How Insurance Companies Can Change The Distribution Paradigm
Tomorrow's Distribution Blueprint—Tailored To Fit
By Paul Idzik, Ann Connolly and SungEun Lee, Booz·Allen & Hamilton
Overview
Insurance companies, particularly multi-line carriers with captive sales organizations, must rationalize their distribution economics and strategy. Time may be running short, however. Direct writers are gaining in expertise, reach and popularity. And non-insurance competitors, such as banks, are already distributing a range of insurance products to their customers. But a more ominous threat may be well-established insurance brands that could explore new channels and more aggressive pricing in non-core lines or geographies. We believe, therefore, that insurers must create internal and external clarity around products, channels and service features. Once this clarity is established, insurance companies can redesign a new distribution blueprint to match the right products with the right customers through the right channels.
Will customers' historical reliance on high-cost personal service for delivery of products continue to dominate the economics of distribution? How quickly will remote channels become accepted for complex financial transactions and products? Is there a mix of channels that can enable a company to more profitably serve different market segments with a more flexible and powerful cost structure? Can the road to change be traveled without destroying the institution?
The stock brokerage industry, for example, has been grappling with these questions for the past two decades. First the rise of discount brokers and then the emergence of on-line trading forced securities firms, large and small, to make choices about distribution channels and structure their organizations accordingly.
Insurance companies, particularly multi-line carriers with captive sales organizations, are the next segment of financial services providers that must rationalize their distribution economics and strategy. Fully understanding what each segment wants in terms of products, services and channel preferences and the potential of each channel to reach particular market segments is the first step in that process. Once this clarity is established, insurance companies can determine a distribution approach that maximizes the value of proprietary channels, exploits non-proprietary channels (if appropriate), and matches the right products with the right customers through the right channels.
Changing Economics Industry-Wide
The winds of change for insurance distribution began stirring in the late seventies and early eighties. In the life insurance arena, the gap between market interest rates and product yields widened, shifting sales toward lower margin products. Property & Casualty (P&C) coverage began to be perceived as a commodity product with little or no differentiating features. This made consumers more price sensitive while focusing attention on after-sales value-added services such as customer-friendly claims handling. As a result, the industry began to re-evaluate the traditional agency distribution paradigm and credible direct sales players began to emerge.
Change has not come quickly to the industry, however. The overwhelming majority (70%+) of life and P&C insurance is still sold through an agency channel. Differentiation through product design has proven difficult. Widespread cross-subsidization of costs has kept insurers from gaining a good understanding of the profitability of each consumer segment (see Exhibit 1). Today's dependence on large installed agent bases at certain companies has kept true exploration of alternate channels to a minimum. And certain brands have become so strongly affiliated with a channel (e.g., State Farm) that the ability to utilize alternative channels is made even more difficult.
Time may be running short, however. Direct writers are gaining in expertise, reach and popularity. Concurrently, electronic commerce is rapidly being sewn into the fabric of everyday business, even for financial transactions. And non-insurance competitors, such as banks, are in the wings. . . not waiting, but already distributing a range of insurance products to their customers.
Consumers Are Ready For Change
Recent experience with deregulation in the U.K. provides another vivid example of just how dramatic the shifts in customer choices can be.
In 1986, in a fully regulated environment, 97% of life insurance in the U.K. (based on first year premiums) was distributed through the traditional channels of career and independent insurance agents. Deregulation came in 1986 with the Financial Services Act allowing banks to enter the insurance market. By 1996, U.K. banks originated 9.6 billion pounds worth of new yearly and single premium business—18% of the total.
De facto deregulation is well under way in U.S. financial services, and the insurance playing field will be very different in the years ahead. Mutual fund sales offer an example of how distribution shifts occur. Today, 14% of mutual fund sales take place through banks. Yet, when banks first began distributing this product suite, only faint murmurs of concern were heard from traditional sources.
As regulatory constraints continue to ease in the United States, similar structural changes in the marketplace will occur. The consequences for major US insurers, already struggling to rationalize existing distribution costs, would be far-reaching. For many players, a loss of 15% to 20% of their business, on top of the pricing pressures from direct competitors and industry capacity, would quickly sink them.
In addition to cross-industry competition, new channels are intensifying the distribution dilemma. Today, relatively few, if any, insurance transactions are initiated and/or concluded over the Internet. That, however, will undoubtedly change as Internet access continues to expand and consumers grow increasingly comfortable with that channel. Indeed, insurance customers already express a strong desire to receive more information and additional services through on-line connections (see Exhibit 2).
We Have Seen the Enemy—and It Is Us
Most insurance companies keep a wary eye on new entrants, such as banks, or new upstarts, such as Web-based intermediaries. They take comfort, however, in the regulatory and brand awareness hurdles that face new competitors. But a more ominous threat may be well established insurance brands, who face few or no regulatory barriers, and could explore new channels and more aggressive pricing in non-core lines or geographies. A major life insurance company with a relatively small but credible P&C business, for instance, has little to lose and much to gain by seeking out new and economic distribution for P&C products. Likewise, a P&C specialist can avoid sending tremors through its own sales force by exploring alternate channels for life insurance products. The financial upside related to well-designed brand extensions has helped fuel significant growth in consumer products and media companies—certainly some opportunity exists in consumer financial products as well. The risk is low but the implications are significant.
The net effect of some or all of these trends will be to change the insurance distribution world rapidly. What can large insurance companies do to evaluate, rationalize and reshape their distribution strategies?
Channel, Product and Service Clarity Is Key
We believe that insurers must create internal and external clarity around products, channels and service features in order to make sense of their distribution options. This clarity will drive distinctiveness in the marketplace and can be achieved through three steps: developing a robust view of consumer preferences, analyzing the economics of both current and potential channels, and developing a clear view of channel power.
Under the current distribution approach, some customer preferences are over-served while others are under-served. Certain product/service attributes appeal to a range of segments, while others are highly desired by one segment and not of interest to another (see Exhibit 3). For example, after-sales service and price sensitivity (axes A and B) are important to both young affluent and middle family consumers. Buying convenience (axis E) is critical to young affluents, but not a major buying motivator for the middle family. Conversely, brand name (axis F) does not move the young affluent to buy, but is highly regarded in the middle family buying decision. These differences can be exploited to develop and target tailored products and services.
Likewise, the economics of current and potential future distribution channels must be analyzed and understood. This includes agency channels, current remote or direct channels and channels that may only be under development or exist "in the lab" today. Industry data paints a vivid picture here (see Exhibit 4), but cost per transaction is only one part of the economic equation. For instance, certain channels foster increased frequency of transactions, persistency or retention rates that may offset higher costs.
Finally, insurers must develop a clear view of "channel power." If product features are basically fungible among various competitors, channel power can provide a clear means of distinction. AIG, for example, has linked with a Web-based auto buying service to provide hot links to AIG price quotes and insurance sales support. Will this prove to be an efficient way to become a consumer's provider of choice? The jury is still out, but it's illustrative of innovative attempts to establish distinctiveness within a customer segment that is already showing preference for a given channel to make a substantial expenditure.
Defining potential channel power also requires an understanding of what value, if any, a given channel can drive. How well does the channel's capabilities stack up against consumer preferences and demands for service? In the U.K., upstart Direct Line shook up the auto insurance market by betting that direct sales of auto coverage at a lower price would overcome consumers' need for face-to-face service. It was a gamble, but it paid off. Since 1984, Direct Line has captured 13% of the domestic U.K. auto market and radically changed the distribution economics for the industry there.
Certain channels may appeal to particular customer groups, but companies must ask a key question: Does a channel effectively reach the customer segment best suited to it? One large insurer's agency system, for example, has tremendous reach among the middle income segment of the market. The economics of life insurance sales, however, have forced agents to focus farther and farther up the income and affluence scale. To help evolve the ability to penetrate the upper income market, this insurer acquired a company whose agents have enjoyed great success in the upper ends of the market. In addition, it began to explore alternative channels for the middle income segment, including workplace marketing. This combination of initiatives uses the company's traditional strength in group insurance (true group) to reach a much wider individual audience (mass group) while simultaneously expanding its capabilities to serve the upper income market.
Stock brokerage firms, historically reliant on "high touch" distribution, are also dealing with the complexity of embedded sales forces, multiple direct as well as niche competitors and fungible products. In general, they are ahead of many insurance firms in driving toward distribution clarity. For example, a few of the powerhouses in retail stock brokerage have taken the bold step of launching on-line trading businesses to serve the increasingly important "do it yourself" investor segment (see Exhibit 5). These new businesses are capturing customers who would go elsewhere by creating clarity around product/service, pricing, and customer segments while leveraging powerful brands.
How It Might Look
With a clear understanding of who the customers are, what they want and which channels are best suited to meet those needs economically, insurance companies can develop a distribution strategy that will keep them competitive.
For example, take a large, multi-line insurer that currently sells similar products in the same manner to all its customers. Under the new distribution paradigm, it would segment its customer audience based on specific criteria, such as income, needs and purchase patterns. For the purposes of illustration, assume this large insurer settles on five segments: lower income customers who must be "sold to," lower income customers who are event driven (such as Home Shopping Network buyers), middle income customers who prefer traditional, high-touch sales methods, middle income customers who are more sophisticated and value convenience, and higher income customers who demand both high service and convenience.
Armed with this segmentation and dedicated to distribution clarity, the insurer could now tailor products, distribution and after-sales support to achieve effective and efficient sales and service.
For example, for the lower income customers who must be sold, economic distribution choices could include bank partners, direct mail and outbound telephone solicitation. The product suite offered could include plain vanilla coverage with few options and little focus on wealth building. After-sales support would most likely be limited to remote contact, such as telephone and mail.
At the other end of the spectrum, higher income customers could be reached through agents, stock brokerage partners, inbound telephone opportunities and over the Internet. Products would include investment options for wealth building, including features that are non-proprietary. Customization of products would be available. After-sales support would be much more extensive than the lower income profile, and might include face-to-face and remote servicing, sophisticated reporting of wealth building and account status, and additional loyalty builders such as newsletters offering advice on relevant topics or targeted offers for value-added products. Within the boundaries of these two extremes, other customer segments would be reached by using a mix of channels and sales support tools.
Defining these distinct customer segments and structuring the organization with the right mix of remote and high-touch distribution, appropriate products and rational levels of after-sales support comprise the basic distribution challenge facing insurers today. The journey will not always be easy, but by focusing on the issues and developing economic solutions that capitalize on existing strengths and competencies, insurers can adequately position themselves to retain and serve their desired customer groups efficiently, effectively and profitably.
Paul Idzik and Ann Connolly are vice presidents with Booz·Allen & Hamilton's Health and Insurance Group. SungEun Lee is a consultant with Booz·Allen & Hamilton's Financial and Health Services Practice.
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