Winning with Wireless: A Challenging Road for Auto Insurers
By John Garabedian, Boyd Pederson and Ryo Tokuda, The Boston Consulting Group
Telematics, the wireless technology that delivers safety services and routes information and entertainment to motor vehicles, presents auto insurers with a significant opportunity to create new value. By utilizing the technology's ability to transmit precise data on vehicle location and driving behavior in near real time, insurers can de-average pricing models, capture a greater share of low-risk drivers, cut the costs of managing claims and enhance the overall consumer experience.
But telematics also presents insurers with steep challenges. There are concerns about the "Big Brother" factor, or the hesitance of some consumers to have their driving movements carefully tracked. Most companies still lack sufficient domain knowledge about telematics to explain its benefits to a curious public. Moreover, one US insurer, Progressive, has already grabbed the first mover advantage with a pilot program and a patent for its pricing method that uses telematics. (Editors Note: In the summer of 2001, Progressive confirmed it had canceled the pilot, citing the costs and limited availability of GPS technology.)
To be sure, the telematics landscape is still taking shape and many questions remain. But a host of players—auto manufacturers and dealers, telematics service providers, content providers, wireless networks, and hardware companies—are already vying for position. Auto insurers, too, should assess their strategies. With careful navigation, they can use their core strengths to enhance the telematics value proposition to consumers and extract sizable worth for themselves. But laying the groundwork will involve complex initiatives such as exploring alignments with auto manufacturers, launching consumer-education campaigns, and finding ways to differentiate their offering.
Indeed, auto manufacturers are a key element of the telematics equation. They could potentially, over time, develop the means to disintermediate insurers with telematics-based insurance offerings at the point of sale. But their lack of insurers' core skills makes cooperative ventures a much more likely scenario.
Meanwhile, other financial services providers should take note that critical elements of the challenge facing insurers are common throughout the industry. The need to forge alliances, the opportunities created by new technology, potential consumer resistance to that technology, and the gauging of long-term competitive threats are issues that many providers are confronting. They should watch attentively as insurers steer their way through the telematics derby.
Insurers need to fuel up for telematics now. Those who do not act risk ceding control of the auto insurance sector to faster-moving rivals (or even to auto manufacturers), within five to ten years.
Keys to Value for Insurers
Telematics uses the satellite-based global positioning system and other wireless technology to track the movements of vehicles and monitor driving behavior. This capacity to follow exactly when, where, and how a car is driven has the potential to revolutionize the auto insurance industry through an innovative concept: usage-based pricing. Instead of age, gender, past driving record, and other traditional elements being the sole determinants of the premium, a driver's current behavior behind the wheel can be a significant factor. The value proposition is compellingly simple: the less you drive, the more prudent your speed, and the safer the route, the lower your bill.
Telematics can thus enable insurers to extract individuals from broad actuarial groups. This de-averaged, fine segmentation of the market could lead to a climate of "adverse selection," in which the underwriter with a better pricing model attracts low-risk customers, leaving high-risk customers with the rest of the pack. The likely migration of correctly priced customers to the telematics product would cause the risk profile of drivers served by traditional insurance to become proportionately worse, pressuring non-telematics insurers to raise premiums sharply. Insurers offering telematics coverage would benefit both from an influx of consumers seeking lower premiums and from a markedly reduced exposure to risk.
Such a scenario is quite feasible. Telematics has the potential to enable lower premiums, and consumers have already demonstrated their interest. For example, in Progressive's pilot program, drivers with telematics coverage reported an average drop in their premium of roughly 25 percent compared with their bill under a standard policy. Moreover, a strong majority of consumers surveyed by the company said they were willing to let their driving patterns be tracked in exchange for a lower insurance bill.
But pricing is not the only key that insurers can use to unlock value through telematics. They can also slash the cost of managing claims, on which about 70 percent of premium revenues are typically spent. Telematics enables this by facilitating immediate contact with the driver after an accident. For example, when a car's protective air bags are deployed, a signal is automatically sent to the driver's telematics service provider, whose call center can contact the vehicle and dispatch medical and mechanical aid immediately. Knowing the exact time and location of accidents helps insurers take control of the vehicle faster, carry out possible repairs with their own vendors, and complete the claim cycle more efficiently. Costs are cut by reducing the time and resources spent on each claim. Rapid service and prompt payouts can help bolster consumer loyalty and be an additional point of differentiation.
Auto Manufacturers Are Gearing Up Automakers have a distinct advantage in the race for telematics revenue because they wire the system into the vehicle and thus have control over its capabilities and the data it generates. All of the major manufacturers have launched businesses that operate as telematics service providers, such as OnStar (General Motors), Wingcast (Ford), and TeleAid (DaimlerChrysler). The cost of the new hardware and software is included in the car's sticker price—basic telematics safety and security services often are, as well—but car buyers must subscribe to value-added services such as navigational aids, route information, and back-seat entertainment.
Most important from an insurer's viewpoint, the driving data collected by the in-vehicle system give manufacturers the raw material they need to bundle a telematics-based insurance product to customers at the point of sale. What is more, the automakers' engineering expertise in integrating the technology into the car's nervous system would likely enable them to provide telematics insurance to the consumer at a lower cost than a traditional insurer could by selling it as an after market, add-on feature. The threat of disintermediation is viable.
But most automakers do not have all the capabilities required to succeed. They lack the underwriting models needed to formulate basic risk profiles for drivers. These profiles provide a base for premium pricing before the driving patterns tracked by telematics can be factored in. Indeed, it is the auto insurance industry's core actuarial skills and risk management experience that carmakers really need. Auto manufacturers also do not possess the broader domain knowledge or have established insurance brand names that consumers trust. In a cooperative structure, manufacturers could obtain these things from insurers, while insurers would benefit from the automakers' customer-acquisition base. As part of a revenue-sharing model, the manufacturer could receive a commission from the insurer for selling the policy at the point of sale.
'Big Brother' Knows If You're Speeding
For some people, having their driving patterns monitored feels like an infringement on personal privacy. A significant effort by insurers will thus be required to educate present and potential customers on the technology's benefits, and to manage public perception of "Big Brother." This may be more difficult in some national markets than others because of cultural differences.
To be sure, the price element alone—lower premiums for safe and infrequent drivers—will provide ample motivation for many consumers to forgo privacy and buy a telematics-based insurance product. But safety and security features—currently the principal driver of consumer adoption of telematics systems—should also be emphasized by insurers as major benefits of the overall experience. Indeed, to get the safety services, your vehicle has to be tracked. And if your vehicle is being tracked anyway, why not buy telematics-based insurance for a potentially lower premium?
Other selling points include the technology's ability to unlock doors remotely and to locate stolen cars, which could prove particularly important in markets where car theft is becoming a large problem, such as Japan. Navigational aids, collision warning systems, real-time traffic updates, and route information concerning hotels, restaurants, gas stations and other services enhance the value proposition. Back-seat entertainment applications are evolving.
The Road Ahead
The telematics value proposition is a compelling one, not just for private automobiles but for trucks and other vehicles, too. Indeed, corporate and commercial fleets, where privacy is less of a concern, could widely adopt telematics systems and help test the technology for the mass consumer market. Current estimates place global penetration at roughly 30 million vehicles by 2005, compared with fewer than five million today. A telematics insurance product offered at the point of sale could improve the economics of the core telematics platform and help make telematics standard equipment on all vehicles.
Auto insurers should position themselves now, while telematics is still in a nascent stage, to capture the potential that the technology presents. They can best do this by taking the following steps:
-- Formulate practicable models for sharing both revenue and customer ownership with auto manufacturers. Such designs will be crucial to forging alliances with automakers to jointly develop and market telematics-based insurance products.
-- Develop a proprietary method of usage-based pricing and analyze its potential benefits. Every insurer with a telematics offering will need its own model.
-- Initiate programs both to gauge overall consumer interest in telematics-based insurance and to develop company and agent knowledge of in-vehicle telematics systems. Before customers can be educated on the benefits of trading privacy for more control over their premiums and other advantages, insurers themselves must understand the technology fully.
-- Continue to burnish their own brands with an eye toward the new channel: point-of-sale distribution by auto manufacturers.
-- Devise an alternate strategy. What if automakers were indeed to "go it alone" and try to become telematics insurers all by themselves? In that event, insurers would need alliances with hardware makers and independent service providers to compete.
The telematics grand prix promises to be an exciting event, and observers will be numerous. As the race takes shape, there may even be lessons for other financial services providers to learn regarding alliances, pricing models and positioning.
Auto insurers, it's time to start your engines.
John Garabedian is a vice-president in the Chicago office of The Boston Consulting Group. Boyd Pederson is a manager in BCG's Toronto office. Ryo Tokuda is a vice-president in the firm's Tokyo office.
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