single benefit level).

Q: For a company with back-office optimisation, how much it will cost to build the live opt model, and how long it will take?

Nicolas Michellod: I do not typically have the price of such a project. I would receommend not to neglect the analyisis phase which consists in identifying the gaps between the pricing capabilities and the desired pricing capabilities. Some insurers will not have the same objectives when deciding to implement real time price optimization but assuming the company already uses back-office price optimization the cultural change has already been made and therefore the change management program linked to such a project is something that can be avoided. In terms of IT investments in IT tools and data integration I think Earnix is certainly better placed to answer the question.

Pricing Practices Survey

Earnix is conducting a survey on pricing practices in European General Insurance.  Insurance executives and pricing professionals that respond to the survey will receive a summary of the results, allowing them to find out how their industry peers have responded to questions such as:

• What are the top challenges in the pricing process?
• What are the external and internal drivers for price changes?
• How often are rates updated?
• How are prices calculated?
• And many more

The survey is accessible online at www.earnix.com/survey.

Pricing Optimisation Webinar with Celent Analyst

Celent senior insurance analyst Nicolas Michellod will be the speaker at a webinar on “Keys to Success in Pricing Optimisation.”  The webinar will take place Tuesday, 17 May 2011 (1600 CET/1500 GMT), and will address the following topics:

• Trends and winning strategies in European general insurance
• Capturing customer value with pricing optimisation
• Real-time pricing: a competitive weapon
• Keys to success in implementing pricing optimisation

Attending the webinar is free but requires registration at www.earnix.com/webinar.

Back in the insurance industry after taking a hiatus to join a hedge fund, Meryl is at a unique vantage point to observe the latest developments in the US insurance market.

Q: Meryl, you were an insurance insider for many years.  Coming back to the industry these days, what are some of the key developments you are seeing in the auto insurance business in the United States?

MERYL GOLDEN: The most noteworthy change I have seen in the US auto insurance landscape over the past few years is the key role the Internet is now playing both as a distribution channel and as an information portal.  The number of customers that utilize the Internet to shop for insurance, whether or not they end up buying over the internet, is much higher today than it was just a few years back.  As a result, insurers that have a strong Internet presence are now the fastest growing in the industry, gaining market share over those that have been slower to embrace this new reality.

The science around it has also evolved quite a bit over the past few years.  Some insurers have made considerable investments in learning how to most effectively  attract Internet shoppers and convert them into customers.  These companies now have a huge advantage over those that were late to make these investments.

Q: The Internet is certainly changing everything we do, so it makes sense that companies that recognized the trend early are reaping the benefits now.  What are some of the other notable changes you are seeing?

MERYL GOLDEN: A second change I am seeing is the reemergence of comparative rating in the agency channel, which to some degree has gone a full circle.  In the “old days”, independent agents used comparative rating in their quoting process. When credit scoring became an important variable in determining the rate, the comparative raters at the time didn’t have the capability to pull the credit score, and the rates they were showing were inaccurate. As a result, agents stopped using comparative rating to a large degree.

Nowadays comparative rating vendors have access to the credit scores and other insurance company algorithms, so comparative rating is back and used by pretty much all independent agents.  Agents can now compare rates from most of the companies they represent at the push of a button, and they’re selling the lowest price rather than features and benefits.

The significance of these first two trends is that they they have made a very competitive marketplace even more competitive by further pushing prices down and accelerating the commoditization of auto insurance in the United States.

Q: This is probably very worrisome to the carriers.  How do you see insurers responding to these challenges?

MERYL GOLDEN: In general, these challenges are forcing insurers to be more innovative.  One area where you can clearly see this innovation is the adoption of a more sophisticated pricing approach.       As an insurer, if you have holes in your product design, they will be exploited.  So pricing sophistication is more important than ever.  Most insurers have already refined their loss cost models and are looking for the next thing to do, which for many is incorporating elasticity into their pricing.  Today quite a few of them have large groups focused on understanding customer elasticity and developing very sophisticated elasticity models.  At least four of the top ten carriers are at this point either actively using or testing pricing optimization solutions in several markets.  This is a significant development over the past few years.

Q: What other innovations do you see in the industry?

MERYL GOLDEN: One other example is the advances in use of telematics.  When I left Progressive we had a telematics product and I would say it was clearly ahead of its time.  Now many insurers are recognizing the value of telematics and introducing some form of telematics into their auto product.  Usually there is a discount for the consumer involved.   There are also many vendors that offer turnkey solutions that insurers can adopt. Privacy is not as big a concern as it once was and many customers are opting to use telematics to get this discount.  My sense is if you’re someone who is a higher than average risk-taker in your driving, you’re probably not going to opt in to telematics, right?  So I think there’s somewhat of a self-selection bias here.  It’s still in its infancy, with most companies just piloting in one or two states, but the use of telematics in insurance pricing is here to stay.

I would say that both price elasticity and the use of telematics are innovations that lead insurers to know their customers better and allow them to adjust their products and prices based on more granular understanding of their behavior.

Q: It strikes me that as insurers collect more data through telematics they have to develop better models for using this data.

MERYL GOLDEN: That is true and they are doing it.  Overall, the amount of data that is now available to insurers has increased dramatically over the past few years.  One of the ways companies use this data is to reduce the time it takes to get a quote..  In the past, if you wanted to get a quote you had to provide everything–your name, address, all the drivers in the household, prior insurance information, the VINs of you cars, etc.– which takes a lot of time!  Now a lot of companies allow you just to give your name and address, and they pre-fill all the information for you.  It greatly reduces the time and effort for the consumer.  It is also a fraud deterrent and greatly improves quote accuracy.

But it’s not just data pre-fill on the front-end that is new and interesting.  There’s so much more data that is available nowadays, primarily because of the Internet. This data can be used for prospecting, potentially to re-underwrite your entire book, as well as during the claims process.

Q: Not having to enter all this data on the application is certainly something I appreciate as an insurance customer… do you see other ways in which insurers are trying to make life easier for the customer?

MERYL GOLDEN: That’s certainly something that is on the minds of insurers because of how competitive the market is. I think companies are really focused much more than ever on the customer experience and are really looking at all of their processes and how they can be streamlined.

Q: Any other changes you have noticed?

MERYL GOLDEN: Yes, there is much more focus on home insurance than I remember.  Many insurers have love/hate relationships with the home business, because of the volatility and poor results.  But they also understand that having multiple products with one company improves customer retention and that many customers prefer one-stop shopping for auto and home policies.  So you see companies like Progressive and Geico that don’t write home insurance partnering with companies that want to write home.  I also see, for the first time, a focus on pricing sophistication in home insurance, where there is a big opportunity for improvement.

Q: These are very fascinating changes in a relatively short timeframe for an industry that has been around for so long.  What do you see coming next?

MERYL GOLDEN: I think we see these same trends continue to evolve.  Having a strong brand, low cost structure, pricing sophistication, and internet expertise will become increasingly important.  I think we will see tighter integration of the distribution channels.  For example, a customer might get a quote on the company’s website, close with an agent in person or on the agent’s website, and get service via a mobile device.  I think the smaller companies and agencies will be at an increasing disadvantage, which will result in further industry consolidation.

Q: What are some of the key trends you are seeing in the insurance industry?

MARK LEWIS: This is a question I get quite often.  When you talk to many insurance companies around the world like I get to do, you can clearly see that this is an industry poised for some fairly significant changes over the next few years.

One trend that has been with us for a while is cost takeout.  It has been capturing a lot of senior executive attention and commanding significant investments.  What I am seeing today is that more and more companies are shifting the focus from simply cost cutting to operational efficiency.  They’ve realized that a serious and sustainable focus on cost is going to be required going forward, which requires greater levels of efficiency.

The second trend I am seeing is a renewed interest in a growth agenda.  After getting past the immediate consequences and re-evaluations associated with the financial crisis, companies are now beginning to re-examine growth strategies.  At the same time, insurers recognize that achieving growth is going to be harder and more difficult than in the past.  That is one of the things driving the industry to re-examine how they’re going about their business and what changes may need to be implemented to achieve growth.

A third trend I am seeing is the need for agility.  I think it relates both to the growth agenda and the operational efficiency.  A lot of insurers are starting to realize that their businesses are just too cumbersome.  They’re going to have to be more flexible and able to move quicker to keep up with the changes that the marketplace is driving, changes coming from customers, from competitors, from regulators.

Last but not least is a slowly evolving trend that has to do with a truly deeper understanding of customers at the center of the business.  While talking about the customer is certainly not new, I think insurers are finally getting serious about this.  There is a much more serious evaluation of the role that the customer plays in everything from products to pricing, market segmentation, and distribution strategies.

Q: How are insurers responding to these trends?

MARK LEWIS: These trends are causing insurers to start realizing the necessity to make changes to their business.  Not just small changes, but serious changes in fundamental parts of the business.  And there are a lot of new opportunities that will open up to insurers as a result of these changes.

Most large insurers have tremendous complexities built into their operations that drive up costs and make it more difficult to leverage the growth opportunities they see around the world.  One of the ways they are trying to attack these issues is by establishing a more standardized target operating model.  You see almost all of them doing something about it, but you see them going about it in different ways because of the varying degrees of willingness to attack their own corporate cultures.

Some companies, such as Allianz in Germany, are doing it country by country, while others, such as Zurich for example, are looking beyond that, trying to come up with a set of processes and practices that could and should be done the same way around the world.

Q: What strategies are insurers employing to achieve growth?

MARK LEWIS: This is a major challenge because most insurance companies operate in markets where there is limited organic growth.  One thing many of them do is look at new markets.

A good example can be observed with MetLife in the United States.  As they began to experience growth pressures inside their US home market, they began pursuing an acquisition-based strategy to buy positions in some new markets.

Mapfre is another good example of an insurer that just a few years ago began pursuing an aggressive growth play outside their home market.  In their case, they pulled back just a little with the onset of the financial crisis and focused on shoring up their existing strengths in Spain.  Now, as they reassess their approach to new markets, they will be doing it from an even stronger position.

The truth is that retaining customers and getting new customers in markets that aren’t growing much require you probably more than ever to be a bit sharper than your competitors.  You’re going to have to evaluate changes to strengthen the competitive position, whether it’s a pricing strategy, product strategy, or distribution strategy.

Insurers are also shifting to address unmet customer needs.  A good example of that is Principal Financial Group.  They were able to recognize new market opportunities that emerged as their customers got older.  They have transitioned themselves from a traditional life insurance company into a pension-based business, and ended up changing their entire business focus and business model to address these opportunities.

So whether it’s going into new markets, going after unmet needs, or strengthening their competitive position, many insurers are making some serious changes to try to adapt, because without change there’s no growth.

Q: Speaking of change, what kind of technological adjustments are necessary for insurers to support these changes?

MARK LEWIS: I think there is a growing realization that the objectives they have require insurers to move the business as well as the technology infrastructure.  They need to address the business process as well as the technology infrastructure at the same time, and not let just technology guys go off and do technology things, and business guys go off and do their thing.  This notion of the interconnectedness and interrelationship between technology and business is something I’ve talked about for 30 years at IBM, so it’s not new.  But in today’s world, it’s probably more important than ever.

Allianz in Germany, for example, is doing some very interesting things around the automation of a couple of their key business processes, rather than attack everything.  They’ve created a highly automated environment around claims processing to strengthen both the business process and the technology infrastructure that supports it.  They have gotten to the point that they can bring in claims, process them, and satisfy these claims in an almost completely automated way.  They carefully designed the process and the system not only to reduce expenses.  They believe it actually has gotten them into a position where they can grow the business and increase customer retention through more effective handling of the claim process.

Q: What are some of the new opportunities that new technologies open up for insurers?

MARK LEWIS: There is a whole set of thoughts that is much broader than insurance, but insurance is certainly part of it, which is the notion of a smarter planet.  There are three fundamental things that are going on in the world today that are causing us to be a part of this smarter planet.

One of them is that we live in a world where technology is being embedded everywhere.  We have a massive explosion of computer chips being embedded in things ranging from postal packages to vegetables that are shipped from one part of the world to another, or even embedded in people and animals.

The second thing is that everything is being connected together.  The fact that we talk to each other with computers and technology is interesting, but much more interesting and much more significant is the fact that it’s not just the people that are communicating around the world, but it’s the objects and the things communicating to each other and to computers.  As you embed that technology and as you see the communication among all this technology happening, you create massive amounts of new data, new information, and a new level of intelligence.

Now, the question is what can the insurance industry do in this new world that we live in?  How do insurance companies leverage this new reality to do things differently with their customers?  How do they use it to position themselves differently against their competitors?  How do they better utilize their workforce, which is also changing as a result of these realities?

I think as companies get motivated to become more agile and to get more growth, they really have an opportunity to leverage new technological capabilities that haven’t existed in the past, and specifically more innovatively address what their customers are looking for.

Q: What in your mind are some of the things that will separate the leaders from the laggards in this smarter world?

MARK LEWIS: I see the most successful insurance companies being much more innovative and aggressive around technology, and in particular the integration of technology with the business.  I see them doing not just a couple of the things I mentioned, but adopting broader and deeper approaches to utilizing information.

Does that mean that you can get a competitive advantage in this world if you’re one of the leaders?  Absolutely!  I think the leaders are beginning to establish and prove that the ability to compete around speed and innovation, driven by better information and better analytics, is a critical differentiator.

Analytics are obviously not new.  What is new is that we have the technological ability to capture, and capture real-time, massive amounts of and new types of data and information that we haven’t had in the past.  And we can process this information at levels of complexity and granularity and at speeds that are well beyond what we could do in the past, using faster computers and technologies like you have at Earnix.  That’s new.

The need to get more granular customer segmentation, more granular products, and more granular pricing, are all driven by the need for growth and the changes associated with it.  There is a fertile ground here for the leaders to get at competitive advantage through the use of analytics.

Q: This is fascinating!  Why isn’t everybody there yet?  What are some of the obstacles insurers have to overcome as they move into this smarter world?

MARK LEWIS: One obstacle is that management teams do not always understand and are not always aware of what’s possible, how better information and analytics will position them to drive their own business objectives.  You still have CEOs that think they’ve got all the information they need because they get a three inch thick report every day.  The leaders are realizing that there are massive amounts of new information and new ways they can use this information to gain a competitive advantage.

Second thing is leadership, willingness, and a commitment to make critical changes.  There is a cultural resistance inside these companies to make the changes associated with taking advantage of information and analytics.  I see many missed opportunities for more granular segmentation, pricing, and product innovation just because management doesn’t want to change.

The third obstacle is lack of a clear roadmap how to strengthen their position with better information and analytics.  I see a lot of people attacking this in an ad-hoc fashion.  They don’t have a roadmap that senior executives can see as a way to getting from point A to point B, where point B is a stronger competitive position that utilizes better information and analytics to strengthen their basic business strategies.

There is also the issue of data availability.  Too much critical information is trapped in what I’d call technological, cultural, and business silos.  Information scattered around the organization can be sometimes trapped because of technology, or sometimes just because one part of the business doesn’t want to share it with others.

Lastly, it’s the ability to keep up with change.  The reality is that change today is happening at an exponential rate and in more significant ways than ever.  Many management teams are struggling just to keep their heads above water.

To overcome these obstacles, there is a new set of leadership skills that will be required in the insurance company of the future.  People in the insurance company of the future will have the ability to work across silos.  They will be more technologically savvy and know what’s possible.  And they will have the capacity to process change and manage change.

Emmanuel Geli oversees the insurance practice for CSC throughout the southwestern region of Europe.  With over eleven years of service with the company, he is responsible for the delivery of strategic business consulting to insurance company clients throughout Belgium, France, Italy, Luxemburg, Portugal, and Spain.

Q: Over the last few years, have you seen any shifts in the needs of the insurance companies you are working with?

EMMANUEL GELI: I would say yes.  As the market becomes more competitive, there is a greater emphasis on operational excellence.  Since price is a key competitive factor in the marketplace, insurers are forced to find new ways to operate as efficiently and cost-effectively as possible.  With approximately 10 % of all premiums collected spent on administrative activities including around 4% for claim management, they must better control their expenses in order to maintain acceptable levels of profitability.

Q: Thank you, that’s a great backdrop to the topic we wanted to discuss in further detail, which is the auto insurance sector.  What trends do you see happening in this sector?

EMMANUEL GELI: Over the past 10 years or so, we’ve seen significant changes, some of which can be attributed to the current economic crisis.  One of the most noticeable patterns we see is a sharp increase in customer churn, or customer attrition.  The average rate of policy cancellations across Europe is about 10 percent.  But, this rate varies greatly by country, as well as by distribution channels.

For example, in France, the churn rate is over 15 percent for bankassurers, while it is about 10 percent for traditional insurers that have strong distribution networks of dedicated agents and brokers.  At the same time, the attrition rate is less than 5 percent for mutual insurers, because of the close affinity their clients feel to the company and the “advisory” services they provide to their clients, which help them build stronger relationships with their policyholders.

Q: What do you consider to be the primary reasons behind these high churn rates?

EMMANUEL GELI:   There are several causes.  First is the changing attitude of insurance customers.  We now live in a world of “mass consumption”, which has resulted in a loss of attachment to specific brands.  In the car insurance business, the fact that the typical client has very little direct contact with their provider contributes to the amplification of this problem, making and car insurance viewed as a commodity.  For example, policyholders have a variety of “self-service” capabilities available to them.

Essentially, the only time a policyholder needs to communicate directly with their insurer or distributor is when they have a claim.  Clients that have submitted claims – and therefore had direct contact with their providers – seem to have much higher satisfaction and loyalty rates than those who have not.  However, material claims have only a 20 percent frequency; more so, most of these claims are for broken windshield, which in most countries do not require any interaction with the insurance company.  So there is little opportunity for the insurer to create meaningful relationships with the customer.

Auto insurance customers nowadays are also more willing to compare different offers from different insurers – a task that has been made easier for them by the many available online comparison portals.  These portals give them a fast and simple way to evaluate side-by-side the premiums, warranties, and claims exemptions or exclusions offered by different insurance companies.

Q: With such high rates of churn, how are auto insurers competing with each other?

EMMANUEL GELI: Auto insurers are in the midst of a major price war.  They’re reducing their car insurance premiums as a means of bringing clients onboard.  Many are using introductory promotions like premium discounts of up to 20 percent for the first three months, or even one or two months premium-free.  The assumption is that once they have a foot in the door, they can more easily cross-sell other property and casualty (P&C) insurance products such as homeowners, accident, or health insurance.

Q: How has rising policyholder attrition affected commissions and distribution costs?

EMMANUEL GELI:   Despite the price pressure, commission payouts and the expenses associated with the various administrative tasks required to underwrite and maintain policies have not changed much.   Commissions for new business typically average between 12 and 16 percent of the annual premium.  For companies that pay commissions, like traditional insurers and bankasurers, the cost of distribution is key.  These expenses can vary based on the scope of the services provided by the distributor, including those activities associated with underwriting, claim management, payouts, etc.

Q: What impact has this had on profitability?

EMMANUEL GELI: Auto insurers must find the right balance between offering a competitively-priced product and reaching their P&L objectives.  Traditionally, profitability was achieved by creating a base of loyal customers, who paid high premiums and didn’t submit claims.  Today,  the average duration a new customers is going to stay with an insurer is about two years shorter than it was just five years ago.  Insurers can no longer operate under the assumption that customers will remain loyal even if the premiums they are paying are too high simply because they’ve been with the company for an extended time period.

Because attrition rates are high, insurers are offering lower premiums to prospective policyholders, despite the high cost of new business acquisition.  The result is that these new customers end up being far less profitable than existing ones.

Q: What steps can auto insurers take to reduce the cost of acquiring new customers?

EMMANUEL GELI: One thing insurers can do in that area is reduce the number of new policy cancellations.  Cancellations that take place before the contract actually takes effect are particularly important, as they happen very frequently.  These can be avoided through pricing optimization as well as process enhancements to improve the underwriting process and secure the sale.  Once a customer gets past the first term, the risk of attrition decreases dramatically, as most policies are automatically renewed without any additional underwriting.

Q: What other actions would you recommend for insurers given the challenges you described?

EMMANUEL GELI:  At CSC, we strongly believe that minimizing customer churn is vital to sustaining acceptable levels of profitability.  This is so important because every year a customer stays loyal has a tremendous impact on profitability – even more so than the claims/premium ratio optimization.  To illustrate this idea, in some cases, our research shows that a one percent reduction in attrition can increase the combined ratio by as much as ten percent.

To minimize attrition, I would suggest several areas that insurers should consider:

• Pricing: Insurers should adopt a new approach to pricing.  Rather than giving price breaks to new customers, insurers should give pricing incentives to profitable customers that stay with them longer.
• Distribution: We believe that companies would be better served by setting commission rates based more on the overall portfolio, instead of focusing mostly on the generation of new business.  This is a tricky issue, but by redefining the commission model to offer incentives for high loyalty levels, insurers can encourage their distributors to make a greater effort to sustain client longevity.
• Service: the service levels clients experience during the claims process have, perhaps, the most profound effect on satisfaction and retention.  Insurers need to find effective ways to increase customer satisfaction while containing the cost of service.
• Value: Insurers need to do more than just pay a claim, they need to truly assist the customer solve their problem.  For example, provide a replacement vehicle while a car is being repaired and the claim is being processed.  In more severe cases of bodily injury, the insurer can arrange for at-home services to assist the injured person rather than litigate the claim.  Insurance companies can further reduce their costs by actually owning the service providers.  For example, some insurers own companies that provide at home tutoring services to injured children.  It’s about cutting expenses while providing greater value to the customer.

Price Optimization in Insurance – A Revolution in Progress provides an in depth discussion on what price optimization is (also sometimes referred to as “demand driven pricing” or “market pricing”), how it is applied in the Insurance industry, and key factors to its success. It touches on subjects like real time price optimization and dynamic pricing, competitive pricing and even notes different vendors of price optimization software, including Earnix.

I found Celent’s description of the different levels of sophistication in demand based pricing to be very concise and accurate: Reactional analysis defines what has been performed, using Reports and Dashboards; Strategic analysis defines what lessons can we draw from the Reactional analysis, using Analytics; Scenario simulation answers what-if questions, using Predictive analytics; and finally Scenario comparison (and selection) defines what is the optimal approach (i.e. action to take), and requires Pricing Optimization.

Another trend Celent deeply analyzes for the first time (that I have seen) is the benefit for real time price optimization, or as they put it comparing “Back Office vs. Front Office” approaches. Rightfully the report focuses on online and European markets as the current segment leading this advancement, but we at Earnix are already starting to see other segments that are moving into the “Front Office” world of Price Optimization.

Celent also reviews some success stories in this area such as Progressive in the USA and Lloyds TSB Insurance in the UK (See related article about Lloyds TSB).

The Perils of Success – Rethinking the Maturing Online Insurance Landscape in Europe discusses the state of online insurance and its foreseeable future, and the evolution of online insurance IT architecture.

In the report Celent notes the reasons for the growth of Internet based Insurance purchase. The growth trend is indeed clear, and there are many good reasons for it. However for me, the most difficult question to “crack” on this topic is why some countries are taking significantly longer than others in developing a significant internet insurance markets. It is no secret that the USA and UK have taken off quite a few years ago, whereas countries like Germany, Italy and France are yet to achieve any significant internet market share. Celent is confident the “lagging” counties will follow this trend soon, but I would like to know “how soon?” and “if it hasn’t happened until now, why would it happen any time soon?”

I enjoyed very much reading these papers as they provide important insights on what we believe are key trends around Pricing and general performance in the insurance market. These research papers can be purchased on the Celent web site.

If you’ve had a chance to read these or other relevant research papers – please join the discussion and let us know your thoughts.

As is often the case when new market categories are formed, different phrases are used to describe the same thing, and sometimes we are not sure what that “thing” is. As the market develops, that “thing” becomes clearer and a new terminology is established. For example, who really knew what ERP or CRM meant in the early 1990s? Now these terms are well understood and have a unique meaning. We at Earnix believe this is happening right now in the Insurance and Banking industry around Customer Value & Price Optimization.

So let’s discuss some of the different ways of saying “Customer Value & Price Optimization for Insurance companies and Banks”.

Let’s start with “Price Optimization.” Is it the analytical components of pricing such as demand modeling and pricing analytics, dynamic pricing, price elasticity, and price sensitivity? Or is it the business part – competitive pricing, pricing management, revenue management, profit management, or good old value based pricing, price execution, and revenue optimization?

Continuing on this point, the mathematical term of “optimization” is sometimes misused in this context. “Profit Optimization” is not a technically-correct term because what is actually implied is “profit maximization”. That is, pricing is the means while profit/revenue/value are the goals, therefore you optimize price to maximize these goals under constraints.

And what about the “Customer Value Optimization” part? Do we mean customer lifetime value, or maybe customer centric, or maybe a combination – customer centric lifetime value?

Or maybe we are talking about the predictive analytics technology we use, or putting it all into a software solution – i.e. pricing software? Or customer lifetime value software?

Well as you are probably aware, I have no answers here except that we are in a fascinating market that is developing as we speak, and so is the terminology around it.

What is clear is that “Customer Value and Price Optimization” software is providing exceptional benefits to our customers – including many of the world’s leading Insurance companies and Banks – some of which have been made public, and many more which have not. Last year, Insurance & Technology featured a number of insightful articles about customer retention and acquisition – here is one of many interesting quotes from one of these articles – “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.” You can find additional relevant articles and discussions from Insurance companies and Banks using Customer Value & Price Optimization solutions on our website.

Please join the discussion – and let me know what Customer Value and Price Optimization means to you.