Customer retention. Case study. Executive summary. General issue

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1 Case study Customer retention Executive summary The client, the life insurance division of a leading Australian bank, was struggling to retain its customers. Customer lapse rates were running significantly above industry benchmarks and, as the global financial crisis put pressure on sales growth, it became increasingly important for the executive team to resolve the issue quickly. Our team identified the linkage between lapse rates and profit, and diagnosed the key drivers of lapses. Next, the team assisted in designing and implementing an overall strategy and specific activities to reduce the lapses. This enabled the client to reduce the lapse rate by 1.1% over the first six months, with the potential to increase it to 2% as longer-term initiatives deliver benefit. General issue In order to protect their revenue sources, businesses engage in both sales activities to acquire new customers and retention activities to retain existing customers. Each of these activities contributes to assuring the ongoing revenue stream of the business. However, during upturns in the economy, sales have traditionally received more focus as it is easier to measure and easier to take the right actions to achieve results. But the very actions that drive up sales in the good times can often adversely affect customer retention. A poorly targeted sales strategy can result in lower levels of customer retention as it can force sales teams to chase lower-quality leads, which, in turn, drives higher levels of customer churn. Whereas sales occur at a particular point in time when the customer purchases a product retention happens throughout the customer s experience with a company across a variety of customer and businessinitiated touch points. The root cause of the loss of a customer can be hard to identify and difficult to correct. Improving customer retention and customer advocacy improves the bottom line of any business. Not only do the advocates of a business churn less, but they are also more receptive to cross and up-sell activities. They also recommend the business to friends, family and colleagues. Nevertheless, the challenges in understanding, improving and measuring retention have led many companies to neglect the issue, potentially impacting it adversely through sales and other activities (see Figure 1). Figure 1. Promoter/detractor analysis Promoters defect less Promoters buy more Promoters drive business Indexed average gross premium volume cancelled per customer Indexed average of newly concluded gross premium volume per existing customer Indexed average new purchase generated through recommendations per customer Promoter Detractor Promoter Detractor Promoter Detractor

2 Authors Andrew Taggart is an executive director in the Advisory practice, Ernst & Young, Sydney, Australia Customer retention Daniel Marlay is a senior manager in the Advisory practice, Ernst & Young, Sydney, Australia Walter Poetscher is a senior manager in the Advisory practice, Ernst & Young, Sydney, Australia Understanding customer lapse behavior through our initial rapid diagnostic analysis provided the basis for developing improvement opportunities. 59

3 Context Despite being a top 10 life insurer in Australia, our client s business was experiencing lapse rates above the industry average. Reducing these lapse rates was a business priority, and the client was looking for advice and support on how to lower its customer lapse rates. The client s previous efforts to improve retention rates had not succeeded. Moreover, there was no real end-to-end ownership of the problem, each part of the business believed that it was not their problem. In addition, prior activities were piece meal in their approach and lacked a concerted vision. In the life insurance market, effective management of lapse rates is critical to ensuring the profitability of the product. There is a significant upfront acquisition cost in the sales process, with typical commissions exceeding the first year s premium. In our client s case, we identified that a 1% reduction in lapse rate would translate into a 7% increase in net profit after tax (NPAT). Appropriate pricing for these products requires assumptions about the average term that a customer holds the product; increases in the lapse rate reduce the average term and can result in a product that is unprofitable. We are flying blind, we don t know who is churning and why. We estimated that a 1% reduction in lapse rate would translate to a 7% increase in NPAT for the client. The external market conditions also contributed to the issues facing our client, with the economic downturn starting to impact the ability to generate further sales. Future sales were going to be harder to win and, potentially, customers were more likely to lapse. First, our client needed to understand the nature of the problem. Where were the opportunities? What were the hot spots? What was driving the lapse rate, and how much could be done to address this? The urgency of the situation meant that our client needed quick outcomes from our project that would start to deliver improvements in the lapse rates immediately. In addition, these quick fixes needed to form the starting point for a longer-term lapse rate reduction strategy. Finally, our solution needed to be embedded within the client to create ownership of the problem. Key challenges Our client had a strong sales performance history that was driven by the leadership team s understanding of how to manage an effective sales force. However, some of the same key attributes that drive effective sales force management can be counterproductive in improving customer retention. Actions that improve customer retention often do not have the instant effect that sales activity tends to have. Our key challenges were to moderate the sales team s desire for instant results and to manage the client s expectations for the time taken to achieve results. As there was no clearly defined accountability for customer retention, the responsibility for improving retention could be avoided and, as a result, retention activities were given a lower priority and often delayed. The client s urgent need for a solution required us to identify quick fixes that would have an almost immediate effect. Equally, we needed to ensure that the quick fixes we identified were not counterproductive and would not drive a worse retention outcome in the longer term. A final challenge was with the client s management reporting system. Different reports provided different values for the lapse rate, and there was no evidence as to which value was a true reflection. This distracted the client from focusing on solutions. In addition, the target lapse rate provided little indication of what the expected lapse rates should be and, hence, a very poor indication of whether the current activity was improving lapse rates or not. A lapse starts with a sale! Client quoted from interviews

4 Customer retention Our approach was based on five phases: identify, diagnose, design, deliver, sustain. This approach was split into three phases, allowing us to provide insight and checkpoints for the client along the way (see Figure 2). Our first phase comprised a four-week rapid diagnostic that: Identified the impact of a lapse on NPAT, the potential causes of customer lapses and the business processes at each customer touch point Diagnosed the actual patterns and drivers of customer lapses using a detailed data analysis of high customer lapse rate hot spots that could be immediately targeted, opportunities for ongoing lapse reduction and the potential financial returns from these lapse reduction opportunities Our second phase comprised: Design of a high-level retention strategy (based on customer value and lapse risk) to guide retention activities and investment. We created a set of shortterm tactical remediation initiatives, including: changes to sales targeting, proactive marketing campaigns, management information, and an execution plan for efficiently delivering these initiatives using the clients existing personnel and resources. Figure 2. Methodology Phase 1 Phase 2 Retentionstrategy Strategy Retention Rapid diagnostic Identify Campaigndesign Design Campaign Diagnose Phase 3 Campaign execution Execution Execution Plan plan Design Call-center strategy Churn reporting Deliver Sustain And our third phase: Delivered the initial execution of the design through the implementation of a series of direct marketing campaigns and an outbound call center function Sustained a 1.1% reduction in the lapse rate in the first six months by transitioning lapse management to a new retention manager at the client Phase 1 rapid diagnostic The first phase of the project covered a rapid diagnostic, which included the development of hypotheses, data analysis, process mapping and the business impact or size of prize calculations (see Figure 3). The key outputs from this phase were an understanding of the problem and recommendations for quick-win retention activities that could be implemented immediately. Our hypothesis development process identified potential causes and recommendations to the retention issue. These were gathered through interviews with personnel involved in different parts of the customer lifecycle within the client. These hypotheses formed the basis from which the improvement opportunities were developed. We carried out process mapping to understand the processes at key customer touch points. From this, we identified potential leakage points and opportunities for improved retention. Figure 3. Rapid diagnostic Insights Processing 140% 120% Extract Analysis 100% Thousands Methodology/approach 80% 60% 40% 20% Customer Policy Billing Driver analysis Analysis data set 0% Sales Geospatial Propensity model 61

5 84.6% of advisor-managed customers provided no reason for their lapse Our data analysis allowed us to understand the current state of the retention problem the client had and to understand the lapse drivers and patterns (see Figure 4). Our team sourced customer data from tables in the mainframe system used to administer the life insurance policies and combined these into an analytical data set. We isolated the effects of individual variables using driver analysis and developed an understanding of the lapse dynamics within the portfolio. The graph below shows an example of the insight delivered by driver analysis. It clearly shows a number of dynamics within the portfolio, including: Figure 4. Lapse dynamics Lapse rate 25% 20% 15% 10% The high initial lapse rates for products sold through telemarketing The spike in lapse rates occurring at the annual policy renewal date The slight increase in lapse rates for advisor-sold policies over time Geocoding the data allowed us to attach location information to each lapse and then use GIS software to produce maps of the lapse rates. These maps facilitated the identification of geographic lapse hot spots. We combined the results from these investigations into a summary of potential lapse reduction initiatives. Using the analytical data set, we estimated the improvement in revenue resulting from implementing each initiative. We identified those initiatives that provided the best quick wins and those that would form the basis for a broader strategy. Throughout the rapid diagnostic process, we worked with a steering committee from the client. This ensured that the client was aware of the work being done, could help to focus it in the right direction and was supportive of the outcomes. Phase 2 retention strategy, campaign design and implementation plan There were two key activities in the second phase: implement the quick win campaigns identified in the rapid diagnostic to start reducing the lapse rate; and develop a strategic framework to guide the prioritization and investment in longerterm retention initiatives. The findings of these two activities helped us to develop an implementation plan for ongoing retention initiatives. We identified pockets of high-lapse rate customers by segmenting the customer base on the key driver variables identified in the rapid diagnostic. These pockets presented the opportunity to achieve quick wins in reducing the lapse rate of the customer base. 5% 0% ,080 1,440 1,800 2,160 Days since purchase Telemarketed product A Telemarketed product C Telemarketed product B Advisor product We worked with the client s marketing staff to develop appropriate direct mail campaigns to take to these customers. By working intensively with the marketing team and reusing components of existing campaigns, we were able to develop these campaigns in a much shorter time frame than was typical for the client.

6 Customer retention We assisted in designing and implementing a campaign-reporting process that provided weekly updates to the client on the lapse reductions achieved through the campaign. Appropriate use of control groups allowed us to provide a true measure of this success. An example of part of these reports is illustrated in Figure 5. In addition to targeting people for retention activities, our hot spot analysis identified that the sales process was pursuing a number of leads that would go straight into a high lapse hot spot. Because these customers had a high likelihood of lapsing early, they would have a negative impact on revenue. By refining the sales targeting process, we were able to stop these particular leads from being targeted. In parallel with the hot spot targeting, we developed a high-level strategic framework for prioritizing and planning customer retention activity. This framework segmented the customer base by value and lapse likelihood (see Figure 6). These key dimensions dictated the level of retention activity required for these customers and the level of investment that was justified to retain them. Lapse likelihood was estimated with a statistical predictive model constructed on the basis of historical lapse data in the analytical data set. We used variable selection techniques including R-squared and chi-squared statistics to identify those variables that were most predictive of lapse rate. We combined these using a logistic regression model that produced a single lapse propensity score for each customer. Figure 5. Lapse reduction Lapse rate % 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% Control group More appropriate cover Reduce cover Week 1 Week 2 Week 3 Week 4 Week 5 Week 6 Week 7 Week 8 Figure 6. Retention strategies Strategy A Focus on customer care Very high High Medium Low Value Strategy B Actively move to lower risk Strategy C Maintain relationship Strategy D Efficiently move to lower risk Low Medium High Very high Contact strategy - Light Contact strategy - Heavy Propensity to lapse 63

7 In addition to supporting the strategy development, our model identified individual customers with a high likelihood of lapsing that would form the basis of a refinement to the hot spot techniques of targeting customers for retention activity. Subsequently, our analysts transferred this model to the client s modeling team to support ongoing retention activity after we had completed the project. We developed a snapshot of each strategic customer segment. This allowed the client to understand the target audience within each of the strategic segments and to develop appropriate marketing and communication strategies for these segments. We assigned each segment a high level retention strategy such as Actively move to low risk or maintain relationship. These strategies provided high-level guidance as to the type and level of activity required. We broke these strategies down into lower-level processes suitable for implementation. At the conclusion of this phase, we collated the tasks for implementing the short- and medium-term strategies into a project plan. This plan indicated when the activities needed to occur, how long they should take, and which person based at the client site was responsible for taking action. Phase 3 transitioning into the business The third phase of the project built upon the foundations laid in the first two phases. It consisted of a more integrated approach that saw us starting to transfer responsibility for some of the processes to client staff. In addition, we implemented the strategy around improving call center retention outcomes. In parallel, we assisted in defining and implementing a better lapse measurement and reporting process. The transition of the retention program to business as usual involved our project team continuing to act in a project management role. However, the responsibility for a significant portion of the actions was now allocated out to staff based at the client. We reported to the senior project sponsor within the client, and this ensured that we had appropriate authority from the client to keep the program moving. A key action in our plan was to improve the call center processes within our client s business to achieve better retention outcomes. We started this by assessing the requirements of the call center from the retention strategy. We then performed an assessment of the current state operating model for the call center and the gaps from the requirements. From this analysis, a series of options for improving the call center capabilities was developed. We assessed the costs and timelines for these options to identify the best of them. Then we developed a business case outlining the costs of implementation, the benefits of the changes and the expected timeline for the best improvement option. We developed a project plan for implementing these changes and integrated it into our overall project management process. Responsibility for implementing each specific change was allocated to the relevant staff member within the client. Appropriate reporting and measurement were key to the continued success in managing lapse rates. At the start of our project, management reporting on lapse rates was inconsistent, with a number of reports providing figures that differed from the finance reports. The target lapse rates did not allow for changes in the business, and the reporting provided little information to assist in addressing lapses. As lapse rates differ across a number of factors product holding, customer tenure and customer age unless the composition of a life insurance portfolio remains static then the expected lapse rate will change. Proper management of lapse reduction efforts requires an understanding of whether changes in lapse rates are due to management action or expected changes from portfolio changes. As part of our redesign of the lapse reporting process, we developed an improved expected lapse measure. Management reporting should also provide information to assist in identifying the cause of any unexpected changes in lapse rates. This information allows management to formulate appropriate remedial action to address these changes. Our redesign of the lapse reporting process included additional information to assist in clearly identifying the causes of change. Finally, we moved the management reporting around lapses from a weekly reporting period that tended to hide the significant changes in lapse rate in the noise of individual customer lapses to a longer reporting period that more clearly indicated the underlying trend. This change, along with a cultural shift in the client away from instantaneous reactions allowed the client to stop chasing spurious differences and focus on the areas that were really affecting the business.

8 Customer retention In this engagement, we identified the following key requirements for improving customer retention: The client needs to build support for customer retention initiatives in its internal culture. A good understanding of customer lapse behavior forms the basis for the development of a retention strategy and actions. Appropriate measurement enables focus on the key areas. Conclusion By the end of the three phases of our project, we successfully reduced the client s lapse rate beyond the targets set for us. The client now had an integrated and consistent lapse management strategy, and the responsibility for implementing this strategy had been assigned to relevant staff. Improved lapse reporting allowed our client to see these improvements and understand what they needed to do to maintain them. Initially, our client s culture focused too heavily on short-term results. Moving their culture to a longer view of customer retention allowed them to focus their efforts on the areas that really mattered for lapse rate improvement and to avoid wasting energy on week-to-week lapse rate volatility. Developing a culture of accountability for lapse rates, and an understanding of the impact on the business, ensured that retention improvement initiatives were followed through and received the required level of support. Understanding customer lapse behavior through our initial rapid diagnostic analysis provided the basis for developing improvement opportunities. Our initial analysis allowed us to target the hot spots of customers who could be retained and allowed the sales team to avoid targeting customers who were likely to lapse. The analysis of value and lapse propensity supported the development of an overall strategy. This strategy allowed our client to understand how to effectively focus their resources on lapse reduction. The change in the client s approach to measurement as a result of our revised management reports shifted the client s attention from less meaningful short-term fluctuations in lapse rates to the more significant longer-term trends. Providing a single reliable data source reduced the time spent previously and carefully selected diagnostic information allowed management to understand the causes of variance and target their actions appropriately. In order to protect their revenue sources, businesses engage in both sales activities to acquire new customers and retention activities to retain existing customers. 65

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