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P&C Has a Problem With Classification

The commercial property and casualty (P&C) insurance industry has a classification problem. The overlapping use of standard industrial codes (SIC), Insurance Services Office (ISO), National Council on Compensation Insurance (NCCI), North American Industry Classification System (NAICS) and a dozen or so other carrier-imagined coding systems are creating a growing number of problems for insurance companies and agents alike. Ambiguity, misuse, line of business (LOB) specificity, misunderstanding and straight-up miscategorization leads to missed sales opportunities, higher underwriting costs and unexpected exposure to risk down the road. It’s time for the industry to examine risk categorization and take a fresh shot at solving the classification problem.

The problem is, many of the fundamental issues stem from limitations of the underlying classification systems themselves.

Dude, SIC

Standard Industrial Classification (SIC) is like the mainframe computer of classification systems. Wildly out of sync with the modern world, it somehow is still extraordinarily prevalent in the wonderful world of insurance. SIC was first established in the 1930s as a way for government agencies to speak the same language with one another. Obviously, American businesses of the ’30s, ’40s, ’50s and ’60s looked very different than the business of today. SIC was developed mostly as a taxonomy for an industrial economy. Attempt to look up the SIC for web developers, for example, and you won’t find it. Many other modern businesses are also missing, because the SIC system itself was retired in 1997. SIC includes broad classifications and generalities, which are largely too unspecific to be of much use in classifying risk. Consider a fairly common code: 5812: Eating Places. Naturally, one would think immediately of “restaurants,” right? Unfortunately, that code also encapsulates industrial feeding, dinner theaters and sports arena concessions. While many insurers would likely write the GL on a restaurant down the street, few would be inclined to touch industrial feeding (whatever that is). What’s good about SIC is that it’s insurance agnostic and has applicability to all lines of business. What’s bad about SIC is that it’s too broad and, perhaps even more of a deal breaker, it stopped being updated two decades ago.

See also: Future of Securities Class Actions  

The Last DJ

There’s a line in a song by Tom Petty & the Heartbreakers that wonders, “the boys upstairs want to see how much you’ll pay for what you used to get for free.” This comes to mind anytime anyone advocates for a proprietary classification system. Setting aside the often-high licensing cost, these schemes are also almost always hardwired to the insurance industry, often because they have roots in rating. There are at least two significant consequences to this hardwiring. First, it creates a user experience challenge. This manifests itself to the policyholder, be it on an insurance form or a website. For an industry outsider, categorizing a business using an insurance code is just plain hard. This user experience deficiency also extends to the agent or CSR who must first be trained in the codes themselves before being able to begin to apply them. Second, and of increasing consequence, these values are not found in publicly available data. As insurers and intermediaries continue to integrate with any and all available public data to improve underwriting and reduce sales friction, proprietary, industry-specific classification is always something that will have to be derived after the fact, creating an exposure for error. With the continued use of proprietary classification schemes, industry participants are paying a bundle to speak a language that’s foreign to the rest of the economy.

LOB-Specific Systems

Workers’ compensation (workers’ comp) is perhaps the best example of a LOB with a classification system developed for pricing. Workers’ comp codes are exceptional for pricing workers’ comp. These codes do the job perfectly, but a coding system designed to attribute premium to payroll classes is not the same thing as a classification system to categorize the aggregate risk associated with the operation of the business. As an example, any insurer that has ever written workers’ comp will know that two of the top “classes” are clerical and outside sales. But what does that business with those exposures actually do? Is a business with clerical exposure an office full of desk workers, or is it a couple of managers at an industrial chemicals factory? The problem with workers’ comp codes, in particular, is that they describe what specific employees at the business do, not what the business itself does in the big picture. Expressing risk appetite is challenging, if not impossible, using payroll codes as a basis, and it’s difficult to convert these codes into eligibility for other LOBs for cross-selling other lines. A higher-level description of what the business actually does is required for portfolio underwriting — payroll codes are not sufficient.

The case for NAICS

NAICS is provided for free by the U.S. Census Bureau. NAICS classification provides very detailed descriptions of what it is that the business actually does, and, thusly, what exposures come with its operation. NAICS replaced SIC in the late ‘90s. In terms of detail, SIC codes are like on old tube TV, and NAICS is like a 4K flat panel. This high-definition classification has been updated to reflect the service economy and has a much lower level of detail describing exactly what a business does. The eating places conundrum discussed earlier in the context of SIC is a great example. With NAICS, it’s actually possible to code the restaurant down the street differently than a snack vendor at a stadium. As an insurer responsible for underwriting such risks, a high-definition description of the business operations is tremendously useful for pricing and underwriting. Clearly, not all eating places have the same exposures, so NAICS is a fantastic way for commercial insurers to express appetite. (Cafes, yes. Dinner theaters, no.) NAICS is also updated on a five-year rotation, most recently in 2017. Each revision builds on the last, incorporating new and emerging business types. Furthering the case for NAICS, the U.S. government has incorporated it as the go-to system for business classification, meaning that publicly-available data sources can and do provide these codes.

See also: Chatbots and the Future of Interaction  

A Call for Class Action

Adoption of NAICS as as a standard for commercial P&C risk classification benefits the industry in all phases of the policy life-cycle — from reducing friction in how products are distributed; to reducing exposure to mis-categorized risk; and to enabling portfolio underwriting, all while supporting the new businesses being created in the modern economy. It’s long past time we all got on the same page.

Commercial Lines: Best Is Yet to Come

The personal lines segment of the property and casualty (P&C) industry has been the golden child of late, having exhibited a willingness and apparent propensity for the adoption of new tech. While personal lines may be the first that place new technology has gained a foothold in the insurance industry, it is hardly where the real potential is hiding.

In contrast to personal lines, which has historically been the industry’s “volume game,” commercial lines remains a segment where high degrees of expertise and specialization allow insurers and brokers to carve out very specific and profitable niches in the market, making the definition of the best risks necessarily relative. The specificity of commercial lines business is precisely why these insurers are poised to become the beneficiaries of new tech driving efficiency gains up and down the value chain.

See also: Innovation: ‘Where Do We Start?’  

Right now, insurance companies are entertaining new ideas about what to cover, how to cover it and how to most effectively bring commercial insurance products to policyholders. In an era inundated by new tech, the bests ways for commercial lines insurers to identify, compete for and win the right to write the best risks include investing in solutions and partners that enable better communication, better products and significantly better distribution.

Better Communication

Within commercial lines, there’s a high degree of variation between how things get done depending on the characteristics of the risk (e.g., exposures, premium size, geography, etc.). The universal truth, however, is that there is a big market opportunity for technology to improve communication and collaboration between underwriters, brokers and policyholders. Insurance policies in general, and complex commercial policies in particular, take too long to write, require too much back-and-forth between brokers and underwriters and let too many premium dollars fall through the cracks due to inability to quickly close a customer.

What is perhaps saddest about the current state of affairs is that the breakdown in communication begins at the start of the sales process. A recent survey from Channel Harvest Research revealed that brokers wish insurers would put greater emphasis on what the company is willing to write. Commercial lines agents often invest significant data entry time on applications or key information into an insurer portal only to be declined due to underwriting ineligibility. One could easily equate such a situation to Amazon asking customers to submit an onerous, multi-page order form for something before revealing whether the product is even available.

Despite this kind of situation having been normalized in the insurance industry, it is also an area where new technology is already making a positive impact in typical insurance processes. The essential first step for any commercial insurer to get a look at the best or most desired risks is to clearly articulate the company-specific definition of the best risks. While this may seem almost oxymoronic, commercial insurers must be able to clearly define and communicate niches and specialties, so that business partners and channels know instantly what is within the company’s wheelhouse without wasting underwriting time with ineligible or undesirable risks.

Better Product

It seems safe to assume that no one responsible for the regulatory aspects of insurance product approval or filing has ever been heard saying “Boy, that was easy!” Regulatory complexities, to make matters worse, can be compounded when an insurer attempts to design and bring to market a non-standard product.

New insurtech entrants are doing everything from automating and managing the filing process with the multiplicity of state insurance divisions to providing artificial intelligence (AI) to identify like contract clauses that can be brought to bear when designing product. Because insurance is responsible for producing an astounding amount of legalese, taking collective advantage of it just makes good sense, doesn’t it? Thanks to insurtech, it’s increasingly possible to automate the development of contract language and manage getting it filed with insurance departments with almost Turbo Tax-like efficiency, helping insurers laser-focus on emerging market opportunities instead of on creating more legalese.

Better Distribution

In the age of the internet, too often there’s a rush to judgment that improving distribution means taking a product online or cutting out brokers and going direct. The truth is that better distribution is smarter, more targeted distribution that puts the buying decision in front of the potential policyholder at exactly the moment insurance is needed for something (and often this requires a broker, especially as you move up market).

See also: Insurtech Is Ignoring 2/3 of Opportunity

Some commercial insurers are finally starting to realize the thinking that every match must be a “home game,” and that distribution and underwriting (the sales process) must happen on a company website or portal, is hopelessly outmoded. Insurers today are delivering APIs to distribution partners, thereby empowering partners to create a native rate/quote/bind experience specific to the channel. Why can’t workers’ comp be sold directly in a payroll app? Why can’t a liability policy be issued directly from drone controller software? Why can’t a policy be endorsed at the time new equipment is procured? Why can’t a cyber policy be issued commensurate with the sign-up for AWS or GCP or Azure? There’s easily as much opportunity, if not more, to sell insurance at the point-of-sale (PoS) in commercial lines as the personal segment. By identifying the right buying trigger, insurers can tap into a supply line of the best risks.

Conclusion

At the end of the day, the definition of the “best” risks varies from one commercial lines insurance company to another, but ultimately, the best risks are those each company individually determines are a good fit for the company strategically. Figure out what best means to your company, clearly articulate your definition of best to the world, tailor product to cover the niche and sell the heck out of it.