“We have met the enemy, and he is us.” Walt Kelly, Pogo To conclude this four-part series on setting your agency up for what it needs to be in 2020 (the first three parts of which can be found here, here and here), I asked a longtime friend to describe the surprise he experienced when it came to leading just such an effort. Many of you will face the same surprise, so what he says is well worth reading. I'll follow his thoughts with two exercises that will help you avoid nasty surprises and will help leaders and agencies make the necessary transition. Here is what my friend wrote: "Like many independent insurance agencies, ours is a family business that has been passed through successive generations. Entering our 85^th year, we are in the midst of a transition from the third generation of family ownership/leadership to the fourth. "Like most agencies, we face an array of challenges. We face looming retirements for our most successful producers and most experienced staff. The decision-makers at both our clients and our insurance carriers are also retiring, and their younger replacements are unaware of all the great work we have performed on their behalf for all of these years. On top of that, we can add increasingly cumbersome regulations — especially in employee benefits — the dizzying array of new, complex product offerings from our carriers and the need for massive technology upgrades. "The pace of change has been accelerating within our agency, but only recently have we begun to deliberately chart a course that will prepare our agency to thrive in the competitive landscape we anticipate in the year 2020 and beyond. Within our partnership group, the concerns and deliberations usually focused on our staff’s willingness and ability to adapt and grow into the roles we will need them to perform in 2020. We focused on planning and communicating our initiatives to garner staff support. We stressed the mutual benefits and long-term opportunities available through our Agency 2020 initiative. Conventional wisdom said the main threat to our success would be skeptical, change-adverse staff members. "The conventional wisdom was wrong. "The main threat to our success was the commitment we had not secured from each other, the agency partners. Midstream, we discovered that we all had different levels of faith, commitment and desire in an initiative that would last beyond some influential partners’ tenures. We were faced with two paths. One involved structural, compensation and leadership changes, and it held the potential — but not a guarantee — of internal perpetuation. The other path meant an immediate and reliable payout by an outside buyer, but also working for someone else and the end of our 85 years of tradition." How to avoid the nasty surprise This article is not a debate on the pros and cons of selling your agency. This article is about unity of effort. This article is about a willingness at all levels to change. This article is about committing to a common goal. If you want to perpetuate your agency in the next five years, your entire organization must be committed to this goal, starting with your ownership. The same is true if you want to maximize your agency’s sale value in the next five years. However, if your ownership’s main goal is to maintain the status quo — the compensation model, the production model, the vacation time — then you do not have real commitment, and you are destroying your agency’s value through inaction with each passing day. To really ascertain your ownership group’s commitment, I believe you need to have a frank and open conversation. Ask each member to independently complete the following exercise. Leave space after each question, and require the respondent to explain her answer. Exercise #1 Relative Value

There are 20 points available in this section. Have each owner assign these 20 points to the following items. Ask which two items he would be willing to sacrifice to protect his top two items.

• Individual production income
• Total agency profit
• Total agency value
• Ability to influence agency decisions
• Ability to craft agency culture
• Lifestyle (vacation time, ownership perks, etc)
• Maintaining the agency as an independent, going concern

Production

Ask each owner to rate the agency on these criteria on a scale of 0 to 10. Scores of 0 to 6 mean, “I’m pretty doubtful about this”; scores of 7 to 8 mean, “We can probably do this”; scores of 9 to 10 mean, “I am very confident we can do this.”

• We have the producers in place or can recruit, train and retain the necessary producers to achieve our year-over-year sales goals for the next five years.
• We have the carrier appointments/relationship or can develop the necessary carrier appointments/relationships to support our agency’s growth over the next five years.
• We have the profit centers or can develop the profit centers we need to support our agency’s growth for the next five years.
• There are enough clients/prospects within our reach that need our products and services, or we can develop that marketplace to sustain our agency’s growth over the next five years.
• The marketplace, industries and populations we serve are in ascendancy.

Infrastructure

Ask each owner to rate the agency on these criteria on a scale of 0-10. Again, scores of 0 to 6 mean, “I’m pretty doubtful about this”; scores of 7 to 8 mean, “We can probably do this”; scores of 9 to 10 mean, “I am very confident we can do this.”

• We can retain, attract or develop enough qualified staff to sustain our agency for the next five years.
• We can evaluate, install and utilize the necessary technology and workflows to keep our agency efficient and competitive for the next five years. We can remain profitable even if commission levels are reduced.
• We can accommodate the physical space needs of our agency for the next five years.

Leadership

Ask each owner to rate the agency on these criteria on a scale of 0 to 10.  Again, scores of 0 to 6 mean, “I’m pretty doubtful about this”; scores of 7 to 8 mean, “We can probably do this”; scores of 9 to 10 mean, “I am very confident we can do this.”

• We have or can develop the leaders and managers our agency will need for the next five years.
• We have sufficient alignment and commitment from our ownership group to sustain our efforts for the next five years.
• Our ownership group is willing to innovate, delay gratification and make personal sacrifices to enable the agency to reach its goals for the next five years.

Now aggregate your data. You will need to identify both trends and outliers, and you must depict the data in a manner that best speaks to your group (narrative, spreadsheet, graph, interpretive dance...). Then gather your group together and facilitate a discussion on each section. Allow all sides to be heard, especially the outliers — they may be out in left field, or they may be on to something. When you get to the end of the list, step back and look at the responses as a whole. Now ask each member to complete the next exercise by providing a detailed response to these questions: Exercise #2 Five years from now:

• This is what I plan to be doing and how I got there.
• This is what the agency will look like:

i.      Volume

ii.      Number of people

iii.      Location(s)

iv.      Products

• This is who will be serving in leadership positions.

Ten years from now:

• This is what I plan to be doing and how I got there.
• This is what the agency will look like:

i.      Volume

ii.      Number of people

iii.      Location(s)

iv.      Products

• This is who will be serving in leadership positions.

Again, aggregate your data and look for those trends and outliers. Ask each member to talk through their vision for the agency. It is unlikely that every vision will be similar, so you will probably have two or more “camps” that form. Ask each camp to contrast its vision with the group’s results from Exercise #1. Are they compatible? Which vision from Exercise #2 best aligns with the reality you determined in Exercise #1? Can your group coalesce around this as the common vision? You probably now see yourself in one of three states: 1) everyone is clustered around a common, viable vision (best-case scenario); 2) a majority feels one way, with a united or fractured opposition group (most likely scenario); or 3) everyone is all over the board (worst-case scenario). If you’re lucky enough to be in Group #1, go out there and get to work making your vision a reality. If you’re unlucky enough to be in Group #3, I suggest girding yourself for a long, frustrating process, and recommend you bring in some professional facilitation. For the majority out there, you will have to find a way to resolve the gap between your majority and minority opinions. Search for compromise. Approach each perspective with empathy. Work to achieve the best possible solution, not just the solution that best suits your personal situation. Here are a few thoughts I recommend you keep in mind: 1) Debate, disagreement and compromise are positive features of any high-performing organization, but the majority must be able to make decisions. A minority opinion cannot hold the agency hostage. 2) The agency’s path forward cannot be responsible for compensating for past mistakes. Your past mistakes are sunk costs. Resolve not to repeat them in the future, and move on. You also don’t have to fix everything at once. 3) Don’t fight over problems that will fix themselves with time. If you can afford to accommodate something for the short term that will benefit the agency in the long term, then make that deal. Working through these exercises will allow your ownership group to agree on the vision that best builds your agency’s value. These are hard, personal conversations, but exercises like this are part of being agency stewards, and as agency stewards it is your responsibility to constantly build agency value. What you choose to do with that value is also up to you. That is the ultimate privilege of ownership.

Just as the Bear Stearns implosion presaged the 2008 financial crisis, the events of the last few days, building on earlier events, are presaging the collapse of the “pry, poke, prod and punish” wellness industry. For those readers still living in Biosphere 2, here is a brief review of how we got here: First was Honeywell’s self-immolation with the Equal Employment Opportunity Commission (EEOC). We’re not sure how Honeywell's benefits consultants failed to advise that all the company needed to do was offer a simple wellness program alternative that didn’t require medical exams, and there would be no way Honeywell would get hit with an  EEOC lawsuit. But they didn't. Second, the Business Roundtable (BRT) decided to go to the mat with the president over this EEOC-wellness issue. It is possible that there is some conspiracy at work here, where large companies really want to retain the ability to shame and fine overweight employees into quitting (because you can’t fire people for being overweight). But we lean toward a less sensationalistic interpretation: that the BRT is simply getting lousy advice, likely from consultants whose business model depends on more companies doing wellness. Because the BRT’s member CEOs have actual day jobs, they can be excused for taking the BRT’s word for the benefits of wellness and not investigating this industry on their own; if they did, they would find that the wellness industry attracts more than its share of well-intentioned innumerates and outright scoundrels, perhaps because the industry lacks adult supervision. Third was our popular Health Affairs posting, which spurred see-we-told-you-so pickups by the Incidental Economist and Los Angeles Times, the latter of which helpfully added the word “scam” to the discussion. Thus, we bore witness to a perfect storm, the first-ever lay media feeding frenzy on wellness, from both the right-leaning Federalist and the, uh, non-right-leaning All Things Considered. Those would be the first times wellness in general (as opposed to specific programs like, for instance, the Truven/Highmark Penn State debacle or Nebraska’s falsified outcomes) has attracted the lay media. Additionally, the comments, even on the typically erudite All Things Considered, were merciless. Skeptics that we are, we still underestimated employee resentment of forced screenings and risk assessments. The wellness true believers’ rebuttals were quite in character. As we say in Surviving Workplace Wellness, in this field you don’t have to challenge the data to invalidate it. You merely have to read the data. It will invalidate itself. Because most of the true believers’ “A Team” are ethically compromised, they had to go to their bench to find a rebutter. Against all those eviscerations in the major national media, they countered with: Siyan Baxter, a graduate student at the University of Tasmania, who claimed a positive return on investment (ROI) for wellness. She wrote in a journal that contains the words “health promotion” in its very title and has never once published a negative article about wellness savings. Publication bias, anyone? That isn’t even the punchline. The punchline is that, as our book predicted, Ms. Baxter self-invalidated. She says, right in the article: “Randomized controlled trials show negative ROIs.” How did she still come up with a positive assessment of wellness? Because she “averaged” those ROIs with studies she herself describes as low quality, to get a positive ROI. (These 5- to 30-year-old studies were conducted in an era when, as the award-winning book The Big Fat Surprise observes, the American Heart Association bestowed a “heart-healthy” endorsement on every box of Kellogg’s Frosted Flakes.) Her approach is, of course, is like averaging Ptolemy and Copernicus to conclude that the earth revolves halfway around the sun. The other rebuttal was from Professor Katherine Baicker, who is considered a deity in this field because she basically launched it with a claim, published five years ago in Health Affairs, that wellness achieves a very precise 3.27-to-1 ROI. (As with Baxter, the wellness programs where Baicker found savings were conducted during the era when the AHA apparently conflated Tony the Tiger with Dean Ornish). Having recently stated she no longer had interest in wellness and having more recently blamed readers for relying on the headline “Workplace Wellness Can Generate Savings” and not reading the fine print, she nonetheless decided to defend her legacy. Her defense on NPR is worth reviewing. Baicker said: “There are very few studies that have reliable data on the costs and benefits.” That, of course, is not the case – the wellness true believers’ own meta-analysis above shows that in well-designed assessments, the programs lose money. Baicker also said: “It could be that when the full set of evidence comes in, it will have huge returns on investment, and the billions we’re spending on it are warranted.” This all sounds a little different from the three significant digits of: “Wellness achieves a 3.27-to-1 ROI.” And it is invalid because, as any epidemiologist knows – and as Dr. Gilbert Welch elegantly explained in Overdiagnosed -- if an impact is truly meaningful, it would show up in a small or medium-sized sample. This means that, if indeed there were “billions” to be saved, we'd know it based on the hundreds of millions of employee-years that have been subjected to wellness in the last 10 years. The “full set of evidence" is already in….and it’s game, set and match to the skeptics.

The risk management and insurance industry has become very concerned about how to attract young people and encourage them to pursue careers there. The industry has taken steps, including with programs such as MyPath  and InVEST, which educate students and young professionals about the industry and career paths that could fit their interests. Looking at the issue from the standpoint of a Millennial working in the industry (I'm 21 years old), I'd like to suggest three other ways to spark curiosity in the “Next Generation”: 1. Auto Insurance 101 Classes Most of the youth population hasn’t considered pursuing a career in insurance or is completely turned off by the prospect. Who could blame them? For many, their only exposure to the industry stems from paying high premiums for car insurance. When I started driving, I paid around $1,200 annually for insurance on a car I bought for $8,000. I didn't understand why I couldn’t just save the money and, if something happened to my car, use it to buy a new one. I didn't realize the exposure I had because I might damage someone else’s car or hurt another person. An insurer could use this lack of understanding to design an auto insurance 101 course that would have two benefits. The course could explain coverage and create intelligent customers for the future. The course could also be designed to spark curiosity in some to learn more about how insurance works and about all the good it can do. Some will begin to ask their parents questions or even pursue studies in risk management and insurance in college. Try adding incentives for taking the classes, such as reducing premiums or providing lower deductibles for the same price. Building intelligent consumers should reduce their risk as drivers, so the incentives might even pay for themselves. 2. Sponsoring Sports Teams, Clubs, etc. Sponsoring sports teams, clubs and other youthful groups in a community or at a high school or college could be strategic in attracting the “Next Generation.” In addition to generating name recognition and positive PR, a company could expose some youthful minds to the industry. For example: Someone sponsoring a local high school soccer team could create a competition to answer the question: How much are David Beckham’s legs insured for? The winner gets a signed jersey from a local Major League Soccer player. Someone sponsoring a local college’s political clubs could create a competition around the question: How much would it cost to insure the White House? The winning club gets a paid trip to the state’s capital and a luncheon with some state officials. 3. Partnering with Teachers to Make “Classroom Insurance Policies” This can be a fun twist on teaching a classroom about insurance. After working with the InVEST program to gain relevant teaching material, reinforce the concepts through a simulation that students can relate to. Create basic “classroom insurance policies” and give students an amount of “money” they can spend to buy different policies and endorsements. This would take some time initially to build the program but would be an enjoyable way for students to learn and get some exposure to reading a policy, applying endorsements/exclusions, etc. An example: Forgetful Student Policy A policy could include protection against forgetting that an assignment was due and would allow the assignment to be made up that night for half the credit (actual cash value). An endorsement could be bought to upgrade the policy so that the assignment could be made up for full value (replacement cost). Exclusions could include large projects or papers. Creating interest and reinventing the image of the business must be an industry-wide, collaborative effort. Understanding that learning can be exciting for these young students and professionals should greatly increase the success of efforts to attract the “Next Generation."  

It seems the only people made “well” from corporate wellness programs are those who collect $6 billion in annual costs. Still, all is not lost. If we use the most basic workings of human nature as a guide we can salvage a more reasonable realm for the notion of employer-sponsored “wellness.” Corporate wellness is seriously flawed on the grand scale it once proclaimed. Here are four reasons why, in my opinion: First: Wellness costs too much and thereby sets a high threshold for return on investment (ROI), which begs failure by any score based on savings. Let’s say you have a 500-person workforce. After a couple of years of “wellness,” 10 smokers legitimately quit for life, and five obese employees legitimately get to normal BMI and sustain it. For these individuals, the wellness program is an amazing success with great implications for future health. Unfortunately, with the average cost per employee in corporate wellness programs at more than $500 per year, two years costs more than $500,000, and a calculation of ROI depicts an abysmal failure. Second: The profit motive of wellness purveyors supersedes common sense. Their sweeping approach provides incentives for assessments to identify candidates at risk and assumes that simple potential indicators of unhealthy lifestyle or other conditions create a savings opportunity. This is absolutely false. One fact is missing. Of the persons targeted, only a precious few are at a personal decision point and have the will to actually attempt difficult lifestyle changes. Targeting must take human nature into account. We can properly diminish the presumed footprint of wellness if we look back and study individuals with actual historic success. Let us understand what indicators of personal human attitude that handful of successes gives us to use as a second-step screen. How much easier is it to realize ROI when only spending $500 per head on a smaller number of likely candidates? Third: There is an absurd, blind thirst in both the private and public sectors to find believable reductions in projected future healthcare costs. The hype of wellness is perfectly suited to quench this thirst. Unfortunately, the absurdity is legitimized by governmental acceptance of the fool’s gold of claimed lower healthcare costs to gain leverage in negotiating state-worker union contracts, rigging budgets and passing federal legislation. (Can you spell ACA?) The term “fool’s gold” has the word “fool” in it for a reason. Fourth: The wellness industry ignores lessons that should be learned from success in its sub-area of  disease management -- specifically, that human nature feels no call to action until mortality comes knocking. Disease management savings can be documented in examples like the PepsiCo program called Healthy Living, initiated in 2003 and providing real savings today. Why does disease management work? In my opinion: People with a disease feel their mortality and are inclined to follow any program that might help. Disease management supports a population with more personal incentive and will. Conversely, the debunked lifestyle approach targets an abundance of people who are personally happy while smoking or overeating. Fewer are suffering the acute implications of their lifestyle. “Wellness” money spent on them is useless. Quick Tip: Trade “Big Wellness” for disease management with limited lifestyle programs Don’t throw the baby out with the bathwater. There are many people who need and will accept disease management. As far as lifestyle, there are but a few people ready to commit to change. The good news is that over time, and organically with no cost, these few might spark an interest by others in any employer population. Keep the doors open for them and keep awareness high. In the meantime, don’t waste real money or use gimmicks on them. I suggest wellness vendors create a new approach that unlocks the psychology of raw lifestyle change, targets the few and is willing to take on smaller footprints. Accept less money but stay for the longer haul. You owe it to the tarnished notion of “wellness” to fix what you broke.

This week’s announcement by the National Insurance Crime Bureau (NICB) that vehicle theft is down by more than 50% compared with 1991, despite an increase in population and registrations of more than 60 million cars, caused me to consider the much bigger implications of shrinking frequency in the entire category of auto claims and what it means to the $200 billion-plus U.S. auto insurance industry. In an impressive achievement, auto claims frequency has been creeping down slowly but surely since the 1986 new vehicle model year, when high-mounted brake lights became standard equipment by federal mandate. While fluctuations did occur in some years, caused by a variety of macroeconomic factors, the trend is assuredly downward. Factors include an aging driver population, reductions in miles driven because of a protracted recession and increasing gas prices, increased migration to more urban areas and the emergence of alternative transportation models. Without becoming distracted by the nuances of frequency variations between various lines of auto insurance coverage (physical damage; collision and comprehensive and liability; bodily injury and property damage), the fact is that the net overall accident frequency trend continues downward. Indeed, adjusted loss ratios for auto insurance carriers fell to an industry average 65.8 in 2013, and some carriers posted even better results. Lower auto claim frequency was clearly a factor. Add to this: the increasing introduction by almost all automakers of driver-assist and crash-avoidance technologies; the rapid penetration of telematics that enable real-time driving hazard and safety alerts; and the specter of fully autonomous (self-driving) vehicles coming faster than anyone might imagine. Further dramatic auto claim frequency reduction can be considered a certainty. The auto insurance premium pie is set to get smaller. Younger consumers, increasingly urban dwellers, are shunning vehicle ownership for improved public transportation systems, municipal-sponsored bicycle-sharing programs and vehicle and ride sharing. And, over the recent prolonged recession, those who did purchase auto insurance become comfortable with higher deductibles as a means of reducing premium costs. That behavior is not likely to change. Usage-based insurance (UBI) programs, at least so far, have attracted mainly drivers with safer records, as well as low-mileage drivers. So, UBI has further eroded auto premium. The claim and loss-cost improvements from these programs anticipated by carriers may or may not materialize in time, but that will depend on carriers learning to leverage data and create custom products much more effectively. Ironically, the auto claim was known as “the moment of truth” for auto insurers – their chance to reinforce the loyalty of policyholders by making good on their service promises at a challenging time for the customer. As the number of opportunities for carriers to provide claim service excellence diminishes, they will have to find alternative customer engagement strategies. Risk reduction and accident avoidance could just be that opportunity. Regardless, the bottom line is this: Auto insurance carriers (as well as their key trading and supply chain partners) should start today to position themselves to survive in a market that is slowly but surely shrinking and changing.

Over the years, I’ve had no shortage of people ask me how they can get my job as a senior risk leader. They get a glimmer of the possibilities from a distance and develop a strong sense that risk management just might be a pretty interesting career track. Those in manufacturing, healthcare and some other sectors insisted that any leader in their ranks, most especially a risk manager, needed to come from within their industry. They were the true believers and were typically inflexible about this minimum requirement. They believed their industries were just too specialized for a risk manager from another industry to succeed. Needless to say, I disagreed vehemently with this view and with others in the insurance industry who take these inflexible positions. Happily, in the last five years, some more progressive leaders in certain industries like healthcare are beginning to revise these positions in favor of seeing the value in having the new eyes, ears and perspectives that can only come from those experienced in industries other than their own. A good trend, indeed. My forte since 2001 and the future of the discipline, enterprise risk management, calls for a very specific move in a strategic direction that aligns with the long-term interests of enterprises. So is there a preferred best strategy to preparing for a career in risk management? The truth is that, while many of us developed the skills and experience that have been most valuable by rotating through the various insurance industry disciplines, there are now a myriad of ways you can find your path into risk management and make it a career. From finance to legal to audit and especially to operations, all these experiences pave part of the way toward success. They are a portion of what risk leaders need most to succeed in this era of a broader more diverse practice of risk management, call it ERM, SRM, IRM or just plain risk management, as I prefer. In fact, a successful risk manager is one who needs a broad exposure to most core functions common to most entities of any complexity. At the end of the day, it’s hard to go wrong in preparing for a risk career, no matter where you spend time getting knowledge about the many sources of exposure that must be “risk managed.”

The California district attorney offices in 22 counties recently filed 171 felony and 28 misdemeanor charges against 187 people for alleged auto fraud involving 40 insurance companies. While these numbers are staggering, the truth is that 49 other states could probably do the same. Insurance fraud is becoming more of a norm than an exception, particularly in the wake of a shaky economy. In fact, 24% of those polled by the Insurance Research Council said it’s acceptable to pad an insurance claim to make up for a deductible, and 18% said it’s okay to pad a claim to make up for premiums paid in the past! In auto insurance, fraud involves several little white lies, including:

1. Falsifying the garaging address
2. Underestimating annual miles driven
3. Omitting some drivers in the household
4. Overstating the extent of damages when filing claims
5. Fudging when and how an accident occurred
6. Forgetting to report changes that may affect applied discounts. According to a 2010 report by Quality Planning, premium leakage cost auto insurers $15.9 billion in 2008. False reporting of vehicle rating factors, including annual mileage and rated territory, accounted for $6.5 billion in lost premium. Driver rating factors, such as unrated operators, accounted for $8.9 billion.

Fortunately, through smartphone-based usage-based insurance (UBI), auto insurers finally have a way to deter and detect fraud, and to recapture a portion of the dollars lost to premium leakage. Here are some reasons:

1. First and foremost, usage-based insurance has a built-in deterrence factor. Those who are more prone to fraudulent activity are least likely to sign up. Therefore, the quality of your policyholder pool naturally improves as a byproduct of UBI.
2. False garaging addresses are easy to detect thanks to the GPS element of a smartphone UBI platform.
3. Annual mileage driven becomes a non-issue because the usage based insurance app periodically communicates with the vehicle’s odometer.
4. Certain smartphone UBI apps develop driver signatures over time and are able to detect when other people are driving by comparing current driving behavior to the normal policyholder driving behavior. This capability could flag the possibility of unreported drivers.
5. Smartphone UBI apps also detect hard braking and sharp cornering events, as well as a vehicle’s geographical location at any given time. This data could be used to corroborate a policyholder’s claim. For example, if a policyholder says a tree limb hit his car in his driveway at 9:09 p.m., but the UBI data shows that the car had a hard braking event that occurred 22 miles away from home at 9:09 p.m. on the date of the reported damage, further investigation may be warranted.

As you calculate the potential costs and returns of usage based insurance, make sure to include the potential impact of fraud reduction in your equation. That figure could be just as important as the new market share you plan to attract.

Waiting on hold. Faxing underwriting forms. Apologizing to customers for insurance-company errors. Sound familiar? Up until now, you and your staff accepted this conduct as the status quo. Your customers did, too. They won’t now! Today’s consumer expects a different experience. She expects to control her interaction with your agency on her terms, 24/7. This change in behavior occurred because of advancements in technology. Propelled by the Web and the computing power of the smartphone, consumers today expect to be able to digitally purchase a policy, make a change to the policy or file a claim. Several forward-thinking carriers anticipated this trend at the turn of the century and started to upgrade their technology platforms. The goal: Speed transaction processing and reduce cost. Many executives complained, however, that the benefits of their technology improvements couldn’t be fully realized because agents refused to improve their technology. Fast forward to today. Because of the advent of cloud computing, agile software development and more powerful processors, agencies can transform their customer experience quickly, at low cost. Leading management systems enable an agency to reconfigure its operations to provide a robust, up-to-date, real-time customer experience. This is one of the greatest advances for the independent agency system in many years. With agile technology and an online presence, successful independents are slowly but surely recapturing market share from less agile captive-agency behemoths. Unfortunately, many agencies encounter a roadblock -- their carriers’ outdated, inflexible systems. This creates a competitive disadvantage for the agency because it detracts from the customer experience. In today’s market, it’s too easy for a customer to switch. Agency owners can no longer put up with a carrier’s antiquated business processes. Remember that point the next time you are looking at two competitively priced quotes from two different insurers. Ask yourself, which one has the best technology interface that leverages your modern agency management system? It’s as important a question today as the commission rate. What You Should Expect From a Carrier’s Technology Platform Customer access: Does your system allow my customers to access your policy processing system from our agency website?

1. Claims filing: Does your first-notice-of-loss system alert my agency by email or text when a customer files a claim? Does your claims system allow my customers to access your first-notice-of-loss process from our agency website?
2. Data analytics: Do you have data analytics tools to allow me to determine the risks to target in my local community?
3. Agency management system integration: Do you interface with my agency management system?
4. Straight-through processing: How much do I have to interface with carrier personnel to issue a policy, make policy changes and adjust a claim?

Since presenting on the topic and writing an article for the Chartered Insurance Institute's' Journal, I've continued to hear a demand for more understanding of Behavioral Economics (BE). It appears the majority of insurers have delegated the challenge of understanding behavioral economics to their risk and pricing teams, and few are engaging actively with their marketing and customer insight teams. I think this is a missed opportunity, not just for better compliance with Financial Conduct Authority (FCA) expectations, but also for the commercial gains to be made from better-designed communications. That said, I suspect the majority of you have at least heard of BE. In recent years, the success of popular books on the subject has ensured plenty of media coverage and social media debate on implications and appropriateness. Easy-to-read books, as introductions to the subject, have included “Nudge” by Richard Thaler and Cass Sunstein. More comprehensive and challenging is a classic text like“Thinking Fast and Slow” by Daniel Kahnemann. Both are well worth reading, and there are now many others to choose from. What makes this subject of greater relevance to the financial services industry is the influence of behavioral economics on the thinking of both the UK government and the FCA. Government policy is being influenced by the work of its “nudge unit.” Meanwhile, the FCA has said that it expects companies to consider how their customers actually make decisions. So what exactly does behavioral economics teach us with regard to how people make decisions? There are numerous experts and many slightly different approaches, but I believe the categorization proposed by the FCA is a good place to start. In its first occasional paper on the subject, the FCA proposed the following list of 10 behavioral biases:

1. Present bias. This is an overvaluing of the present compared with the future. This might be manifest in choices that look like immediate gratification or in ones that look like procrastination. An insurance example might be customers only considering premium cost now, not a full comparison of the cover provided for the future.
2. Reference dependence and loss aversion. Loss aversion can be seen in tests where people will consistently seek to avoid a loss that is certain, even if having to take a gamble or pay more to do so. Reference dependence is the assessing gains or losses in comparison with a subjective reference point. Retailers use this a lot. I’m sure you’ve experienced supermarket product pricing manipulated to make a relatively expensive choice look more mid-market by comparing that choice with higher, “dummy prices.” For an insurance example: Customers might make different decisions if just shown the costs of monthly or annual premiums on a renewal letter, as opposed to seeing a comparison with last year’s premium, as well.
3. Regret and other emotions. Here we are dealing with irrational actions to avoid experiencing such negative emotions in the future. This might involve procrastinating on important decisions, like being checked out by a doctor, or willingness to pay for products that avoid decision making (like premium products promising to cover everything you need). A worrying example for insurers is consumers' unwillingness to engage with a need for life insurance, because of their discomfort with imagining the death of a loved one.
4. Overconfidence. That is, overconfidence about the likelihood of future events or our abilities, or rationalizing past events (with the benefit of hindsight). For instance, almost all drivers believe they are above average. Another example is what’s called the planning fallacy, where most people consistently underestimate how long it will take them to get something done. Within insurance customers, we can see this bias at work in consistent under-estimating of cover needed or assuming an ability to self-insure or financially cope without protection.
5. Over-extrapolation. Here we are dealing with making predictions on the basis of too few data points. A classic example is in the behavior of most investors. Most people will underestimate the level of uncertainty and buy or sell shares on the basis of insufficient data to make a robust forecast. One could say that the same behavior is also exhibited in consumers' use of insurance comparison sites. Undue importance can be given to simply the cheapest price or known brands, to shortcut decision-making time, rather than make a rational comparison of cover, service, recommendations, etc.
6. Projection bias. This is the expectation that your current feelings, attitudes and preferences will continue into the future. So, you underestimate the potential for change. A classic example of this is the effect of the weather on sales of houses and cars. The feel of a house, or looks of a car, on a sunny day is projected into the future and bought without sufficient investigation -- leading to higher sales on sunny days. An insurance example could be seen in the low engagement of the working population with critical illness cover or health insurance, because of a projection of current good health into the future.
7. Mental accounting and narrow framing. This is the behavior whereby people treat money or assets differently according to the purpose assigned to them, and consider such decisions in isolation rather than look at the overall impact. For instance, people not paying off debts while putting funds into savings accounts with lower interest rates. An insurance example is perhaps the estimates made of sum insured, which are more driven by impact on regular premium and budget allocated, rather than purchases made and value of possessions.
8. Framing, salience and limited attention. This means reacting differently to essentially the same choice, because it is presented differently, partly because of limited attention to all but the most salient points. For example, shoppers are more likely to buy meat labelled 75% lean than meat labeled 25% fat. For an insurance example, consider the different responses to financial statements when the same information is simply presented in different ways. Simpler presentation that causes the most important information to be salient can change engagement and action.
9. Decision-making “rules of thumb,” or heuristics. This is the tendency to simplify complex decisions by choosing more familiar, status quo or less ambitious questions instead. An example is where interviewers will choose candidates most like known colleagues or be swayed by stereotypes. For insurance, one sees customers simplifying many decisions in this way, for instance: “Is my pension fund performing well, and do I need to increase my contributions to achieve my goal?” can be simplified to: “Is anything wrong, and do they say I have to do anything now?”
10. Persuasion and social influence. This behavior includes being persuaded because a seller is likable or comes across as a good person. There are examples of people being unduly swayed by apparent social norms, like increases in recycling because local government shares the percentage of others in your area who are recycling. For insurance, the change in consumers assuming that they “should” use comparison sites to shop around, because of an impression that everyone does so now, has been influenced by consistent advertising on TV and other media. It is interesting to see this reflected in customers who make a buying decision first, then find some evidence on a comparison site to justify the choice afterward.

There is much more I could share on BE, but this is a long enough post that I hope you can judge your interest in this topic. Do comment if you'd like to see more on this topic, especially how to apply this theory in practice.

We can know, looking back at last year, how much risk an insurer was exposed to. And we can simply look at the balance sheet to see how much capital they held. So that is the way we have tended to look at solvency. Backwards. Was the insurer solvent at the end of last year? Not really useful information. Unless… Unless you make an assumption about the future. Not an unusual assumption. Just the common assumption that the future will be like the past. That assumption is usually okay. Let’s see. In the past 15 years, it has been correct four or five times. But is that record good enough for solvency work -- a system that might give the right answer a third of the time?! There is a solution. Regulators have led us right up to that solution but haven’t yet dared to say what it is. Perhaps they do not know, or even are not thinking that the backward looking problem has two aspects. We are making two heroic assumptions:

1. We are assuming that the environment will be the same in the near future as it was in the recent past.
2. We are assuming that the company activity will be the same in the near future as it was in the recent past.

The regulatory solution based on these two shaky assumptions is:

1. Stress scenarios
2. A look forward using company plans

Solution 1 can help, but solution 2 can be significantly improved by using the enterprise risk management (ERM) program and risk appetite. You may have noticed that regulators have all said that ERM is very important. And that risk appetite is a very, very important part of ERM. But regulators have never, ever, explained why understanding risk appetite is important. Well, the true answer is that it can be important. It can be the solution to one part of the backward-looking problem. The idea of looking forward with company plans is a step in the right direction.  But only a half step. The full solution is the Full Limits Stress Test. That test looks forward to see how the company will operate based on the risk appetite and limits that management has set. ERM and risk appetite provide a specific vision of how much risk is allowed by management and the board. The plan represents a target, but the risk appetite represents the most risk that the company is willing to take. So the Full Limits Stress Test would involve looking at the company with the assumption that it chooses to take the full amount of risk that the ERM program allows. That can then be combined with the stress scenarios regarding the external environment. Now, the Full Limits Stress Test will only actually use the risk appetite for firms that have a risk appetite and an ERM program that clearly functions to maintain the risk of the firm within the risk appetite. For firms that do not have such a system in place, the Full Limits Stress Test needs to substitute some large amount of growth of risk, because that is what industry experience tells us can happen to a firm that has gone partially or fully out of control with regard to its risk taking. The connection between ERM and solvency becomes very substantial and realistic:

• A firm with a good risk management program and tight limits and overall risk appetite will need the amount of capital that would support the planned functioning of the ERM program. The overall risk appetite will place a limit on the degree to which all individual risk limits can be reached at the same time.
• An otherwise similar firm with a risk management program and loose risk appetite will need to hold more capital.
• A similar firm with individual risk limits but no overall risk appetite will need to hold capital to support activity at the limit for every single risk.
• A firm without a risk management program will need to hold capital to support the risks that history tells us that a firm with uncontrolled growth of risk might take on in a year. A track record of informal control of risk growth cannot be used as a predictor of the range of future performance. (It may be valuable to ask all firms to look at an uncontrolled growth scenario, as well, but firms with a good risk control process will be considered to have prepared for that scenario with their ERM program.)
• A firm without any real discipline of its risk management system will be treated similarly to a firm without an ERM program.

With this Full Limits Stress Test, ERM programs will then be fully and directly connected to solvency in an appropriate manner.