• Carriers must continue to invest in understanding
consumer and policyholder expectations. The
industry’s long history of designing products and
services based on underwriting’s, producers’ and legal
expectations has made it a challenge to change insurance
to a customer- focused business. Making the change is
complex and often wrenching, but an enhanced consumer
analytics program that can help determine ways to attract
and retain more customers is a good first step in meeting
this challenge.
• Revisit your customer experience programs. Candidly
assess your organizational commitment. Are your actions
aligned with your slogans? Are you measuring what’s
important, holding people accountable, and rewarding
them for improving the customer experience?
• Change traditional distribution platforms. Most
carriers have been hamstrung by their existing
distribution platforms and have been nervous about
disrupting them. This is a rational concern, but we
believe change has to occur to promote future success.
Taking a long-term view can facilitate this change;
organizations that view the ideal distribution model of
ten years from now (versus just next year) tend to be in
a better position to align distribution with the market’s
changing expectations.
• Design products for consumers rather than
producers. Obviously, you can’t generate revenue
from a product that a producer won’t sell, nor can you
meet changing consumer needs if you only offer what
producers will sell. Accordingly, test a new product aimed
specifically at a consumer need and design it for the web,
which will maintain simplicity.
• Differentiate your value proposition through
thoughtful advice. More and more consumers don’t have
a good understanding of how to protect what’s important
to them. Prescient carriers will develop new ways to
provide them helpful advice, including by utilizing
technology to deliver personalized insight.

Policy shopping and switching behavior is growing,
resulting in a larger “at risk” market and increasing difficulty
retaining policyholders. Shoppers increased from 27 to 33
percent of total insurance customers between 2009 and
2011, and of those who shopped, switchers increased from
37 to 39 percent (10 to 13 percent of all customers) from
2010 to 2011. Shopping frequency is either “frequent” (at
every policy renewal point) or “infrequent” (because of a
negative experience, or every three to five years to ensure
they are paying appropriate market rates).3 Shoppers’
behavior is either “sequential set” (driven by the lowest
price) or “consideration set” (based on customer experience).
“Consideration set” customers value brand and policyholder
experience almost twice as much as price. Sequential set
customers are the most price sensitive, will switch for
any discount, and are the least profitable segment. As a
result, insurers are addressing the following realities when
determining the best ways to attract and retain customers.

• Customers are increasingly willing to switch channels;
defectors frequently switch to competitors who
exclusively use a different channel than their previous
carrier. For example, direct-channel GEICO lost 17
percent of defectors to agent-based carrier Allstate and,
comparatively, Allstate lost 24 percent and State Farm 19
percent of defectors to GEICO.
   • Most customers (54 percent) initiate contact online.
Follow-up is most often via phone, and then customers
proceed through whichever channel the carrier
routes them.
   • Customers want convenient one-stop-shopping, and 50
percent of customers want to buy at least two bundled
products at the same time or through the same carrier.
   • Customers requiring several policies will pay up to 23
percent more for their coverage if one insurer can meet
their needs.
   • Although brand and experience are relevant factors
for switchers, low price is the primary driving factor.
Although only 44 percent of switchers state that price
was the most important purchase factor, results prove
otherwise; across the industry, 88 percent of switchers
defected to the lowest price provider, and 81 percent
of retained customers’ current carriers offered the
lowest price.

The costs of marketing to a fickle customer base contribute
to a rising expense ratio and a higher product price. The
challenge for insurance carriers is to be high on potential
customers’ brand “call list” without increasing existing
marketing investments. Potential solutions for moving up
the call list are plentiful (e.g., improved organic search
results, social media engagement, and quote aggregators),
but require careful planning and tactics across channels
related to costs, risks, and ROI.4 It is important to note that
in-person transactions continue to decrease as shopping
preferences change, with in-person purchases dropping six
percent between 2009 and 2011. Beyond the web, mobile
is becoming more important, and top direct players offer
innovative and robust quoting capabilities. Moreover, social
media is important for both agents and direct businesses,
enabling more frequent engagement with customers.

Growing cultural diversity and changing family structures
continue to heavily influence demand and life and
retirement purchasing patterns. Of particular note, the
percentage of white non-Hispanics has dropped from 83 to
69 percent of the population over the past four decades.1 As a
result, effectively reaching certain multicultural markets has
become even more critical to insurers’ success. In addition,
especially since the financial crisis of 2008, the transition
into adulthood is occurring at a slower pace, which has
delayed the types of life events (e.g., marriage, parenthood)
that typically drive the purchase of life insurance.

For example, only 60 percent of the 30- to 44-year-old
demographic has gotten married, as opposed to 84 percent
forty years ago. Family composition also has undergone
significant change since the early 1970s, contributing to
the need for more effective target marketing strategies. In
particular, single parent households have increased from
19.5 to 29.5 percent in that time, and females are making
more financial decisions than ever before.2 In the wake
of these demographic changes, carriers that are able to
accurately assess and address a given household’s needs
(primarily through advanced analytics and technological
innovation), as well as build strong relationships across
generations, will gain a potent competitive advantage.


There is a gap between consumer need for and availability
of solutions for managing not just financial capital, but also
human and social capital.

Among the most significant current opportunities for
insurers is optimizing the customer experience and
improving how they interact with customers. The
widespread revolution of e-commerce and mobile
technology over the past two decades has led consumers
to expect convenience, simplicity, transparency, and
disintermediation. Combined with rapidly changing
demographics, economic and regulatory uncertainty,
and the constant struggle to competitively differentiate
themselves, changing customer expectations are causing
insurers to ask the following, basic questions about how their
business models should evolve over the next decade:

For the most part, carriers are not
meeting changing consumer and
policyholder expectations, and
in turn are missing out on a vital
competitive differentiator.
When asking themselves these questions, insurers should
be cognizant of the rapidly changing market in which
they operate. The diagram on the next page highlights
the mismatch between traditional offerings and current
demographics, as well as the gap between coverage
needs and consumer demand (which is especially
true among younger consumers). Of particular note is
how non-traditional customer segments representing
different ages, cultures, family structures, and socioeconomic
backgrounds are emerging as significant
growth opportunities.

Compounding these developments are technological
advances that have transformed consumer preferences
about how they interact with insurance carriers. This is
creating new distribution and communication channels that
are changing how insurers conduct business and manage
relationships. While older generations tend to be less at
ease with these shifts, younger consumers are generally
comfortable utilizing digital platforms to become more
informed shoppers and buyers. Moreover, though this
lucrative segment likely will remain relatively small,
there is an increasing number of self-directed consumers
who have a strong desire to play an active role in their own
financial planning.

At the same time, the declining number of traditional
insurance agents is reducing insurers’ ability to have
sustained customer interactions. Traditionally, agents would
help clients become more financially literate by explaining
financial products and services, as well as individual
financial and coverage needs over time. Despite the rise in
self-directed customers, this lack of personal interaction
is hurting insurers’ overall ability to market and sell more
complex products, particularly via online channels.

A volcano erupts in Iceland and cancels air travel throughout
Europe and across the Atlantic for several days in 2010,
causing an estimated $2 billion in business interruption
losses. An earthquake, tsunami, and nuclear disaster strike
Japan in 2011, causing an estimated $5 billion in global
business interruption losses. These and many more recent
natural disasters, most notably the 2011 Thai floods and
last autumn’s Hurricane Sandy, have resulted in significant
supply chain disruptions.
Natural catastrophe (or “nat cat”) modeling effectively
began in the aftermath of Hurricane Andrew, which struck
Southern Florida in 1992. Since that time, both insurance
companies and their insureds have had the benefit of risk
models to guide decision-making on properties at-risk of
nat cats such as hurricanes, earthquakes and tornadoes.
Over the past twenty years, nat cat models have continued
to develop and become institutionalized at insurance
companies the world over.
Similar to the growth of “nat cat” models following
Hurricane Andrew, we believe that the insurance industry
will start to focus on modeling contingent business
interruption after the significant losses following the storms
referenced above.
There is currently a limited amount of insurance available
to cover this risk. According to the third edition of the
Dictionary of Insurance Terms, the “Contingent Business
Interruption Form [provides] coverage for loss in the net
earnings of a business if a supplier business, subcontractor,
key customer, or manufacturer doing business with the
insured business cannot continue to operate because of
damage or destruction. For example, a specialty hot dog
stand noted for its great buns cannot sell its product if the
bakery supplier of hot dog buns burns down. In instances
where a business is heavily dependent on its suppliers or
subcontractors, interruption of the flow of material from the
supplier usually results in a substantial loss” (p. 100).
One of the reasons for limited contingent business
interruption (or “CBI”) capacity is that insurance companies
do not have the benefit of a risk model that can inform CBI
underwriting, pricing and risk management. The industry
has recognized the need for such a model for some time but,
despite several notable attempts, no-one has yet been able
to produce one that adequately quantifies the dynamics of
CBI risk. The reasons for this are fairly straightforward:
First, nat cat models are anchored to and focused on specific
regional perils such as Florida wind events or a California
earthquake, etc., while a CBI model would have to be far
broader in scope. For example, the supply chain effects of
the Thai floods were far broader than many industrial firms
and insurance companies originally anticipated.
Second, the exposures that nat cat models quantify are
generally very well defined; for example, the location of a
property to a peril (often segmented down to the zip code
level), as well as the property’s physical dimensions and the
quality of its construction, are fairly easy to discern, and
thus can be subjected to intensive engineering analysis. In
contrast, CBI exposures are less well-defined and therefore
obfuscate classical analytical techniques such as statistical
and engineering analyses.
This is not to suggest that nat cat models are in any way
perfect. They are not. All models are simplifications of
reality that are designed to facilitate decision-making.
As a result of that simplification, they are subject to error
(known practically as “model miss”). The fact that nat cat
models sometimes miss the mark is effectively why property
underwriting is a business rather than a science. And in that
business, nat models help to facilitate a much more informed
view of property underwriting and risk management than
would be available without them

Because they are simplifications of
reality, models are not perfect. However,
they do help facilitate a much more
informed view of underwriting and risk
management than would be available
without them.

• While US insurers are making strides towards RMORSA
readiness, many of them still have a number of material
gaps. There are many important advantages to having a
well embedded ERM framework with clearly defined risk
limits that allows insurers to exploit key opportunities
and maximize risk-adjusted returns, while protecting
policyholders’ interests. Meeting regulatory requirements
as a by-product of an effective ERM framework and
risk-aware culture, rather than seeing the RMORSA as a
purely compliance requirement, will help differentiate
tomorrow’s winners in the market.
• Companies that do not yet have a fully operational
RMORSA strategy and process have much to gain, such
as a better ratings agency view of their ERM framework,
lower impact regulatory exams, better risk practices,
and enhanced collaboration between actuaries and asset
managers. Dedicating resources and budget to develop
the overall risk strategy will help companies with less
developed strategies and processes to catch up to their
more advanced competitors. In the longer term, all
market participants’ focus will move beyond regulatory
compliance and become more strategic, as companies
surpass the basic requirements and approach their
RMORSA from a primarily commercial, value-adding
perspective.
• The level of board engagement will need to increase for
most insurers as the implementation date of the new
RMORSA requirements approaches. Risk committees will
have to have formal terms of reference in order to comply
with the NAIC’s expectation of governance structures that
clearly define and articulate roles, responsibilities
and accountabilities.
• Insurers would benefit from establishing a formal
risk appetite statement with their boards. This is a
fundamental component of the ERM framework for any
organization. Companies with less complex risk profiles
should develop a risk appetite statement commensurately;
a relatively simple risk profile does not mean a formal
risk appetite statement is any less relevant. A formal
risk appetite statement should be the universal currency
within an organization against which it assesses all major
decisions. A robust and useable risk appetite statement
enhances risk governance and provides a platform on
which to engage every stakeholder.
• High on the list of many insurers’ ERM priorities
should be:
»» Investment in formal and fully operational stress
testing programs;
»» The development of new (or refinement of existing)
economic capital models to allow prospective
assessments of solvency and capital positions over
longer time horizons;
»» The subsequent independent validation of these
models; and
»» The refinement of risk quantification techniques and
available data and information.
• If regulators are to be certain that an organization has
a well established and embedded risk culture and ERM
framework, the insurer will need to:
»» Fully document and rigorously manage risk
policies; and
»» Design and implement risk management dashboards
or management information suites where they do not
currently exist.

Internal risk and capital models are at the heart of an ERM
framework. The latest draft of the NAIC ORSA Guidance
Manual requires models to meet the highest quality
standards, be appropriately calibrated (“real time”),
and fully tested and documented, as well as subject to
independent scrutiny and validation.
Nearly two thirds of respondents report using an economic
capital measure in addition to the more traditional capital
metrics of statutory capital, GAAP and rating agency
capital. US domestic companies have the lowest take-up
rate of economic capital (51 percent), compared with US
international groups and subsidiaries of overseas groups.
This is likely to be driven by the need for international
groups to comply with other regulatory regimes. Where
economic capital is used, 71 percent have the capability to
project it – a requirement if this is to be used as a RMORSA
metric. Of this group, 41 percent report the ability to do so
over one year, while 55 percent can make projections beyond
three years.
In quantifying risks, market and underwriting risks are
most likely to be stochastically modeled, and 40 percent of
companies reported that they had infrastructure or data
issues that prevented them from following their desired
approach to risk quantification.
39 percent of companies believe their risk aggregation
approach needs improving or is at a low level of
sophistication. However, for US domestic companies,
this increases to 60 percent. This may be a feature of
groups having to address aggregation across entities and
geographies, as well as across risk types. This may result in a
greater focus by groups on this topic and therefore a higher
level of comfort in their approach.
44 percent of companies reported not having a model risk
management framework that includes model validation
requirements. These respondents either have no model
risk management framework, or their requirements do not
include validation.

We believe a robust stress and scenario testing process is
an essential part of a risk management framework. The
RMORSA process is an ideal opportunity to perform a
comprehensive stress and scenario exercise. When properly
orchestrated, the RMORSA will take place in conjunction
with an organization’s business planning process. This is an
ideal time to stress- and scenario-test business plans, risk
exposures, and appetite metrics in a comprehensive and
coordinated manner.
However, the majority of survey respondents said that their
companies do not have a fully operational stress testing
program. Furthermore, the maturity of stress testing varies
across the life, P&C and health insurance sectors. Moreover,
only three quarters of responding companies have a risk
dashboard or risk management information pack. Of those
with such information, 36 percent reported that the process
to produce this information takes longer than a month, while
60 percent of companies produce this quarterly, and only 20
percent do so monthly.
Correspondingly, only 78 percent of companies reported
having a formal process to address risk identification, and
only one in five reported having a dedicated emerging risks
team. Moreover, many companies indicated they do not
have fully documented risk policies that cover the significant
risks to which they are exposed. In addition, only 41 percent
of companies reported that they actively review, update and
enforce all risk management policies.
Lastly, only 55 percent of companies reported a high degree
of coordination between and among risk, finance and
compliance functions, and a further 42 percent reported a
moderate level of coordination. Of those who reported a high
degree of coordination, 28 percent reported that they fully
embed risk appetite in the business planning cycle.

A governance structure based on a “three lines of defense”
model is emerging as a leading practice in the industry.
A key component of successful ERM is a risk culture that
permeates the organization and drives a sense of shared
responsibility for risk management throughout the company.
However, 38 percent of survey respondents reported that
company boards are not engaged or are only passively
engaged in risk management. In addition, only two thirds
of companies indicated that they have a dedicated chief
risk officer (CRO), and where companies did not have a
dedicated CRO, three quarters of them reported that other
positions cover the role, often on a part-time basis. In 40
percent of companies, the CRO does not report directly to
the CEO or the board; the other most common reporting line
is to the chief financial officer. And, while almost all board
risk committees have formal terms of reference in place,
with corporate risk committees and other risk committees
achieving almost the same level of formality, the existence
of formal terms of reference starts to fall off dramatically
for business unit risk committees. 84 percent of companies
responded that the risk function is responsible for risk
oversight, with business areas owning and managing
the risks.
Regardless of the reporting structure a company
employs, the CRO or risk committees will be largely
responsible, either solely or jointly, for compliance with
the RMORSA requirements.

In our experience, risk strategy should be at the heart of
the organization. Risk should be a core consideration when
setting strategy, formulating business plans, managing
performance, and rewarding management success. Risk
appetite should be clearly articulated and reflect the
organization’s risk carrying capacity, business strategy, and
financial goals. Processes and procedures should be in place
to manage risk on an enterprise wide basis within defined
boundaries, without stifling day-to-day operations.
Survey respondents’ most commonly reported objective
for risk management is to control and limit risk events.
Among publicly traded survey respondents, 90 percent
indicated that shareholder value enhancement is also a risk
management objective.
Only 65 percent of companies indicated they have a risk
appetite statement that reflects tolerance, strategy and
financial goals, suggesting there may not be sufficient focus
on linkages to top down strategic objectives and metrics
across the industry. As might be expected because of their
resources, the largest organizations scored very well in
having formal risk appetite statements for each key risk
category, such as market, underwriting, credit, liquidity, and
operational risks.
Only three quarters of companies have a risk-specific
limit framework to guide the business’ compliance with
risk appetite. Where limit frameworks are in place,
this understandably has a high correlation with the
risk categories most typically reflected within appetite
statements. 25 percent of companies reported that risk
appetite metrics are not part of the business planning
process, while only 57 percent include some, highlighting
a significant disconnect between risk management and
strategic decision-making.