It’s ‘haves’ vs. ‘have-nots’ in insurance technology race for survival

Spurred by intensifying competition, breakthroughs in analytics are transforming insurance markets, according to an industry leader. Sophisticated insurers able to harness large volumes of high-quality data to drive decision making can look forward to a long and prosperous future, said Frank J. Coyne, chairman, president and chief executive officer of Insurance Services Office, who also warned that insurers unable to keep up in the intellectual and technological arms race face a grim prognosis.

“In just a decade and a half, approximately a third of the insurers serving the United States vanished as escalating competition ate into top-line revenue growth and bottom-line profitability. But it isn’t just the intensity of competition that’s changing,” Coyne said. “The nature of competition is changing too, as advances in predictive modeling and other analytical techniques enable leading insurers of all sizes to target their marketing, underwriting and pricing as never before.”

He said a chasm is growing between insurers using state-of-the-art analytics and those who aren’t — the “haves” and the “have nots.”

“Increasingly, the ‘haves’ will be able to write business at the margins they target,” Coyne said. “The ‘have nots’ will fall victim to adverse selection, as more sophisticated insurers target the risks apt to prove profitable. And the bar will rise continually as competition drives weaker players from the field. Today’s ‘haves’ are at risk of becoming tomorrow’s ‘have nots.'”

Technology meets claims
Coyne said advances in analytics are also transforming loss settlement. “Smart insurers are using advanced analytics — such as data mining, pattern-recognition technology, data-visualization tools and scoring — both to detect insurance fraud and to expedite payment of meritorious claims,” the ISO executive said.

Coyne was speaking to the 800 attendees at ISOTech, an insurance technology conference.

This focus on claims can be an important competitive advantage given that claim fraud adds approximately 10 percent to loss and loss-adjustment expenses, he noted.

Coyne said the use of predictive modeling in personal auto is “fast becoming a competitive necessity, if it hasn’t already.”

Predictive modeling is getting more powerful, he continued. “Today, sophisticated insurers are using models based on credit information and territory or ZIP code level data. But visionary insurers will soon be using models based on hundreds and even thousands of variables for individual addresses. These next-generation models have already been developed, and they are much more powerful. The days when personal auto insurers base decisions on credit and territory or ZIP code level data are numbered.”

Commercial lines
Coyne noted that the use of predictive modeling and other advanced analytics is spreading to Main Street commercial lines business. With premiums for businessowners policies averaging approximately $1,500, spending significant sums on painstaking underwriting is out of the question. “But with the right technology, it only takes a junior underwriter seconds to enter a few facts from a policy application and get a score that indicates whether the risk should be underwritten,” said Coyne.

He added the use of technology still depends on certain basics. “Yet even the most sophisticated modeling won’t yield correct underwriting and pricing decisions if the information on applications is wrong,” he said, citing the $16 billion in lost premiums that poor data cost U.S. personal auto insurers in 2005. “Predictive modeling and intelligent database matching now enable insurers to spot flawed information and stop premium leakage.”

Confronting catastrophes
As competition intensifies, keeping up with advances in analytics is only one of many challenges confronting insurers. At $61.8 billion, last year’s catastrophe losses dwarf even those in 2001 when the World Trade Center was destroyed and those in 1992 when Hurricanes Andrew and Iniki struck.

Citing research by AIR Worldwide, Coyne noted that the biggest factor contributing to the upward trend in catastrophe losses is exposure growth associated with increases in the number of homes and businesses, in the size of homes and commercial structures, and in construction costs. Continuing exposure growth means catastrophe losses should be expected to double approximately every 10 years.

Today’s catastrophe models enable insurers to measure, manage and price for catastrophe risk.

“But the answers that come out of catastrophe models are only as good as the exposure data fed into them. Research shows that many insurers are at risk of underestimating their potential catastrophe losses because of poor-quality exposure data,” Coyne said.

Focusing on man-made catastrophes, Coyne cited terrorism as a risk that will be with insurers far into the future. “Modeling indicates that an attack on New York using weapons of mass destruction could lead to losses on the order of $780 billion,” Coyne said. “Yet the Terrorism Risk Insurance Extension Act and its reinsurance backstop expire at the end of 2007.”

Coyne urged insurers to develop a long-term mechanism for covering terrorism, “be it public, private or a partnership that brings government and the private sector together.”

ISO’s CEO also highlighted other potential threats that may one day cause huge losses, including avian flu, nanotechnology, genetically modified organisms and personal injury coverage in the Internet age.

“A pandemic could cause huge losses as businesses are shut down and decontaminated, while new nanosubstances are already being used in consumer products such as cosmetics, sunscreens and wound dressings, even though it’s too soon to tell whether use of such substances will have long-term health consequences,” Coyne explained.

“Similarly, genetically modified forms of tomatoes, potatoes, soybeans and many other crops are already in the food chain, even though it’s too soon to tell whether consuming them will negatively affect people’s health or the environment.”

The personal injury coverage provided by homeowners and umbrella liability policies protects insureds who are sued for libel. Now, with millions of people blogging and with the advent of “gripe sites” focusing on specific products and companies, the potential exposure is enormous.

“Surviving and thriving in the insurance business will require monitoring and proactively addressing emerging threats before they cause huge losses,” Coyne said. “Surviving and thriving will also require devotion to the core fundamentals of the business — cost-based pricing, solid underwriting, strong loss adjudication and sound risk management. The challenge is to keep up as advances in analytics change what constitutes superior execution against the fundamentals.”