Tanvir Hanif Fabienne Konik Paul Francis. General Insurance Getting Back to Basics

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1 Perspective Sarah Butler Tanvir Hanif Fabienne Konik Paul Francis General Insurance Getting Back to Basics

2 Booz & Company is a leading global management consulting firm, helping the world s top businesses, governments, and organizations. Our founder, Edwin Booz, defined the profession when he established the first management consulting firm in Today, with more than 3,300 people in 58 offices around the world, we bring foresight and knowledge, deep functional expertise, and a practical approach to building capabilities and delivering real impact. We work closely with our clients to create and deliver essential advantage. For our management magazine strategy+business, visit Visit to learn more about Booz & Company. CONTACT INFORMATION Sydney Sarah Butler Partner sarah.butler@booz.com Paul Francis Senior Associate paul.francis@booz.com London Fabienne Konik Principal fabienne.konik@booz.com Tanvir Hanif Principal tanvir.hanif@booz.com

3 General insurance Getting Back to Basics General insurers, with the notable exception of AIG, have so far made it through the current global financial and economic crises relatively unscathed. But no one should be complacent: 2008 was shaping up to be a difficult year even before the latest round of banking collapses triggered by the credit crunch: the fight for market share was intensifying and claims relating to severe weather were eating into profits. Economic difficulties will add further pressure to the bottom line, just at the very time that some regulators are demanding higher levels of capital; as we enter an economic recession in many of the major western economies, there is a danger that some consumers begin to regard insurance policies as a discretionary purchase. To compound difficulties further, highly volatile markets mean that insurers cannot rely on investment returns to bring businesses back into the black. Insurers who manage to succeed in this increasingly challenging environment will be those who get back to basics, focussing on risk selection and pricing, slashing costs in claims and other functions, improving effectiveness in distribution and carefully managing capital. They will also make better use of new technologies to leverage the power of information and analytics. Avoiding the middle ground: scale versus specialisation Insurers need now to make a strategic choice: to pursue scale or to specialise: those players who continue to operate the middle ground will become takeover targets as the global insurance market consolidates. Scale is preferable: sub-scale players face higher operating expense ratios and potentially higher loss ratios due to less effective underwriting or claims management. The big personal lines players in markets like US, UK and Australia leverage their scale and purchasing power in the auto and home supply chains. Scale allows fixed costs in IT and delivery platforms to be shared. More information and expertise enables better underwriting and Booz & Company 1

4 customer targeting, and better claims decision making. Finally scale can bring diversification benefits and lower reinsurance costs. Larger players such as AXA and Aviva have been able to leverage their operating model, reduce marketing spend, and lower operating costs by consolidating their global brands under one umbrella. Scale has also helped them to negotiate better commissions. However, achieving scale is by no means straightforward. Organic growth is tough in mature markets where switching rates average less than 10% per annum. Acquisitions will provide the most effective route, particularly cross-border deals, where in-country consolidation has already taken place. There are, moreover, likely to be greater opportunities to acquire distressed assets as those players facing financial difficulties put up insurance businesses for sale. The benefits of scale can, however, be elusive. It is often just as important to achieve local as global scale: most providers for claims are small businesses without a national footprint, and those insurers with strong local presences will inevitably have greater clout when it comes to dealing with these local businesses. In some cases, it may be preferable to take the specialised approach: in order for this to be successful, players need to take a highly targeted approach, focusing either on particular customer segments (such as over 50s), channels or products where they can command a price premium, sell more effectively or better manage risks. Achieving a step change in costs: claims is the major lever Given the growth challenge in the current environment, insurers should leave no stone unturned in attacking their cost base. The greatest scope for cost-cutting in general insurance lies in claims which accounts for between 60% and 80% of costs. Given that claims is a core part of the customer promise, any cost cutting needs to be carried out carefully. This is especially true for intermediated businesses, where damage to the relationship from mishandling one claim has repercussions to the overall relationship. However, done well, claims can be the major lever to cut cost and also form a core element of the customer value proposition. On the claims operations side, insurers need to streamline and simplify the process. Claims should be segmented and aligned to risk, with increased use of straight-through processing for simple claims allowing more time and resources to be allocated towards early proactive management of complex claims. People are just as important as IT, and information is a critical enabler to better decision making and fraud reduction. There are also benefits from enhancing the customer experience, with fast resolution, clear roles and in emotive cases, for example theft of jewellery, there may be advantages to paying the claim quickly without excessive scrutiny. On the claims management side, the focus should be on active management of the supply chain: the choice of an optimal claims model is critical. For example, in motor insurance, partnering relationships with preferred supplier networks can lead to higher quality and lower costs, in particular if insurers can guarantee flow so the repairers can optimise their businesses. Tendering models can also reduce costs by creating greater competition with the added benefit of improving transparency however this may be less attractive to customers who no longer have any say in the selection of the repairer. Progressive s concierge model and other drop and go models can help balance loss of choice with a convenient customer experience. Establishing relationships with suppliers with a narrower focus on particular types of repair, e.g. specialists in Small and Medium Accident Repair Techniques (SMART), can result in a different type of work mix and skills and deliver up to 30% efficiency savings. In other lines of business, for example personal injury claims, early intervention and ensuring appropriate treatment by the right provider can improve customer outcomes and lower costs applying a similar philosophy to sports medicine. As well as claims, there is also typically opportunity to reduce cost in functions such as product & underwriting, distribution, IT and support functions by addressing structural opportunities such as consolidating sites, streamlining processes and cutting non-value added overhead. Innovation comes to the fore: customer focus The acquisition and retention of customers will increasingly depend on innovation. This is all the more important in the current market given the increased tendency to see many insurance 2 Booz & Company

5 products as luxuries during the economic slowdown, particularly among Gen Y consumers. There are of course some factors, such as climate change, which reinforce the need for insurance products, but these also contribute to higher risk levels and more expensive policies. With a few clear exceptions, scale players would do well to learn from the specialist players who have driven innovation in products like pay as you drive and product features such as no claim cash backs. Low switching rates in general insurance in mature markets mean that a clear segmentation strategy, coupled with customer retention initiatives, is also essential. This must be aligned to the overall strategic choice of scale versus specialisation. Segments can be defined not just in terms of demographics, but also by what the customer needs, and the economic value to the insurer: for example, clarity seekers are looking for simple, clear product information and advice, as well as confidence in product features and benefits; the provider should focus on delivering a highly personalised service in order to explain the product and answer questions. Some successful insurers have realigned around specific segments in order to improve end-to-end execution, for example over 50s, young drivers. Other insurers meet distinct customer segment needs with a common back-end to capture the benefits of scale. Customer retention should hinge on a clear understanding of what it is that drives customers to switch. There is a range of tools which can be used to improve retention, including loyalty and multi-policy discounts and phased re-pricing to keep premiums below trigger points at which customers choose to shop around. Some tools are more problematic: increased use of direct debits tends to increase retention, but it may also attract poorer quality business, while product bundling such as linking mortgage and home insurance sales may run into regulatory barriers in some markets. Distribution: blurring the boundaries between manufacture and distribution Major shifts in product distribution are occurring: in personal lines these are driven by two key trends. The first is the move towards online channels. Globally, face-to-face sales remain the strongest channel for insurance products; in UK and Australia, however, the direct channels are dominant. However there is a growing demand from customers to be able to purchase, not just obtain quotes for, products online, which has fuelled growth of players like GEICO in the US. The second trend, most notable in the UK, has been the response to the emergence of online aggregators. Aggregators have increased commoditisation and reduced margins for insurers and and in turn produced two main responses: adoption of the aggregator model by development of cheap, no-frills offers, and in some cases, such as Tesco, the creation of an ownbrand aggregator with more limited market coverage; or clear separation from aggregator channel where insurers such as Direct Line and Aviva have either refrained or retreated all together from participating, instead reinforcing own brand and channels. In order to stay ahead of the curve, general insurers need to decide how best to capitalise the shift towards online sales for example by producing a segmented online offering, without neglecting the established direct channels or creating channel conflict with intermediaries. Creating the on-line Southwest or Michael O Leary equivalent in insurance is hard though as only 10% costs for direct players are in distribution so a full rethink of the product offer and claims model is needed. The other major challenge in distribution, in particular in commercial lines, and personal lines in most European, Middle East and Asian markets, is to address the blurring of boundaries between manufacturers and distributors, as well as the emergency of new players such as bancassurers, mortgage brokers and supermarkets. Large brokers like AON have extended into risk management; re-insurers are offering a broader range of services. Insurers like Aviva in Europe and Wesfarmers in Australia, have addressed the changing distribution landscape by acquiring intermediary networks; others have built up tied agents to distribute their products. Traditionally these insurers have viewed intermediaries, rather than the consumer, as their customers: however, they now need to think about the end-customer value proposition rather than just the intermediary value proposition. They also need to enhance their sales practices and take a whole of account focus. Growth: targeting emerging markets As in the life sector, margins in established markets are under pressure: traditional insurers Booz & Company 3

6 face greater competition from new entrants such as online aggregators and bancassurers, and as a result may need to look further afield to increase profitability. Emerging economies, in particular the BRIC countries (Brazil, Russia, India and China) will be obvious destinations for expansion. The exploitation of opportunities in emerging markets will require know who as well as know how : successful players will need to position themselves early in order to maximise competitive advantage. Radical and sustainable change: transforming the operating model In order to respond to an uncertain and fast-changing environment, choosing the most effective business model to support the insurer s chosen strategy is essential. Insurers have traditionally been structured as end-to-end businesses along channel or product lines. In intermediated businesses, focusing on channel, for example, allows for top-down account management, while meeting brokers preference for whole of account management. However, it does create complexity at the interface between product manufacture and sales. A product focus will simplify that interface, but is less attractive to brokers and agents because it creates multiple points of contact to the intermediary. Increasingly, scale players are exploring functional models, for example integrating claims and product manufacturing to support different customer segments and channels. While many firms focus primarily on executional delivery decisions such as standardising best practices and eliminating duplication, successful players will need to take a bolder approach in order to deliver significant savings. Prioritising strategic operating decisions, such as whether to outsource or even eliminate certain services, as well as structural delivery decisions such as creating a common back office, can deliver much higher savings. In order to make changes sustainable, there needs to be a clear focus on those areas which deliver most effective execution, namely information flow and decision rights, rather than just structure. This transformation will only be possible if the mindset and culture of insurance companies, who have often followed traditional models with insufficient pressure to streamline their businesses in order to gain competitive advantage. That pressure is building rapidly now; those players who are to build a sustainable and profitable future will need to react quickly. Next steps: inertia is not an option Insurers will need to undertake how they will respond and take a critical look right across their entire business model. In the current environment time is a luxury not available in Financial Services, and therefore insurers need to be structured, yet agile, about their approach. For example, many Booz & Company clients are having to understand right at the outset the strategic priorities of any change: for instance, are maximum synergies hitting the bottom line more important, or a rapid response which may yield more moderate returns but will provide the market with confidence that the insurer has a plan to manage performance in the current environment. Insurers may have avoided most of the attention in the press to date. However, now that the issues in the banking sector have been addressed, the attention of key stakeholders - investors, traders, regulators, governments, and customers - will turn towards insurers. There are already signs that insurance groups are beginning to come under pressure for example, in the Netherlands, AEGON which has a small general insurance portfolio has recently been bailed out by the state. As the banking community has shown us, once market confidence is dented, even relatively healthier institutions can fall victim to the spiral of negative sentiment leading to downgrading of ratings. Insurers will need to understand strategies to move forward quickly and effectively. Those who fail to do so may find themselves making uncomfortable headlines in an extremely difficult financial and economic environment. 4 Booz & Company

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