Insurance models for the
Against a backdrop of rapid technological change, record low fixed-income yields and
perpetually softening insurance rates, it’s no wonder that many insurance businesses
are considering a change in strategy. Barely a week goes by without a new report warning
of threats to traditional insurance business models and competitive pressures on the
established insurance market hubs.
At Quantemplate, we work with businesses across the market and have seen a diverse
range of strategic models first-hand. Whether they are small teams focused on niche
areas or large funds providing capital across the market, the companies best suited
to prospering in the technology age have one thing in common: they have identified
a segment of the market aligned to their client and capital constraints and focused
their strategy accordingly.
In this report, we highlight five key strategies currently being adopted by successful
insurance businesses. All of them touch on Lloyd’s ‘Vision 2025’1 core topics:
Distribution, Capital and Convergence, and Market Operations. These topics are not only
relevant to Lloyds but to the health of the global insurance market.
Core Capital Providers
Large reinsurance firms provide
capital to the wholesale market in the form of long-term reinsurance relationships. These
businesses also offer clients access to capital markets by underwriting Insurance Linked
Securities and other Alternative Risk Transfer services like whole account covers or
Very significant capital is
required ($10bn+) for this strategy and these funds must be fixed as these services equate
to renting out one's balance sheet and the client base is particularly sensitive to credit
rating fluctuations. The volume of premium required to maintain such a large capital base
is only sustainable with strong long-term ceding company relationships. This sticky approach
to providing reinsurance also requires sufficient resources to weather periods when pricing
is below technical profitability.
Loyal cedants provide a reliable income.
There is often an ongoing and complex flow of premium and claims settlements between the
large capital-providing reinsurers and their clients which weds the parties through thick
In the BCG report “The London Insurance Market's Historic Role Faces a Tipping Point”2
was found that “London's expense ratios were 9% higher than that of its peers (Bermuda,
Zurich, Singapore) in 2013”. One solution to this problem is for these firms to become
core capital providers who offer long-term capacity that can be delivered
with proportionally lower operating costs as small teams underwrite a limited number of large
Underwriting large whole-account reinsurance
throughout the market cycle can result in technical accounts being marginal or unprofitable
for extended soft periods.
Methods for Enhancement
Such firms may need to reduce
acquisition expenses to counter the increased technical cost of claims. Unlike underwriters
operating lower down the capital structure, they can obtain a very large written premium from
relationships with a relatively small number of ceding insurers. Accordingly, the headcount
required to maintain these relationships and to manage the account should proportionally be
far lower than more transactional insurers.
Additional income (some of which is not correlated to insurance risk) can be made from direct investments.
Often core capital providers possess an asymmetry of knowledge on the insurance market and can use this
to make investments that outperform (e.g. taking equity as well as offering reinsurance capital to innovative
insurers). The provision of data and technology to ceding clients is also a strong selling point for many
core capital providers. This helps strengthen relationships with clients as they rely on the wider risk
management services. Swiss Re is a good example. The firm provides clients with Sigma Research3
to proprietary risk modelling tools such as CatNet4
for natural hazards and
for life and health exposures.
Firms with flexible capacity provide liquidity
to underserved sections of the market, peak exposures and emerging risk classes. After more than a
decade of average rate softening, it is easy to forget that insurance buyers have an inelastic demand
(in so far as insurance is a prerequisite for most financing) so when capacity is scarce the
ramifications are serious.
Traditionally, flexible capacity has gained market exposure through investments in high level
Insurance Linked Securities (ILS) and collateralised reinsurance. As these instruments provide
collateral to cover losses, the capacity provided did not incur the extra costs and complication
of obtaining a credit rating or regulatory approval. In the wake of the large 2005 and 2006
hurricanes, a wave of ‘sidecar’ reinsurance vehicles were created to deliver capacity through
whole account quota share reinsurance. The most recent development in flexible capacity has been
the establishment of hedge fund-backed reinsurers looking to use technology to deploy capital
more effectively lower down the risk structure. This can be seen in a statement by Brian Duperreault
of Hamilton Re in an interview with Intelligent Insurer:6
‘The true benefits of a technology-driven approach will be felt on
the insurance side to a greater extent than on the reinsurance side.
Being closer to the risk would benefit this approach.’
The received wisdom states that a
new reinsurer requires $1bn+ of capital to secure an ‘A-’ or higher credit rating. This nimble
strategy must be light on iron-clad underwriting restrictions as the attractive opportunities can
appear in any sub-section of the market (see Quantemplate report7
on the market structure).
For many opportunities, the carrier will have limited proprietary results on which to base
their pricing decisions. Furthermore, securing inuring reinsurance is challenging as capacity
for the exposures is in short supply and historic data limited. Accordingly, access to contingent
capital is vital for successful solvency risk management. Companies that successfully employ this
strategy benefit from express or implied guarantees from well capitalised parent companies. These
are often hedge funds or diversified conglomerates with Berkshire Hathaway being the most prominent
Firms with the flexibility to deploy capacity
in well-priced insurance sectors (or even high-yielding alternative assets when attractive insurance
deals are scarce) have the opportunity to outperform competitors that deliver consistent capacity
throughout the cycle.
Per-unit underwriting and acquisition costs
are high as only a very small proportion of reviewed risks will go on to be ‘bound’. Moreover,
the cost of technology and quantitative staff is a material consideration as reinsurers will
be recruiting from the same talent pool as hedge funds and investment banks in an environment
where actuaries are in very short supply as a result of Solvency II.
Difference in average starting salaries by role
Methods for Enhancement
summarises Hamilton Re’s priority to use technology to enhance underwriting: ‘[a quant
driven insurance company] would use data integration, data analytics and algorithms and apply
this methodology to elements of insurance such as underwriting, claims management and other
areas’. This requires technical infrastructure to receive, structure and model
underwriting submissions with an integrated view on the capital impact of each deal.
In order to assess new and emerging risk classes quantitatively, it is necessary to
adapt proxy data, sourced from similar risk or asset categories.
Smaller teams can apply specialist
skills to the underwriting of niche risk categories. They add value by sourcing and selecting
risks more effectively than less focused competitors. These skills can range from the application
of proprietary pricing models or targeted marketing campaigns designed to attract choice business
(e.g. DUAL successfully targeting the professional indemnity market). These ventures by their
nature need to be highly focused on a specific customer base to avoid the dilution of their
brand and reputation.
This segment is best served by
firms with small or medium capital ($10 - $500m) where capacity is provided by delegated authorities
or substantial purchases of reinsurance. Stand-alone MGA’s (as opposed to broker-held binding
authorities) or small Lloyd's syndicates are the best vehicles for this strategy.
Specialist underwriting teams managing
third-party capacity are specifically promoted by Lloyd’s of London in their Strategy Report
2015-16: ‘Many of the initiatives being pursued by the larger brokers reflect their desire
to increase their efficiency and deal with a smaller number of carriers. Lloyd’s can support
this through the creation of efficient access to Lloyd’s capacity e.g. through the creation of
The creation of consortiums not only lowers the cost of broker placements but also
rewards the skills of the underwriter delivering a non-risk bearing commission or management fee.
Niche underwriters require flexible
capacity on pricing and terms. Marketing channels are built over years and reputations can be
irrevocably damaged by withdrawing from a sector, even if technical rates become unprofitable.
Securing and maintaining lenient capacity can be a tricky tightrope to walk as it brings to the
fore the age-old agency challenge of balancing prudency in underwriting and the provision of
good service to the customer.
Methods for Enhancement
Technology and brand identity
are the two most powerful tools available to the niche underwriter. Successful firms
outperform their cohort on both fronts and this is how they secure capacity from would-be
competitors. An example of innovative technology application is the US crop insurer,
Climate Corporation. It developed a real-time weather forecasting system that could predict
the probability of loss-causing events to such a level of
granularity that farmers could buy insurance for a single field even in view of a storm
on the horizon. This level of customer service was unprecedented in the traditional crop
insurance market, which meant that Climate Corporation rapidly gained market share.
Full Service Insurance
Many large insurance firms believe
themselves to be ‘full service’ providers as they underwrite across all
conventional business lines. However, it is possible to take the concept a few steps
further. True full service insurance is about creating long-term, service-driven
relationships with retail clients much like the retail banking industry. The value
here is meeting the wider client needs in risk management and risk mitigation rather
than purely in the delivery of capacity.
Although the provision
of full service insurance does not necessarily require a large balance sheet to
accommodate peak commercial exposures, there is a significant cost in terms of
technical infrastructure and customer service. For this reason most businesses
that successfully employ the full service strategy have capital resources of over $1bn.
Delivering a high quality holistic
service reduces the focus from a purely cost-based decision. Instead, the customers consider
the full utility of the risk management service when determining the value of the offering.
BCG’s publication Perspectives In Insurance9
highlights the New York-based health insurance
service firm Oscar. ‘With its Facebook-like features, Oscar’s website has achieved a level
of ‘stickiness’ that is rare in the insurance industry. Approximately 5 percent of Oscar’s
customers return to the site on a daily basis’.
When customers maintain their relationship
with an insurance carrier for the long term, then risk-costing calculations can be set for
similar durations. This allows full service firms to weather volatility in results through the market cycle.
As is evident from the EY satisfaction
survey, cost and scope of coverage are the two most important factors for customers. For this
reason, a full service insurer must deliver solutions for multiple lines of business and cover
a broad section of insured types. This contradicts many ‘selective underwriting’ strategies
where each risk is written or declined on its own merits. Accordingly, the insurer must be
prepared to have a broad and inclusive approach to risk selection tailored to satisfy the
coverage requirements of their target customer base. This may result in some under-performing
parts of the account being subsidised by the wider portfolio.
Top reasons for closing or replacing a policy
Methods for Enhancement:
The tactics required
for full service insurance are directly aligned with the desires of the retail insurance
- Cost / coverage
- Claims handling
- Ease of communication
Each of these factors require integrated technology to enable the customer to find their
solution, provide the underwriting information, receive the policy and make claims. As the
second largest motor insurer in Australia, Suncorp saw an opportunity to integrate their
various supply chains by working with entrepreneurs to improve the efficiency of process
and the flow of information. Suncorp has built a nationwide repair network, that utilises
data driven repair segmentation and advanced process technologies to reduce vehicle
turnaround times by over 50% in some cases. By developing adjacent capability in parts
supply and the distribution of repair information, and then linking these businesses
together, Suncorp has improved the flow of information, capital and work through its
supply chain, providing markedly better outcomes for customers and improved cost management
for the insurance business. These benefits will continue to accrue as Suncorp deploys
deeper IT integration and engages forward thinking technology partners to enable end-to-end
The most prominent examples of
streamlined insurance distribution are the online aggregators that have grown to dominate
the British motor insurance market. The Actuary article ‘Rise of the Motor Aggregators’10
by George Maher and others at Towers Watson states that ‘aggregators have commoditised
the motor market. Where there was at best a tenuous relationship
between the market structure and profitability prior to 2002, after 2002 as competition increased
[driven by the entry of the first online aggregator], profitability decreased with a correlation
of almost -96%. This is only natural as insurers are no longer competing on brand, marketing,
service or other intangibles to the same extent; rather, they are competing almost solely on
price and their position on the aggregators’ screens.’
Although this seismic shift in control
and profitability is of great concern to insurers, the vast majority of these cost savings
have been passed directly to the consumer (Cost & Terms is by far the most important factor
identified by Ernst & Young in their 2014 Global Consumer Insurance Survey11
Unlike underwriting risk,
intermediation through aggregation is not a capital intensive business. There is a cost
in software development, negotiating partnership deals and establishing a brand. It is
estimated that $5 million would be the entry level capital required to create a streamlined
distribution service. However there are significant ongoing costs in the form of advertising,
software development and user experience improvements.
From the introduction of the mechanical
loom on textiles to Uber’s current disruption to the taxi sector, advances in technology
have optimised many markets for the better, even if they have caused initial discomfort.
The provision of insurance has no goods supplied at the point of sale, and limited unique
services delivered in claim settlements. With this limited differentiation of each vendor’s
service, it is natural to assume the consumer will desire online aggregators to move up the
value chain into the more complex commercial and specialty insurance markets. Simply Business
is a pioneering example.
Without a capital ‘barrier to entry’,
the aggregation space is itself becoming increasingly competitive. The perpetual reinvestment
of income into advertising initially lead to the service operating on thin margins but for
the leading UK motor aggregators who formed in the early 2000’s their profit margins
averaged 14% between 2010 and 2014. Although the commercial insurance sector is in the sights
of the aggregators, there is much work required to harmonise the underlying data structures
and communications systems before these more complex markets can move to more streamlined
distribution models. However, with Lloyd’s focus on Market Operations and the increasing
number of technology products working to the Acord Standards12
it is likely the infrastructure will be ready sooner than many would like.
Methods for Enhancement
Like all consumer-facing
businesses, the key to successful aggregation is building a defensible brand. David Jackson
of Direct Line highlighted this in his Insurance Age article Get Into Aggregators13
‘The reason comparison sites have become so important in our
market is that they do exactly what the customer needs them to do – make it easy and simple
to buy insurance.’
Although delivering a selection of alternative insurance coverage options
and prices is their prime objective, aggregators can enhance utility with high-quality technology.
This includes user experience improvements in mobile accessibility, and ‘frictionless’ payments,
similar to those developed by the consumer website Amazon.
The London Insurance Market's Historic Role Faces a Tipping Point
Reimagining customer relationships:
key findings from the EY Global Consumer Insurance Survey 2014
Perspectives In Insurance
Rise of the Motor Aggregators
2014 Global Consumer Insurance Survey
Get Into Aggregators