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8 Make-or-Break Rules for Innovation

Following these rules won't guarantee success -- business is a contact sport -- but will help you turn size into an advantage.

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In my last posting, I laid out three reasons for why large companies should out-innovate start-ups to capture the disruptive opportunities that are being enabled by a perfect storm of technological innovations. In this post, I offer eight rules for how they can do so. 

Based on research on thousands of innovation efforts—both successes and failures—that went into The New Killer Apps: How Large Companies Can Out-Innovate Start-Ups, corporate innovators should apply these rules to help their companies get out of their own way and leverage their assets. By doing so, they can take better advantage of innovation opportunities than start-ups can. 

The eight rules fall under three general categories that distinguish winners from losers: Thinking Big, Starting Small and Learning Fast. 

Think Big

Successful innovators “think big” by considering the full range of possible futures. They facilitate innovation by daring to pursue “killer apps”—new products and services that might rewrite the rules of a category. By contrast, failed innovators tend to “think small.” They assume that change will be a slight variant of the present and just look for incrementally faster, better or cheaper innovations. Here are three rules designed to help you think big: 

Rule 1. Context is worth 80 IQ points. As you start to “think big,” you must understand the information-technology environment in which you are operating. Six technological innovations—combining mobile devices, social media, cameras, sensors, the cloud and what we call emergent knowledge—are reshaping both what is possible and the competitive landscape in every information-intensive industry. Mary Meeker, the noted business analyst, argues that these technologies are putting more than $36 trillion in market value up for “reimagination.” ($36 trillion is the total market value of the 10 industries most vulnerable to change over the next few years.) You must understand all the traditional forces inside your industry and come to grips with these six technological megatrends, both individually and in combination. 

Rule 2. Embrace your doomsday scenario. Thinking big is not just about bold aspirations; it also requires understanding the starkest threats facing your organization. One reason to look for doomsday scenarios is that it helps spot vulnerabilities and spark improvements even if doomsday never comes. Another reason is that it helps to build alignment. Getting beyond vague views and developing detailed, shared views of existential threats and how quickly they might arrive can help management teams develop consensus on timing and move forward in unison. But people tend to avoid thinking about truly worst-case scenarios, so this rule is designed to make sure that they do so. 

Rule 3. Start with a clean sheet of paper. A markets change, large companies’ strategic assets too often become liabilities. Success brings with it priorities to juggle, budgets to protect, bonuses to maximize, resources to defend, loyalties to reward, egos to stroke. People have all sorts of incentives in big organizations to slow or halt innovation, and many manage to do so. That’s why it is important to periodically start with a clean sheet of paper and think about key trends and looming inventions, then envision how everything could come together to transform the business—without worrying about what people, capabilities and other assets have to be added or subtracted to become that perfect version of the business. 

Start Small 

Successful companies “start small” after thinking big. Rather than jumping on the bandwagon for one potentially big idea, they break the idea down into smaller pieces for testing and take the time to make sure that key stakeholders are working in unison. By contrast, companies that fail in the face of a disruptive technology tend to swing from complacency to panic. Initially, they not only don’t see the opportunities; they can’t accept that they’re in danger. When they finally see the disruption, they panic. They make a last-chance, massive bet on a single idea—only to have it not pan out. Here are three rules that ensure you are starting small: 

Rule 4. First, let’s kill all the finance guys. To start small, make sure you don’t settle on financial projections too soon; they can’t be accurate, and they hamstring innovation. By definition, disruptive innovations deal with future scenarios that are hard to read and where the right strategy is not clear; the right strategy has to emerge over time. This rule, then, is a reminder to take a more iterative approach to understanding the finances of new businesses. A culture has to be established, beginning at the very top of the organization, that says newborns get to crawl and walk and maybe even start preschool before their talents are evaluated. 

Rule 5. Get everyone on the same page. While the tendency is to leap into action as soon as a possible killer app is identified, it is crucial to take the time to step back, assess where the organization is and identify possible impediments to change. One challenge is to understand who wins and who loses if the envisioned innovations succeed. If an innovation has to kill the core business to succeed, it won’t be possible to get everyone to embrace it. Those in the existing business will always try to kill rather than be killed. In some cases, you can delay an uprising by being discreet. In other cases, where those not on the same page can’t cripple you, you can be overt and simply pit a new business against the existing one (while protecting the new efforts sufficiently). Another challenge is to understand the cultural implications of the desired innovation. Many executives believe they can change a culture to suit a strategy, rather than try to make the strategy fit the culture. That route is possible but usually takes longer than most are willing to admit. Sometimes it is better to work with what you’ve got. The key is to understand that there is no silver bullet to managing change. Instead, you must form a cleared-eye view of the particular circumstances that must be addressed and manage accordingly. Remember Nelson Mandela’s admonition, “Lead from the front but don’t leave your base behind.” 

Rule 6. Build a basket of killer options. Once you are ready to start building killer apps, make sure to invest only small amounts and test a number of possibilities. At the early stages, any fledgling killer app is more likely to fizzle than sizzle. Do not waste a lot of money plunging toward The Answer. What you really want is a finely nuanced understanding of The Question. Do this by employing the discipline associated with financial options. Rather than investing tens or hundreds of millions of dollars to build out a full-fledged business, invest in iterative experiments that can be expanded as they prove out, or be set aside if they don’t. It is important to limit the number of options to a handful. Innovations of transformative potential require CEO attention—which is limited—to make sure the efforts are protected from the organizational antibodies; to make sure they do not take on a life of their own; and, to shepherd them to scale if their potential proves viable. (In most organizations, only the CEO can play this role.) Our experience is that the right number is around three “killer options” and no more than five. 

Learn Fast 

In addition to thinking big and starting small, successful innovators “learn fast.”They take a scientific approach to innovation. They figure out how to gather comprehensive data and quickly analyze both what’s working and what isn’t. They have the institutional discipline to set aside or alter projects based on that analysis. By contrast, companies that fail have neither the time nor the inclination to learn. They fall into the “it’s all about implementation” trap and end up expertly implementing a failed strategy. Here are two rules to make sure you are learning fast. 

Rule 7. A demo is worth a thousand pages of a business plan. Too often, early success or optimism about a big idea quickly transforms it into a conventional business development program: a long march where the only acceptable outcome is to get a product to market. As a result, people do all the analysis they can, however imprecise, and the result becomes The Plan. Some of this is due to habit—planning is what big companies do, and business initiatives can’t typically proceed without detailed business plans and reams of confirming spreadsheets. Our research revealed the need for less planning and more testing. Rather than prematurely building out the new business, keep prototyping to explore key questions, such as whether the technology will work, whether the product concept will meet customer needs and whether customers will prefer it over the competitive alternatives. 

Rule 8. Remember the Devil’s Advocate. Setting up the right process for demos, prototypes and scaling is crucial but only half the battle. The other half is making sure you ask the tough questions during the process and remain open to hearing uncomfortable answers. Devil’s advocates are individuals or groups whose role is to stress test critical assumptions, key forecastsand other make-or-break aspects of a potential killer app. The goal is not to interject an abject naysayer into the decision-making process but rather to drive at the answer that best serves the long-term success of the organization. Nor is the goal to relegate the task of critical thinking to the devil’s advocate. Instead, the devil’s advocate process serves as a safety net, and, because everyone knows that tough questions are forthcoming, they’ll be more likely to confront them. Done right, a devil’s advocate frames the most important questions that need to be answered before moving to the next stage of commitment. The advocate also guides the process along, making sure that the right amount of uncertainty is reduced at each step and that the possibility of a graceful exit is always preserved.  

Following these eight rules won’t guarantee killer-app-level innovation. Business is a contact sport. Some companies win. Some companies lose. That won’t change. What following these rules will do, however, is help you overcome the biggest barriers to innovation and turn size into an advantage. You’ll do a far better job of sensing what’s really going on in your market and of putting yourself at the forefront of the powerful trends that are transforming our economy.

How Internet of Things Puts Industry at Risk

Insurers must stop thinking about protection and must focus on prevention, in a personalized way -- or will leave the market open for outsiders.

To put the  impact of the Internet of Things (IoT) into context, consider industry estimates: By 2020, there will be 8 billion people on earth and 50 billion connected things, with 5 million apps; that means nearly six connected things per person. By 2035, there will be 1 trillion connected things, with 100 million apps. That is powerful! The IoT is so much more than a cool, emerging technology. And it can do so much more than change a process in the business value chain. The IoT is transformative … because it is about fundamentally changing business and revenue models. Companies that are focused on using IoT only in selected areas of the existing insurance value chain will miss one of their biggest opportunities to reimagine the business of insurance. They will put their companies at risk. Why? Because other companies and industries are thinking bigger and including new services and integrated offerings that are made possible by the IoT. Their transformations will potentially change every aspect of insurance. The Internet of Things is rapidly transforming standalone products into complex business solutions that combine or integrate sensors, software, analytics, processors and digital user interfaces into the product, all connected to the Internet. The IoT creates the opportunity to reimagine a product, taking it from what it was to what it could be, redefining the customer experience by providing real-time information, alerts, services and much more. In so doing, the IoT counters the rapid commoditization of products – new products can include integrated, valuable services. As an example, one company that manufactures a “commoditized product” embedded sensors, at the company’s expense. At the time, 100% of the revenue was from selling the product. Today, the company has built services, both independently and with an ecosystem of partners, that use and analyze the data from the product. The result: The product is seen as more valuable; the company is experiencing market-share and revenue growth; the business model is now both manufacturer and service provider; and more than 80% of customers purchase services along with the product. The company's service revenue is now more than 50% of overall revenue. And this was all done in just three years! For insurance, the first foray into the IoT was in telematics, but insurers did so within the historic context of how the insurance product was defined, designed and priced. The added dimension of pricing for miles actually driven differentiated the pay-as-you-drive (PAYD) product. The majority of insurers have followed this approach, missing the bigger and transformational opportunity with IoT! The IoT, whether using telematics or other sensors, has the potential to deliver a plethora of new services that can be purchased by customers, changing the definition of a product and flipping the business and revenue model. Products can go from being risk-protection products to risk-prevention products with embedded services that also provide protection. Our inability as an industry to reimagine our businesses, our products, our services and our entire revenue model is why we will be competitively challenged by other industries … because they already are disrupting historical assumptions and business models. Industries and companies outside of insurance are embracing the IoT at a rapid pace: automotive, manufacturing, retail, communications, healthcare, banking, agriculture, transportation, consumer products, food production and more. These companies are transforming their business and revenue models through new, smart, connected products with embedded IoT sensors that are merging products and services into a new product with new capabilities that redefine the value proposition. These companies are creating profound and personalized customer experiences that strengthen and deepen customer relationships, attract and draw customer loyalties, divert and capture revenue and more. Examples from other industries, and the resulting transformation and innovation of business and revenue models, emphasizes the power and potential of IoT in a number of dimensions:
  • The connectivity of the devices with applications, analytics and services enables healthier, safer and more efficient, effective and enjoyable experiences for businesses and individuals.
  • IoT allows new business models that put the customer in control, enabling personalization of the products and services.
  • It fuels an emerging market shift where the customer will own her data, authorize use and expect something in return for that use.
  • IoT creates the opportunity to create new products, services and solutions and to enhance existing products to strengthen customer insights and loyalty, increase competitiveness, create new revenue options and grow market share.
Because insurance is part of every industry and reaches nearly every individual or business, the insurance industry has the opportunity to be at the center of this IoT revolution. But it will be necessary to flip the business model. Insurance must embrace the transformation from focusing on risk protection to focusing on risk prevention – with protection included in a personalized way. Insurance can become central to collective connectivity -- with the connected car, the connected home, the connected life and the connected world. Remember this quote from Charles Darwin: “It is not the strongest of the species that survives, nor the most intelligent that survives. It is the one that is the most adaptable to change.” Change is coming with a connected world of everything. We can either define the change, or it will be defined for us by those companies and industries rapidly adopting the IoT.  

This article is based on a new SMA research brief: “The Internet of Things: Creating a Connected World – Disrupting and Transforming Business and Revenue Models.”  Click here to learn more about SMA’s research.

Denise Garth

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Denise Garth

Denise Garth is senior vice president, strategic marketing, responsible for leading marketing, industry relations and innovation in support of Majesco's client-centric strategy.

'Agency 2020': Can You Get There? (Part 1)

This diagnostic will help agencies fully critique themselves and prepare for the strange new world that is rushing at us.

It’s been 45 years since astronauts Neil Armstrong and Buzz Aldrin first walked on the moon. “That’s one small step for man, one giant leap for mankind,” Armstrong said. Many consider this to be mankind’s greatest adventure. Today, you should begin planning for the greatest adventure in your agency’s history. Now is the time to prepare for what I call “Agency 2020.” This is your mission: to survive and prosper in tomorrow. It’s a Star Trek mission. Your challenge is to seek out new life (future consumers) and civilizations (niches and affinity groups), to boldly go where no man (or insurance agency) has gone before. This preparation is merely one “small step” to fully critique, improve and prepare your agency today so that it can explore strange new worlds – the global and virtual marketplace – that will be prevalent in 2020. In other words, you need to prepare your organization for the one “giant leap” required for future prosperity. To give you perspective on the world of 2020, consider this statement from a July issue of The Kiplinger Letter: “The next big phase in computerization: connecting all objects of all sorts … buildings, industrial machinery, appliances, medical devices, vehicles, roads, containers, apparel and much more. In an ‘Internet of Things,’ 26 billion objects will communicate with others by 2020 … up from a piddling 1 billion things doing so now.” Other sources suggest even greater connectivity – with some predicting 50 billion or more “things” talking to each other daily. That is seven times what the world’s population in 2020 is predicted to be (7.6 billion people, according to infoplease.com.) That connectivity will be transformational. Everything will be in flux: industries, delivery systems, communications, smart data, products offered and not offered, risks, pricing, value-added services, insurance (healthcare, loss control, underwriting, risk management, safety, etc.), banking and education and even everything about how, what, where and why clients shop and buy. When one thing is different, it’s change. When everything is different, it’s chaos. The year 2020 will have chaos, and in chaos there’s great opportunity. If my first few paragraphs have confused or upset you, don’t worry. We’ve already walked on the moon! Anything is possible. To do great things, you merely need a purpose and a vision, a commitment to both, a plan and the discipline to live the commitment you’ve made. Join us in this exciting five-year mission. Let’s start at square one. As the American businessman and writer Max Depree notes: “The first role of the leader is to define reality.” This article offers a simple process to follow through on Depree’s advice. Questions are asked, and you merely answer them – honestly and completely. Today you are establishing your starting point for your trip to tomorrow. Remember, if you misrepresent on the front end – you will not reach your planned destination. This process will be simple. Some questions are included under each category below. This is an essay test. But it’s essential that you answer as truthfully and as completely as possible! Ask, ponder, challenge, reflect and ask again. 1.         Leadership
  • What is your culture? In other words, what is tolerated? What are your house rules? As the leader, do you control and direct the culture, or does the culture dictate to you? Be honest.
  • What is your reality – i.e., history; financials; SWOT analysis identifying your strengths, weaknesses, opportunities and threats; marketplace presence by way of customers served and carrier relationships; demographics and geography; viability (is yours a Rust Belt or Silicon Valley organization); etc.? Also consider where your world is heading.
  • Is passion or pessimism the rule in your environment? Is your team passionate in what they do? Are clients passionate about what is being done and how you serve them? Do your team members see themselves as victims or victors? Is your team committed to the adventure called tomorrow –  or are individuals looking to jump ship at the first opportunity?
  • Are plans in place for the perpetuation of leadership, key roles, books of business, market niches, offerings, opportunities, relationships, technology, etc.?
2.         Operations
  • Are you low-tech (suicidal), medium-tech (terminal in the long run) or high-tech (viable and vital and the only acceptable option)?
  • Is your team adaptable – willing and able to embrace technology, the virtual world, social media and innovation as it occurs? Do you have a balance of generations – Greatest, Boomer, X, Y and C – and the wisdom and perspective each can offer? Is there balance in your management and operations, or are you fragmented?
  • Are you paperless, client-defined and -driven, connected, tech-committed and -focused, virtual and balanced in the new world of “Tech-Knowledge-Y”? Are you really?
  • Are you “owned” by yesterday and its traditions – office buildings, eight hours at the desk, hierarchy, producer- and product-defined and -driven and based on seniority rules, that family is more important than performance, etc.? Be honest.
3.         Marketing
  • Do you know your customers as individuals, in niches, as parts of an affinity group? Are you willing to serve them as a “niche of one?” Every consumer in 2020 has unlimited options!
  • In your current system, do products and services dictate your focus? Or do the wants and needs of your clients and prospects dictate what products and services you offer?
  • Are you structured based upon Peter Drucker’s 1993 concept of “price-driven costing?” (That is, determining what your customers think a service or product is worth and then designing it accordingly. ) Do you control or influence the price of what you sell? Can your clients afford your product offerings? Are you constantly striving to bring your cost down?
  • As markets innovate and become more competitive, can you profitably deliver what you sell at a price the market is willing to pay? Do you block markets to protect your client or your agency? Do you and your clients have a conflict of interest in the world of “hard” and “soft” markets? Can you retain clients if your offering was quoted net of commission and you had to work on fees, not commissions? Be truthful.
4.         Communications
  • Do you know your clients – their wants, needs, values, expectations and fears? Or do you merely know their purchases? What is important to them? What is their risk-taking tolerance, and what are their available resources?
  • Do you sell products/services/commodities? Or do you facilitate your clients’ buying what they want and need? Are you more focused on closing a transaction or creating a positive experience?
  • Do you have a formal system of client-relationship management? Do you tailor solutions for clients’ problems, or are you merely the checkout counter once they find what they need? Can you anticipate their future needs?
  • As an intermediary between your clients and the marketplace, do you stand closer to the client … or the carrier? Who “owns” you? Are you addicted to existing products, commission streams and delivery models? Or are you willing and able to take “the road less traveled” and find the future as it will be?
(Suggested reading – Unbundling the Corporation, by John Hagel III and Marc Stinger, Harvard Business Review, March-April 1999) This brief inquiry was designed to create “chest pains,” because “chest pains” will often change behavior. This article is not intended to be an all-inclusive study but rather a reality test of your leadership. Are you willing to see your agency and the marketplace as it really  is -- or only as you want it to be? If you don’t get the starting point right, the end game of Agency 2020 is impossible to target accurately. You can’t get there from here! First, test your resolve, your commitment and your discipline. If these are real, go back and answer the above questions more honestly. Future articles will provide a process that will facilitate your “small steps,” or tactics, as well as the “giant leaps,” or strategies, so necessary for success. Subsequent articles will cover:
  • A process for discovery of 2020 as you project it to be
  • How to maximize the efficiency and profitability of your agency today
  • How to answer the one question that is all-important for each stakeholder: What’s in it for me?
  • How to design a blueprint for your Agency 2020 initiative
  • And how to facilitate the transition of all stakeholders from where they are today – to where they are willing and able to be (and must be) tomorrow – whether those stakeholders are inside or outside of your organization
Don’t panic or become discouraged. Remember, we’ve already walked on the moon! Commit to 2020 – and be disciplined to your commitment!  One day you’ll be ready to declare your purpose and vision – your organization’s leadership role and success in 2020!

Mike Manes

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Mike Manes

Mike Manes was branded by Jack Burke as a “Cajun Philosopher.” He self-defines as a storyteller – “a guy with some brain tissue and much more scar tissue.” His organizational and life mantra is Carpe Mañana.

A Bizarre but Common Strategy: Hiring Incompetent Producers

That's what employers do when they decide that all revenue is equally valuable.

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Hiring incompetent producers is apparently the strategy of a group of agency owners who told me that my advice that no producer is better than a bad producer was:
  1. Just wrong
  2. Too harsh
  3. Short-sighted
I have seen some consultants make the same case, so I thought I should have an open mind and reconsider my position. The consultants’ point was that every commission dollar sold is worth (pick a multiple) 1.3 or 1.5 or 2.0 times. That makes every commission dollar a commodity. From the agency owners’ perspective, one way to build value is to put as many commission dollars on the books as possible because the value is same regardless of whether the sales are profitable or unprofitable. The value is not affected by whether the sales are personal lines or commercial, whether the accounts carry more or less E&O risk. All sales carry the same value, in this perspective. Some people will argue I have taken the consultants’ and agency owners’ point too far, but that is impossible. Remember, their point was that poor producers, meaning unprofitable producers, still have enough value to justify keeping them. This means that even if the producers’ sales have a negative 20% profit margin, which is common, the consultants and agency owners believe these sales have the same effective value as books of business with a 20% profit margin. The strategy of adding sales without regard to profitability is quite relevant if the agency can grow fast enough and sell itself quickly enough. More than one such flip has made an agency owner wealthy. The key is how long the producer is with the agency before the sale. Let’s say that at the end of five years a producer has generated $150,000 of commissions. The profit on this book is (using industry standards for agencies with $1 million to $2 million in revenue): incompetent   This excludes all administrative wages such as the bookkeeper, receptionist, claims and so forth. It excludes ANY owner compensation. It understates the CSR compensation, too, because the average commercial CSR makes much more than $35,000. If we include these real additional expenses proportionately, this book likely is still losing money in the fifth year, anywhere from $10,000 to $30,000. Losses in the prior years were even greater as the book was built. Over five years, then, the agency has likely lost between $75,000 and $150,000 net. Using $75,000 and a one-times multiple and an agency sale in year five, the agency still nets $75,000 (($150,000 times 1.0) - $75,000) = $75,000. But if the agency hangs on too long or the five-year loss is too great, this strategy fizzles. So to make this work financially, the agency owner has to have a firm and fast exit plan. Why not hire quality producers initially? Then the agency gets profit and value simultaneously. Besides, who in their right mind would pay the same multiple for an unprofitable book as for a profitable book? Let’s use an EBITDA example. If the profit is $25,000 and the EBITDA multiple is six, then the value is $150,000. What is the value of a book with a loss of $25,000 and a multiple of six times? Why would someone pay the same multiple for a low-profit book as for a high-profit book? Maybe the thought is that books all average out. But why do they have to average out? A poor producer cannot take an entire book, even most of a book, with him if fired. If the producers were so good, they would not have been fired. So agency owners can eliminate unprofitable producers and reassign their books to staff or other producers at lower commission rates, which is common when books are transferred between producers. This is a key secret to the success some serial acquirers have achieved. They completely understand that poor producers are unnecessary so when they buy, they fire and they keep the business but make it profitable. Even if 20% is lost, that is 20% losing money vs. 80% making money. I truly feel for agency owners struggling to find quality producers. If it was easy, everyone would do it. Is hiring poor producers really the solution, though? My experience, and I’ve seen the hard data, is that when agency owners properly prepare their agencies for finding quality producers, use the right interviewing tools and tests and create a quality development/management plan, successful hire percentages quadruple. All the work -- and it is a lot of work --  is before the hire, and, given all that agency owners already have to do, finding the time and energy for this key element is not so easy, but it is essential if the goal is to truly build profit and value.

Chris Burand

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Chris Burand

Chris Burand is president and owner of Burand & Associates, LLC, a management consulting firm specializing in the property-casualty insurance industry. He is recognized as a leading consultant for agency valuations and is one of very few consultants with a certification in business appraisal.

New Confusion on ACA and Healthcare Reform

Customers are making choices, and insurers are in the middle of getting rates approved. The time for Congress to act is now.

Recent events have added a layer of confusion for healthcare reform that needs to be resolved now. The already confusing Affordable Care Act, with its massive regulations, reached a new tipping point as two separate federal appeals courts made contradictory rulings regarding federal subsidies for lower-income enrollees.  One ruled that a strict interpretation of the law limited subsidies to those states running their own exchanges, while the other indicated that the law would also apply in those states using only the federal exchange. The conflicting rulings raise a very important issue for the many hundreds of thousands of people who have made insurance decisions in the affected states, relying on what they have been told. Individuals in one of the specified lower- income categories were told they would receive subsidies from the federal government. They reviewed their options and made specific choices based on the information they received and, without some clarification by the courts or Congress, are having the proverbial rug ripped from under their feet. Will there be a subsidy or not? Insurance companies and health plans are in the middle of getting rates approved under the assumption that certain people will be there to sign up for the rates. If the underlying population group radically changes, rates will not reflect who is signing up. The lack of a subsidy will drive up the cost to each individual, making insurance unaffordable. This is unacceptable no matter what side of the aisle you’re on. Someone has to step in quickly and resolve this issue. If there was ever a time to act in Washington, DC, this is the time. Either there are subsidies for all Americans, no matter what state they live in, or there should be no subsidies for any. This is a broad entitlement issue, not a political issue.  Many of the states that didn’t establish state-run exchanges (and, thus, may lose access to subsidies) are “red” states, so any financial blow will fall disproportionately on conservatives. Democrats, meanwhile, want the president’s signature legislation to succeed. So, both sides have a significant reason for prompt resolution.  Let’s get to it.

David Axene

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David Axene

David Axene started Axene Health Partners in 2003 after a successful career at Ernst & Young and Milliman & Robertson. He is an internationally recognized health consultant and is recognized as a strategist and thought leader in the insurance industry.

Looming Problems for Insurance in California

The author, the Republican candidate for insurance commissioner in 2014, sees numerous risks, especially for health insurance.

The dust is settling on the first round of Obamacare, but the radical changes to our insurance markets and healthcare are far from over. In the years ahead, the California insurance market runs the risk of having less competition, with fewer products and higher prices that shortchange consumers, unless we change direction soon. For a foreshadowing, look no further than Covered California, the health insurance exchange set up by the state to administer Affordable Care Act (ACA) plans. Covered California celebrated the news that 1.4 million Californians signed up for new health insurance plans through the exchange, but this number is likely vastly inflated, considering what will certainly be duplication in signups and customers who will default on their premiums. Covered California conveniently left out the fact that it canceled nearly a million plans even though the president himself - the Obama in Obamacare - told states they didn't need to cancel plans to be in compliance. The exchange’s decision left helpless consumers scrambling to find plans in the wake of the unnecessary and harmful decision. Nine million Californians might lose their plans next year when the ACA mandates affect employer-sponsored insurance. That number might even be higher. I won't see Covered California trample on these millions of families like it did with the million individual-market consumers. That's why I sued the exchange, to stop it from overstepping its authority and pulling the health insurance rug out from underneath a quarter of the state. My suit also takes dead aim at the reckless spending and waste at Covered California. The exchange infamously squandered nearly $1.4 million on a video of '80s fitness sideshow Richard Simmons prancing around on a stage with a contortionist in an attempt to reach out to millennials. I wish I was making this up, but I'm not. That $1.4 million is more than many Californians will make in a lifetime of work. The exchange, only four years old, already projects a $78 million deficit in 2015/16 and more than $30 million the next year. Politicians can't sit back and watch this happen. Without intervention, Covered California could come to the state’s general fund to bail it out or raise the monthly surcharge on health insurance plans so high that it will discourage people from buying insurance in the first place. Obamacare has valuable components, such as the coverage for pre-existing conditions, but under the costly and ineffective administration of Covered California it veers toward disaster. Meanwhile, attempts to amend California’s Medical Injury Compensation Reform Act, passed in 1975, could raise the liability limits for doctors. This would drive up insurance costs above even the inflated ACA-compliant plan costs and choke off the supply of medical care in the state, as doctors leave or limit the scope of their practices to manage their higher exposure. Even worse, a proposition on the ballot in California this fall would give the Department of Insurance (DOI) authority over increases in health insurance plan rates. This may sound good for consumers, but it's just the opposite.  As with any other product, it's competition - not government control - that drives down prices. Under this insurance commissioner, the DOI has hardly been the consumer's friend. The DOI already pressured Anthem Blue Cross, one of the state's largest health insurance providers, out of one critical state insurance market, leaving families with fewer choices to meet their healthcare needs. DOI is also slow to approve rate decreases that would benefit consumers. Rate decrease applications take between four and 12 months, leaving ratepayers hung out to dry while the bureaucratic process grinds on. Approvals of new products are slow to non-existent, meaning that Californians are robbed of advances that people in every other state use to protect themselves, their families and businesses, all while saving money. Putting this DOI in charge of health insurance would be a death blow to innovation and competition, leading to higher costs for everyone. This is a wild time in insurance in California, and Californians need an advocate fighting for them, now and in the future. With the right ideas and right leadership, California can enjoy a future every bit as great as its past.

Ted Gaines

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Ted Gaines

Ted Gaines is a state senator in California and the Republican candidate for insurance commissioner in November 2014. He serves as the chair of the Senate Republican Caucus, as well as vice chair of the Senate Insurance Committee. Ted served in the state assembly, where he was a member of the rules committee.

It's Time to Revisit Payroll Calculations Used in Work Comp

A simple change would resolve a major conflict concerning bonuses.

For as long as anyone can remember, the basic method for calculating workers’ compensation premiums is RATE x PAYROLL x EXPERIENCE MOD. Rates vary based on job classification codes (which is much more complicated than it sounds), and the experience mod is based on prior losses. This is how premiums have been calculated for years. This method inevitably leads to a payroll audit at the end of the policy term to determine whether any audit premium is owed. This issue can lead to conflict between the carrier and the policyholder. One reason there is so much conflict is because of how “payroll” is defined by the rating agencies (NCCI, WCIRB, etc.). Actual wages paid to your employees are easy to define. But “payroll” goes beyond wages. There is some variation by state but, for the most part, “payroll” used to calculate workers’ compensation premiums includes things like vacation pay, holiday pay, bonuses (including stock), sick pay, auto allowances and commissions. The list is very extensive. An area of much contention right now relates to the inclusion of bonuses. Bonuses in the form of cash or stock are both treated as payroll. But I have frequently heard complaints from employers who were upset because they received a large premium audit bill because of these bonuses. Employers argue that these bonuses usually do not increase carriers’ claim exposures. Each state has a maximum indemnity benefit rate, with the highest being around $1,000 a week. That means that, if an employee earned wages of more than $80,000 a year, there is no impact on his benefit rate if he has a workers’ compensation claim. So a bonus would have no material impact on the claims exposure for a carrier. The problem arises because the payroll rules are outdated based on the reality of the U.S. workforce today. It used to be that only the top executives in companies received substantial bonuses. The payroll rules in every state include caps for the directors and officers of companies for this very reason: the recognition that their higher wages did not increase the carrier’s exposures. However, we are no longer a country where the majority of our workforce is in the manufacturing industry. A significant percentage of the workforce is now in highly skilled “white collar” jobs. More and more companies are using bonuses to assist in retaining their skilled workforce. Companies are making these benefits available to a wide segment of their workforce, far beyond the directors and officers who were considered in the rules for calculating workers’ compensation premium based on payroll. The solution to this is relatively simple – extend to all employees the director/officer payroll caps used in calculating premiums. Nevada has done this for several years. Implementing this change would not be overly complex, as these payroll caps and the methods for calculating them are already in place. This issue is currently being discussed by the NCCI Underwriting Committee. If NCCI were to recommend such a change, I would expect it would be quickly adopted by both NCCI states and the independent bureau states. Would these changes result in lower premiums for employees? Perhaps for some employers, it could. But other employers could see higher premiums as carriers adjust their rates to ensure adequate premiums are being collected. The workers’ compensation industry’s combined ratios have been more than 100% for a number of years. Because of this, carriers have to be cognizant of the impact any changes in premiums would have on their surplus. As workers’ compensation continues to evolve, we must constantly review the rules and regulations governing the industry to ensure they are still appropriate. Perhaps it is time to review one of the most basic issues, the method of calculating premiums.

EEOC Suit Against CVS Raises Concerns

Provisions commonly used in settlements with terminated employees are being seen as gag orders and are now open to challenge.

The Equal Employment Opportunity Commission has challenged the legality of provisions commonly included in severance, separation or other settlements with employees being terminated. These provisions state that settlement benefits are to be paid only if the employee doesn’t file charges or otherwise communicate with the EEOC. Employers planning to use such provisions should note a lawsuit filed by the EEOC against the nation's largest integrated provider of prescriptions and health-related services, CVS Pharmacy. In Equal Employment Opportunity Commission v. CVS Pharmacy, Inc., CA no. 14-cv-863 (N.D. Ill., 2014), the EEOC charges that CVS unlawfully violated employees' right to communicate with the EEOC and file discrimination charges. The EEOC says CVS committed the violation through an overly broad severance agreement that included five pages of small print. The lawsuit claims CVS violated Section 707 of Title VII of the Civil Rights Act of 1964, which prohibits employer conduct that constitutes resistance to the rights protected by Title VII. The lawsuit also is notable because it is not filed in response to an investigation of a discrimination charge. According to the EEOC, Section 707 permits the agency to seek immediate relief without the same pre-suit administrative process that is required under Section 706 of Title VII, and does not require that the agency's suit arise from a discrimination charge. "Charges and communication with employees play a critical role in the EEOC's enforcement process because they inform the agency of employer practices that might violate the law," according to the EEOC attorney leading the litigation, John C. Hendrickson. "For this reason, the right to communicate with the EEOC is a right that is protected by federal law. When an employer attempts to limit that communication, the employer effectively is attempting to buy employee silence about potential violations of the law. Put simply, that is a deal that employers cannot lawfully make." EEOC District Director Jack Rowe added, "The agency's most recent strategic enforcement plan identified 'preserving access to the legal system' as one of the EEOC's six strategic enforcement priorities. That was no accident. The importance of employees' ability to participate in the agency's process, free from fear of adverse consequences, cannot be overstated. It is always difficult for an employee to report employer discrimination to federal law enforcement officials. Anything that makes that communication harder increases the risk that discrimination will go unremedied." The litigation showcases the need for employers to use caution when attempting to prevent employees from reporting to or cooperating with regulators investigating suspected discrimination or other legal violations. The EEOC’s challenge in the CVS litigation is not unique. Challenges have arisen under a wide range of federal and state laws. The Labor Department Wage and Hour Division has rules that say employers will receive no shield from investigations by the agency or from enforcement of wage and hour laws on settlements with terminated employees that didn’t involve the division. The Justice Department and other government enforcement agencies often view confidentiality provisions as prohibited obstruction or retaliation. In addition, government investigators often view the existence of gag rules as evidence that an organization does not maintain the required culture of compliance. The CVS litigation also cautions businesses against taking for granted the appropriateness of their current agreements with employees. The EEOC challenge is just one of several developments that can affect the design and use of severance, separation and other settlement agreements with employees intended to resolve employment discrimination claims. While many employers may assume they can safely use agreements used in connection with previous terminations, the CVS litigation highlights the potential advisability of seeking the advice of qualified legal counsel, even if the employer benefited from the advice of legal counsel in drafting the previous agreement.

Cynthia Marcotte Stamer

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Cynthia Marcotte Stamer

Cynthia Marcotte Stamer is board-certified in labor and employment law by the Texas Board of Legal Specialization, recognized as a top healthcare, labor and employment and ERISA/employee benefits lawyer for her decades of experience.

Bitcoin Is Here to Stay and Will Transform Payment Systems

The question is how to regulate enough to protect consumers while not stifling innovation.

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Since the digital currency known as Bitcoin came on the scene in 2009, much has been written about it, both good and bad.  However, it seems clear that Bitcoin's underlying “protocol” has the potential to transform the global payments system. Entrepreneurs are flocking to the Bitcoin protocol. Private equity and venture capital, most notably in Silicon Valley, have also begun to make substantial investments in the technology. The technology for "crypto-currencies" like Bitcoin may hold particular promise for opening up the financial system to the masses of individuals in the world’s poorest countries, the majority of whom do not have access to bank accounts. The technology also has implications far beyond the financial system and could have fundamental impact on voting, legal contracts and real estate transactions, to name just a few. A debate is raging over whether Bitcoin should be regulated, and, if so, how far regulation should go, to minimize any dangers while not suppressing innovation as Bitcoin develops out of its “infancy.” Several events have galvanized those in favor of more robust regulation. In October 2013, the FBI arrested Ross Ulbricht, a.k.a. “Dred Pirate Roberts,” who is alleged to have been the mastermind behind Silk Road, a website that was devoted to selling illegal drugs and other illicit items and services. The sole medium of exchange on Silk Road: Bitcoin. In January 2014, Charlie Shrem, a well-known member of the Bitcoin community and the CEO of BitInstant, one of the best-known and largest Bitcoin exchanges at the time, was arrested on money-laundering charges. Then, Mt. Gox, a Tokyo-based digital currency exchange, collapsed, and the loss of millions of dollars of customer Bitcoins spread through the news like wildfire. Taken together, these events have caused many fraud prevention professionals working in law enforcement, regulatory agencies, compliance departments and other institutions where digital currencies could conceivably be an issue to eye Bitcoin and other “alternative” currencies with a healthy dose of skepticism. In spite of these events, Bitcoin has been gaining support commercially among merchants and retailers. The Sacramento Kings of the National Basketball Association, the Chicago Sun-Times and Overstock.com, among others, now accept Bitcoins as a method of payment. Thousands of small businesses scattered across the U.S., with notable concentrations in San Francisco and New York, also are accepting Bitcoins. Because Bitcoin is a disruptive technology, there were no real applicable regulatory or enforcement mechanisms in place when Bitcoin came into existence in 2009. The nature of the Bitcoin protocol is such that regulations already in existence, in most cases, could not be easily adapted. The exchange, transmission, trade, securitization and commoditization of Bitcoins all have regulatory implications. Regulators are rightly concerned about such issues as consumer protection, anti-money laundering/countering the financing of terrorism, fraud prevention and other important issues.  However, because of Bitcoin’s disruptive nature, the application of existing regulations often places Bitcoin in a regulatory “gray zone.” In March 2013, the U.S. Financial Crimes Enforcement Network, known as FinCEN, issued guidance that characterized Bitcoin exchanges in such a way that they must register with FinCEN and follow the Bank Secrecy Act’s (BSA) anti-money laundering (AML) regulations. Exchanges also must develop bank-level AML and Know Your Customer compliance standards for their businesses. In July 2014, the New York Department of Financial Services (NYDFS) issued proposed regulations regarding “virtual currencies.” The proposal has entered a 45-day comment period. The proposal would require companies involved in virtual currency business activities to have in place policies and procedures designed to mitigate the risks of money laundering, funding terrorists, fraud and cyber attacks. At the same time, the regulations seek to impose privacy and information security safeguards on companies operating in this environment. As the country’s leading financial center, New York has taken the lead in proposing regulations that seek to balance the need for anti-money laundering, fraud prevention and consumer protection safeguards against the desire to promote innovation within the nascent digital currency industry. Though it is unclear whether the proposed regulations achieve these ends, it might be argued that these regulations are preferable to a regulatory vacuum that leaves industry insiders and investors with more questions than answers. However, the danger of overregulation is that it could drive away legitimate industry actors and the innovation that would follow. Absent investment and innovation in the industry, the technology is largely left in the hands of those who wish to exploit it for nefarious purposes. Only time will tell. KEY TAKEAWAYS 1)  Digital currency technology is here to stay, and overregulation could stifle investment and innovation in the industry, leaving the technology in the hands of those who wish to exploit it for nefarious purposes. 2)   Bitcoin technology is still in its infancy, and venture capital and private equity elements are beginning to show real interest in the technology’s exciting potential to transform certain business practices across a wide range industries. 3)  Regulatory agencies have only recently begun to take notice of the potential issues that this disruptive technology presents.

David Long

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David Long

David M. Long is the principal of Northern California Fraud Prevention Solutions (NCFPS), a digital currency anti-money laundering and fraud prevention consultancy. David serves as assistant professor of criminal justice and legal studies at Brandman University, affiliated with Chapman University.

Splitting California Into 6 States? Crazy

Among the issues not addressed by the 2016 ballot proposition is how to handle the state's highly complex workers' comp system.

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If a million people say a foolish thing, it is still a foolish thing. Anatole France Maybe that quote should be, “If 1.3 million people. . . . “ That’s because Tim Draper, having spent $5 million, secured 1.3 million signatures and put a measure on the 2016 California ballot that would split the Golden State into six states. Calling himself the “risk master,” the 56-year-old, billionaire tech investor expresses his quirky desire to “reboot and refresh our state government” by creating separate areas that would be more governable – think “Hunger Games.” California is the largest state by population, with 38 million people (12% of the U.S.’s total of 316 million), and third largest by area behind Alaska and Texas. It is the world’s 8th-largest economy. If Draper’s measure were approved, the new state of Silicon Valley would be the wealthiest in the country. Central California would be the poorest. No state has been created from an existing one since West Virginia split from Virginia in 1863. But California has had at least 30 serious proposals to divide it into multiple states since its statehood in 1850, including a proposal passed by the state senate in 1965 to divide California into two states with the boundary at the Tehachapi Mountains, near Bakersfield. In 1992, the state assembly passed a bill to allow a referendum to partition California into three states: North, Central and South. Pundits referred to these proposed states as Log Land, Fog Land and Smog Land. It is said that the area of the state adjacent to Oregon, long known by the fiercely independent locals as Jefferson State, produces 60% of the U.S. marijuana crop. Three years ago, ex-Google engineer-turned-political-economist Patri Friedman came up with a goofy proposal to build his own floating libertarian nation 12 miles off the coast of California – Googleland? Assuming the current state legislature and Congress both approve of Draper’s nonsensical measure, the area we currently call California would have 12 senators in Congress, not two. As much as Texans like their beer, I’m not sure they’d like to see California get a six-pack of senators. Among the serious repercussions that Draper fails to address are vital state infrastructure issues. These include water distribution, transportation systems, state prisons, the University of California system of 10 campuses and two national laboratories – and the largest and most progressive workers’ compensation system in the country. Workers’ compensation laws in the U.S. are promulgated on a state-by-state basis. Besides a myriad of workers’ compensation laws, each state’s bureaucracy must produce and enforce a plethora of complex regulations, licensing procedures, collateralization requirements and other rules. States have choices to make about self-insurance, including about workers’ comp pools of smaller employers. Perhaps one or more of the new six California states would be monopolistic – where workers’ compensation coverage is purchased through the state (as in North Dakota, Ohio, Washington and Ohio). Another possibility is an “opt-out” program (as in Texas, Oklahoma and Tennessee) that allows employers to litigate injuries in the civil system, as an alternative to the “exclusive remedy” system. As if this weren’t enough to be concerned about, the legacy of the current active California workers’ compensation claims would be an issue. Three key institutions were created by the state legislature and are operated like private companies: the State Compensation Insurance Fund (SCIF); the California Insurance Guaranty Fund (CIGA); and the Self-Insurers’ Security Fund (SISF). SCIF is the state’s largest workers’ comp insurer and provides an insurance alternative to those companies doing business in California that are unable or unwilling to: (1) purchase workers’ compensation coverage from private competitive insurance carriers, or (2) self-insure. CIGA provides insolvency insurance for property casualty insurers admitted to doing business in the state. SISF provides protection to the state and taxpayers for non-public, self-insured entities by taking over workers’ compensation obligations from entities that have defaulted (79 since its formation in 1984). These three entities combined cover billions of dollars of known and incurred but not reported (IBNR) workers’ compensation with open claims going back as far as World War II. Their combined assets total in the billions. How would those three entities be broken up into six pieces and reestablished?

Jeff Pettegrew

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Jeff Pettegrew

As a renown workers’ compensation expert and industry thought leader for 40 years, Jeff Pettegrew seeks to promote and improve understanding of the advantages of the unique Texas alternative injury benefit plan through active engagement with industry and news media as well as social media.