Beyond the secular forces we described in our “Future of Insurance” series, more immediate and cyclical issues will be shaping the insurance executive agenda in 2016. Commercial insurers (including reinsurers) face tough times ahead, with underwriting margins that are being pressured by softening prices and a potentially volatile interest rate environment.
Recently, reserve releases, generally declining frequency and severity trends, as well as lower-than-average catastrophe losses have allowed commercial insurers to report generally strong underwriting results. However, redundant reserves are being (or have been) depleted, and the odds of a continued benign catastrophe environment are low. For example, one insurance executive recently observed, “The odds of this long of a lucky streak occurring is less than 1%.”
The commercial insurance market has, in recent years, had generally strong underwriting results, but this could change—potentially, very soon.
With varying degrees of focus, commercial P&C insurers have been mitigating the risk environment by taking a variety of strategic actions. In 2016 and beyond, they will need to accelerate their strategic efforts in four key areas: 1) core systems and data quality, 2) new products, pricing discipline and terms and conditions, 3) corporate development and 4) talent management.
Core systems and data quality
93% of insurance CEOs—a higher percentage than anywhere else in financial services—see data mining and analysis as more strategically important for their business than any other digital technology. Nevertheless, many commercial insurers operate with networks of legacy systems that complicate the timely extraction and analysis of data. This is no longer deemed acceptable, and leading insurers continue to transform their system environments as a result. Significantly, these transformations do not focus solely on specific systems for policy administration, claims, finance, etc.
To ensure timely quality data across the entire commercial P&C value chain, commercial insurers also focus on how the various systems are integrated with one another.
To put this into context, when a dollar of premium is collected, it not only “floats” across time until it is paid out in claims, it also “floats” across a variety of functions and their related systems: Billing systems process premium dollars; ceded reinsurance systems process treaty and facultative transactions; policy administration systems (PAS) process endorsement changes; claims systems process indemnity and expense payments.
Actuarial systems in disconnected data environments prevent the timely and efficient extraction and analysis of internal data and also complicate the focused and efficient use of external data, especially unstructured data. “Big data” is becoming increasingly popular considering the insights that insurers and reinsurers can derive from it. However, such insights only become actionable to the extent that companies can assess the external environment in the context of the internal environment—in other words, to the extent that big data can enhance (or otherwise inform) the internal data’s findings.
If all functional and systemic codes are not rationalized on an enterprise-wide basis, it is very difficult to efficiently accumulate and analyze data.
New products, pricing discipline and terms and conditions
Commercial insurers and reinsurers are not generally known as product innovators, but they can be. For example, as the profile of cyber-related risks increases, the need for cyber-related commercial insurance grows, thereby offering numerous opportunities for product innovation.
Because cyber is a relatively new exposure, frequency and severity data are nascent, therefore both pricing and risk accumulation models are in various stages of development. As a result, prescient insurers are carefully tracking and comparing their cyber pricing practices and coverage grants with those of key competitors. To be effective, such practices should be consistent with existing price, terms and conditions and monitoring processes. For example, tracking actual-to-expected premiums and rates is a common practice, which leading insurers perform regularly (i.e., at least quarterly, with monthly tracking common).
Insights from this kind of analysis apply to both new and existing products. The underwriting cycle is inherently a pricing phenomenon, and insurers and reinsurers that have greater and more timely product and pricing insights have a competitive advantage relative to those that do not. To explain, in addition to lower rates, the “soft” parts of the underwriting cycle tend to be characterized by the loosening of policy terms and conditions, which can erode profitability as quickly as inadequate prices. Therefore, the most competitive insurers and reinsurers carefully and continuously track the adequacy of policy terms and conditions. Recurring actuarial analyses and standardized reporting can monitor changes in pricing as well as in terms and conditions. However, identifying emerging underwriting risks is inherently qualitative. Therefore, this analysis can be time-consuming, especially for insurers with suboptimal PAS environments. However, almost all companies find the analysis well worth the effort.
The combination of historically low interest rates, favorable frequency and severity trends and the relative lack of severe catastrophes has resulted in record policyholder surplus across P&C commercial insurance. Executives have a number of options on how to deploy surplus, one of which is corporate development.
Commonly, “corporate development” means mergers and acquisitions, but it can also encompass book purchases/rolls, renewal rights and runoff purchases. Determining the best option depends on many factors, including purchase price, competitive implications and an assessment of how the acquired assets and any related capabilities can complement or enhance existing underwriting capabilities.
Accordingly, some insurers are beginning to augment traditional due diligence processes (such as financial diligence, tax diligence and IT diligence) with underwriting-specific diligence to help ensure value realization over time.
If a corporate development opportunity offers underwriting capabilities that at least align to—and preferably enhance—existing capabilities, it can help facilitate a smooth integration, thereby mitigating underwriting risk (a key cycle management consideration).
For the most part, commercial underwriting decisions cannot be fully automated because they require judgment. Therefore, it is natural for underwriting talent to be a top priority. However, insurance executives have lamented that it is a major challenge for the industry to attract and retain knowledgeable personnel.
Two trends make commercial insurance talent management particularly challenging. First, experienced underwriters are leaving the industry. According to one study, “The number of employees aged 55 and over is 30% higher than any other industry—and that, coupled with retirements, means the industry needs to fill 400,000 positions by 2020.” Second, underwriting talent is relatively difficult to attract. For example, according to the Wall Street Journal, insurance ranks near the top of the list of least-desirable industries—according to recent graduates. The image of the insurance industry is that it is generally behind the times and offers little in terms of career development. Therefore, developing a performance-driven culture that enables the recruitment, development and retention of underwriting talent is more crucial than ever.
To help accomplish this, insurers should employ and should continuously assess tools and resources that educate and empower underwriters through all phases of their careers. This is important because the expectations in commercial underwriting are high, and the nature of the job requires a diverse range of skills (e.g., analytical, relational, sales, financial and risk). Furthermore, the best commercial underwriters are entrepreneurial, which employers should highlight as they recruit and manage their underwriting staffs.
Commercial insurers face a looming talent crunch and have to find ways to present themselves as—and actually be—a place where young people can have rewarding careers.
The relatively strong underwriting results of recent years are likely to soften in the coming year. Accordingly, commercial underwriters will need to accelerate their strategic efforts in:
Core systems and data quality,
New products, pricing discipline and terms and conditions,
Core systems transformations go beyond individual system competencies. To ensure timely, quality data across the entire commercial P&C value chain, insurers also are focusing on how the various systems are integrated with each another to facilitate the timely and efficient extraction and analysis of internal data and the focused and efficient use of external data (especially unstructured data).
There are opportunities to create new products, but, to be profitable, insurers must exercise pricing discipline and must carefully and continuously track the adequacy of policy terms and conditions.
Current surplus levels have enabled insurers to invest in corporate development, and some insurers have augmented traditional due diligence processes (such as financial diligence, tax diligence and IT diligence) with underwriting-specific diligence to help promote value realization over time.
Commercial insurers have an aging workforce and are facing an impending talent crunch. Automation cannot replace the judgment that is required for effective underwriting. Therefore, it is vital for insurers to develop a performance-driven culture that enables the recruitment, development and retention of underwriting talent over time.
For U.S. property-casualty insurers, 2016 will be a year of continuing disruptive change. Digital technologies, such as social media, analytics and telematics, will continue to transform the market landscape, recalibrating customer expectations and opening new ways to reach and acquire clients. The rise of the “sharing economy,” under which assets like cars and homes can be shared, is requiring carriers to rethink traditional insurance models. Combined with an outlook for slower economic growth, increased M&A and greater regulatory uncertainty, the stage is set for innovative firms to capitalize on an industry in flux. Insurers that stay ahead of these shifts should reap substantial benefits, while laggards risk falling behind, or even out of the race.
Competitive pressures in the insurance industry have been building as cost-effective solutions in digital communication, distribution and infrastructure become widely available. Digital technology is eroding the advantages of scale enjoyed by established insurers and empowering smaller players to compete for market share through more flexible pricing models and new distribution channels. The recent launch of Google Compare, which enables customers to comparison shop for insurance, is the start of a larger wave of “InsuranceTech” activity in 2016.
At the same time, customer expectations and behaviors are evolving at a rapid pace, often faster than traditional mechanisms can react. Driven by their interactions in other digitally enabled industries, such as retail and banking, property-casualty customers are increasingly demanding a more sophisticated and personalized experience – including digital distribution, anytime access, premiums accurately reflecting usage and individual risk and higher levels of product customization and advice. Policyholders are also seeking coverage of broader risks, such as cybersecurity risk and under-protected property exposure.
Significant change to insurance ecosystem
Almost eight years after the global financial crisis, most major economies are still operating at well below potential. Although the U.S. is doing better than many countries, forecast growth of less than 2.5% for 2016 is unlikely to boost employment or wage growth significantly. With little sign that inflation is picking up, the Fed is intent on keeping interest rates near their current lows for the foreseeable future. Meanwhile, concern around the slowdown in China and other key emerging markets will continue to dampen U.S. growth prospects.
Despite sluggish economic conditions, property-casualty insurers should do well next year because of the favorable underwriting performance of the commercial lines sector and rising personal lines premiums. Softness in reinsurance pricing may increase opportunities for companies to cede capacity into the reinsurance and alternative capital markets, as well as achieve more stable reinsurance protection through broader terms and conditions. The industry will enter 2016 with a strengthened balance sheet and a strong base of invested assets from several years of solid reserve development and benign catastrophe experience.
But that is where the good news ends. In 2016, return on investment for firms is likely to continue to slip from its 2014 peak because of a combination of capital accumulation, competitive pricing, weakening investment returns and rising loss costs. Losses and expenses are growing faster than revenue, forcing companies to actively seek new solutions. In personal automobile and workers’ compensation, rising frequency and severity are beginning to erode loss ratio performance.
Competition is putting downward pressure on pricing, particularly in the commercial property and liability lines. This is compounded by slowing growth in commercial exposures because of economic weakness.
Regulatory headwinds ahead
In 2016, property-casualty insurers will face heightened political and regulatory uncertainty. An open presidential election for both parties, along with congressional and state elections, creates the potential for radical change with taxation and regulatory repercussions. Meanwhile, the Fed is preparing new capital standards for significant insurance companies, and HUD and the Federal Insurance Office may intensify investigations into the affordability and accessibility of personal lines insurance to customers from different backgrounds. The IAIS is also pursuing international capital standards through field testing, and the results may come into clearer focus in 2016.
The NAIC and states may separately advance their expectations of best practices in risk management, governance and solvency as current programs enter their second year of full rollout. All jurisdictions will likely push for better information, reporting and compliance in such areas as accounting, solvency, fair practices, transparency, governance and marketplace equity.
Impact of external forces on the US property-casualty market in 2016 (0 = Very low impact, 10 = Very high impact)
Coping with transformative change: priorities for 2016
In such a fluid, fast-changing environment, insurance firms need to build a road map for strategic transformation aligned to new customer imperatives. Refining legacy products and approaches is not enough – what is required is a fresh, outside-in approach that starts with the customer and carries through to digital trends and market shifts, both inside and outside the insurance industry.
1. Position Your Organization for Digital Leadership
Preparing for further digital disruption
As digital service models become more common in other industries, the property-casualty sector will need to align to the rising expectations of consumer and commercial customers. Digital technologies, such as mobility, social media and telematics, will continue to disrupt all parts of the property-casualty insurance value chain – from client acquisition to claims and servicing. Although the industry is ripe for digital transformation, many traditional insurers still display a low level of digital maturity, struggling to develop digital strategies that enhance the customer experience, extract efficiencies and drive future growth.
Priorities for 2016
Lay the groundwork for digital transformation. To meet changing expectations, insurers need to digitize interactions with customers, employees and suppliers. Building new distribution channels and working closely with existing distribution partners to enhance the customer experience is a strategic imperative.
Build a back-office to support the digital frontline. In 2016, carriers must continue to invest in back-office systems to enable digital enterprise platforms. These should be designed to allow
for future expansion, omni-channel distribution and an improved customer experience, while minimizing customer service costs and protecting against escalating cyber risks.
Start new market initiatives now. As back-office systems are being readied, leading insurers should not wait for full integration, but push forward with next-generation portals, redefining customer experience, data access, queries and navigation. With the rise of real-time risk monitoring, there is a knowledge shift taking place between customers and insurers. Insurers need to tap into client and industry data sources to take full advantage of this new risk-information flow.
2. Prepare for the next wave of M&A activity
M&A will accelerate in 2016
Uncertain economic and regulatory conditions have caused insurers to cut costs and expand product and geographic diversification. Under growing pricing pressure and competition from non-traditional sources, in 2015 insurers turned to transformative mergers to achieve these goals. This surge in M&A activity is
expected to continue in 2016, as acquirers seek to build scale and access US markets.
Priorities for 2016
Establish a well-defined process for post-merger integration. Mega consolidations require immense integration of systems and data. Companies involved in M&A should assemble the necessary building blocks to create single technology platforms, self-service customer portals and omni-channel distribution systems. Replacing duplicative technology, outdated service centers and first-generation mobile-enabled distribution will remove cost redundancies and inefficient processes. Successful mergers could create lower-cost infrastructures, which will enable these combined entities to invest in data sources and analytical tools that improve pricing, risk analysis and claims management.
Gain greater access to insurance buyers through M&A. Consolidation in the insurance broker and independent agent markets has tipped the balance of power toward distribution. In response, insurers in 2016 will look to gain direct customer access by purchasing specialty distribution and continue the trend of underwriters acquiring managing general agencies with exclusive books of business to increase premiums in less price-sensitive lines. Access to captive distribution should help tilt the scales back toward underwriters.
Take steps to protect against tougher competition. Insurers that refrain from the M&A frenzy will require a strategy to compete more effectively against larger, better capitalized companies. Recruiting human capital will become paramount, as will accessing distribution that provides high-retention, profitable business.
M&A activity in 2016 will make insurers vulnerable to takeovers, particularly those with the potential to provide an acquirer with greater product diversification, wider market access, stronger analytics and increased cost efficiencies.
3. Create a culture of continuous innovation
The innovation imperative
The rise in usage-based insurance, digital distribution channels and other disruptors is shaking up the industry. Widespread data availability and advanced analytical techniques are enabling new market entrants to absorb risk that was once the exclusive territory of insurers. Larger and more efficient capital providers entering the industry are siphoning off premium that ordinarily flowed to insurers. To stay relevant, traditional insurers need to shed their conservative orientation and cultivate a culture of innovation.
Priorities for 2016
Explore new technologies and start-up models. Competition is heating up as an array of new Fintech companies offer services that were once the exclusive domain of traditional insurers. To cope, insurers will need to adopt, acquire or even fund new technologies and experimental models that may even compete with their existing businesses. Recently introduced property-casualty insurance products, such as insurance for cyber risk, ridesharing and drone exposures, suggest that insurers can rise to the innovation challenge.
Be prepared to cannibalize parts of your business, before competitors do. The property-casualty insurance industry has not been known as a change leader. A growing asset base is a vital sign of stability for clients, but, as a business grows, more processes are added, creating bureaucratic layers that stymie innovation. To offset these institutionalized barriers to change, insurers will need to develop a culture of innovation that allows for internal competition.
4. Shift from a product to a service orientation
Staying relevant in a fluid marketplace
Changing customer needs are making many of today’s insurance services less relevant. With a few notable exceptions, the traditional product suite has been relatively static and has not kept pace with evolving risks. Personal lines insurers are seeing reduced demand for their services because of advanced safety technology, the growth of the sharing economy and changing demographics and customer behaviors. Likewise, commercial lines insurers are coming to grips with new industries, emerging risks and a client base with significant access to their own risk data. Access to better data and analytics empowers customers to retain more risk, and much of the risk at the other end of the spectrum has been taken by capital market alternatives, leaving traditional carriers scrambling for the leftovers.
Priorities for 2016
Think outside-in, not inside-out. To adapt to this fast-evolving marketplace and differentiate themselves from competitors, insurers must enhance their service capabilities while developing products better able to serve new customer needs and behaviors. By providing services that build on the customer experience and changing expectations, insurers can foster stronger, more holistic relationships with clients and ultimately improve policy retention and generate higher margins.
Take a value-added, advisory approach. Customers are increasingly looking to their insurance partners for risk advice, not just insurance products. To enhance their brand and improve performance, insurers must be ready to provide customer-centric services to satisfy these expectations. Insurers will need to analyze their clients’ exposures and develop risk-mitigation strategies and insurance coverage tailored to their needs. The rise of real-time risk data in both personal and commercial lines provides an opportunity for innovative insurers to address uncovered or mispriced risks.
5. Build a next-generation distribution platform
The rise of omni-channel distribution
Independent and captive agents have dominated the property-casualty insurance industry for decades. Even today, many insurance buyers rely on a trusted adviser to assist them with personal and business insurance purchases. But the days of a single distribution channel are over for many insurers. Consumers are demanding omni-channel access to insurance products. Insurance buyers want the same flexibility to learn, compare, purchase and report a claim as they have become accustomed to in other industries.
Priorities for 2016
Come to grips with pricing transparency. Creating an effective omni-channel platform is critical, as it allows insurers to promote their customer service capabilities, product differences and claims-response times more widely. But the rise of aggregator and non-traditional comparison models has also made it easier for buyers to shop for the best rates. In a digitally enabled environment of price transparency, there will be further pressure in 2016 for insurers to streamline costly and duplicative infrastructure.
Consider acquiring captive distribution. As insurance products become more commoditized, insurers may want to acquire captive distribution to add customers and boost business. By acquiring managing general agents (MGAs), insurers can gain access to experienced underwriters able to secure and retain profitable business, along with the systems and tools for underwriting and processing that business. Insurers will need to integrate these systems into core underwriting platforms to avoid duplicating costs.
Rethink compensation plans for distributors. Private equity-financed broker consolidation, going on for nearly a decade, will continue to shift bargaining power in favor of distributors. Agent and broker control of profitable businesses has allowed some large distributors to negotiate greater compensation. This power shift is happening at a time when rate softening has become the norm. As a result, insurers in 2016 should consider changing the industry’s level-commission compensation standards in favor of greater up-front payments that reward access to new profitable customers.
6. Drive performance through analytics
The new role of analytics
Disparities in frequency and severity trends among several large personal auto insurers highlights the importance of data and analytics in driving underwriting results. Harnessing large volumes of data from real-time sources can help insurers develop new products and refine pricing strategies. When combined with a robust operating strategy, advanced analytics can significantly increase underwriting profitability and provide a valuable market differentiator.
Priorities for 2016
Apply proven analytics to the homeowners market. In 2016, personal lines insurers will increasingly apply analytical capabilities developed in the personal auto sector to the homeowners market. Greater adoption of technological innovation in the home creates an opportunity for both real-time risk assessment and pricing strategies, similar to the trend unfolding in the personal auto market. As insurers move back into the homeowner market, they will be better equipped to understand and price risks.
Use analytics to manage commercial market risks. As risks rise, small business owners are seeking broader insurance coverage and a simpler sales process. Insurers with the analytical capabilities to manage evolving risks and the technological know-how to create an automated sales experience will be better equipped to meet fast-changing customer needs. The experience in using analytics in the small commercial market will provide insurers with a blueprint for gaining efficiencies in the larger commercial market.
7. Develop and attract the right talent to lead change
Coping with a widening talent gap
Existing insurance teams often are not prepared for today’s fast-changing digital marketplace. But filling the talent gap can be challenging, because the insurance industry is not often the first choice of new graduates from top colleges and universities. With finance, technology and consulting attracting most of the promising students, a talent chasm is forming in the property-casualty industry. Insurers must recruit and retain next-generation innovators and leaders – while retooling existing teams with new skills.
Priorities for 2016
Develop new roles to facilitate change. As insurers embrace innovation and adopt more advanced digital platforms, they will need to establish new business roles to drive these initiatives. For instance, the stronger focus on analytics is increasing the demand for data scientists – able to apply predictive analytics and other sophisticated quantitative tools to support underwriting and claims- handling processes.
Create an environment that rewards innovation. A culture of innovation will help attract Millennials and entrepreneurial talent with fresh perspectives. Bringing in new ideas and skills will be essential for insurers pursuing technological innovation in an industry not known for change. To acquire and retain this new crop of talent, insurers will need to set up systems to reward innovation and risk-taking in alignment with new strategic imperatives.
Expand risk advisory capabilities. Customers are increasingly interested in working with true risk advisers and finding insurance solutions that match their lifestyles. Traditional product approaches directed at individual risks are falling out of favor as customers seek more holistic solutions. In 2016, insurance teams will need to develop expertise in health, wealth and risk advisory, so that they can bundle products and provide value-added services to customers.
8. Make risk management a C-suite priority
Coping with complexity
Economic, financial and political uncertainty, combined with linked global markets and disruptive technological change, has created a more complex and volatile landscape for insurance firms – heightening the need for best-in-class risk management. Faced with a challenging environment and driven by regulatory demands, insurers have made risk management a C-suite and board-level priority, with risk managers being held accountable for improved financial performance and value creation.
Priorities for 2016
Keep on top of changing regulations. Emerging regulatory regimes include calls for greater uniformity at the state, federal and global levels, but the ultimate form of these requirements is far from settled. As always, insurers will need to stay on top of shifting regulatory frameworks, communicate the industry impacts and respond to changes as they emerge.
Watch for emerging risks, such as cyber-attacks. With access to growing volumes of sensitive data, both large and small insurers are seeking greater cyber risk protection. Corporate boards are becoming increasingly aware of the damage a cyber-attack can cause, including potential liability at the board level and the destruction of reputation and brand. Risk managers must stay ahead of the ever-increasing sophistication of hackers.
Remember, protection is only as strong as the weakest link in the chain. Even if an insurer is well insulated from cyber-attacks, its outside vendors may be vulnerable. Vendors that have access to an insurance company’s systems, such as its underwriting platform, can inadvertently provide hackers with a conduit to valuable company data. Risk managers must be careful with data released to third party vendors for any reason, especially when that data is subsequently returned to the company.
This article was written by David Hollander, Thomas Cranley, Gail McGiffin and Jay Votta. To access the full white paper, click here.