Come 2014, Industry Should Look Very Familiar

Before Spitzer Bombshell, PCI Execs Saw Current Players Adapting to Succeed

Ten years from now, some of the players within the property/casualty insurance industry will have changed but the industry itself will not look dramatically different from what it is today.

Smaller companies and independent insurance agents will still be big.

Market share between small and large insurers will still be about the same as it is now.

Aggregate industry financial returns will still be poor compared to those of other industries.

Consolidation will still be going on at the carrier and agency levels.

Customers will still be deciding the direction of the industry and distribution.

The best performers among insurance companies will still be those that do the best underwriting.

The industry in 2014 will look a lot like it does today because the future borrows heavily from the past. Also, it will look familiar because it assumes that most current industry players will themselves change so that they successfully navigate the challenges brought about by technology, demographics, weather, mismanagement, regulation and other external and internal forces.

That’s a summary of what insurance company executives told attendees at the Property Casualty Insurers Association of America annual meeting before the Spitzer bombshell when they answered the questions, “What will the industry look like in 2014 and how will it get there?”

Smaller insurance companies–those with surplus under $50 million–still manage to capture above 58 percent of the insurance market, despite the fact that this is no longer a “Mayberry-type” world, the president of one of these smaller companies reminded his PCI audience. Neal W. Menefee suggested this measurement would likely hold true in a decade as well, although smaller insurers will have to adjust to some new realities first.

Menefee is CEO of Rockingham Group, based in Harrisonburg, Va., which writes personal lines insurance in Virginia and Pennsylvania through Rockingham Mutual Insurance Co., Rockingham Casualty Co. and Rockingham Mutual Service Agency Inc.

Menefee explained that, historically, smaller companies like Rockingham have succeeded by understanding niche markets, whether they be geographical or product oriented; by being followers, not leaders, in innovation and risk; by providing better and more localized service; and by achieving quality loss ratios to offset their somewhat higher expense ratios.

But, Menefee said, technology is changing this success formula. Large companies such as GEICO and Progressive are using technology to carve out their own niches, to create tiers and multilevel products that help improve loss ratio, and to deliver quality convenient service.

“Large companies can deliver better service than they used to so that smaller companies can now be beat on their loss experience and on customer service,” he said.

So where does that leave smaller companies? “It means that smaller companies must go back to their roots,” Menefee claimed. “They must focus on the underserved.”

At the same time, they must adopt a new mindset. Whereas small insurers used to be followers, they must become innovators again. Whereas before they were reactive, now they must proactively embrace the newest technologies. In a future environment where inexpensive will beat the expensive, simple will beat the complex, and open will beat the closed, smaller companies will still compete, he predicted. Instead of offering coverage for high-risk drivers, they may be selling insurance for robots or for persons wishing to travel back in time, but they will still be in business, he added.

“The sun is rising for small companies who are seeking opportunities,” Menefee insisted.

Donald Southwell, CEO of Unitrin, spoke about personal lines distribution in the United States by suggesting that the future is really out of the industry’s hands. Illinois-based Unitrin boasts $7.5 billion in assets and more than six million insurance policies in force. It sells property, casualty, life and health insurance and consumer finance products.

“While companies sometimes think they make the decisions, customers will actually decide the future of distribution, not companies. If we think we control it, we are kidding ourselves,” Southwell said.

He noted that 20 years ago captive sellers looked to be taking over the industry but that hasn’t happened. He maintained that “lines are blurring” between and among captive agents, independent agents and exclusive agents. Independent agents sometimes look more like captives; some captive agents are becoming independent. Many independent agents are also Internet aggregators and bank agents. Perhaps no force will have more effect on the future than technology, suggested the Unitrin CEO.

Many baby boomers and most, if not all, younger customers are comfortable with technology and expect it to be part of transactions. “For younger kids, technology is like the automobile was to the older generation. They can’t imagine living without it.” Also, the Internet has created “ubiquitous lower cost networks” in which every insurance company, large or small, can participate.

Technology can also facilitate what Southwell referred to as the “disaggregating” of distribution. As company consolidations continue, they offer agents fewer choices and as agents consolidate, they in turn become less personal. This opens the door for the breaking down through technology of the distribution process into separate segments such as the finding of prospects, the selling of the product, the giving of advice, and the servicing of claims. The rise of service centers and the spread of separate companies that just provide leads for sales are examples.

In this changing environment, insurance providers have to understand what their customers think are important from among four key values: price, product, convenience and relationships, according to the Unitrin executive.

Price obviously is very important and in getting to price, scale of operations is important. This is where direct writers and direct response companies have an advantage. Product is important. The product includes the expertise and the advice offered by agent. “This is where agents shine. Agents confront the complex needs and unpleasant topics for clients,” Southwell added.

Convenience can mean different things to different people. It can be dropping by to a local agency or claims office or it can mean shopping or filing a claim over the Internet. Finally, relationships are important.

“People buy from those they know and trust, and again independent agents have the advantage here,” he offered.

Southwell suggested that reaching customers could be a bit trickier than just focusing on one value. Not every customer shares the same values to the same degree and every customer has a different blend of values, so success may demand a more complex approach.

That view might help explain why his own company, Unitrin, is bullish on the independent agency distribution force, but is also involved in some direct response.

Mark Watson, CEO of Argonaut Group Inc., believes that well-run commercial lines insurers and independent agents will continue to do well in the years ahead, even though the industry’s overall financial picture will still not be much to brag about.

Headquartered in San Antonio, Texas, Argonaut is a national underwriter of specialty insurance products in niche areas of the property and casualty market. Collectively, Colony Insurance, Rockwood Casualty Insurance Co., Argonaut Insurance Co., Argonaut Great Central, Grocers Insurance and Trident Insurance Services underwrite products in excess and surplus, specialty commercial, risk management and public entity.

According to Watson, the number of commercial insurers always remains fairly constant–when one drops out, another tends to surface. The market share of the largest 25 commercial writers doesn’t change much either; they control about 60 percent of the market, which means that smaller companies in commercial lines have managed to maintain their share.

He sees plenty of opportunity in the commercial market, which is now topping $200 billion and should continue to grow. Twenty-five years ago, independent agents controlled more than 70 percent of this market; they still do today and will in the future.

The excess and surplus commercial lines market has also enjoyed substantial growth, and now account for 14 percent of the commercial insurance marketplace–an 11-fold increase compared to the three-fold growth for the standard commercial insurance market. Watson suggested that the E&S markets tend to gain and retain more business with each insurance cycle and that would probably continue to happen.

Noting that 1978 was the last time the industry showed an underwriting profit, Watson reminded the PCI audience that the industry’s overall returns have been relatively mediocre for decades. He does not see this turning around soon, nor does he expect that “prosperity is going to break out” all of a sudden.

The reason the industry’s results will not improve much is because the internal and external forces that contribute to these results are not about to change, according to Watson.

“You have to look to the causes of the poor return at equity in the past,” he said, offering a long list including that insurance products are hard to differentiate; there is no cost to customers to switch carriers; agents try to sell at the lowest price while claims intermediaries try to get the most in payments; there are low barriers to entry and high barriers to exit the industry; the cost of litigation is rising; there are still regulations that control pricing; and there is no uniform voice for the industry in Washington, D.C.

Since these factors are not likely to change, neither will the industry’s aggregate returns improve much in the next decade.

“That’s the bad news,” Watson said. “The good news is that the aggregate returns do not have to equal the returns of any individual company.” The aggregate returns hide the tremendous differentiation among insurance companies.

Just as the factors behind uninspiring aggregate financials have not miraculously morphed, the key to success for individual insurers has not changed either. Sound underwriting remains the factor “most highly correlated with a better performance,” Watson said.

In addition to underwriting, accurate reserves are important. Senior management should focus on risk management and not on earnings management. He also cited the need for good financial discipline including transparency and accountability.

“To succeed, it’s not an intellectual challenge, it’s an execution challenge. The good performer can become the stellar performer in the next 10 years,” Watson said.