Chasing the Alpha: How Commercial Lines Insurance Leaders Outperform the Market

Executive Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3

Challenging Times for US Commercial Insurance Markets . . . . . . . 4

Defining Market Leading Performance: The Alphas . . . . . . . . . . . . 6

Drivers of Alpha Companies’ Success . . . . . . . . . . . . . . . . . . . . . . 9

Looking Ahead: Change Imperatives for Future Alphas . . . . . . . . 12

An Opportunity to Shape the New Performance Frontier . . . . . . 14

Table of Contents

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Interestingly, a handful of commercial insurers outperformed their peers. Between 2007 and 2011, these “Alpha” high-performance insurers consistently fared better than their competitors across three fundamental performance measures:

• Combined ratio

• Market share growth

• Total return to shareholders

How did they do it? The Alphas made critical strategic decisions, choosing markets and distinctive ways to compete. Although significantly different from each other in their market segment focus (specialized niche markets versus broad-based multiple lines), they share four core differentiating attributes worth closer examination.

1. Underwriting discipline (despite business growth pressures)

2. Targeted broker relationships and service

3. A value proposition bolstered by value-added services

4. Optimal operating cost and service balance alignment with competitive positioning

Going forward, the Alphas of tomorrow will shape the performance frontier of the commercial insurance industry by making a whole-hearted commitment to competitive differentiation and an aggressive pursuit of success essentials. For example, while underwriting discipline with next-generation data analytics will continue to be essential, future industry leaders will also strategically optimize their product and customer portfolios for market success. Also, timely insight into targeted customers’ and brokers’ behaviors and preferences, coupled with speedy deployment of value-added services, will form the basis of superior broker and customer relationships to drive profitable growth.

As future Alphas expand the performance frontier, they will need to dynamically balance operating costs and superior service experiences based on changing expectations and technology trends. Overall, the mix of efficient technology-based processes, multi-channel communications and value-added services deployed by industry high performers will vary to match their individual strategies and keep pace with change.

Ultimately, insurers that make clear strategic choices, circumvent legacy operating constraints by using technology to incubate new operating capabilities and deliver targeted broker and customer value propositions, will gain early-mover advantages and become the Alphas of the future.

The past five years were challenging for US commercial insurers, having written 13 percent less premiums in 2012 compared with 2008.1

Executive Summary

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Challenging Times for US Commercial Insurance MarketsIn the past five years, commercial insurers in the United States have been challenged from all sides, making it difficult to succeed—let alone excel. The global economy grew an anemic 13 percent from 2008 to 2011 against a backdrop of 65 percent growth in global gross domestic product in the preceding five years.2

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Figure 1. US Commercial Insurance Industry Net Written Premiums (2007 – 2011)

2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 201123%

24%

25%

26%

27%

28%

29%

30%

31%

32%

Figure 2. Expense Ratio Trends for the US Commercial Insurance Industry

$220B

$210B

$200B

$190B

$180B

$170B

$160B2007 2008 2009 2010 2011

Source: A.M. Best Data

Source: A.M. Best Global Insurance Database

Significant decreases in premium revenues and investment returns A drop in overall demand for commercial insurance impacted the insurance industry during the downturn. From 2007 to 2011, the value of the US commercial insurance industry (in net written premiums per year) contracted by 13 percent3 (Figure 1). Looking forward, current projections indicate slow growth of 1 to 4 percent for the industry over the next five years.

Compounding the industry’s revenue challenges over the last several years, historically low interest rates depressed US insurers’ investment income. In March 2012, United States 10-year government bond yields sat at 2.1 percent compared to 4.4 percent six years earlier.4 As they make their way out of the downturn, many insurers have learned to no longer rely on investment income as a dependable inflow of cash.

This period of financial crisis has also coincided with the occurrence of some of the worst catastrophe losses in US history. Extreme weather events—including hurricanes Irene and Sandy and 2011’s record-breaking tornado season—culminated in higher-than-usual claims costs during the same years.5 Specifically, catastrophe losses for leading insurers increased 300 percent from 2008 to 2011.6

Rising operating costsAs revenues fell, the industry experienced rising expense ratios7 (Figure 2), causing a heightened focus on cost reduction. For many commercial insurers, cost reduction initiatives—such as deploying systems improvement programs and investing in back-end technology such as highly-automated claims processing systems— became a primary and consuming focus.

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Figure 3. General Commercial Insurance Business Models

Commercial Multi-Line Insurer

• One-stop shop for enterprises seeking coverage for a range of commercial insurance needs

• Primarily provides products and services through brokers

• Operational capabilities are more focused on operational excellence versus specialization

• Focused on unusual/specialized and higher severity risk coverage

• Risks are typically long-tailed

• Interaction with customers is primarily through brokers experienced in specialty lines

• Operations capabilities—underwriting, claims, etc.—are highly specialized and rely on in-depth knowledge of the industry or risk

Commercial Specialty Insurer

To identify the US commercial insurers that have excelled through this period of unprecedented challenge, we assessed market share gains and losses, combined ratio performance and total return to shareholders.

We found three companies—collectively referred to as the Alphas—that outperformed the industry measurably on all criteria. This small group spans the sectors of commercial insurance, with one a commercial multi-line insurer and two that are specialty insurers, as defined by their predominant business models (Figure 3).

Defining Market Leading Performance: The Alphas

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2007Total Market Size in Net Written Premiums = $212.5B

2011Total Market Size in Net Written Premiums = $188.4B

Source: A.M. Best Data

Figure 4. US Commercial Insurance Industry Net Written Premiums (2007 – 2011)

Source: A.M. Best Data

54.8%

12.1%

33.1% 55.3%

13.3%

31.4%

Alpha Competitors

Other Top Competitors (With >1% Market Share)

Rest of US Commercial Insurance Market

Figure 5. Expense Ratio Trends for the US Commercial Insurance Industry

80%

85%

90%

95%

100%

105%

110%

0% 5% 10% 15% 20% 25% 30%

Com

bine

d Ra

tio

Market Share (% of total NPW)

2007

2011

2011

2007

2011*

2007

2007

2011

2011*

2007

*Note: The competitor dots combined ratios represent a weighted average based on net written premiums

Multi-Line Non-Alpha Competitors

Specialty Non-Alpha Competitors

Multi-Line Alpha 1

Specialty Alpha 1

Specialty Alpha 2

Market share gainsThe commercial insurance market in the United States is concentrated with about 80 percent of the market spread across the top 100 competitors8 and the top 13 competitors controlling roughly 45 percent.9 Over the past five years, the Alphas have gained market share, outperforming their competitors and creating a countervailing trend in a shrinking commercial insurance market (Figure 4).

Superior combined ratio performanceAmong the leading US commercial insurers that gained market share, the Alphas also consistently generated combined ratios at, or below, 100 percent (Figure 5). They grew their businesses by acquiring productive risks and avoided negative underwriting results despite high catastrophe losses. Other insurers that increased their market share wrote less-attractive risks or relaxed their pricing discipline, effectively driving up their combined ratios as catastrophe-driven losses mounted.

As combined ratios were rising sharply in the industry due to pressure from both losses and expenses, the Alphas executed differing strategies that consistently balanced expenses and losses to make a profit. One Alpha, for example, is known for having a low expense ratio whereas expenses at a second Alpha are above the industry average. Both Alphas made proactive choices to invest in their capabilities differently, in alignment with their unique strategies.

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Source: A.M. Best Data

Source: Accenture analysis of data from company annual reports

% Change in Loss Reserves

% Change in Net Written Premiums

Figure 7. The Alphas’ Loss Reserves and Growth (2007 – 2011)

-8%

-6%

-4%

-2%

0%

2%

4%

6%

8%

2007 2008 2009 2010 2011$38.9 $38.1 $37.6 $37.1 $37.9

2.6% Loss Reserve Decrease

0.2

0.4

0.6

0.8

1.0

1.2

1.4

1.6

1.8

0.0

TRS

Mon

thly

Val

ues

Oct ‘07

Feb ‘08

Jun ‘08

Oct ‘08

Feb ‘09

Jun ‘09

Oct ‘09

Feb ‘10

Jun ‘10

Oct ‘10

Feb ‘11

Jun ‘11

Oct ‘11

Feb ‘12

Jun ‘12

Oct ‘12

1.64 Multi-Line Alpha

1.55 Specialty Alpha 1

1.46 Specialty Alpha 2

0.89 Competitor 9

0.79 Competitor 70.78 Competitor 6

0.57 Competitor 1

0.42 Competitor 4

0.25 Competitor 3

Market Leaders

0.84 Peer Average

Increase in Total Returns to Shareholders (TRS)The commercial insurers that expanded market share and maintained low combined ratios predictably also delivered excellent returns to shareholders (Figure 6). In evaluating TRS, we considered the types of risks companies assumed and the ultimate impact on shareholder return.

While loss reserve changes have been known to mask true performance, they were not a factor in the superior returns posted by the Alphas. In fact, these three market leaders with the highest TRS show little change in their loss reserves (Figure 7). In some cases, loss reserves increased faster than growth in net written premiums.

Figure 6. Total Return to Shareholders for Leading US Commercial Insurers (2007 – 2012)

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Despite significant differences in the strategies and business models of the top performers, the Alphas share four similarities in the way they operate that significantly contributed to their success.

Drivers of Alpha Companies’ Success

How one Alpha Improved Its Underwriting ProcessOne Alpha chose to strategically transform underwriting, an already strong capability backed by a robust, shared organizational understanding of the types of risks the company was willing to accept. This insurer undertook a substantial and complex initiative to centralize select underwriting functions using business process management principles. The effort included investment in systems integration and standardization. The results optimized business processes, decreased back-office costs, improved operational efficiency, improved risk management, and strengthened process discipline. By investing to take their underwriting from “good” to “great”, this commercial insurer now targets the most profitable segments, focuses on the appetite set by its leadership team and generates accurate pricing even more consistently.

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Underwriting discipline (despite business growth pressures)On average, loss ratios for the Alphas over the past five years were consistently 7-12 percentage points lower10 than their competitors’ loss ratios. Seeking to achieve this margin while growing market share, these companies have systematically invested in three key capabilities:

Underwriting Process Excellence. The Alphas developed consistent, repeatable underwriting processes through continuous improvement driven by insights from periodic audits and analysis. They reduced deviation from best practices through process definition, communication with frontline staff, and systems to monitor process compliance. They improved communication with brokers about the types of business to pursue, and enforced underwriting discipline at the point of agents’ submissions.

Data-driven Decision Making. Better use of data to understand, segment, and price risks helped the Alphas differentiate themselves. Additionally, they have and continue to invest in rules-based engines and predictive modeling to more effectively mine data and improve risk selection.

Industry Focus. The Alphas restructured underwriting to be more industry-focused by assigning industry experts to specific customers and segments and fostering collaboration with cross-industry functional specialists. Deeper industry understanding avoids commoditization, aligns with targeted customer segments, differentiates products, provides superior levels of service and simplifies the sales process.

Targeted broker relationships and servicesThe Alpha companies also stand out by the strength of their relationships with selected broker partners. Recognizing that services, time and attention are too valuable to spread across low-return agents, these commercial insurance leaders invest selectively in high performing agents that are aligned with their market strategies and have the capabilities necessary to grow. The following initiatives were prominent in the Alpha companies’ efforts to shape their broker partner bonds.

Responsiveness and robust information. A case study of a non-US insurer that entered the North American market highlights the importance of responsiveness. The new entrant which, at the time, deployed a direct sales model was having a very difficult time adapting to the North American culture of relationship building with brokers. Ultimately, the company had to implement a companywide mandate promising to “return your phone call within 24 hours” as a first step in adjusting to the local way of doing business. On the other end of the spectrum is a multi-line Alpha which prides itself on having a slightly higher expense ratio resulting from investing in agent-broker relationships. Doing so helped the insurer become a preferred carrier at many top brokerages.

In 2011, one multi-line Alpha made key changes to improve its online capabilities to make information more readily available for brokers. It introduced a unique Web-based portal that allows nearly 1,000 of its risk managers and brokers to manage key aspects of their insurance programs online. By becoming easier to work with, the carrier is driving increased business with brokers and marketplace growth. Because the online tool is mostly self-service, the insurer is seeing a decrease in call volumes and lower costs.

Array of products and consistency of risk appetite. The risk appetites and product and service offerings of the Alphas have been highly consistent over the last several years, increasing the probability that a broker will earn a return from investing time, talent and marketing dollars to acquire those types of risks. Deploying capacity and pricing consistently and being known for expertise in certain lines of business send a positive message to brokers, enable long-standing relationships and support shared knowledge. This consistency allows the Alphas to generate stronger premium growth and superior risk/reward alignment with their brokers.

Ease of doing business and superior claims handling. Certain ease-of-doing-business elements that appear to pay high dividends with brokers include self-service, single points of contact for issue resolution, consistently accurate reports with online access, and value-adding communication. Brokers also place high value on superior, customer-focused claims service. The Alphas include differentiating customer claims experience traits, such as “slow to litigate”, and regular and effective closed-file claims audits enabling continuous closed-loop feedback and operational improvement. Streamlining the claims process for fairness, speed and exemplary customer service not only strengthens broker relationships but also holds the potential to measurably improve customer experience and renewal rates while lowering costs.

1 2

10

Figure 8. Expense Ratios for Alphas versus the Rest of the US Commercial Insurance Industry

Source: A.M. Best Data

2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

100%

90%

80%

70%

60%

50%

LeadersLaggardsTotal U.S. PC Industry

12%

-4%

3%

-5%

5%

4%7%

12%10%

9%

9%

Value proposition bolstered by value-added servicesAlphas differentiate themselves through value-added customer services, such as loss control consultations. Many carriers invest in value-added services. Yet, most struggle with developing and administering the performance management needed to determine which services have a real and positive impact on profitable growth. Without the requisite data and analytic insights to create a fact-based linkage between value-added services and core product sales or customer retention, these investments are simply educated guesses. In addition to value-added services for customers, leading companies add services for their broker partners, encouraging even closer relationships. Potential examples of value-added services for brokers could include platforms for small- to mid-size brokers to better serve their customers and collaboration mechanisms to help brokers access products and services outside their own footprint.

Operating cost and service balance Certain Alphas achieve industry-leading combined ratios by establishing rock-bottom expense ratios, individually as much as 40 percent lower than the industry average (Figure 8). Their lean operations, standardized back-office processes, and investments in technology allow them to pass on savings to commercial customers in the form of lower rates. Company culture is a key factor in this low operating cost strategy. For example, one Alpha is known for its conservative fiscal nature. Employees are assigned frugal budgets to which they are expected to adhere, with few exceptions.

A key challenge to this low cost strategy, however, is maintaining a preferred status with brokers and providing satisfactory customer service while keeping acquisition and administration costs low. Leading low cost insurers strike a competitive balance of service and cost by rigorously maintaining “must-have” service throughout the value chain.

In contrast, some Alphas made a deliberate decision to deploy a somewhat higher cost structure to distinguish their service. Differentiated service gives them latitude to charge higher prices and, ultimately, net a benefit to the bottom line. Whether or not a company decides to run with the bare minimum or a more complex value delivery model, maintaining a precise understanding of costs is a common element of the Alphas’ resource deployment strategies.

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To be an Alpha performer in the future, US commercial insurance companies can learn from the drivers of success for today’s Alphas, but will also need to make their own strategic choices going beyond the tactics of today’s leaders.

Tomorrow’s Alphas—whether commercial multi-line or specialty insurers—will not be generalists. Without decisive strategic choices about the specific markets, industries, specialties and geographies in which they wish to compete, they will not be able to afford the investment necessary to transform their business models and shape tomorrow’s performance frontier.

Looking Ahead: Change Imperatives for Future Alphas

Business portfolio optimization for sustainable profitabilityGoing beyond the superior process, analytics and expertise-driven underwriting discipline of today’s Alphas, insurers need to identify, limit, and, when necessary, exit lines of business that do not offer optimal returns or growth opportunities. Insurers must also consider inorganic options to acquire desired business lines or customer segments to help solidify their positions in targeted segments. Such portfolio optimization allows insurers to re-focus on the customer and broker relationships that matter most—those that comprise a significant portion of the current business, represent growth potential, and align best to the carrier’s value proposition.

This optimization runs the risk of harming long-standing and productive broker relationships through the resulting inconsistency of appetite and pricing. Robust data and careful analytics are required to ensure that decisions to limit or exit lines of business are made based on holistic business cases and occur as infrequently as possible.

Growth through next-generation broker segmentation and partnershipTo more sharply target their investments in productive broker relationships, we expect future Alphas to shift toward individual behavior- and preference-based business partner segmentation models. This replaces current models that rely largely on outdated, expensive and inefficient survey-based means of data collection and interpretation. Currently being used in numerous other industries, this approach, coupled with interactive technology, has the potential to reveal new insights and refine target broker and customer segmentation.

Behavior-based target marketing requires a sophisticated analytics capability. Today, insurers can efficiently develop it from the ground up or acquire it from external sources as a managed service. Quick market deployment of service capabilities that answer emerging customer and broker needs will set apart winning players, giving them first-mover access to richer, more desirable customer and business partner opportunities. Innovative, preference-based segmentation helps insurers create more flexible service models with measurably superior account service capabilities that work in conjunction with operating model improvements.

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Recasting value propositionsThis wealth of broker and customer insight also enables the introduction of more tailored products and value-added services that differentiate and produce returns. Some sectors of commercial insurance will experience greater commoditization while others will become even more complex due to globalization and the appearance of new and unexpected perils (e.g., climate change). Insurers must seek new ways to satisfy brokers and customers, align interests and generate value. The pace of change for brokers and customers has never been faster, creating a challenge and an opportunity for future Alphas to recast their value propositions.

Future Alphas will need core competencies in gathering intelligence about broker and customer behavior and preferences; quickly developing, testing and piloting products and services and closely monitoring and analyzing performance. This intelligence should also include the link between new products or services, relationship longevity and profitability. Surmounting or circumventing legacy system constraints, building pragmatic analytics capabilities and fostering innovation and experimentation are all fundamental building blocks for future Alphas.

Enhancing sales and service: The multi-channel world of tomorrow The precise balance of operating cost and service levels as a strategic enabler is not a static calculation for today’s or tomorrow’s Alphas. Instead, changing customer and broker expectations in a multi-channel world must drive consistent reassessments. The availability of technologies both inside and outside the insurance industry with the potential to change the cost/service equation will continue to change the shape of the achievable performance frontier.

In large and mid-market commercial insurance, the complexity of ‘pre-bind’ sales and ‘post-bind’ on-boarding processes presents an opportunity for insurers to differentiate their brand by providing accurate and timely information through multiple channels, thus speeding up sales and reducing rework through selective automation and self-service.

After-sale account servicing, claims, and renewals also represent major opportunities for distinctive multi-channel service. To raise customer satisfaction and therefore reduce attrition, insurers should draw on innovative technology—such as analytics and cloud computing—to provide the ability to:

• Exchange information with greater accuracy and speed across multiple touch points without multiple or redundant customer contact

• Make decisions based on the most up-to-date information

• Easily disseminate value-added information to brokers and customers

For example, a mobile claims app integrated with a self-service portal can give customers and their brokers a quick, easy and secure way to file, update and monitor claims 24/7.

Other potential operating model shiftsIn addition, future Alphas need to consider selectively transforming other aspects of their operating models. Specifically:

• Setting new standards; borrowing practices from leaders in other industries (such as Google, Apple, and P&G) that have proven to be effective in addressing changing customer expectations

• Automating or accelerating sales, underwriting, servicing, and claims transactions wherever possible, along with related data collection, cleansing and dissemination to improve costs and service

• Investigating alternative territory structures and models for managing support functions, centralizing and scaling where possible

• Investing to make IT and operational improvement delivery capabilities more agile and robust

• Take advantage of big data analytics— For example, harvesting and analyzing insight from social media, to proactively identify brand risk, manage brand reputation and spot business opportunities

Designing and building business transformation programs outside the legacy environment avoids the crippling costs of integration and improves the chance of success. However, insurers that choose to house new capabilities within new business structures must carefully identify and manage interactions with the existing business so that capabilities can effectively co-exist. Clear vision, leadership alignment, and a culture of adaptability are key ingredients to enabling and sustaining successful transformation.

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As US commercial insurers consider actions to become future industry Alphas, they need to focus on gathering customer and broker intelligence that reveals new insights, adopting performance standards and technologies common in other industries and enabling organizational agility to execute exceptionally. This will help insurers reduce the inherent risk in transforming their operations and shaping a new performance frontier without relinquishing early-mover advantages.

An Opportunity to Shape the New Performance Frontier

Insurers in a wait-and-follow mode will be at an increasing disadvantage as the rate of change in enabling technologies and customer expectations accelerates. Similarly, rapid advancements in technology and data handling are likely to lower entry barriers for non-traditional players. Google’s entry into the insurance aggregator market should register as a warning. Being a future leader of the pack may require competitive parity with non-traditional players who could bring a disruptive set of capabilities without legacy encumbrances.

Insurers must be crystal clear about their source of competitive differentiation today, and for the foreseeable future, and define themselves in terms of the capabilities that match the needs and preferences of their chosen markets. Such leaders will shape a new performance frontier, becoming the Alphas of the coming decade and beyond.

1 World Bank

2 World Bank

3 A.M. Best Global Insurance Database

4 Bloomberg, US Generic Government 10 Year Yield (USGG10YR), http://www.bloomberg.com/quote/USGG10YR:IND/chart

5 Star Tribune,”Storms push insurance rates sky-high,” October 22, 2012

6 Munich Re, 2011 Natural Catastrophe Year in Review, January 4, 2012

7 A.M. Best Global Insurance Database

8 A.M. Best Global Insurance Database

9 Note: Top 100 competitors have ~80% of the market

10 A.M. Best Global Insurance Database

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About Accenture

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