Insurers Seek Competitive Edge Through Underwriting Analytics
Innovation Through Insight
Similar analytics-driven risk selection has made a big splash in the auto insurance realm, as exemplified by Progressive's (Mayfield Village, Ohio) ability to generate billions of pricing cells. But as important as this capability is to Progressive's strategy, its returns diminish as competitors catch up in their use of analytics.
Super-refined pricing based exclusively on analysis of loss costs has its limitations, according to Murli Buluswar, VP of Los Angeles-based Farmers Group's ($15 billion in 2006 written premium) Insight & Innovation (I&I) group, which he describes as an internal analytics consulting function. "Achieving better pricing will drive benefits from positive selection, but once your competition catches up, adverse selection, as defined by attracting the least profitable segments for which you are underpriced, is a bit of a moot issue," he says. "Getting perfectly accurate pricing at a micro-segment level isn't itself a driver of growth."
Carriers can have hundreds of millions of pricing cells, but, obviously, they can't charge hundreds of millions of different price points. And as competitors grow more proficient at pricing, differences in price will be very small -- perhaps pennies. Furthermore, a strategy based exclusively on price counts on uniform price sensitivity on the part of customers. In this respect, according to Buluswar, "If you think about how underwriting is done today, it's a bit of a faith-based initiative."
For "perfect" pricing to be an engine of growth, Buluswar continues, reducing the price for more-desirable risks must result in a carrier underwriting more of them relative to less-desirable risks. But, "That may not necessarily happen. You might stumble upon it, but it is not necessarily a natural outcome of any price changes you make," Buluswar asserts.
"To think that trends are influenced solely by price is to imply that customers are driven by price and nothing else," Buluswar says. "If that were true, then every insurance customer would go to the lowest-priced carrier, which does not appear to happen today."
In a world where competitors have comparable pricing analytics capabilities, "Low-cost models insulate you from adverse selection only to the extent that it is actually happening -- so first of all, you should find out whether it really is happening or not," Buluswar advises. "But even then it only lets you get to a portfolio-level equilibrium, which you already had -- it doesn't actually help to improve your overall economics anymore."
According to Buluswar, to improve Farmers' economics, I&I is applying highly refined analytics to understand the holistic relationship with a customer. "Arriving at perfectly accurate pricing is a good place to be, but it's an incomplete picture," Buluswar remarks. "To the extent that you're causing some [price] volatility, you have to ask, 'What is the net outcome of that volatility at the portfolio level from a growth and profitability standpoint? Who is going to leave you, and what is that lost opportunity worth to you?'"
Deeper Connection
Again, pricing risk is just one factor in the profitability equation. "If we weave that in and build a deeper connection with the customer, not only from a pricing standpoint but also from a customer-experience standpoint, it can be a meaningful growth opportunity," Buluswar adds. "In today's world there is no segmentation around whom we should be chasing for underwriting follow-up and who we shouldn't -- we pretty much just do it across the board."
Since I&I was founded in September 2006, it has significantly raised the appetite for data at Farmers and now is the main customer for warehousing projects at the carrier. I&I's key analytical platform is SAS (Cary, N.C.), according to Buluswar. The group also uses San Diego-based Salford Systems' TreeNet data mining solution, which Buluswar says "is particularly good at understanding interactions between different segments, such as the predictive value of marital status and gender -- each might be predictive individually but might be more predictive together."
The I&I team consists of about 40 professionals with expertise in a variety of areas, including MBAs, actuarial science, statistics and economics, according to Buluswar. About half that team, he notes, is supplied through a close partnership I&I has forged with Jersey City, N.J.-based Fractal Analytics, a global service provider focused on profitability enhancement through innovative uses of analytics. "With a combination of analysts here and offsite with Fractal, I can staff a team at roughly 40 percent of my loaded cost, and what I'm getting is the crème de la crème of what India has to offer," Buluswar comments.
While I&I's mission is to drive analytics-related innovation throughout Farmers Group, its largest client is product management, Buluswar relates. "Our No. 1 contribution needs to be in the area of pricing strategy," he says.
Within that context, I&I goes through what Buluswar describes as a challenging process to pull data from a variety of Farmers sources and runs that data through predictive models to generate customer metrics that are delivered to the project managers' desktop pricing platform for further use. "It includes understanding each individual customer's loyalty as you project it, how many relationships you expect them to have and how you expect that to manifest itself in revenue," Buluswar says.
"What used to happen was the project managers would run various scenarios around different loss costs," Buluswar recalls. "They're still doing that, but with the added benefit of understanding what impact it will have on the future and how it affects average customer loyalty and other insights that relate to longer-term profitability."
Starting in the first quarter of 2008, Buluswar notes, pricing developed with the addition of I&I's activity will go to market. The group's goal by the end of 2008, he adds, is to achieve annualized run rate improvements of 100 basis points in new business growth and the same in cost savings. "We believe we can achieve this by creating efficiencies and science-driven insights in the areas of underwriting, product development and pricing strategy, retention, service center management, and agency recruiting and management, as well as insight on Farmers' relative brand position," Buluswar says.
Anthony O'Donnell has covered technology in the insurance industry since 2000, when he joined the editorial staff of Insurance & Technology. As an editor and reporter for I&T and the InformationWeek Financial Services of TechWeb he has written on all areas of information ... View Full Bio
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