Commoditizing Insurance – Quo Vadis?
by Joseph Petrelli
Let’s define three terms. According to Investopedia, commoditization is defined as the process by which goods that have economic value and are distinguishable in terms of unique attributes or brand end up becoming simple commodities in the eyes of the market or consumers. When products and services are commoditized, the lower the price, the more attractive the product or service — despite unique attributes or branding.
According to Wikipedia, “[i]n the social sciences, unintended consequences (sometimes unanticipated consequences or unforeseen consequences) are outcomes of a purposeful action that are not intended or foreseen. The term was popularised [sic] in the twentieth century by American sociologist Robert K. Merton.”
Investopedia defines data analytics as the science of analyzing raw data in order to make conclusions about that information.
Two facts about the U.S. property and casualty (P&C) insurance marketplace that demonstrate the impact of the U.S.’s primary insurance marketplace on the reinsurance community may astound you. In the U.S., the aggregate percentage of personal automobile insurance direct premium written is 35 percent of our total
P&C insurance market. Homeowners insurance accounts for another 18 percent of the primary U.S. market. Permit me the liberty of rounding the homeowners percentage up from 18 percent to 20 percent. I do not believe that this is much of a stretch when one considers that personal umbrella insurance, fire and allied lines, flood, etc. are associated with homeowners insurance purchases.
With this as a backdrop, we can explain our perspective on why ILS and catastrophe bonds are evidence of the commoditization of primary insurance products and, in turn, the commoditization of the reinsurance utilized by those primary carriers. However, ILS and catastrophe bonds were not the cause of the commoditization of reinsurance.
Abstract :
In late 2019, an article authored by a legacy insurer rating agency suggested that the glory days of reinsurance might be over due to the emergence, existence and evolution of insurance linked securities (ILS), catastrophe bonds, and related investments that appear to serve as a surrogate for reinsurance treaties. Demotech has a different perspective on the rationale of the glory days of reinsurance. We believe that if the glory days of reinsurance are over,
ILS and other investments utilized as surrogates for reinsurance were acknowledgements that the glory days were over, not the cause. We believe the
demise of the glory days of reinsurance was the commoditization of the personal lines of insurance where reinsurance was and is a critical component of insurer capacity.
Going back one step further in the commoditization of personal lines of insurance, we believe that the commoditization of personal lines of insurance was, in part, an unintended consequence of the introduction and implementation of data analytics. Read on to understand our perspective.
Go back 15 or 20 years ago. Progressive, an acknowledged thought leader in telematics and data analytics, aired commercials that focused on price comparisons against their personal automobile insurance competition.
As their data analytics capabilities were (apparently) superior to their competition’s capabilities, Progressive would assist consumers by referring them to a lower priced competitor by naming that lower priced competitor.
Progressive did so with the confidence that their price was the correct price, and the competitor(s) with the lower premium had underpriced the exposure because they did not fully understand the exposure.
Seeing Progressive’s success, other personal automobile insurers adopted a similar approach to analytics, pricing and advertising to consumers. Soon consumers from coast to coast were presented with a variety of national insurers focused on saving them up to 15 percent on their premium in 15 minutes or less, or some other reference to lower cost. An insurer’s capability to accomplish offer savings was based upon its internal data analytics, underwriting criteria and the nuances of its pricing model; however, the message that consumers heard was not about the capability and competence of the actuaries, data scientists and underwriters but rather, ‘lower cost — for the same thing I have now.’ Why pay more than I need to, when all I need to do is change insurers?
As insurers refined their focus on telematics, data analytics, and the stratification of consumer exposure so as to offer the appropriate premium, the 35 percent of U.S. direct premium written that is personal auto insurance underwent a process of commoditization as consumers came to believe that cheaper was better, product differentiation was not a factor and a cheaper alternative was readily available.
Despite unique attributes and the brands that insurance companies had built up over decades, e.g., good hands, good neighbors, being on your side, etc., I respectfully submit that in their zeal to utilize big data and data analytics to identify and write the better risks within an insurer classification, and thereby use their data analytics to send what they believed to be mediocre business to competitors who may have missed critical aspects of data analysis, the unintended consequence for personal lines auto insurance was the commoditization of the product. Hearing the message ‘cheaper is better and readily available’ eroded the unique attributes and brands. Price became the focus of the consumer’s decision process.
Once a product has been commoditized, unique attributes and brands are
not factored into an evaluation of cost. Consumers perceive a higher premium as ripping them off, rather than an offer of more complete coverage.
As carriers developed and implemented aggressive marketing campaigns to attract consumers, securing their personal auto insurance ultimately proved to be insufficient. The insurance industry sought to bundle, or otherwise combine, homeowners insurance with the consumer’s commoditized personal auto insurance. Bundling emerged as an opportunity to save even more money on an insurance purchase. Another 20 percent of U.S. direct written premium was commoditized by association with the previously commoditized personal automobile insurance!
Consumers thus thought that cheaper was better, and paying more for the same product was unnecessary. Another unintended consequence occurred, and suddenly 55 percent of the U.S. P&C insurance dollar volume was commoditized.
The impact on the reinsurance community was less immediate, albeit inevitable. Once again, ‘reinsurers followed the fortunes.’ A definition at www.uslegal.com states that the “follow the fortunes doctrine is a principle applicable to the Insurance law. According to this rule, a reinsurer is bound by the reinsured’s decisions regarding payment of settled claims so long as the decision was made reasonably and in good faith.” The commoditization of reinsurance, and the introduction of ILS and catastrophe bonds, i.e., piles of cash up front rather than a reinsurance treaty with the implicit expertise of the reinsurer, is the equivalent of reinsurers following the fortunes of reinsureds regarding pricing, in addition to the payment of settled claims.
Once the primary products of the reinsureds became commoditized, and consumers became convinced that ‘a lower premium was better,’ the reinsurance sector’s “follow the fortunes doctrine” was (unintentionally) expanded to include reinsurers following the fortunes of primary insurers’ unintended consequences of data analytics and the commoditization that followed. It seems like a reasonable conclusion that if you reinsure a product that has been commoditized, the perspective on your reinsurance will, eventually, become commoditized.
When first introduced to the marketplace, insurance-linked securities andcatastrophe bonds were essentially a large pile of cash set aside in case a specific event occurred within a defined time period. This was viewed as equivalent to leveraging the balance sheet, underwriting expertise and claims experience of a reinsurer. When the comparison of cost of securing a catastrophe bond versus a reinsurance layer in a treaty was made, the incremental cost to reflect the unique attributes and brand(s) of an established reinsurance community added to the cost of a primary product that was being sold to consumers based upon the assumption that ‘lower cost is better than higher cost.’
Concurrently, while the reinsurance community competed with ILS and catastrophe bonds with respect to primary carriers, reinsurers embraced the savings of ILS and catastrophe bonds for significant segments of their own retrocessions. Reinsurers who were attracted by the allure and savings associated with cat bonds and ILS should have seen and understood the beginning of the commoditization of reinsurance. If the glory days are over, ILS and cat bonds are the exclamation point, not the cause.
The emergence of Tremor Technologies ‘to shape a future with technology that seamlessly transfers any risk to the capital best suited to bear it’ is another specific example of ‘better, cheaper, faster’ where you might get allthree concurrently!
Some primary carriers may have seen commoditization coming, and taken evasive maneuvers to ascribe a cost differential to expertise, unique attributes and their brand. One example is Farmers Insurance’s initiation of a series of commercials to educate and inform consumers that Farmers Insurance personnel are knowledgeable professionals who have been there and done that. “We know a thing or two, because we’ve seen a thing or two.”
In 2012, Nationwide traveled back to the future when, during opening ceremonies of the 2012 Olympics, it brought back their familiar and famous tagline, “Nationwide is on your side.” In the insurance industry, where consumers often view a claim as the consumer against the appreciably larger insurance company, Nationwide sought to set itself apart from the other insurers. It was on the consumer’s side. They are one of ‘us’, not one of ‘them’.
State Farm’s “Like a good neighbor, State Farm is there” was created in 1971 by singer-songwriter Barry Manilow. This jingle has been heard, seen and read everywhere since then. Yet, more recently, in a rebranding, State Farm has focused on financial planning and being viewed as proactive, as opposed to reactive, to incidents like claims. The focus is on facets of life, from funding college to funding retirement. You need State Farm 24/7/365, not just on the rare occurrences when you are involved in an accident.
State Farm is “Here to Help Life Go Right.” They are an insurer that is competent, capable and indispensable.
Demotech believes that these recent examples demonstrating that insurers are transitioning from ‘cheaper is better’ to ‘competent’, ‘accommodating’, and ‘part of your everyday life’ are a response to the unintended consequences of the commoditization of 55 percent of the U.S. P&C insurance marketplace. In turn, reinsurers should applaud the return of ‘competence, accommodation and expertise’ to the attributes of the primary insurance products that they reinsure. This is the only way that the reinsurance associated with those primary insurance products might return to its glory days! (apologies to Bruce Springsteen!)
To paraphrase David Blunkett, ‘We’ve got to get … in touch with the people we seek to represent and to avoid self-inflicted wounds.’
Joseph Petrelli, ACAS, MAAA (MBA), is President and Co-Founder of Demotech, the second largest rating service in the United States based upon count of uniquely rated insurers, specializing in evaluating the financial stability of independent, regional and specialty insurers.
