Managing the risks of the 21st century

Today's insurers turn to sophisticated data management strategies to gain an edge in an increasingly complicated marketplace.

by Jackie Zack

By its very nature, the insurance industry faces challenges and scrutiny unknown to many other segments of the business world. Thanks largely to record-setting hurricane strikes in the United States and an abnormally high number of typhoons in Japan, it's estimated that property and casualty insurers worldwide faced record claims of approximately $42 billion last year—higher than in 1992 (Hurricane Andrew) or 2001 (the 9/11 attacks), according to a report by the Swiss Reinsurance Company. That figure does not include the nearly $5 billion in claims expected as a result of the deadly tsunami that struck December 26, 2004.

But paying claims is what insurers are in business to do, and any failure to that end is extremely visible. Should an insurer struggle to pay on legitimate claims, the cries of outrage from government agencies, investors and policyholders would be deafening.

While disasters and catastrophes grab the headlines, insurance companies are also faced with several deeper issues that play pivotal roles in their long-term success. Producer management and customer acquisition, retention and growth remain as important as ever, while increased profitability through more effective underwriting, pricing and claims settlement drives business strategy, technology and processes. But some of the biggest hurdles for insurers are the numerous compliance and regulatory issues that will have a profound impact on the industry's financial practices and even its stability. A veritable wave of industry regulation over the past five years has created a pressing need for better management of a broad spectrum of data.

First rule: Obey all other rules
The Financial Services Modernization Act (Gramm-Leach-Bliley) has major privacy and security implications regarding the disclosure and use of consumer information. The USA Patriot Act of 2001 requires insurers not only to establish and maintain programs to detect money laundering and other suspicious activities related to the financing of terrorism, but also to perform audits verifying their compliance—all of which require faster access to better customer data.

The Health Insurance Portability and Accountability Act (HIPAA), implemented to protect the privacy of U.S.consumer medical information records, mandates that health and life insurers utilize procedures to make certain the appropriate parties receive only the information deemed necessary for delivery of health services.

While initially HIPAA applies to health insurers, most other insurers expect it will be extended to any medical record information as well, not just health insurance. And the Sarbanes-Oxley Act mandates a range of corporate compliance requirements designed to prevent financial malpractice.

U.S. firms aren't the only ones faced with the problem of developing new financial models and business processes to accommodate ever-increasing examination. Looming over insurance companies operating in the European Union is Solvency II, a set of regulations that at its core links regulatory capital to risk and compel public disclosure of all findings. Similar guidelines are in the works for U.S. companies, driving interest in enterprise risk management by insurers.

Add to the mix new international insurance accounting standards from the International Accounting Standards Board sometime in 2005, and it's obvious that more sophisticated approaches to risk management, financial reporting and corporate governance will be a top priority for the IT departments of insurance companies around the globe.

"Looming over the industry is, 'What is going to happen in 2005?' This will be the spotlight throughout the year—any shift will have a significant rippling effect on general business practices, business operations and IT priorities," says Deb Smallwood, vice president of insurance at TowerGroup, a research and consulting firm specializing in global financial services.

Approached properly, however, the new guidelines could serve as a catalyst for readiness. "Many leading insurers are already leveraging their Sarbanes-Oxley compliance as an opportunity to build a strategic infrastructure that will allow them to comply with future regulations, not just the current mandates," says Patricia Saporito, insurance industry director for Teradata.

Smallwood emphasizes the importance of an enterprise data strategy, driven by a data warehouse that enables insurers to see the big picture when dealing with projects and regulations. "If (you) look at the U.S. Patriot Act, at HIPAA, at Sarbanes-Oxley—there might be a component common to all three, like security," says Smallwood. "So (companies) should not address security three different ways, but have that common thread and look at it from an enterprise perspective."

The industry's "sweet spot"
In addition to helping insurance companies comply with regulations, data warehousing plays a role in creating new, more profitable products. In the past, insurance companies gained much of their profits through financial investment as opposed to returns on underwriting—but that strategy is changing.

"The industry is finally realizing that maybe we should be more profitable in the products we sell vs. relying on investments," Smallwood says. "There are insurance companies out there seeing great profit margins on products." The options for such a strategy are numerous:

• Presenting new or different coverages
• Delivering better customer service
• Cross-selling additional products
• Up-selling higher policy limits or additional coverage on an existing policy

In particular, the life and annuities side of the industry is trying to develop new product offerings and build effective processes to make them more profitable. Unlike property and casualty insurance where coverage might need to be renewed annually, many life insurance policies are in force for an indeterminate period of time; even a small decrease in support costs for these existing long-term policies can yield impressive savings.

Selling costs for life products are generally loaded on the front-end, so retention is critical to profitability. Life and annuities insurers are looking for economical ways to support products they have already sold, as well as ways to leverage new technology to support new products.

A good example would be the use of data analysis to target which clients with yearly renewable term-life insurance policies would be likely to convert to a 10- or 20-year fixed-rate policy—an offer that simultaneously provides savings to the consumer while providing the insurer with a guaranteed revenue flow. Database marketing can also help insurers spot redundant renewal efforts and yield vital information on each step in the customer interaction process. This could lead to cost reductions, whether in fewer mailings or in more selective marketing techniques.

A basic step in developing products is evaluating customers' risk characteristics and their buying preferences and behaviors. Armed with that knowledge, insurance companies can find the "sweet spot" of sales—offering the right product to the right customer, at the right price and at the right time.

"Insurance companies are using demographics and external and internal data to produce better policies, better products or better service for their policyholders," says Smallwood.

Determining which sales channels are most effective can also help insurers increase profitability and create economic value to stay ahead of the competition. Assessing the lifetime value of the agent is paramount to success.

Many companies simply look at agents in terms of revenue they produce, not the net profit they represent. Particularly in life insurance, companies spend significant amounts of money to attract, recruit, train and license agents—but industry-wide agent retention rates are extremely low.

If five agents are hired today, only one will still be in the program four years from now, so there's understandably keen competition for successful agents. Part of an insurer's relationship with its agents and brokers has to do with its products and prices, but just as important are the service options it offers.

A company that provides its sales partners with the analytical tools to identify good candidates for cross-selling and up-selling, or information technology enabling better customer service at little or no extra cost, becomes a much more attractive option when the time comes for an agent to choose an underwriter for a customer.

When the price is right
Another thing technology can help insurance companies do is to better manage their pricing scenarios and pricing sophistication. Effective product pricing involves many factors:

• Cost of customer acquisition
• Underwriting expenses and outlays
• Profitability of the customer base
• Customer retention rate

"It means understanding the risk attributes for each customer, classifying them accurately and getting the right price for the risk exposure," says Saporito. Insurers increasingly realize they need to develop more granular or detailed pricing tiers to achieve true profitability. Improving pricing and underwriting sophistication actually involves four key factors that all require detailed, historic data: granularity of pricing cells, dispersion of premiums, the interaction of rating or risk variables and identifying new variables. True industry leaders are addressing all four factors."

A key factor in determining the appropriate price is the cost involved in underwriting. Insurance companies are challenged with processing more applications in less time and with better accuracy; to remain competitive, insurers need to be efficient in analyzing the risks they accept while at the same time reducing operating costs.

Automation can play a vital role in achieving these goals—and underwriting is ripe for just such a solution. But it means insurance companies will need to invest in technology tools like analytics, workflow engines and process managers to create workstations that tie data together. The goal is not only to facilitate straight-through processing, but also to have the proper analytics and internal and external data to support underwriting more profitable business.

Knowledge is power
It's clear that 2005 will pose a number of challenges for the insurance industry to optimize profits, contain costs, mitigate risks and deal with compliance issues. What it all boils down to is fully utilizing detail data—and knowing what steps to take and the order in which to take them.

Insurers are embracing enterprise data strategies and using them to develop specific business intelligence applications to meet the challenges head-on. They are turning to predictive modeling to enable more effective marketing, pricing, fraud detection and underwriting.

Data ultimately leads to knowledge—and that, like insurance, is something you can't have too much of. T

Jackie Zack, a Michigan-based business, technical and feature writer, has written for several trade journals.