E-Commerce Business Models for Insurance: Application to U.S. and European Markets * July 5, 2001. Gergana Rakovska

E-Commerce Business Models for Insurance: Application to U.S. and European Markets * July 5, 2001 Gergana Rakovska Center for Risk Management and Insurance Research Georgia State University P.O. Box 4036 Atlanta, Georgia 30302-4036 Tel: 404-651-4250 Fax: 404-651-1897 * The author expresses her appreciation to Martin Grace and Robert Klein for helpful comments. 1

I. INTRODUCTION The insurance industry appears to be lagging in the rapid evolution of financial services and e-commerce. While banks, securities brokers and investment companies have an established an online presence, the insurers faces strategic challenges in utilizing the Web. More and more insurers offer online quotes and applications, with certain segments such as auto and home insurance leading the pack. However, insurers are still hesitant to approve policies online and are adding these services slowly to their sites. Other barriers impede completing insurance transactions and providing other services over the Internet. Also, SEC regulatory requirements and state securities law will complicate online sales of certain products, such as variable annuities. The trend toward purchasing policies online will be slower for some types of insurance than others. It is anticipated that online distribution of personal insurance coverages will continue to expand rapidly. However, according to Forrester Research (2000), most companies believe that it will be more difficult to sell products such as term life and home insurance on the Internet. Business models for selling complex products such as annuities, universal life and variable products are still in the formative stage of development. This disparity is causing a noticeable gap in the business models between property-casualty and life insurers. Property-casualty insurers such as Progressive have moved aggressively into offering its insurance products for sale online, while most life insurers have focused on providing consumers with educational materials and agent locators. This paper discusses some of the fundamental issues surrounding the use of alternative Internet business models in insurance. It also examines the application of 2

different models using specific examples of insurance websites and strategies. The paper focuses on the impact of the Internet on insurers and the marketing and distribution of insurance products. The paper is organized as follows. The next section summarizes what is known about Internet trends and online insurance supply and demand. It also discusses the potential role of Internet to become an important distribution channel for insurers because of its potential to reduce transactional costs and create new intermediaries. Section III examines some of the commonly used business models for online distribution in the insurance industry. The paper concludes with observations on the future of online distribution in the insurance industry and the importance of developing Internet business models that compliment and facilitate corporate strategies and objectives. 3

II. THE CURRENT STATE OF INSURANCE E-COMMERCE Insurance companies are adapting to the Internet and are beginning to redesign workflows and increase internal efficiency. Consumers buying over the Internet look for added value. Ultimately, only the most efficient companies will be able to provide this value profitably. Insurance companies have focused on the use of the Internet by personal consumers to shop for insurance, but the scope of insurance activities potentially affected by e- commerce is much broader than that, giving rise to a host of interesting issues. These activities include not only transactions between insurers, intermediaries and buyers, but virtually every major business function performed by insurance firms. Hence, there is an array of potential applications, as well as alternative business models. This paper focuses on distribution, recognizing its interaction with other insurer business functions affected by information technology. The challenge for any particular insurer is developing a coherent strategy and implementation plan suited for its particular objectives and characteristics. A. Property-Liability Insurance At this stage, most consumers are still only looking to buy property-liability insurance on the Web. The non-life insurance products most commonly purchased online are personal auto, home and travel insurance. In these areas, use of the Web should ultimately decrease acquisition costs, although advertising expenditures could be high. 4

Larger insurers seek to persuade their customers to buy insurance directly through their websites and achieve distribution efficiencies. The threat of Web-based distribution is that it could divert revenue flows from existing insurers and alter the structure of the market. The large insurers, with high backend service requirements, are most likely to be the winners in Web-enabled propertyliability insurance transactions. If these companies can also persuade their customers to buy directly from their websites, then they will have won a combination of inexpensive distribution (no commissions) and a compelling value proposition. This is what most insurers hope to gain. B. Life Insurance Life insurance does not appear to be in the vanguard of those lines being sold over the Web. Consumers tend to require high level of advice before they decide to purchase life insurance products. However, several developments could make the Internet an important venue for future competition among life insurers. These developments are: The Web is successful in attracting mutual funds savings, which means that it could have the same role in traditional life insurance as a savings vehicle. At present, advice-based distribution is one of the principle barriers to entry for life insurance and long-term savings. New technologies allow the Web to provide sufficiently good advice according to personal needs of the customers. These are long-term issues, but they need to be considered in a broader context of life insurance sales. If the insurance industry follows the development of financial services on the Web, then the Internet will ultimately account for a significant percentage of personal property- 5

liability insurance policies and perhaps life insurance policies, particularly simpler termlife products. This may place some insurers using traditional distribution systems at a disadvantage. The potential problems that could occur according to an Ernst & Young (2000) report on E-commerce are: Insurance companies dependent on independent agents are likely to bid up commissions to secure their cash flows. Insurance companies dependent on their own selling agents are likely to employ more agents to retain their sales volume. The products sold on the Web are not tied with high commissions and are more attractive for the customers. This could increase the volume of these types of products and erode the revenues of other products and traditional insurers. This process implies that, at some stage, the function of advising consumers in purchasing insurance is likely to migrate to the Web, through whatever conduit is most appealing to the consumer: personal computer; television; or other devices. As more insurance business migrates to the Web, and traditionally sold life insurance becomes more expensive, more consumers are likely to be attracted to the Web. At this stage, we believe that insurance companies will need to reduce the commissions charged, which could adversely affect the economic circumstances of traditional independent agents. C. Theoretical Framework: Distribution vs. Manufacturing 1. The Impact of the Internet on Insurance The new technology has strongly affected the consumer. Ready access to the Web gives the consumer much more information and the technology exists to harness this information for the benefit to the consumer. According to Conning & Company (2000), there were more than 50 millions Internet shoppers in US at the end of 2000. The impact 6

of the Internet on the distribution and manufacture of insurance is likely to be very different, however. In distribution, the empowerment of the consumer implies that products should become simpler. Products should be more transparent and unsupportable commission loadings decreased. Most consumers will need advice on financial matters and financial advisors could help the consumers to purchase the appropriate product. The advice service could be bundled with the sale of the product, or unbundled. As with traditional distribution, potential conflicts of interest between providing advice and selling financial products will need to be addressed. Regardless of how the principal-agent conflicts are resolved, the Internet could play a large role in consumer search, choices and transactions. The Internet poses some potential threats to the insurance manufacturing process (underwriting and servicing insurance policies), but also presents many new opportunities. The principal threat is the potential for diverting business away from existing distribution channels. If this proved significant and companies did not obtain compensating revenues elsewhere, then the fixed costs of maintaining traditional distribution channels would have to be addressed. Apart from this problem, the opportunities for large insurance manufacturing units should be significant. The Internet and consequent Web applications should help companies reduce both distribution and manufacturing costs, although any relative advantages among insurers are likely to be short-lived as most companies are preparing for the new economy. Large companies may reap some economies of scale, which could give them a more enduring advantage over new economy manufacturing units and 7

existing traditional players. However, the presence of significant scale economies is not obvious and it is also possible that smaller insurers may successfully use e-commerce to serve niche markets. Figure 1 compares costs for different distribution channels, based on a study by Booz- Allen & Hamilton (1997). Figure 1 Cost of Insurance for Different Channels of Distribution $160.00 $140.00 $120.00 $100.00 $80.00 $60.00 $40.00 $20.00 $0.00 Internet Direct Broker Agent Costs per 100$ premium Source: Booz-Allen & Hamilton (1997) The impact of the Internet on insurance internationally, especially in Europe, is more difficult to ascertain. It appears that the distribution of insurance products has been modest, owing to a variety of factors, including: Low Internet penetration - in 1999, the Internet household penetration was 15% for Western Europe (Forrester Research, 2000). Focus on other type products such as stock trading etc. Insurance companies are presently reliant on high-cost distribution through existing channels. They are not keen to upset their existing distribution channels 8

because they know that conflicts between channels could have a significant impact on their sales. Insurance is a low frequency product and in the initial euphoria of Internet distribution insurance has not been on the top of the agenda. The average family in Europe may buy between two and three insurance products per year. In an area such as life insurance, where commissions are high, there is a vested interest on the part of both distributors and insurers to perpetuate the notion that insurance is complex. Hence, it requires the advice of an agent and the continued payment of high commissions. 2. The Internet, Commoditization and Insurance The term commoditization often arises in discussing insurance e-commerce. The term implies relatively simple, homogeneous products that can be readily compared among insurers. Standard auto, home, travel and term-life insurance products might best fit this description, with the understanding that no two policies sold by different companies are exactly alike, nor is the bundle of services associated with these policies. Internet-based distribution could foster greater commoditization. This phenomenon is likely to be strongest where the decision making process can be separated from the point of sale. For instance, most auto owners are required to carry third-party liability insurance subject to certain minimum provisions, such as minimum policy limits. Thus, the decision to buy auto insurance has been made before the purchase of a specific insurance policy from a specific company. The Internet should help the consumer to buy these kinds of products on the best terms. For those who are prepared to make their purchases over the Web, there are a 9

number of search engines that can obtain the lowest price for any given product and provide certain other information, such as the financial rating of an insurance company. Once online purchases are available for a broad segment of customers together with the convenience of the Web (easy at-home usage), it could commoditize the selling of insurance products. Poor claims handling could impede this trend, however. At this point, is not immediately clear how widespread the usage of the Web will be, but over the next few years it is entirely possible that the Web will be made amenable to general access. These could lead to more commoditization of the insurance product than currently appears conceivable. It is easy to see how property-liability insurance can be commoditized. The reverse is true for life insurance. The product migration to the Web could constitute a cross-selling opportunity for non-life and life products, which has not been a huge success to date. In fact, life insurance and personal investment and retirement products probably present the greatest potential for growth for any technology that can first overcome the traditional advice barrier and then unbundle the products into the constituent elements of: 1) termlife insurance; and 2) savings, which could include mutual funds. The favorable tax treatment of life insurance probably poses the most significant barrier to this process of unbundling. Efforts to withdraw some of this tax advantage in Europe appear to have been largely unsuccessful. The average investor will probably want advice on investment products, especially life insurance, so the transition to a commodity transaction may be more difficult than would seem theoretically possible if consumers became educated about insurance. The advice could be provided over the Web in the form of search engine, but this always assumes that the consumer knows what to 10

search for, and this is far from likely to be a case. It is also far from clear that consumers would be prepared to accept advice from anyone but a trusted adviser, as their future livelihood is at stake. This process could be taken one stage further if products are unbundled. For instance, unit-linked life insurance could be easily separated into its constituent elements that are a mutual fund and term-life insurance (e.g., Skandia does this). This is provided that a wrapper could be manufactured to endow the product with all the relevant tax advantages that life insurance normally enjoys (e.g., Skandia provides this too). 3. Distributions and Manufacture 1 The impact on insurance distribution and the impact on insurance manufacture are likely to be profoundly different. Most European insurance companies incorporate both distribution and manufacture and will be affected by e-commerce, but the effects may take some time to realize. The main effect will likely be significantly lower expense margins for distribution, with expense margins for other functions remaining relatively the same for larger insurers. However, it is not likely that any insurance companies have even started to disaggregate the profitability of their distribution and manufacturing plants and are unlikely to do so for some considerable time. Companies pay distributors commissions, and some other expenses, and receive premiums in return. If the distribution channels of insurance companies are to be judged on their profitability, then the distribution plants themselves must have the ability to perform on an equal footing with their rivals. This 1 This section is drawn from Ernst & Young (1999). 11

would imply opening up distribution to the products of other insurance companies, or adopting a truly open architecture philosophy. Most insurance companies combine manufacturing and distribution functions, which usually generates superior returns. It is likely that these insurers should continue to generate superior returns, although the new economy poses new treats to these companies. However, the distribution mechanisms of these companies are expensive with agents receiving relatively high levels of remuneration for distributing what is often a commodity product. The cost of online sales are likely to be substantially lower than the cost of traditional sales, although there is no need for the Internet based distributor to reduce the distribution costs below the level which makes online distribution attractive enough to acquire business from traditional channels. The most obvious approach would be to link online insurance to a tied sales force to charge the commission level, which gains them the business. This already happens in the corporate non-life market. Having provided net premiums to the tied distributor, this allows the company to sell this product through independent distribution (Web or traditional) with little or no further channel conflict. The existing distribution channels should be populated with other financial services products, not just to make them more attractive to the consumer, but also to better utilize the sales space. If the company does not have the manufacturing capacity to provide the other insurance and financial services products, it could use the manufacturing capability of other companies. The object of manufacturing is to maximize an insurer s profitability. This is probably best achieved by: Focusing on the manufacturing process, which clearly helps isolate the metrics of profitability. These are often confused with those of distribution. 12

Efficiency is the most important advantage that companies will require. The most profitable companies have almost always been most efficient. New technologies give insurance companies a unique opportunity to maximize their efficiency. Those companies, which are among the first to exploit the advantages offered by new technologies, should reap the greatest benefits. Redesigning workflows and reducing duplication of effort within an insurance company can achieve efficiencies. Scale is also important because it reduces much of the manufacturing cost per unit. This is most easily achieved by consolidation. The benefits of scale belong to the manufacturer and realistically do not need to be passed on to the consumer unless compelled by competition. This is why consolidation will continue, although this may happen independently of the new economy. Profitable pricing, at a level which maximizes customer and distributor demand. Most European insurance companies outside the UK and the Netherlands have developed with manufacturing and distribution under one roof. This has worked relatively well, because until recently there have been no viable distribution channels outside those owned by insurance companies and the banks. This clearly has favored the existing insurance companies who had no reason to alter the status quo. The rise of the independent intermediaries will put pressure on these insurance companies to reconsider their vertical integration. In some instances, there may not be immediate pressure to separate distribution and manufacturing functions, but other insurers may need to consider alternative structures sooner. 4. How Technology Affects Individual Products The new economy and evolving new technology enables established insurance companies to re-design work flows, utilize Web-based systems, focus on the consumer 13

and gain access to much more information. The one common area that most companies are likely to focus on is improving efficiency and using new technology to reduce costs (see Figure 2). Figure 2 Estimated policy administration costs for a basic transaction (US$) 20 18 16 14 12 10 8 6 4 2 0 Agency Call center Internet Source: Meridien Research Analysis, KPMG Research 2000 Companies with manufacturing and distribution under one roof face problems with value destruction. At present, many have inefficient distribution channels, which only sell the products of the parent company. The initial promise of new distribution channels is the ability to sell insurance products at very profitable margins because of lower distribution costs. As Internet-based competition among insurers increases, however, then prices will likely fall. To counter this, companies are trying to enhance their value chain by selling other insurers products using the same channel. In the long-term, if this strategy is to be successful then distribution is going to have to be fully independent and the ability to support high margin products will be much diminished. 14

Property-Liability Insurance The impact of the Internet and new technology is likely to be felt most in the field of distribution. Those companies that utilize independent distribution channels are likely to be in the best position to adapt. There will be an inevitable dislocation in pricing. In addition, there could be considerable value destruction from the removal of highly priced products. Figure 3 How insurers rated the suitability of products for online sales and services (%) 100% 75% 50% 25% 0% Motor Travel Household Health Accident Traditional Life Term Life Pensions Disability Mortgage Source: Tillinghast- Towers Perin Survey 2000 Service Sales Both Sales&Service Most areas of property-liability insurance according to Delloite & Touche are characterized by: The provision of products that the consumer needs to purchase. For instance auto insurance is required by law, and the fear of total loss is usually enough to require the customer to purchase home insurance. Furthermore, most lending institutions require home insurance as a pre-requisite for a mortgage. 15

This need for insurance does make it much easier for distribution of insurance to be sold over the Web, or at least make it much easier for the distribution of insurance to be drawn away from traditional insurance channels. The need for a high-level back-end service. Extensive claims handling is an essential part of insurance companies activity. Compulsory auto and home insurance enables distribution to be drawn away from existing channels. This means that these products could be sold easily through the Internet, especially as progress of technology makes this whole process easier. Moreover, the consumer continues to learn that the Web is an easy way to purchase goods and services. Thus, the ability to sell property-liability insurance over the Web is likely to increase. When property-liability insurance is sold over the Web to a meaningful degree, then the lower costs of selling insurance over the Web are likely to make it much more difficult for physical channels and it is likely to result in lower pricing over the Web. This does not mean that the insurance costs will necessarily decline. Those companies that are dependent on their own physical distribution channels, will face: Having to reduce payments to their exclusive agents to the level of those provided for the Web-based sales. This of course means that these exclusive agents need to consider other sales opportunities. Maintain commissions and support costs for agents, but take the hit on margins, as companies have to face competition from Web-based suppliers. 16

Insurers also may opt for some form of middle of the road solution where they reduce the commissions paid and also receive lower margins. This adjustment process is likely to be difficult. Companies are clearly aware of what is going to happen and they are in the process of providing their agents with increasingly diverse sets of financial service products. Life Insurance Life insurance and long-term savings are areas of considerable interest. At present, the Internet does not provide advice-based delivery of these products. Another impediment to the sales of life insurance and long-term saving products is that significant sums of money often are invested. In this regard, the consumer is likely to feel more at ease with paying the premium to a trusted intermediary than over the Web, although an increasing level of mutual fund sales are transacted this way. Further, consumers may be more comfortable purchasing short-term contracts that they can choose not to renew if they become unhappy with the contract or the insurer. There may be higher costs associated with terminating long-term contracts. The primary products available now on the Internet are term life and annuities. In the long term, advice on life insurance and savings vehicles will expand on the Web. Given the huge margins that are available on providing this advice, and the ability of a Web-based intermediary to provide advice that is commission neutral, there is likely to be a significant shift to the Web. In this process, the manufacture of life insurance is likely to benefit the most. At this time, the pure distributors of life insurance products are likely to be most hurt, while the hybrid companies will suffer value destruction. 17

5. The Current State of Online Insurance 2 The majority of the data available on insurance websites relates to the US. These data are analyzed and their implication for European markets considered. It is possible to identify five stages in the introduction and development of the use of new information technology in insurance markets: 1. Traditional insurers focus only on distribution and manufacturing. They do not consider Web-based distribution and manufacturing in their future development. Probably only a few companies do not at least pay minimal attention to how Webbased systems might be used more broadly. 2. E-insurers start up with the focus on distribution. These new start ups are essentially Web-based independent intermediaries and make it easier for the consumer to compare prices between insurers that do not own the intermediary. Levels of complexity vary, but at its simplest, price comparisons only can be made, and in other cases the new company can manage the actual sale of the insurance product. Only simple products are sold through this mechanism. 3. Traditional insurers improve their Web-based capabilities. A common additional service is providing information about insurance and assisting consumers in assessing their insurance needs. This is the basic reaction to the arrival of new technologies. A wait and see approach has been adopted by a majority of traditional insurers as they evaluate the implication of e-commerce. 4. Online distribution capabilities are adopted more widely. Traditional insurers increasingly offer the capability to sell their own products online. Intermediaries increase the number of insurers whose products they include on their shelf space and they extend the range of products sold. At the same time, the 2 This section is drawn from CSFB Research (2000). 18

manufacturing process is streamlined as e-enabled facilities are established to provide policies at minimum cost. 5. Competition between traditional and e-insurers becomes more intense. This is particularly true for the Internet distribution side. The provision of third-party products is necessary for companies to remain e-competitive if their only value proposition is lower cost at point of sale. This favors the separation of distribution and manufacture. The best companies should be able to increase their revenues by selling their products through all independent channels (traditional and Webbased), rather than rely on an exclusive distribution channel. In addition, those manufacturers that have e-enabled their business process, extracting maximum cost efficiency and benefits from economies of scale, should be in a position to offer the best cost based value proposition. At this stage, there is probably no company that can deliver substantial value-added advice to rival that of the advisor over the Web. E-insurers have empowered the consumer, acting as the catalyst that has forced traditional incumbents to fight back. In addition, many have now established business models for insurance e-commerce and are viewing e-commerce proactively as a means of increasing distribution and reducing costs. However, at this time, the volume of insurance products sold via the Internet is relatively low. Business models for insurance E-commerce can be categorized with the classic build/buy/borrow model of business marketing strategy (Conning & Conning, 2000) classification: Company site (build) o Contract/referral generator o Sales initiation o True online sales 19

o Online sales of specific products Supermarket/mall (buy) o Carrier leads o Agent referral o Online agency Relationship-based (borrow) o Portals, banners o Event triggered links 20

III. INTERNET BUSINESS MODELS Management teams across the insurance industry face the dilemma of how to respond to the new market environment. The previous section defined the primary business profiles for insurance e-commerce. At the same time, a new threat is emerging on the horizon. In the U.S., where Internet developments are far more advanced than in Europe, a new breed of player has appeared. These companies have shown different degrees of innovation. As insurance markets have evolved, they are providing easier access and broader product choice. Through the use of marketing and technology, companies are overcoming historical barriers and increasingly empowering customers. With the advent of the Internet, business flows have been reversed, as customers are able to approach companies in an open space environment. Below, we discuss the application of different Internet business models in insurance markets. A. Model One: Marketing Support Only Figure 4 Model One: Marketing Support Only Company Customer Direct Channel 21

The marketing support approach is the first step to e-commerce for most insurers. Many insurers feel comfortable maintaining this strategy in view of the nature of the customer base. The majority of European insurers have already adopted this sort of capability. For example, according to the Allianz (www.allianz.com) website, the number of visitors is below 222,000. This represents less than 1 percent of the number of Allianz policies, indicating that its website does not yet play a major role in its marketing activities. The website has some decision support tools such as calculators and quotes but does not provide a facility to complete policy applications online. It is important to consider the characteristics of an insurer s customers and target markets. There is a higher opportunity cost associated with the time expended by higherincome consumers (who are more likely to use computers). They may not find it more efficient to utilize the Internet if they cannot complete transactions online. Companies tapping the low end of the market are faced with the opposite problem; clients are not prepared to use the facilities provided by Internet. Therefore, the company has to follow an educational campaign to prepare its customer base gradually to be able to interact in a virtual environment. Prudence suggests that insurers use mechanisms that are tailored to the realities of their customer base, even if those mechanisms lag behind what would be technologically possible. The Allianz Web site is a platform designed to inform customers (or potential customers) and to present the company s product and services. Each part of the company s website offers possibilities for dialogue with experts by mail or telephone. It assures customers that it will connect them with the right expert, someone with answers and the ability to develop solutions. The company is still heavily dependent on its agency 22

network. Its Internet strategy is therefore aimed at strengthening its traditional distribution channel. B. Models Two & Three: Online Distributions of Traditional and Internet Products The second step in the traditional path followed by insurers is to facilitate sales of insurance products online. This is the most advanced staged for the majority of traditional insurance companies. In a personal lines environment, this is the most aggressive stance without disrupting the conventional business flow. For some companies, this could be their ultimate objective in relation to e-commerce. These models tend to sell very simple products and tend to specialize in a narrow product range. Figure 5 Models 2/3: Online Distribution Company Customer E-commerce Webinsurance (www.webinsurance.com) is a sales channel dedicated exclusively to insurance products provided by companies of the Winterthur Group. Winterthur is part of Credit Suisse Group. Webinsurance offers the opportunity to obtain quotations for insurance products and services and useful information related to the customer s financial 23

needs. At this stage, the service is available in Belgium, France, Germany, Italy, Portugal, Spain, Switzerland, the UK, the US and several other countries. The Web is used as a gate to all companies in the group. In the case of Webinsurance, all countries covered are connected to a common platform. This can present some difficulties in designing the right product. In a cross-border scenario, consistency will become paramount. The common types of insurance offered are travel, home and auto. The website offers health insurance only in France. There is a clear emphasis towards property-liability insurance products in online sales. The greater complexity of life, health and retirement products and different social insurance systems among countries makes it more difficult to offer common products across national borders. It is interesting to examine the websites used by Webinsurance in different countries and consider their consistency in terms of communication and products.for example, some of these websites have only advisory capabilities in the form of contact buttons. With developing technology, these sites are likely to adopt digital imaging facilities with online financial advisors. It is also important to note how companies are using high frequency activities (such as traveling) to attract customers for other products and focus their marketing on consumers who are more likely to purchase these products. Figure 6 AnnuityNet.com AnnuityNet.com (www.annuity.com) is the leading marketplace for direct-sold annuities. Self-directed investors and financial advisors use the site for a pre-screened 24

selection of simple, low-fee retirement products from a wide variety of leading companies. The site functions like a discount outlet mall for high-quality goods. The site attracts potential customers through print articles and publications, as well as advertisements on MSN, AOL and Quicken. AnnuityNet.com offers annuities from the following companies: Aegon; Keyport Life Insurance; Lincoln Life; American Century; Bankers Trust (Deutsche Bank); Janus Capital; Fidelity Management; and Other leading asset managers. To complete its offerings, AnnuityNet.com also provides additional services from BancOne, TD Waterhouse, and OnMoney.com. Further, the company is linking with a number of fee-only financial advisors. The array of products and services is illustrated by the combination of providers, although AnnuityNet.com remains a fairly specialized player. One of the advantages of the site is the choice of products (simple, low advice requirement) from sound companies at low fees. The shortcomings of such a model are evident, however. Integrated financial advice requires a set of features that are not easily packaged in a virtual environment. 25

C. Model 4: Online Administration Figure 7 Model 4: Online Administration Company Customer E-commerce Individuals Brokers Companies Model 4: Online Administration possesses extended capabilities in offering services to different types of customers and intermediaries. American International Group s (AIG) site (www.aig.com) provides services to individuals, brokers and companies. AIG is a US-based international insurance and financial services organization and the largest underwriter of commercial and industrial insurance in the US. Its member companies write a wide range of commercial and personal products through a variety of distribution channels in approximately 130 countries. AIG s global business extends to financial services and asset management, including aircraft leasing, financial products, trading and market making, consumer finance, real estate investment management, and retirement savings products. AIG created www.aig.direct.com to enable its companies to offer a full range of insurance products, services and resources through a customer friendly online process. The AIG e-model is designed to offer the following features: One-stop shopping through a comprehensive portfolio of products. 7 day no obligation quoting. 26

Leading edge Web-based customer service, including: claims first notice, policy processing, and online customer service for most products. Insurance-related content and resources, including calculator tools, feature articles, expert advice and money saving tips. Accessaig.com offers an example of a sub-channel aimed at intermediaries. This is one of the features that differentiates AIG s model from the previous two presented above. Figure 8 Accessaig.com Learn More About... WORLDRISK SM Gold Package - Management Liability Products Producers: Your sales process just got easier! Register to explore our Virtual Office TM to find out how. What is Virtual Office? Virtual office is the brokers' online destination at accessaig for transacting business with AIG member companies. AIG Virtual Office offers instant quotes, online binding and an underwriter response within two days for many products! Click here to register now Umbrella Elite SM XWC-Elite Excess Workers' Compensation and Employers' Liability RecallResponse SM Products for the Power Industry Homeowner's Insurance Auto Insurance Licensed Brokers & Agents: 27

AccessAIG.com offers products to intermediaries (brokers) through the Internet. The service provides basic advice and is aimed at servicing advisors around the clock. The company provides online phone or fax facilities to conduct transactions. This is a model that other big players are likely to adopt. The audience is not restricted to individuals but encompasses brokers and risk managers and even insurance companies. Of course, the suitability of this e-commerce model may vary between personal and commercial insurance markets. D. Model 5: Product Portals Figure 9 Pivot.com Pivot.com (www.pivot.com) is a subsidiary of ilife.com, one of the well-known portals of online personal financial resources and e-commerce solutions. It has teamed with insurance companies to provide low-cost insurance solutions to consumers via Internet and the telephone. The site represents more than 100 insurance companies. In addition to enabling consumers to quickly and easily apply for insurance via Internet, the fully interactive Pivot Web site also provides insurance education. Pivot s efficient marketing capabilities have enabled the agency to be selected as the fulfillment arm for various third party marketing arrangements. Consumers are contacted by telephone by an agent after they have sent an application. 28

Portals are one of the most powerful models in offering financial services and products through the Internet. Portals and virtual malls offer a unique opportunity to sell financial services and products as consumers engage in on-line searching and shopping. E. Model 6: Point of Sale Portals Special events are good opportunity to offer a series of complementary products. It is particularly suitable for companies with recognized power brands associated with expertise in satisfying specific business segments. BabyCenter, Inc (www.babycenter.com) leverages its position in one of the most important life-changing events, having a baby. Babycenter.com offers guidance, with an easy-to-use site that features original, high-quality content and practical advice from trusted sources, such as obstetricians, pediatricians, and fellow partners. Figure 10 Model 6: Point of Sale Portal 29

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Figure 11 Babycenter.com Family Family Finances Finances There's no question that a new baby directly affects the family finances. Suddenly, you may be living on a lower income if one spouse works less or not at all and have more expenses, including costly daycare. Financial planning and saving are in order, but it's not as daunting as it sounds. Here are a few things to consider: What's below: Do we need life insurance? Do we need disability insurance? Do we really need a will? Does it make sense to set up a trust for my child's future now? How will baby's arrival affect our tax status? Will my health insurance needs change? Can we afford daycare? How will we afford a child? The Family Finance Center of BabyCenter.com includes detailed explanations for topics such as life and disability insurance. The site contains links for different products. Because of the particular needs of the site s visitors, the package concept is quite appealing in these specific circumstances. This sort of scenario constitutes a difficult competitive ground for traditional insurance companies. Such enterprises compete with the aim of becoming product providers. 31

F. Model 7: Aggregation 3 Figure 12 Model 7: Aggregation The Aggregator business model offers an electronic marketplace in which consumers can compare the products and prices of different insurers. The model is particularly suitable for independent financial advisors, brokers and knowledgeable customers. Most of the existing literature on e-insurance predicts that aggregators will expand rapidly in the near future and will be one of the most successful online insurance distribution mechanisms. They offer platforms for consumers to compare basic products offered by different insurers. However, there is a potential problem in comparing bundled products where product features are not equivalent. This model is very good for simple individual 32

products, such as term insurance, annuity, home insurance, and auto insurance for low and middle-income customers. Aggregators do suffer from a low frequency of insurance purchases. As this model does not tend to generate revenues, it is very difficult to build customer and brand loyalty. The challenge for aggregators is to gain a dominant market position quickly to attract a higher number of sellers. Choice and quality are the key success factors. InsWeb (www.insweb.com) operates an online insurance marketplace in the US. InsWeb directly links customers and insurance companies, providing customers with the insurance they need and insurance companies with the customers they want. InsWeb has relationships with more than 40 companies and offers a sophisticated, integrated online platform that delivers benefits to both consumers and insurance companies. This model offers several benefits to consumers: One-stop comparison shopping for multiple insurance products in an unbiased marketplace; Accurate, insurance company-sponsored quotes; and Convince, control and privacy without sales pressure. The model also offers several benefits to insurers: Lower customer acquisition and service costs, cost efficient distribution capabilities of InsWeb s Internet model; Access to pre-screened and qualified customers (reducing adverse selection) from the growing population of technology-oriented consumers who shop online; Rapid feedback on market performance enabling quick and easy adjustments to product offerings; and 3 This section is drawn from SIGMA (2000). 33

Improved underwriting profitability and the opportunity to provide enhanced product offerings. InsWeb s customers follow a three-step procedure to obtain coverage. Figure 13 InsWeb Site The key success factors in this model are choice and quality. InsWeb has made agreements with the most respected names in the industry. Table 1 lists the companies and their ratings according to A.M. Best as of June 6, 2001 (www.ambest.com). InsWeb receives referral fees from carriers once a consumer selects a carrier s quote among the list of those that offer a product to meet his/her needs. A complete shopping session takes place when the consumer has proceeded through the application process and has selected a quote from the resulting list of carriers. The carrier then pays InsWeb a fee and follows up with the consumer to sell the policy. InsWeb s revenue was $21.8 million for 1999, which represents a 407 percent increase from the previous year. The company reported a net loss of $36.2 million for 34

1999, compared with $22.5 million for the previous year. The company estimates revenues of $30 million in 2001 and to breakeven in the first quarter of 2003. In 1999, the number of completed shopping sessions totaled more than 2 million, representing an increase of 416 percent over the previous year. The number of unique user sessions on InsWeb in 1999 totaled more than 7.8 million (a 166 percent increase from the previous year). Table 1 Insurers on InsWeb Company Rating Company Rating AIG A++ Homesite Insurance NR Allstate A+ Kemper Direct A Allstate Life Insurance Company A+ Meridian Insurance A American Family Insurance A+ The Midland Life Insurance A Company American Skandia A The MONY Group A Amica A++ National Merit A Amica Life A New York Central Mutual A+ Auto Club Insurance Association A North American Companies A and Affiliated companies CNA A Northwestern Mutual Life A++ Cross Country Home Services NR Ohio National Financial Services A+ CSE Insurance Group A- Old Republic Life Insurance A Company Electric Insurance Company B++ Permanent General A- Explorer Insurance Company A Progressive Insurance A+ Financial Indemnity Company A+ Prudential A- GE Auto Insurance Program A- Sun Life Financial A++ GE Term Life Insurance Program A+ Travelers Insurance A++ GMAC Insurance A+ Tri-State Consumer Insurance A Company Great-West Life & Annuity A++ Western and Southern Life A++ Insurance Company The Hartford A Western-Southern Annuities A++ John Hancock A++ Zurich Kemper Life A 35

InsWeb s volume demonstrates that on-line insurance has active participants. InsWeb is still in the start up phase and therefore its bottom line results are still affected by the investment strain from building the technology platform and expenses incurred in raising the company s profile in the market. InsWeb is now pushing to expand its online insurance agency, where it receives agency commissions from carriers for completing the process and closing the business. This expansion offers InsWeb increased revenue opportunities (such as renewals) and better predictability of its business. InsWeb predicts that agency commissions will represent about 10 percent of its business in 2001 and 40 percent by the end of 2002. In the second quarter of 2000, 1,913 policies were sold with renewals averaging 90 percent of sales. This represents a 27 percent increase from the 1,511 policies sold in first quarter. However, these trends do not guarantee success for InsWeb given the rocky experience of other Internet companies. Companies implementing the aggregator model as InsWeb are introducing a competitive dimension that traditional distribution channels do not offer. The closest analogies in traditional distribution are brokers or financial advisors. The difference between this way of obtaining advice and players like InsWeb is that the customer now gains direct access to the available choices. The intermediary acts as a window offering the options; its bargaining power is restricted by the need to provide choice. Currently, the majority of the aggregators earn their commission from the insurers that use their platform. Given the increasing competitive environment and the need for greater independence, these virtual markets will need to obtain the commissions from customers rather than insurance companies. This trend, however, could put downward pressure on commissions going forward. 36

G. Model 8: Online Risk Market Figure 14 Model 8: Online Risk Market The Internet revolution has also developed in the business-to-business (B2B) area. Although the previous examples mostly involve the insurance market, this model is particularly relevant for the reinsurance market. The development of alternative risk transfer methods has created opportunities for innovative solutions to the transfer of special risks. Financial reinsurance, securitization and the use of derivatives have opened the risk management process to the capital markets and non-traditional players. The risk exchange concept aims at improving the information flow and therefore transparency in a business area where the magnitude of potential losses have precluded many players from entering this market. Capital markets have shown, in certain circumstances, a higher risk appetite than traditional players. The capital markets also dwarf the capacity of the reinsurance market. At the same time, reinsurers may also find it attractive to use these vehicles to aid their diversification of risk. 37

Figure 15 Catex CATEX is the world s largest Internet-based B2B exchange for insurance, reinsurance and risk management. The exchange offers global pricing transparency and transactions detail for all lines of commercial insurance and reinsurance. CATEX facilitates the exchange of information between buyers and sellers of risk and helps them to make more informed business decisions. The exchange was established in early 1996 to facilitate the swapping of catastrophe exposures between interested parties. Since its inception, CATEX has greatly expanded its operational scope to include all lines of commercial insurance and reinsurance. The risk instruments now being managed through the system include traditional premium indemnity transactions, Second Event Covers, Industry Loss Warranties, Stop Loss and Aggregate covers, treaty and facultative covers. There are have been more than 1,400 risks posted on the exchange and the more than 500 completed transactions representing in excess of $3 billion of insured exposure in 2000. Posted risks included aviation and aerospace risks, accident and health, marine, energy, political risk, weather, credit, auto liability and others. The CATEX community of subscribers is composed of more than 170 corporations representing nearly 2,000 individual end users. These intermediaries, reinsurers, insurance carriers, and corporate risk managers are located in over 85 cities throughout the world. The CATEX 2001 Trading System consists of five main modules: 38