“We survived! Actually we did pretty well over the last couple of years. We’re feeling good about 2011. After all, if we can do well during the Great Recession we can prosper in any market.”
Senior Insurance Executive, December 2010.
These comments are not unusual. During a series of calls I held in December with colleagues representing all aspects of the insurance industry I found similar upbeat predictions. Everyone is focused on growth and the stock market rally at the end of the year coupled with improving employment numbers and consumer sentiment has created a sense of optimism.
I’m a little more tempered about this year – especially as it pertains to the financial performance of the Insurance Industry. Success will require a detailed understanding of how the key drivers of the business impact performance. Companies will have less margin for error as they balance each component of the business. Here’s my industry outlook for 2011 with those considerations in mind.
Property & Casualty
I like to view the P&C business through the four major drivers of the business: (1) Pricing and Underwriting; (2) Claims; (3) Investments; and (4) Distribution.
1. Pricing and Underwriting
· Will this be the year when the hard market makes it return? Doubtful. Reinsurers are still flush with capital as reflected in reinsurance treaties renewed with economic terms that were 5 – 10% lower than 2010.
· As the soft market continues, pricing sophistication and underwriting discipline will become even more critical. Pricing optimization using complex algorithms and other predictive analytic tools no longer represent the “bleeding edge.” Today almost all carriers employ some sort of predictive analytic pricing mechanism. As the technology gets less proprietary and expensive these tools will move “down market” to small carriers, MGAs, MGUs, and individual brokers. There’s a new game developing - capturing the most profitable customers and steering the unprofitable ones to your competitors.
· Two observations to make my point. (i) Last year I had the opportunity to spend some time in Canada with one of the country’s largest P&C insurance companies. Their auto book of business performed poorly. In fact, most of their competitors also experienced poor results – combined ratios well over 100. One didn’t. This carrier used proprietary pricing tools that enabled it to significantly outperform its competitors creating a competitive advantage on rates and quality of business; and (ii) Companies operating in Europe, especially the U.K. and Germany remain ahead of their U.S. counterparts in their use of price optimization software. I’ve had the opportunity to see this first hand while working with several European insurance companies over the last several years. I was impressed with how much more competitive their markets are and how agile and adept companies are in using technology to identify and exploit profitable markets.
2. Claims
· As the economy improves claims costs will rise. The recent rise in oil and other commodity prices will contribute to increasing costs. As companies begin to hire again and production increases, claims frequency will increase. Obviously the various lines of insurance will be impacted differently with auto and workers compensation seeing the largest initial increases in frequency.
· Can the industry’s luck continue regarding CAT losses? Most people that follow weather related CATs don’t believe so. The mammoth storms that have hit the U.S. in December and January suggest we may get “our fair share” of severe weather this year.
· Claims departments have reduced costs aggressively over the last several years. Mostly by using technology. These efficiency gains will provide less of an impact on performance this year because they are already “baked in.” Organizations must find new ways to leverage technology to offset their accelerating claims costs.
· The “Zappos” Leap - The Self-Adjusting Claim. Nobody thought you could create an online business selling shoes. After all people want to try them on and make sure they fit before they decide to make a purchase. Zappos changed the shoe buying experience with a business model that turned the shoe buying experience on its head. The same opportunity exists with Claims. What’s the next Zappos Leap or significant change in the traditional Claims process? I believe it’s the self-adjusting claim. What do I mean? It’s a claims process that allows the claimant to act as the claims service representative and the use of technology to allow for an automated adjustment process. It already exists in small ticket warranty claims in the U.S. In the U.K., it’s being used to adjust low severity auto claims.
3. Investments
· 2011 is all about the Bond market. Early indicators suggest a perfect storm of low yields and inflationary pressure that will hurt the performance of bond portfolios.
· I think it’s safe to conclude that insurers should not expect their investment income to contribute to the bottom line as materially as it has in the past.
4. Distribution
· Personal Lines – The rebirth of the independent agency continues. For the last twenty years the captive agency companies ruled at the expense of the independent agent. That’s no longer the case. Many consumers still want to discuss their insurance needs with someone local that they trust. But they don’t want just one product choice a la State Farm or Allstate. They want someone who can find them the right coverage at the cheapest price. The independent agent becomes the local intermediary between “do it yourself” and the captive model. Direct to consumer will continue to see gains in market penetration but at slower growth rates than in the past. Captive agencies will experience the greatest challenge as their business model offers the least customer choice to the consumer.
· Commercial Lines – “$500,000 is the new $5 million.” A common statement frequently uttered in Silicon Valley it also applies to Commercial Lines. Let me explain. For almost a decade the commercial markets have been soft. Commercial agencies had to write more business just to stay flat. Add to that roll-ups and other combinations by private equity backed investor groups in the mid 2000s and a top producer has been living a high-pressure life. As the economy improves many of those top producers will start to look for better opportunities. I predict that many good brokers will form their own brokerages instead of just moving to a competitor. Start-up costs are significantly lower today than in the past enabling many brokers to break free of the larger agencies.
· Niche Markets – Program business or niche markets will continue to expand in 2011 as better data, lower acquisition costs, and market awareness enable MGA/MGUs to develop small risk segments for target markets.
My 2011 P&C Outlook “The Perfect Storm” – The P&C insurance industry faces a perfect storm in 2011. Premium growth remains flat due to the continuing soft market, claims costs begin to accelerate, fixed income investments perform poorly impacting investment income, and distribution costs increase as the market remains highly competitive. Unlike many other years, executives will not be able to depend on one part of the business to offset poorer performing segments. This will be a year where the top performing organizations will be able to separate themselves from their competition and gain market share. Let the games begin!
Life Insurance
Change is afoot! 2011 promises to be an interesting year for the life insurance industry as three big issues began to change the industry.
1. Automated Life Underwriting Comes of Age: Everyone in the life insurance industry acknowledges that the sales process is antiquated. What consumer product today takes 45 days to purchase? For over a decade now companies have been trying to come up with an automated approach to life underwriting that will enable the consumer to purchase underwritten life insurance in a matter of minutes. Automated life underwriting using data instead of fluids had early success with Transamerica’s program, but Deloitte Consulting’s recent launch of their sophisticated electronic underwriting tool should bring automated underwriting into the mainstream. Life Insurers pressured by shrinking margins can no longer ignore the increased volume and profitability this process will provide.
2. The Internet moves from lead generation to sales engine: Automated underwriting will impact term sales first enabling consumers to purchase their coverage online in minutes instead of weeks. While regulatory hurdles remain, I expect a true immediate issue underwritten term product to be available online before the end of the year. Then there will be a mad dash by every carrier to have their own similar offering. Look for an alliance between one of the large Internet life insurance sites and a life insurance company to be announced during the first half of the year.
3. The traditional life agent continues to get squeezed: The low-end term market continues to move to the large direct players (Internet and phone). Annuity sales continue to gravitate to the Banks and the new changes to the estate tax laws have wiped out the need for permanent insurance for a large percentage of wealthy clients that would have needed life insurance for their estate tax needs. Finally, for those agents that have prospered by selling whole life insurance as an investment, the low returns in the bond market will make those sales less attractive. Declining dividend rates for the fifth year in a row will also impact existing policies negatively causing increased lapse rates. The traditional life agent will have a smaller pool of prospects in a more competitive market.
4. Commission disclosure changes compensation structures: This is the first year that New York State requires insurance carriers to disclose agent compensation at the time of the sale of a life insurance policy. In an era of heightened scrutiny of financial products by consumer watchdog groups, I expect the size of life agent commissions to come under renewed focus. Over the course of the next few years I believe more states will embrace this type of disclosure leading many insurance carriers to modify commission structures to be paid over several years as opposed to up front. This will hurt life agents in the short run and probably spell the demise of those just making enough to survive under the current system. For those that do survive, the life insurance business will become a more attractive business based on an annuity style stream of income.
5. Private Placement Insurance Product Sales Pick up Momentum: Private placement insurance sales have been growing over the last several years as high net worth individuals and their advisors recognize that it remains one of the only tax efficient investment tools available today. While the Bush tax cuts were extended an additional two years, no one expects the current rates to continue indefinitely given the size of the U.S. budget deficit. Even if rates don’t rise, loopholes may be closed thus increasing the effective tax rate for high net worth clients. Expect this product line to become more popular in 2011.
About the Author: Brian Cohen currently serves as the President and CEO of Strategic Growth Advisors LLC (“SGA”) an independent boutique consulting firm that works with companies in the insurance industry to improve their bottom line and accelerate their growth. SGA also assists strategic and financial investors in identifying acquisition and investment opportunities in the insurance industry. Mr. Cohen has an extensive insurance background having spent nearly a decade as a senior executive with the Farmers Insurance Group of Companies. He served as Chief Marketing Officer and Senior Vice President of Sales and Marketing where he led Farmers’ 15,000 strong exclusive agent sales organization. He most recently led the successful turnaround and sale of Clear Technology, a global software company that focused on the insurance industry. Mr. Cohen can be reached at bcohen@sgadvisors.net.
