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HOW DO YOU ADAPT YOUR INSURANCE PRICING STRATEGY IN THE FACE OF INCREASED PRICE COMPETITION?

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By Ketil Kristensen, Senior Advisor, Insurance, SAS

 

Many countries in Europe have in previous years experienced increased price competition for general insurance products. Especially in Southern Europe, the competition has been very fierce, fuelled by online price comparison websites. In Spain, Portugal and Greece, there has been a substantial drop in average premiums for products like motor, home and health insurance. This poses a real threat to the profitability of property and casualty insurers.

While some insurance products are highly specialised and almost impossible to compare, most common products have increasingly become commodities. Consumers can now easily compare them online.

When comparing insurance policy prices and details becomes as effortless as getting quotes for airline tickets or hotel accommodation on price comparison sites, more insurance companies will eventually enter the market. And thus price competition will increase.

 

Preparing for a price war

Once the price war starts, there is no way to avoid it. And insurers need to meet their competitors head-on.

To win a price war, insurers need to be meticulous when they set the premium levels. They might also need to rethink the definition of “profit” when they are making pricing strategies for the future. In a market where premium levels are volatile and the competitive situation may change rapidly, insurers also need the capability to evaluate potential future scenarios in a short period of time.

 

Setting the premiums right

In the fast-paced digital era, customers expect insurance prices to be easily available online. They will make inquiries for insurance covers for their cars or homes on price comparison websites and expect the prices to be available immediately. From an insurer’s point of view, the premium customers will see on their screens when comparing insurance policy prices is the sum of the insurer’s technical premium and the commercial loading.

The technical premium represents the break-even price that the insurance company would charge for the policy if it had no costs and no desire to make a profit. Commercial loading represents the sum of the insurance company’s costs and the profit it expects to make on the policy. Technical pricing is the subject of many actuarial textbooks. But as machine learning algorithms make their way into actuarial departments, we will need to rewrite those books. Modern pricing techniques that include machine learning algorithms are a notable improvement compared to traditional models. If applied properly, ML models will result in more accurate technical pricing given the same data.

But what about commercial loading? How much profit should the insurer aim for?

Every one of us has a different tolerance for how much we would pay for, e.g., a car insurance policy. Some customers don’t consider price to that important. Others will try to search for a better deal elsewhere, regardless of how much time the process would take. Most customers are somewhere in between.

Being able to price the insurance products analytically based on the “willingness to pay” is, for many actuaries, seen as the holy grail of insurance pricing.

 

Personalised premiums

Most insurers already do personal pricing to some extent today. For example, they give different discounts to policyholders with equal risk. However, there is often a great potential to do segmentation and price calculations in a more analytical manner. Ideally, insurers would like to set the premiums as high as possible, but not so high that customers move their policies to another insurer.

On the other side, insurers would like to move customers away from their competitors by offering low premiums – but not too low. The insurer must first determine the price sensitivity of insurance customers and then price each insurance policy so that it maximises the profit for the insurer.

Insurers that can quickly reoptimise changing prices in the online market will also quickly identify customers that are at risk for churn. They can then perform the appropriate actions to prevent this from happening.

 

Rethinking ‘profitability’

When insurers think “profit,” they usually mean the income statement for next year. This is about to change. The concept of Customer Lifetime Value (CLV) is becoming more and more common in the insurance industry. And many insurers are now refining their pricing strategy based on a maximisation of the CLV of all its customers, thus not focusing solely on the profit definition in the income statement. The CLV of an insurance customer is the net present value of this customer for the insurer, where behavioural effects like renewal, cancellation and cross-selling of other insurance products are considered for the entire lifetime of the customer.

To accurately compute CLV for a customer, the insurer will need data that describes the behavioural patterns of the customer. Most insurance companies have quite a lot of such data available – the problem is usually that it is not adequately structured. In practice, to quantitively identify the customer lifetime value, insurers need to integrate both actuarial and customer behaviour models. Once a system for this is in place, insurance companies will have a strong quantitative foundation to compute the customer lifetime value of their policyholders.

 

Competitive insurance pricing

When a customer determines where to buy insurance, the price is the most important factor. Thus, to stay competitive and still run a profitable business, insurers need to set their premium levels just right. The evolution of price comparison websites – which provide real-time quotes on competitor prices and increased access to data that contains information about the customer’s insurance risk – has made the actuary’s job of calculating the premium more complicated.

Over the years, SAS has worked together with insurers to ensure that strong system support is in place to compute premium levels down to an individual policy level. These pricing systems have been put through the test in some of the most competitive insurance markets in Europe. They have turned out to be a valuable strategic tool for insurers to balance the desire for profit against the desire for market share. And maybe most important of all, they have enabled these insurance companies to effectively join the price war, fight it and still make a profit.

 

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HERE’S HOW INSURANCE IS SET TO CHANGE

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By Adam Goldsmith, Insurance Specialist, SAS UK & Ireland

 

Making predictions about the state of any industry in the coming year is a nigh-on impossible task. But looking to the longer-term, the patterns we’re seeing in insurance firms, which have been inspired by the pandemic, have revealed in no uncertain terms that the industry is in flux. Change is here, and its impact will be felt for many years to come.

Woken up by the sharp jolt of the pandemic, insurance will experience dramatic change by 2025. But not all firms will adapt fast enough to the new insurance landscape or new expectations from customers. Those that pay attention to long-term predictions like the following could reap the rewards post-pandemic.

 

1. Knowing customers inside-out through their data will be non-negotiable

A typical Insurer today is set up in very traditional manner. There remains distinct, separate departments for the key functions: including assessing risk, acquisition, customer engagement, claims handling, customer protection and renewal.

Yet very few insurers have a truly joined-up view of a customer’s full journey with their organisation, let alone what can be done to optimise each interaction. What’s needed is the ability to understand each customer touchpoint as they traverse through their journey, as well as the ability to make decisions as to how best to engage them.

Insurers often cite legacy policy admin and claims systems as the biggest barrier standing in the way of this approach being adopted. By 2025, however, the most successful insurers will have broken those barriers down, gaining an unprecedented understanding of their customers’ needs and preferences, and the ability to offer pricing plans that are both fair and competitive.

 

2. Automation and algorithms will become the bedrock of all insurers

We’ve long heard of ‘digital transformation’ being a key objective for insurance executives. However, by 2025 it’s expected that successful insurers will have completed this transformation. Digitalisation will no longer be the differentiator, it will be the default. As a result, a new way to drive business advantage will have to emerge – and it will be centred on the use of algorithms to drive business decisions.

This is not a new concept. Gartner describes ‘algorithmic business’ as the ‘industrialised use of complex mathematical algorithms pivotal to driving improved business decisions or process automation for competitive differentiation’.

We’ve already seen some insurers start this journey in their claims function. Companies, including Aviva, have long automated decisions concerning whether a vehicle is deemed a total loss or not. However, the trend will become much more prevalent, with Gartner research predicting that, by 2023, over 33% of large organisations will have analysts practicing decision intelligence, such as decision modelling.

 

3. The customer will see positive change as they interact with their insurer

It’s clear by now that COVID-19 will fundamentally change how insurance is done – both in terms of how customers want to interact with insurers, and also how insurers need to adapt. While we hope this pandemic won’t be with us forever, it has opened the eyes of many executives to what is possible within the customer-facing parts of their organisation.

From my discussions with insurers, many have commented on how well employees and customers have adapted to the new normal. While there were initial logistical hurdles in virtualising contact centres, they’ve been impressed at how well staff have adapted under pressure to deliver what customers and shareholders expect. Many are likely to follow the approach of Lloyds in allowing staff to work remotely for the foreseeable future.

 

4. Prevention will be prioritised over payouts

Insurance has long been society’s safety-net, protecting us when something goes wrong in our lives. Yet, it would be to everyone’s benefit if risk could be avoided altogether. The use of telematics to assess the risk of younger drivers was the first big industry push here, but by 2025 we will see this becoming ubiquitous across many other products and customer demographics.

The recent example of Munich Re’s acquisition of IoT service provider Relayr will benefit manufacturers with a ‘pay as you use’ model. This will enable them to be more flexible and react faster to market changes. The IoT Observatory is also exploring new ways that data extracted from connected sensors and devices can help to transform risk assessment and empower insurers with data.

This is no small step for any traditional insurer. But it is one that puts a truly customer-centric lens on the service that insurers deliver. Data-driven risk prevention allows for significant product differentiation, taking insurers out of their comfort zone and enabling them to explore whole new opportunities.

 

5. Fraud prevention must shape up for a post-pandemic world

Come 2025, we will be living in a very different world with new risks that require novel insurance solutions to resolve.

One of the largest looming threats is insurance fraud. Analysis from the Insurance Fraud Bureau shows that fraudulent claims rose by 5% in 2019, and there are concerns the current economic climate could see this rise even further. In the aftermath of the 2008 Financial Crisis insurance fraud rose by 17%, and there’s no guarantee this won’t happen again on the back of growing practices like crash for cash fraud and ghost broking.

Putting in place an effective defence mechanism to intelligently detect, prevent and investigate potentially fraudulent claims will be an essential requirement by 2025. A soft defence is a liability while those that take fraud detection seriously will drive a more profitable outcome. This is especially true when it was announced recently that close to 20% of each policy premium is goes to cover the cost of fraud.

Insurers must be holding a finger to the wind during this unusual time, as many of the themes and patterns emerging now will shape the industry going forward. Insurers must figure out how to adapt their decision-making processes now, to take on an unpredictable and exciting future in insurance.

 

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VOLATILITY IS CRYPTO’S BEST FRIEND

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Stephen Ehrlich, Co-Founder and CEO at Voyager Digital.

 

Volatility is good for crypto. It serves multiple purposes as the whole crypto ecosystem matures, which we have to remember is an industry and technology that is still only just over a decade old. New and emerging industries are by their nature volatile as they move towards mainstream adoption. But the volatility attracts people, investors and technologists, who drive the pace of adoption forward and as it grows, volatility naturally decreases. In the case of Bitcoin, its volatility has steadily been decreasing over time and even the recent sharp moves have not seen such a big rise in volatility compared to historically (see chart below).

Chart showing Bitcoin Price and Volatility

Source: https://www.buybitcoinworldwide.com/volatility-index/

Volatility continues to attract participants as it is unquestionably in our human nature to be drawn to assets that are subject to rapid price appreciation. Throughout history there have been numerous asset bubbles that have burst, with Dutch tulips of the 1600s being the one that most referenced in relation to crypto-assets. But do tulips really provide any utility apart from looking and smelling good? Many crypto-assets actually provide a purpose, a utility, and serve as the backbone to new technology protocols upon which useful apps are being built. This is why we are seeing greater adoption and as the whole market continues to grow, we are now seeing institutions embrace Bitcoin by diversifying into it as an alternative store of value. This is why volatility is good for crypto. But another harsh reality is that it allows people to learn about the risks, as well as the rewards, of getting involved. Hopefully this is done with the assistance of their chosen broker or through educational webinars, video, and other collateral.

Yes, there will be many that will get their fingers burnt, especially if they employ leverage into their trading without a disciplined approach to managing risk. The same can be said of the internet boom and bust in the late 1990s and early 2000s that saw many a “dotcom” go bust. Leverage was around in those days too, so unfortunately many people learnt the hard way, but it is a necessary evil for the industry to become even more established. For Bitcoin, we have seen multiple bubbles burst, with 2017/18 being the last cycle and soon after the sceptics were suggesting the end for crypto-assets was nigh. But those who see the technology’s potential were keeping their heads down and building amazing platforms and applications. If we take a look at Bitcoin today, it’s clear that the end is nowhere near.

Volatility also attracts the attention of regulatory authorities, another natural evolution of nascent industries. On occasions though, there can be overregulation. Whilst the sentiment behind the UK’s FCA ban on retail investors being able to trade crypto derivatives is right, in respect to trying to provide greater investor protection, it can limit choice and ultimately drive investors to offshore brokers that may afford much less regulatory protections. If an investor really wants to employ leverage in their trading then they’ll find a way to do it, so perhaps rather than an outright ban, perhaps limit the amount of leverage they can use instead.

Bans certainly don’t help liquidity and are actually counterproductive. We’ve seen multiple decisions to “ban” crypto reversed as authorities realise that people simply circumvented it by using a VPN or other means to buy Bitcoin. India is now set to vote on a crypto ban, but at the same time they are due to introduce their own Central Bank Digital Currency, which in itself sends out mixed messages. As governments become more knowledgeable on crypto-assets and understand how they are totally borderless, bans are likely to become less and liquidity will continue to improve further.

Coinbase’s prospectus filing and the fact that the SEC is allowing this anticipated $100b direct listing to come public, with significant consumer involvement, is further acceptance of digital assets by the authorities. The continued evolution of the industry going mainstream and public companies vetted and allowed to move forward by the SEC, foreshadows the long-term outlook by the SEC that this industry is here to stay and regulation and acceptance of digital assets as an asset class is forthcoming. Regulation adds legitimacy to the industry and will attract a broader audience of investors and participants, as oversight gives comfort to a larger group of investors.

Regulation is very important, but it needs to find the balance that protects consumers, yet also fosters adoption of what is a truly ground-breaking technology and asset class. So, for those people that complain about crypto markets being too volatile, we NEED volatility in order for the whole ecosystem to thrive.

 

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