Financial Services Point of View UK SME Pricing Put Your Underwriters Back in the Box Author Christopher Sandilands, ACII, Senior Manager
We have been spending a lot of time over the last few months talking to our UK clients about SME 1 insurance. As we laid out in our recent publication 2, the UK SME insurance market is undergoing huge structural change at the moment, with wide-ranging innovation in distribution and manufacturing, and intense levels of competition between incumbents and new entrants. However, one theme tends to dominate our discussions: What is best practice SME pricing and how do we get there? Our response: Put your underwriters back in the box, and reshape your organisational model. Why is the market focusing on SME pricing? SME distribution is changing in two ways: first, the entrenchment of broker portals (e.g. Acturis, OpenGI, SSP) as a major part of the broker value chain, and second the emergence of direct portals as a growing and potentially significant part of the future distribution mix (e.g. Towergate s Your Insurance, Simply Business), with particular traction in the micro end of the market. Exhibit 1: Trends in SME distribution Insurer Examples: Open GI SSP Acturis Extranet Broker portals High Street Brokers Direct portals Face to face/phone SME Customer Examples: Insurantz.com SMEinsurance.com Simply Business insurance-for-business.co.uk Your Insurance Constructaquote.com Direct insurers Examples: Direct Line for Business Premierline Direct Hiscox 1 Small and Medium (sized) Enterprise 2 SME An industrial revolution see the Oliver Wyman website (www.oliverwyman.com) for details
As far as pricing is concerned, the challenges and opportunities are similar for both of these channels. They are both built on e-trading with a growing share of cases being priced and bound without underwriter intervention. Importantly, both channels normally present brokers and proposers with a range of quotes, meaning that pricing is becoming increasingly transparent, placing huge pressure on insurers capabilities. The changing landscape provides both an opportunity and a challenge for SME insurers. The growing, innovative players tend to talk about cherry-picking business through superior pricing, whilst the large incumbents talk about defending against the threat of anti-selection. An important and very clear feature of the current market is the pricing capability gap that has opened between the market leaders and laggards. So why put underwriters back in the box? Competitive conditions at the micro end of the UK SME insurance market are becoming ever closer to the personal lines market. Not only is the behaviour of buyers, existing brokers and insurers changing, but personal lines brokers and insurers are also targeting the SME market with increasing intensity and success. Personal lines players have made two advances in their own businesses. First, they understand that the customer experience and journey is critical to making sales in a market dominated by remote channels, and have prioritised marketing related activities in their business model. Second, they have transitioned to pricing approaches which are compatible with delivering this customer journey. This means the ability to deliver prices to customers without the need for human interaction. To ensure the adequacy of rates calculated automatically in a highly transparent market, the rigorous and granular analysis of pricing data has also been prioritised in the business. Copyright 2011 Oliver Wyman 3
SME insurers need to make similar advances, particularly for micro business. Significant investment will be required for insurers to redesign their approach to SME business and their business model. There should be a significant disempowerment of underwriters in favour of broader customer experience teams, and a commensurate investment in pricing-related processes and infrastructure. We will see more underwriting price sophistication going forward in property and packages, with more risk selective underwriting. Those with better algorithms will be able to read new data faster and respond to opportunities, the players with just four rating factors will get selected against. For example most of my SME pricing team have personal lines modelling backgrounds UK SME Insurer Source: Oliver Wyman interviews We cite four pieces of evidence to support our case. Why insurers need to invest in pricing: The evidence #1: What our clients tell us about their businesses We have had in-depth discussions with the majority of UK SME insurers over the last few months. Most have been very candid about their SME capabilities, and in particular the weaknesses of the SME business compared to their personal lines operations. Here is a summary of what we typically hear about the SME business: It s a business where the underwriter is still king We don t capture and use data consistently The underwriters finally admitted that they have a lot of data, but I m not sure they use any of it Our conclusion: Most of our clients have a long journey ahead of them to move to a customer-oriented business model driven by data and analysis. Most large SME incumbents are run by underwriters who have a natural preference for technical and judgementled underwriting over delivering a slick, largely rules-bound and automated customer experience. 4 Copyright 2011 Oliver Wyman
This in itself has two implications. First, insurers need to undertake root and branch change projects to adapt to the new market environment. These projects will need to be driven by the strategy team, not by the business, because the vested interests of the business will be too strong to guarantee reaching objective conclusions. Second, to sustain the new customer orientation in the future, the most successful SME businesses will be led by Commercial Directors rather than Senior Underwriters. #2: What SME direct portals tell us about the pricing process We have also had extensive dialogue with the SME direct portals over the last two years. These conversations provide strong confirmation that many insurers have very limited oversight of their underwriting processes and risk costs. For example, one portal executive told us that one of the greatest benefits some of his panel members gained from being on the panel was feedback on their pricing level and process. The portal would provide insurers with insight on questions which always generated referrals, but which would then always lead to a decline by the referral underwriter. This allowed insurers to refine their underwriting process across all channels. Our conclusion: Whilst almost all insurers would define underwriting as one of their core competencies, processes have historically seen underinvestment. This is not surprising. When judgement and the underwriter are king, clearly defined decision processes are not necessary, and would not be accepted in any case. This will be exposed as the volume of business transacted through remote channels, requiring good customer journeys, increases. Power brokers originally from the personal lines sector are increasingly applying techniques from volume lines or personal lines to commercial business, for example lifetime value and price optimisation models, unpackaging products and taking commission on annex products and so on. Insurers [are seeing] underwriting margins for new business get crunched UK SME Insurer Source: Oliver Wyman interviews Copyright 2011 Oliver Wyman 5
#3: What we hear about pricing accuracy A critical part of the underwriting capability needed by insurers in the new world is pricing accuracy, which includes both level (at appropriate granularity) and agility (i.e. the ability to change rates quickly based on analysis). Personal lines players review prices on a very frequent basis (e.g. twice weekly or more) to measure their performance in the highly dynamic aggregator market. The level of analysis is also increasingly granular, for example, moving to four or more postcode digits. By contrast, some SME clients still talk about annual adjustments to whole portfolios. By way of example, we heard a very revealing anecdote from a panel executive on this matter. We were told about an insurer who joined the panel and had to reduce all rates to a quarter of their initial level to be competitive. This suggests not only that the insurer had little insight into market pricing, but also that the insurer could not even identify broad segments where prices were out of line with the market. As a consequence, this insurer is now surely being selected against on the panel. Our conclusion: As the market moves towards personal lines style distribution techniques, insurers need to ensure that they are moving to personal lines style manufacturing techniques. Not only will insurers need to understand profitability at a much more granular level and with much shorter review cycles, but they will also need to be able to conduct pricing experiments on particular customer groups in order to exploit elasticities. This will lead to major skill shortages in the relevant pricing and analytical marketing disciplines, and a commensurate gap in the capabilities of slow-moving insurers. Many competitors cannot afford to wait to upgrade their SME pricing capabilities. Leading players are already able to cherry-pick business, and the pace of this will accelerate, rapidly eroding the profitability of many blocks of currently profitable business. Given that this will be true not only on currently small direct portals, but also on broker portals which already carry material volumes, and that building the process and infrastructure to upgrade pricing capabilities cannot happen overnight, insurers should start investing immediately. 6 Copyright 2011 Oliver Wyman
Exhibit #4: Technology problems Technology constraints are another recurrent discussion point in our conversations in the SME market. For example, the direct portals have almost all chosen to build stand-alone infrastructure and have uploaded insurer pricing parameters, rather than querying insurers systems. There are two reasons: first because many insurers systems are too outdated for an effective interface to be built, and second because portal executives doubt most insurers ability to develop their proposition quickly enough to meet their own development requirements. Our conclusion: Insurers find it more efficient to maintain rates on several portals rather than upgrade their existing technology. Insurers have a huge technology gap in SME, which will need to be closed as more and more business is electronically traded. As volumes on portals grow, work-around solutions will soon crack. That said, some insurers are investing in their SME technology too early. We are absolutely adamant that insurers need to be clear about their SME strategy, based on a clearly thought through consensus view about market development, before touching technology. Building SME technology before being absolutely clear about strategy is to build another legacy problem for the future. Summary: What does this mean for SME competitors in future? We see huge opportunities in the UK SME market for those players who move quickly to turn market changes to their favour. The leaders of UK SME businesses need to have an honest look at their businesses and consider whether pricing processes and infrastructure are in place to allow them to gather and use data, like they can in personal lines. Those who believe that they are behind the market need to invest urgently in building the processes and infrastructure to gather, monitor and act on data, which will in turn enhance both the customer experience and underwriting performance. Copyright 2011 Oliver Wyman 7
We see an investment in pricing as a no-regret investment. It protects against anti-selection for defensive players, and is the basis of profitable growth for more aggressive players. There is a fundamental uncertainty about which channel or channels will be dominant in the SME market of the future, but the ability to price accurately at a granular level will be a key success factor in all of them. Exhibit 2: Pricing capability is a no-regret investment no matter which channels become dominant in the SME market of the future Market Development Current Distribution Models No Regret Investment Possible Scenarios for the Future Broker Portals Rise of the Specialists Direct offerings from insurers take off either as mass market propositions or as segment dominators Extranets Ability to price accurately and at a granular level Rebirth of the Extranet Extranet is reborn as insurers invest and find ways to create differentiation in their proposition for brokers Rise of the Direct Portal Direct portals take off, similar to aggregators in the personal lines market Other Entrenchment of the Broker Portal Broker portals continue to grow as market remains intermediated but with increased use of technology 8 Copyright 2011 Oliver Wyman
Oliver Wyman is an international management consulting firm that combines deep industry knowledge with specialised expertise in strategy, operations, risk management, organisational transformation, and leadership development. For more information please contact the marketing department by email at info-fs@oliverwyman.com or by phone at one of the following locations: EMEA North America Asia Pacific +44 20 7333 8333 +1 212 541 8100 +65 6510 9700 Copyright 2011 Oliver Wyman. All rights reserved. This report may not be reproduced or redistributed, in whole or in part, without the written permission of Oliver Wyman and Oliver Wyman accepts no liability whatsoever for the actions of third parties in this respect. The opinions in this report represent the views of the author(s) and may not necessarily reflect the views of other partners within Oliver Wyman or the company. This report is not a substitute for tailored professional advice on how a specific financial institution should execute its strategy. This report is not investment advice and should not be relied on for such advice or as a substitute for consultation with professional accountants, tax, legal or financial advisers. Oliver Wyman has made every effort to use reliable, up-to-date and comprehensive information and analysis, but all information is provided without warranty of any kind, express or implied. Oliver Wyman disclaims any responsibility to update the information or conclusions in this report. Oliver Wyman accepts no liability for any loss arising from any action taken or refrained from as a result of information contained in this report or any reports or sources of information referred to herein, or for any consequential, special or similar damages even if advised of the possibility of such damages. This report may not be sold without the written consent of Oliver Wyman.