2014 PERSONAL LINES OUTLOOK Achieving profitability through excellence in underwriting… A SPECIAL REPORT
By Dax Craig, President and CEO, Valen Analytics
There appears to be violent agreement that 2014 is the year of advanced technology, data and analytics in insurance.
Of course, these kinds of prognostications don’t sneak up on anyone. A convergence of growing organizational eagerness and sophisticated tools is allowing momentum to build for the next generation of underwriting to emerge.
Market dynamics are always an important factor in what ultimately makes the cut from strategic planning to implementation. The investment environment, increasing regulatory pressure and rising costs are influencing a more analytical approach to underwriting in order to increase profitability.
With its historically volatile performance, homeowners insurance will be a particular focus in personal lines this year, as carriers adopt new approaches to drive profitability through underwriting.
2014 will provide a focus on shoring up the foundation needed to enable insurers of all shapes and sizes to become more analytically-driven. And while carriers make progress, securing the necessary talent needed to succeed is a growing and industry- wide concern.
Homeowners in the Spotlight
Shifting Focus Toward Homeowners, Following Trends in Auto Market
Analyses of the auto insurance market proliferated at the end of 2013, with some declaring pure direct writer, GEICO, the inevitable winner in the “battle of the titans” against Progressive and other major players because they are unencumbered by an agency force. Time will tell if that’s the case, but one thing is clear: Scaling profitable market share in auto can only be done by technology focused and analytically- driven carriers, with substantial marketing resources.
Allstate CEO Thomas Wilson thought about getting out of the homeowners insurance business following the destructive 2005 hurricane season but chose not to because customers prefer to bundle coverage. Therefore, getting out of homeowners would negatively affect Allstate’s auto business. Allstate instead looked to use reinsurance more effectively, raise rates, improve underwriting and exit some high-risk markets.
The trends in the auto market foreshadow what other lines of property and casualty insurance will face in 2014 and beyond, most urgently in homeowners. Consumer demand for online shopping increases pricing competition and customer acquisition costs and at the same time lowers retention rates – the combination of which can squeeze margin for carriers who do not have advanced pricing tools. This dynamic forces insurers to sharpen their pencil and strategies to differentiate their brand and gain a competitive advantage. For carriers not as advanced as the larger auto carriers, it can represent fundamental shifts in their business and operating models.
Partially due to continuing market share consolidation and pricing stagnation in auto, there is increasing focus on homeowners insurance. A recent report by Aon Benfield shows 15 percent growth in direct written premium for homeowners between 2009 and 2012, compared to just 6.5 percent for direct personal auto premium. With the historical volatility and poor performance of the homeowners line of business, a number of new underwriting approaches are entering the market. At the same time, the industry is adapting to a changing consumer and regulatory landscape.
Consumer Demographics Changing the Game
“Show me the money (i.e., discounts), give me all the info I need wherever I am and in real-time, and make sure your customer service is stellar or I’ll write up what a horrible experience I just had in 140 characters and share it instantly with all my friends.”
Exhausted yet?
The Millennial generation, at 77 million strong, demonstrates very different buying behaviors and demographic patterns than previous generations. These young consumers are having a notable impact on personal lines insurers. They primarily choose urban living, with very little difference between those who are parents versus non-parents, according to a study from the American Public Transportation Association. They are less likely to drive cars and prefer multiple modes of transportation. In fact, a study from USA Today shows that Millennials are less concerned about owning either a home or a car.
This budget-conscious generation is reacting to the dismal economy and job market they encountered upon entering the workforce, as well as the significant levels of student loan debt many of them carry. They are much more sensitive to taking on long-term debt and minimizing monthly expenses. Because they have a job scarcity mentality, Millennials value being unburdened in case they need to relocate for their career.
These trends also affect home building. While the news about housing starts is promising (up 22.7 percent in Nov 2013 – http://www.bloomberg. com/news/2013- 12-18/builders-began-work-on-most-u-shomes- in-more-than-five-years.html), real estate developers are responding to the Millennial generation’s desire for high-density urban living and hesitancy to commit to a mortgage – at least for now. While no one can predict how the home ownership trend will play out for the long-term, the insurance industry needs a product mix and customer service approach that meets the needs of this demographic population.
Knowing Who and What You Insure
Advancements in Advanced Data & Analytics
Traditional property inspection methods being used today only deliver an actionable result 25 percent of the time, which means 75 percent of inspections are a waste, according to a Claims Journal study. This ineffective use of resources isn’t sufficient to address the profitability issues that have plagued this line of business for years. In fact, since 1990, the Homeowners industry has only experienced four years with combined ratios below 100. To combat the high combined ratios, carriers divide losses into two categories – catastrophe and non-catastrophe – and continually perform analyses to determine what characteristics about a home, the insured and the weather have the greatest impact on controlling losses.
Again the auto insurance industry shines as being out in front of the P/C market with introducing usage-based insurance and collecting data on individual behavioral attributes. While it’s still an uphill battle for consumer adoption, the technology momentum is here to stay. Insurers are leveraging new data sources and analytical insights to improve their strategic approach to marketing, underwriting and claims.
What Florida Means Nationally For Non-Cat Risks
With the downsizing of Citizens Property Insurance, private carriers are adding substantial exposure to their portfolios in Florida. Catastrophe related risks are more widely understood and analytical tools such as cat models have been in use for a number of years. Carriers are easily able to diversify and avoid concentrating risks in a small geographic area. What they are focused on now is looking more closely at their non-catastrophe risks.
According to an Insurance Journal study, only 39 percent of total homeowners losses were catastrophe-related. The lion’s share of losses, at 61 percent, are non-cat related. The question then becomes: Are carriers spending enough time and resources developing underwriting strategies for their non-cat losses? As an example, Valen breaks down risks as mitigatable versus non-mitigatable as a way to help carriers reduce losses within their control. This shift to addressing losses based on a carrier’s ability to affect the outcome and drive down loss ratio, will grow in 2014. Analytically-driven carriers will leverage superior data collection methods and align underwriting strategy with field execution to win a greater percentage of profitable market share.
Market Share Consolidation Concerns
In the late 1980s and 1990s, new marketing and risk assessment strategies fundamentally changed the credit card industry. Technology and information-based companies like Capital One flourished and garnered significant market share while those who clung to traditional methods floundered. How did they do it? Analytics. In 1988 Capital One (originally Signet Bank) was founded because it saw an untapped opportunity to leverage credit score and consumer spending patterns to find the best risks within the subprime market and revolutionize the credit card industry. Similarly, in the ‘90s, Progressive Insurance pioneered the use of analytics, also leveraging credit score to insure nonstandard risks at profitable rates to dominate the auto insurance market.
The adoption of sophisticated technologies essentially creates a perfect storm: those who utilize analytics create positive selection, gaining profitable market share, while those who don’t use analytics suffer from adverse selection, ending up with poorer performing risks because they are working with outdated pricing and risk assessment strategies. As Matthew Josefowicz, Managing Director of Novarica, noted in a recent report, “The massive proliferation of easily accessible data combined with the increased power of modern analytical tools has the potential to transform the insurance industry dramatically over the next decade. The strategy and operations of insurers in the near future could be nearly unrecognizable to current market leaders.”
Valen conducted an analysis using the latest data from AM Best that shows how many P/C carriers are performing better or worse than the average combined ratio by line of business. A majority of carriers are performing better than average across all lines of business, both from a percentage of market share and total number of carriers. It isn’t the case that only large carriers with economies of scale are able to leverage the latest tools to segment their portfolios and use sophisticated pricing strategies. In fact, a recent report from Conning shows that small and mid-size carriers in personal lines are outperforming the market from a profitability and growth perspective. “The group of successful insurers was able to find growth opportunities…growing 68 percent in the homeowners line while the total homeowners market managed only 22 percent growth,” Conning said. If a majority of the market achieves underwriting profitability, individual carriers will have to increase their level of sophistication in order to maintain a distinct competitive advantage and protect their market share.
Reinsurance Considerations
A notable trend is the growing number of reinsurance carriers providing credit to primary carriers using predictive analytics within underwriting. “The relationship between a primary carrier and their reinsurers is paramount, and the progress reports carriers provide on their underwriting operations are critical to reinsurance pricing at the time of renewal,” said Bret Shroyer, FCAS, SVP of Reinsurance for Willis Re. “Reinsurers are placing increasing value on the reliability of analytically-driven underwriting decisions and providing more favorable credits to primary carriers who are ahead of the market in adopting the latest data and analytics strategies. It adds substantially to the overall ROI of using predictive analytics for risk selection.” Reinsurers are also using their own analytics to assess risk for new and renewal business by quantifying the quality of a primary carrier’s overall portfolio.
The other major trend is outside capital flooding into the reinsurance market (http://www.artemis.bm/blog/2013/08/29/ alternative-capital-a-disruptive-force-inreinsurance- goldman-sachs/ and http://www.artemis.bm/blog/2013/08/29/al ternative-capital-a-disruptive-force-in-). Time will tell if these new investors will stick with the market long-term, or exit when the next big catastrophe hits. If there is an abrupt shift in alternative capital exiting the market, reinsurance rates would increase substantially and create upheaval in the primary homeowners market.
Regulatory Changes Heighten Need for Data and Analytics
A heightened focus on regulation was all but guaranteed with the Federal Insurance Office report released in late December 2013. Initial reactions to the report are mixed, but the reality of increasing regulatory pressure is not lost on insurers. Carriers that have quantifiable means to demonstrate that their rating methodology and processes meet consumer fairness standards will be ahead of the game.
According to a 2013 KPMG survey, 60 percent of executives cited regulatory and legislative pressures as the most significant inhibitors of growth in the coming year, a 13 percent increase from their 2012 survey, and 19 percent increase from 2011’s. “Insurers have experienced a significant shift in the marketplace; in just two years, industry executives have abruptly diverted their attention from pricing concerns to regulatory matters,” said Laura Hay, national leader of KPMG LLP’s insurance practice. “This turnabout is even more significant when you consider that economic conditions have only slightly improved during this time period, so the combination of these two factors creates an exceptionally challenging market.”
Further to this point, the head of KPMG’s U.S. insurance regulatory group, David Sherwood, added “Regulators continue to ask tough questions and regulatory intrusion is set to increase in the coming years. More than ever, regulations and agendas established internationally, in Washington, as well as in local jurisdictions, have as much influence on the industry as market conditions and consumer confidence.”
Organizational Readiness & Talent Crisis
Getting Ready for Advanced Data & Analytics
Implementing sophisticated analytical tools within underwriting requires a commitment to becoming a more analytically- driven organization. Those carriers that take a holistic approach and execute a defined strategy in manageable steps will see far greater success.
C-level commitment, usually from the CEO directly, is helpful. CEOs typically want to know three things:
• That the predictive model works;
• That predictive analytics will drive meaningful and demonstrable benefits: for example: profits, loss ratio improvement, and pricing accuracy;
• The implications to the organization: IT impact, changes to the underwriting workflow and implications to key stakeholders, such as agency relationships.
Tad Montross, Chairman and CEO of Gen Re, noted that predictive modeling is changing the game and requires execution excellence. He suggests answering questions like:
• What is the appropriate risk appetite?
• Do we understand the sensitivity to the assumptions being made in the model?
• What are the model’s limitations? How do those limitations impact projected results?
Source: “Model Mania” by Tad Montross, Chairman and CEO of General Re Corporation
Other notable items include how information will be consumed within the organization, and how predictive scores will work in synergy with the expertise your underwriters bring to the table.
Selection Bias is Key Concern
Additional considerations are whether the data assets required to build a robust predictive model include selection bias, which can occur when predictive models are built solely on a carriers own data. Your company has a risk appetite along with risk selection and underwriting guidelines that help define your profile of business. For this reason, your data only contains those policies that you chose to write and does not include policies you didn’t write or didn’t even see. Therefore, if you build a model on your data alone, the dataset will only include those policies that your underwriting practices selected and, by definition, does not represent the entire market. Many carriers use third party data or leverage data consortiums to augment their own policy data.
Talent Crisis
As you evolve your organization, your talent pool will also need to grow. At the same time the insurance industry is improving underwriting performance – in large part to make up for lost investment income – it is also facing a serious talent shortage. Estimates range with studies suggesting that 20 percent of underwriters are nearing retirement. A broader study says 400,000 positions across the industry need to be filled within the next several years.
Insurance recruiting firm, The Jacobson Group, tracks employment trends. A recent blog post from Co-CEO Richard Jacobson noted: “One of the primary reasons that the [insurance] industry labor market seems so tight is that its employees are older and more tenured than the rest of the U.S. economy, and even than the rest of the finance world. The bad news is that the issue is getting worse. Only 26.67 percent of the insurance industry’s workers are under the age of 35. This number also compares unfavorably to the overall economy (34.07 percent) and the non-insurance finance community (30.66 percent). We are not bringing enough new talent to the industry.”
The younger generations expect to use leading edge technology in the workforce, and companies adopting advanced data and analytics will be able to use this as a recruiting tool to attract top talent.
A year of promising returns and meaningful organizational progress is doable, if the industry sustains its focus on advanced data and analytics.
Valen has several complimentary resources and studies on the latest underwriting techniques and pitfalls to avoid, along with ways to address the talent crisis.
Valen Analytics helps carriers manage and segment their portfolios in order to drive underwriting profitability. Valen’s InsureRight Platform is the only solution with proprietary insight into portfolio metrics and risk characteristics to identify pockets of pricing inadequacy and redundancy. A dynamic portfolio management tool provides access to Valen’s contributory database containing policy level analysis not available elsewhere. The Valen contributory database has scored over 20 million policies using robust predictive models in Homeowners, Workers’ Compensation, Commercial Auto & Telematics, Commercial Package, Commercial Property, and BOP.
