Benefits of Price Optimization Across the Credit Life Cycle

Our friends at Zoot Enterprises recently discussed developments in price optimization technology with Frank Bria, banking professional services director for Earnix. His insight reveals the benefits to be gained by financial institutions across the entire credit life cycle by using this new technology.

What are the most common applications of price optimization today?

Frank Bria: Right now price optimization is most commonly used in banking and insurance to set the prices of loans, deposits and policies where there is a significant ability to differentiate pricing. Fundamentally, scientific pricing leverages the “law of large numbers.” In sectors where a robust set of customers exist, price optimization is applicable.

There is a perfect opportunity to take advantage of price optimization in renewal conversations for insurance policies or loan refinancing. There is typically room to move a customer up or down by using what you already know about them.

Many institutions are not taking advantage of the historical information they have right now when repricing their customers. There is great opportunity for meeting your strategic goals when you capitalize on that known information.

Big strategies of growth are implemented one loan at a time and therefore the better you segment and match product and price to the customer the better you are compared to the competition. The customer interaction in real-time and decision is the key to achieve those corporate goals with the help of predictive analytics decision tools.

How is price optimization different that other models being used?

Frank Bria: Optimization is different from modeling in that it asks a different question. Modeling asks: If I do X, Y and Z, what will happen? Optimization asks: What should I do?

Modeling is extremely important as a prerequisite to optimization. Optimization checks all of the possible scenarios you could follow and finds the best possible course of action. Let’s say you have 10,000 CD customers up for renewal. It is not humanly possible to check every scenario to determine the most favorable renewal for each account. Optimization gives you options. Whether your goals are less profit and more retention or gaining the maximum profit with less retention or a little of both, optimization reduces the work to find the right answer to achieve your strategic goals.

What questions can price optimization answer that other techniques can’t?

Frank Bria: Optimization basically allows you to consider millions of scenarios that would be otherwise impossible. In simulations where people were placed in front of a computer and asked to change a certain number of variables to find the best result, in every case the user couldn’t match the computer-generated optimal scenario. Why? Humans tend to use a pattern based approach. For example, they might move all prices up or down. Patterns are sub-optimal. A person cannot replicate the computer when it comes to optimization.

Models are built to predict outcomes, but not suggest strategies. Optimization gets closer to an answer by suggesting a strategy to achieve the outcome you want.

Why isn’t price optimization used more widely?

Frank Bria: There are three main reasons why price optimization hasn’t been widely adopted. First, the technology is fairly recent. The initial projects in lending and insurance were being tested in 2003-2004. Next, we have to take into consideration the technology maturity timeframe. Right around the time price optimization should have been really taking off the global financial crisis hit and disrupted the regular progression of technology throughout the industry. Finally, this is a fundamental mind shift in terms of how we think about pricing. The familiarity with using models is already ingrained in the industry. Any new concept requires an education process. The good news is that nowadays the industry is in a discussion of big data analytics. Those really looking at moving forward are looking at optimization as a way to leapfrog the competition. In some sense, the stars have now aligned.

How can it be used in lending to have a positive impact on collections?

Frank Bria: If we can understand consumer behavior we can better tailor decisions that have a global portfolio impact. Lenders have broad targets they need to hit but they also need to have conversations with debtors. Optimization provides the strategy by taking a top down approach. By looking at the overall portfolio target, collections can determine the optimal strategies for each individual borrower. This is backwards from how things are being done today. It is difficult to manage a collections portfolio to achieve top level number with independent conversations happening at front line that are not tied together. Optimization provides a plan of execution and is the only technology able to do that. This is a very new area and the first projects in collections are happening right now. As with any first mover they will have a huge competitive advantage.

Optimization ensures that profitability is being managed not only from the perspective of controlling losses, but an establishment of portfolio mix. This provides a great benefit to credit risk managers. Optimization provides more control mechanisms than a modeling-only approach at a much more granular level. Credit risk departments can proactively ensure that price changes on the marketing side do not have a negative impact on the portfolio.

What do you see as the biggest benefits for banks implementing price optimization?

Frank Bria The financial benefits are huge. Lenders can achieve 10-20 basis points of additional profitability in their deposit and lending portfolios. For every billion dollars in the portfolio, that adds a million in profit. The technology investment required to achieve these numbers is one of the best ROIs available in the industry.

Another benefit is the ability to manage portfolios and targets. With an optimization approach senior level executives can establish budget targets and determine the amount of growth possible given their infrastructure. Optimization is the enabling technology that allows them to understand and manage strategic targets for profitability and volume by developing an “on-the-ground” execution plan.


This interview was also published in Collections & Credit Risk


Infographic: key findings from our North American Auto Pricing Survey

Infographic 2012NA-Auto-Pricing-Survey (short)

New Insurance Realities and How They Impact Pricing

An interview with Sammy Krikler, Earnix Co-founder and CTO, and Barak Melnik, VP Products and Business Development

Sammy Krikler, Chief Technology Officer and co-founder of Earnix, is a renowned expert on P&C insurance pricing. Sammy is involved in a number of functions at Earnix including Product R&D and Client Professional Services. He spends most of his days working with Earnix customers to address the evolving challenges of optimizing pricing and customer value.

Barak Melnik is responsible for developing Earnix’s solution roadmap and business development strategy. He joined Earnix from the London office of McKinsey & Co, where his work included helping insurance companies in areas related to pricing and underwriting as well as channel management and marketing. 

Q: You spend significant time with insurance executives. What are the new things that are challenging them these days?

Sammy: One of the biggest challenges insurance companies are facing these days is the proliferation of distribution channels. The degree of evolution may be different from one market to the other, but the overall trend is similar. More companies at more countries are going directly to the consumer. Aggregators are also becoming more prominent in many countries. Overall, consumers have more choices in how they buy insurance coverage, which means greater competition among insurers and among the distribution channels. It’s a challenge as well as an opportunity.

Barak: Another important development presenting an opportunity and a challenge for insurance companies is the availability of data. It goes both ways: with more channel competition and especially with the growth of the online channel, consumers have more access to information about products and prices. At the same time, insurers also have more information about the customer. One good example is the growing use of telematics, which gives insurers data they did not have in the past. The next big step could potentially be utilizing social network data…

Q: What do these changes mean for the people in charge of pricing at these insurance companies?

Barak: The big picture is that insurers have more opportunities to create a strategic advantage through sophisticated use of pricing. The challenge is to step up their pricing capabilities to deal with a more complex world. It requires a multi-channel pricing strategy. It requires the ability to handle many more product permutations. Since the market is more dynamic, it requires agility to make frequent price modifications and information systems that can deploy new pricing schemes swiftly.

Sammy: The basic challenge for insurers remains the same as it has always been. It’s not about winning the business but winning the business you want. What insurers can do today that they were not able to do in the past is gain a more holistic understanding of the customer. Insurers have always known how to calculate risk, even if its calculation is constantly improving by adding new factors. Now they are also able to calculate things such as demand elasticity and lifetime value, so the definition of “the business you want” can be more complete and better aligned with overall business goals. Insurers that are able to weave this kind of sophistication into their pricing and have the agility to keep up with market dynamics as Barak said can have a real competitive advantage.

Q: What are some of the steps that you see insurers take in order to gain this competitive advantage?

Sammy: One reason we are so busy these days is that insurers in pretty much all geographies are really stepping up their pricing sophistication, both in terms of processes as well as the systems to support them. It’s also an organizational and cultural challenge. They need to become more nimble. They need to break down some of the organizational silos and enable collaboration to speed things up. Some companies are better equipped to make these changes than others. In some cases new companies have an opening to get a leg up on incumbents, and that creates some very interesting market opportunities.

Barak: In addition to the organizational change that Sammy mentioned, insurance companies are also making investments in technologies that can support the need for faster response and collaboration. Similar to the breakdown of organizational silos, they are breaking down some of the system silos and putting real-time integration in place. In most insurance companies we still find that the analytical tools used by the pricing teams are disconnected from the production rating engines. However, we are observing a significant shift towards analytical pricing systems that s are now integrated in real-time to customer-facing operational systems. We also see more companies embracing the cloud to speed up some of these changes.

Q: To sum it up, what advice do you have for insurers that are looking to take on the challenges and make the most out of the opportunities presented by today’s market?

Sammy: One thing I would say is stay ahead of the curve. Before too long, all insurers will have to change how they manage pricing. It is better to be the one leading the charge than the one defending your turf.

Barak: I would add that the pace of change we are seeing today is only going to accelerate. Those that are left behind now are going to have a tough time playing catch up in order to stay competitive in the future.

Consumers to insurers: know me, reward me (from E&Y)

If you really want to know what consumers think about the insurance industry and what they expect from insurers, this information is now at your disposal courtesy of our friends at E&Y insurance practice.

Ernst & Young surveyed more than 24,000 consumers of insurance products in 23 countries across seven global regions, making this body of research one of the largest surveys of consumer attitudes about the insurance industry ever conducted.

The survey has a wealth of valuable insight that would take quite some time to digest. It presents key global trends as well as significant regional variances.

Some of the highlights include:

  • Insurers have a long way to go in meeting consumer expectations. For example, consider the amazing fact that 75% of non-life insurance consumers across the globe were not contacted by their existing provider prior to their policy renewal time.

As David Hollander, Ernst & Young’s Global Insurance Advisory Leader says: “This is the best time for insurers to make key investments in data analytics, predictive modeling and service-related technology that will help identify product leads and develop tailored messaging and personalized offers for existing consumers. With consumers claiming they are open to being sold new products when the time is right, insurers need the technology and systems in place today to manage their sales efforts across a large customer base.”

You can find additional information and download a complete copy on the E&Y site.

Insurance Analytics – Turning Data into Dollars (from Deloitte)

The insurance team at Deloitte has recently published an excellent new report on insurance analytics.

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.

Strategy Meets Action: An Interview with SMA Founder Deb Smallwood

Deborah Smallwood is the founder of Strategy Meets Action, a strategic advisory firm offering a unique blend of advisory, research, and consulting services. Insurers and solution providers turn to SMA for insight and guidance on business and IT linkage, IT strategy, and how to make smarter IT investments across the business value chain.

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.

Additional Nuggets from the Celent Pricing Optimization Webinar

The recent  pricing optimization webinar with Celent’s senior insurance analyst Nicolas Michellod has generated a great amount of interest among European insurers and others.  Nicolas and Celent have been kind enough to allow us to post here a quick recap of some of the key questions addressed in this webinar.

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.