A great deal of activity is underway by insurers investigating or implementing new distribution channels. For every line of business across P&C, there are compelling reasons to expand distribution beyond the tried and true channels. This is not to say that agent/broker channels or the direct distribution models are less important or going away. It is more about reaching new segments, addressing new customer expectations and meeting customers at their point of need.
There are two important dimensions to the strategies: 1) determining the right mix of channels for each company, and 2) managing those channels, including any related channel conflict. SMA addresses these two dimensions in a new research report, P&C Distribution R(evolution): Blending Old and New Models.
Determining the Right Mix of Channels
Depending on how you count, there are at least eight different models for distribution in P&C, and variations within each of those. There are the models most in use today – captive agents, independent agents and brokers, MGAs and, in some segments, the direct model (call center/web). Then there are those that have been around for a while but are experiencing a surge in interest, such as selling through affinity groups or bundling insurance with the product to be insured. Even worksite marketing, which has been primarily the province of voluntary benefits and life/health, is an option for P&C distribution.
Now, introduce some of the digital age models like the creation of a digital brand or selling through emerging ecosystems like smart homes or connected vehicles. And, of course, there are many insurtech distribution players now in the mix, either in the form of digital agents or MGAs, new digital brands or new affinity or ecosystem partnerships. As with many strategy options in the digital age, there is no shortage of choices. More than ever, the key is to take an outside-in view to identify more discrete customer segments, the risks unique to those segments, and the best channel to reach those customers with products that serve their needs.
Some insurers will stick with one primary channel and work to strengthen the relationships and the technology capabilities supporting that channel. However, many are expanding by offering new channel options. When this occurs, there is often an issue of channel conflict, especially when an agent channel has been the primary channel. This is nothing new – insurers have been dealing with this since the early days of the internet, when it became apparent that new distribution models would emerge. However, our findings indicate that the agent/broker community, in general, now accepts the notion of multi-channel distribution. It does not necessarily mean that they are happy about it, but most understand it is the reality of the P&C world today. The key for insurers is finding the right approach to differentiation.
The Future of Distribution
We expect to see a more varied mix of distribution channels for P&C. There will likely be all manner of channels. As connected world ecosystems continue to evolve around property, vehicles, farms and other areas, the paths to the customer will expand. New technologies are likely to increase exposures in some areas (such as cyber) and introduce unexpected risks that need insurance coverage. And, yes, in the midst of all this change, there will still be agents and brokers playing a key role in insurance distribution in the future.
“California is the lab for managing exposure to wildfire risk,” according to Lynn McChristian, a professor of risk management at Florida State University. If carriers and reinsurers can make it there, they can make it anywhere.
The past several years have seen a steep increase in the severity of wildfires, with the 2017 and 2018 seasons causing $24 billion in insured losses in California alone. Rates are climbing there, and coverage is dropping—there is clearly insufficient wildfire coverage to meet market demand, especially in high-risk, wildland-urbane interface (WUI) communities.
These historic losses, combined with insufficient solutions for managing wildfire risk, mean insurers are trying to get a handle on their wildfire portfolio accumulations and gather perspective on relative risk. Simply put, the old way of doing things has been proven not to work—and insurers are demanding better.
The flaw with historical wildfire risk management: Fires don’t burn in a circle
The California wildfires illuminated that many companies do not have clear best practices around managing wildfire risk, primarily because it has often been considered part of wider policy terms.
One solution is to limit accumulations between highly correlated areas of wildfire risk. Historically, insurers have looked at their concentrations of wildfire risk at the county level, along with using ring accumulations as a tool to assess risk. But fires don’t burn in a circle, and they don’t know postal code boundaries. Now, RedZone, a wildfire modeling company, has used millions of wildfire simulations to identify burn patterns across the landscape to create areas called “correlated risk zones.”
These zones are essentially regions that look completely separate but, statistically, burn together. They provide a logical and credible alternative by which to manage portfolio risk accumulations, alongside traditional loss modeling techniques. A more consistent approach to managing capacity can also improve risk-based pricing.
Solving a portfolio-scale problem requires changing the way we think
“Models have focused on risk at specific locations, but this is a portfolio-scale problem,” RedZone CEO and founder Clark Woodward says.
The above screenshots show RedZone’s models for use in portfolio-level analysis. On the left is RedZone’s burn probability layer. When combined with the image on the right, which is RedZone’s hazard control zones, you can develop a firmer understanding of portfolio composition when it comes to accumulations and likeliness to burn.
Accumulation analysis involves defining zones of correlated risk—where properties are likely to be damaged by the same event in the same year—and estimating the probable maximum loss (PML) within each zone. By evaluating accumulated wildfire risk, insurers can assess where additional properties may be insured with minimal increase in exposure to extreme losses.
Reinsurance broker Willis Re has also brought to market a new methodology for wildfire underwriting and customer-specific portfolios. By helping carriers understand not only individual risk selection but geographic areas that are driving up their PMLs, Willis Re can, in turn, help them diversify their portfolios and drive down reinsurance costs.
Practical innovation that can be deployed now
It’s taken a beat—and a harsh reality check—but better wildfire risk management strategies are now coming to fruition. Providers like RedZone, Willis Re and Insurity are working collaboratively to create solutions, like the correlated areas of risk discussed here, that provide better, more logical ways of managing wildfire accumulations.
This technology can be quickly deployed and implemented alongside traditional risk management strategies. This allows insurers to avoid disruption while employing a consistent approach to managing capacity across both underwriting and portfolio management and, ultimately, better serve and protect insureds against wildfire risk.
P&C insurers are staying the course when it comes to their original digital and technology plans and investments for 2020. Many insurers report no changes to their plans, with some reshaping and a few accelerating, but very few pausing or retrenching. These are the big themes in SMA’s new research report, P&C Tech Plans in the COVID-19 Era: SMA Market Pulse Insights. 2021 plans may paint an entirely different picture, but, for now, P&C insurers are moving full speed ahead.
As might be expected, the plans vary significantly by line of business. Commercial lines insurers are much more cautious than their personal lines counterparts, chiefly due to the larger negative impact of the pandemic. Still, our SMA market pulse survey of insurance executives confirmed what we have been hearing from our clients:
95% of personal lines insurers are moving forward with their overall technology plans and investments, with only 5% retrenching.
75% of commercial lines insurers are moving forward with their overall technology plans and investments, with 25% retrenching or pausing.
Our survey also showed that many of the insurers that are moving forward are reshaping and reprioritizing projects while keeping investment levels steady and striving to maintain momentum. Digital payments appear to be one of the hottest areas, as insurers have been obligated to send employees into physical offices to print and mail paper checks. Core systems also continue to move forward, although interestingly nuanced by line of business and with differences between policy, billing and claims plans.
Digital transformation plans are quite different for personal and commercial lines insurers. On the personal lines side, there is a trend toward accelerating plans, while commercial lines insurer plans are mixed. Only about one-third of commercial lines companies are continuing with digital transformation plans unchanged, while another third pause or retrench and the final third reshape or accelerate.
Overall, the response to the pandemic from P&C insurers has been remarkable as companies continue to support their distribution partners and policyholders. Plans are likely to morph even more as the pandemic continues. SMA intends to conduct the market pulse research on a regular basis throughout the remainder of 2020 and report on changes to insurer plans along the way.
In the midst of all the chaos, insurers are being put to test in real time. For all, it becomes the moment of truth for our industry and every individual company.
The strength of our industry is shining through. Insurers have quickly adapted to the new norm. Insurance executives are mindful of how this pandemic could hurt revenues and the bottom line, all financial ratios, even investment returns and stock prices and possibly coverage/claims.
At the same time, we continue to serve as a safety net for society, mitigating risks for all types of disasters – man-made or natural. This is who we are and what we do – as an industry and as each company in the ecosystem. As always, we will assess our strengths and our gaps and adjust our strategies and plans accordingly.
As a vehicle for insurers to understand and monitor the pulse of our industry in the middle of this pandemic, SMA just published a research brief that outlines the “The 10 Moments of Truth and Watch Points for the Future: How Insurers are Responding to COVID-19” highlighting the “whats” and “hows” of insurer response to this new norm. Each Moment of Truth reflects our reality as of April 1; insurers will continue to adapt to our changing environment every day. This brief also highlights the watch points to track and monitor for each Moment of Truth, as insurance evolves over the next several months.
Below is the list of SMA’s 10 Moments of Truth:
Demonstrating Insurance Strong
Stressing Every Risk and Continuity Plan
Working Remotely Effectively and Efficiently
Sustaining Current Levels of Service
Keeping Momentum Going Across Initiatives and Plans
Changing the Rules of Engagement
Innovating in Real Time
Keeping Everyone in the Loop
Demonstrating the Value of Digital Investments
Identifying the Gaps in Digital Strategies
One thing that this pandemic has already taught us is that we have never needed a digitally connected world more than we do now. Couple this with the reality that a crisis often brings about needed change. The needs, possibilities and opportunities that become clear during this crisis will stand out even more in our environment of fear and uncertainty.
Just remember, we are all part of this amazing insurance industry, and we are all standing strong. We will continue to stay present in this Moment of Truth.
P&C insurance is becoming less important financially because the insured world is becoming safer. The safer the world, the less insurance people need to buy to protect them against losses. The less important any good or service is, the less valuable it becomes, and people will not pay as much for it. It is just simple economics.
Before jumping to conclusions like most people do when I present these facts, it is important to understand the difference between the insured world becoming safer and the part of the economy that is not insured by private companies. In the U.S. (unlike some other developed economies), the government provides most flood insurance. A material portion of the population does not buy insurance, so they become part of the non-insured world. Many of the disasters you see on the news are not insured because people did not buy insurance for those catastrophes. Lots and lots of people may lose their homes to an earthquake or forest fires, but many of those people will not have insurance coverage for those types of events. In many cases, insurance coverage is not readily available so events become uninsured. The insurance companies have made the decision to only insure people and property they are confident they can insure for a profit. Many insureds have decided to forgo purchasing coverage for many kinds of risks because they are either too expensive to cover or, in consumers’ minds, the risk is too small. What does get insured because of carriers’ conservative approach and the insureds’ cautious approach is the part of the economy that is becoming ever safer. If we’re not careful as an industry, we will eventually have nothing left to insure.
Here is the proof the insured world is becoming safer (all data is based on A.M. Best’s latest Aggregates and Averages). The following two charts are for frequency, which is a better metric relative to whether more or fewer adverse insured events are occurring. For many reasons, severity may take a different path primarily because large losses tend to make up a larger portion of the remaining claims when frequency decreases.
These charts exclude physical damage to autos because that one single line defies other trends. In other words, hail and flood auto claims are not becoming less frequent. The charts above do consider non-auto property hail claims, however, and, even with those claims, which include damage to hundreds of thousands of properties over the last few years (primarily in four states), the absolute number of claims is less. Considering that there are hundreds of thousands more businesses, people, homes and drivers, claims have decreased from around 54 million per year to, even in a cat year like 2017 (2018 numbers have not fully developed), only 50 million. The insured world is safer.
The chart below clearly shows that claims relative to GDP are in a steady decline. Even if auto physical damage claims are added to these charts, the overall trend does not change. The difference is that the steepness of the decline moderates.
If it was not for severity increasing in pure dollar terms, which should be expected, the decrease would be even more pronounced. I do not have the definitive data, but my guess is the severity increase over the last three years is due to the hail storms and the horrible California fires. I can personally testify to hail claims totaling cars — if you don’t live in a severe hail state, it is difficult to appreciate the damage a hail stone the size of a golf ball, much less a tennis ball, can do.
The increasing safety of the insured world is a threat to carriers’ and agents’ existence because the problem is likely to grow. The safety improvements in vehicles, blue collar work environments and, perhaps especially, water shut-off devices, along with technology that will reduce exposures, means insurance will become even less valuable soon.
The above charts show obvious points. Improved regulations involving better zoning distances, airbags and even OSHA have all made our world safer. I am glad many of the tort reforms seem to have minimized or at least in some states reduced some of the ludicrous litigation that seems to benefit no one but a few plaintiff attorneys and the defense attorneys hired to defend against those nebulous suits. The fewer the losses, the less important insurance is. The less important insurance is, the less people will pay for it. Add record surplus, and talk of a true hard market becomes obvious wishful thinking unless some key carriers have managed to underestimate their reserves by large amounts.
The increasing safety of the world is out of the industry’s control. We must adjust. Two other factors affecting the results shown in these charts are within our control. The first is how carriers adjust claims and underwrite. Based on real world experience with agents every day and some interesting published articles, some of which are more direct in their accusations, it is thought that some carriers have taken approaches that make getting a payout for a legitimate claim so difficult that frequency and severity are depressed. Similarly, some of the public has become aware, and agents definitely are aware and often educate their customers, that filing small claims should be avoided. These claims should be avoided because the pricing penalties assessed for minor claims are far too high.
This situation presents an opportunity in my mind for carriers that don’t suppress claims or make processing claims inordinately difficult to let the world know they are easier to deal with in a claim situation. It is also an opportunity for agents to educate clients on the differences in claims-paying behaviors. Every agent knows different companies’ tendencies with regard to claims, but many agents are reluctant to discuss those tendencies. Just as with any situation where full disclosure is limited, those with more dubious practices get the benefit, and those with the best practices fail to get full credit. Maybe use one of the publicly published claims satisfaction surveys or create your own.
The second way in which the industry almost certainly needs to change to offset the safer insured world is to change its current focus on insuring 1950s America. 1950 was about manufacturing. 2020 is about services and data. It seems every insurance company is telling every agency that their target market is manufacturers, which is proof of 1950s thinking. The industry needs to insure today’s economy.
Ever try to buy a full data policy for self-created data (which obviously is the most valuable data for a huge proportion of businesses)? Ever try to buy a policy providing coverage for intangible assets? How about intellectual property? Today’s economy is built on intangible assets, data and intellectual property. Most machines and buildings are almost unimportant because most are fairly easily replaced, or substitutes can often be easily identified (excluding highly specialized firms). Companies and governments run on data, not lathes. Few companies go out of business because they can’t find a temporary building following a fire. Businesses do go out of business after cyber-attacks, reputational damage, theft of data and theft of intellectual property. In fact, think of it this way: What is the bigger danger even to a manufacturer — the building burning down or someone in another country stealing the company’s design and then undercutting the price by 50%? There is only one answer to that question.
The Hartford did a study in 2015 showing reputational harm was the most severe small business claim (40% more than the average fire claim). I can only imagine that the spread has increased. In 2017, Deloitte published a study that reputation was more important than getting the strategy wrong for 87% of executives. A CNBC article from Oct. 13, 2019, reported on a study by Hiscox stating that 60% of small businesses go out of business within six months of a cyber-attack. Many other studies support the same statistics but carriers and agents continue to focus on $x liability limits, $x property and workers’ comp.
Some readers may be thinking that policies exist for cyber, reputational harm, etc. (notwithstanding the fact that many cyber policies are arguably worse than no policy at all because at least not having a policy is free). Those readers are missing the point. A BOP or package policy provides coverage if a machine or building burns or is stolen or is blown away. Where is the same property coverage for a destroyed reputation or the theft of self-created data? I know Lloyd’s has some coverages available, but 99% of carriers are focused on what was important in 1950. Customers are concerned with what is important today. Carriers and agents that continue trying to insure the needs of 1950 will have a short life.
Another reason today’s exposures are not covered is that many agents do not understand business income coverage, so they either don’t sell it or they don’t sell it correctly. Next to cyber, business income is arguably the most difficult coverage to understand. Furthermore, the simplified solution that many agents choose to follow is offering the same business income solution to every client, as if all insureds were identical (and if you are thinking ALS is a universal solution, you are wrong). This is just bad thinking. Business income coverage in and of itself is far more important for many insureds, especially if one includes true contingent business income that goes beyond standard forms.
Whether you are working for a carrier or an agency, you need to insure the economy of today and tomorrow. You have complete control over this aspect of the insurance industry’s diminishing in economic importance. If you focus on what is important in today’s economy, you become a hero with a much more secure future by using the tools that are already invented such as business income coverages, much less creating tools to insure data and intangible assets. Let’s finally let go of 1950s thinking.