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FinancialInstitutionsCenter
Productivity and Efficiency inInsurance: An Overview of theIssues
byDouglas O. CookJ. David Cummins
96-57
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THE WHARTON FINANCIAL INSTITUTIONS CENTER
The Wharton Financial Institutions Center provides a multi-disciplinary research approach tothe problems and opportunities facing the financial services industry in its search forcompetitive excellence. The Center's research focuses on the issues related to managing riskat the firm level as well as ways to improve productivity and performance.
The Center fosters the development of a community of faculty, visiting scholars and Ph.D.candidates whose research interests complement and support the mission of the Center. TheCenter works closely with industry executives and practitioners to ensure that its research isinformed by the operating realities and competitive demands facing industry participants asthey pursue competitive excellence.
Copies of the working papers summarized here are available from the Center. If you wouldlike to learn more about the Center or become a member of our research community, pleaselet us know of your interest.
Anthony M. SantomeroDirector
The Working Paper Series is made possible by a generousgrant from the Alfred P. Sloan Foundation
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Douglas O. Cook is at the Wharton Financial Institutions Center of the University of Pennsylvania, and J. DavidCummins is the Harry J. Loman Professor of Insurance and Risk Management at The Wharton School of theUniversity of Pennsylvania
This paper was made possible by the Wharton School Financial Institutions Center through a grant from the SloanFoundation. Any errors and omissions are the sole responsibility of the author.
Productivity and Efficiency in Insurance: An Overview of the Issues 1
Draft: October 11, 1994
DO NOT QUOTE OR CITE WITHOUT AUTHOR'S PERMISSION
Executive Summary : In this paper we have identified the major developments and issuesthat affect productivity and efficiency in insurance. We have used the designation "Life" torefer to developments and issues affecting life insurers and "P/C" for those affectingproperty/casualty insurers. The following is a listing of these issues:
1. Marketing, Relationship marketing, Distribution, Electronic data interchange,Market segmentation, Service centers, Point of sale policy illustrations, Unbundlingof services, Innovative policies and products
2. Underwriting and expert systems3. Data processing, General issues, Outsourcing vs. in-house, Centralization vs.
decentralization, Mainframe vs. mini vs. workstations, Image systems, Technology,systems, and software, Links between mainframes and pc networks
4. Claims settlement5. Miscellaneous, Total quality management, Reengineering, Downsizing Mergers and acquisitions, Management reporting6. Financial risk management, Overview of risk, Balanced view of risk, Perspective on
risk, Catastrophic risk, Asset-liability management, Capital budgeting, Derivatives,Regulation
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Productivity and Efficiency in Insurance:
An Overview of the Issues
I. Marketing and Customer Service
A. Role of relationship marketing -- Life
The marketing literature has suggested that relationship marketing -- establishing,
developing, and maintaining successful relational exchanges -- may play an important role
in whole life insurance sales. This is due to the fact that whole life satisfies the criteria
under which relationship marketing is considered to be most effective: The service is
complex, requiring customization and long-term delivery, buyers are informationally
disadvantaged concerning the service, and there is a high degree of uncertainty related to
future needs and available service.
The Federal Trade Commission (FCC) and other critics also contend that the
distribution of whole life insurance suggests relationship marketing. It is typically sold by
an agent who is the primary contact person. Buyers rely on this person’s advice in making
the policy choice decision. In making their initial purchase, customers tend not to
comparison shop. Agents follow up the sale by helping customers make policy changes as
their needs change. Although most policyholders are satisfied with their whole life
policies, critics contend that customers are naive. They cite evidence which shows that
whole life has an implied rate of return below market interest rates and that implied rates of
return exhibit large cross-sectional variation. Critics argue that price competition is
ineffective and that obtaining comparative information is costly and difficult for consumers.
In the absence of price competition, firms offer high commissions in order to attract the
best sales people who then establish a close relationship with customers. Consequently,
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lower cost competitors are unable to gain access to the customer and the buyer makes
suboptimal decisions based on counsel which he is unable to evaluate.
Opponents of this view argue that the economic incentives associated with
relationship marketing are consistent with buyers’ needs since buyers require periodic
reassessment and need someone to provide service and represent beneficiaries in claims.
They also claim that buyers are in general frequently exposed to negative product
information. They question whether relationship marketing is sufficient and cite evidence
of recent increasing rates of whole life policy lapsation and replacement.
In order to help resolve the relationship marketing controversy, Crosby and
Stephens (1987) tested two competing models for explaining buyer satisfaction of whole
life insurance services. The first model, termed the relationship generalization model
(RGM), postulates that buyer satisfaction is determined by satisfaction with the contact
person and institution. The second model is called the rational evaluation model (REM). It
proposes that other interactions such as the handling of customer service requests influence
buyer satisfaction. A questionnaire was mailed and follow up telephone interviews were
completed for a sample of 1648 respondents. Results supported the rational evaluation
model but not the relationship generalization model.
Crosby, Evans, and Cowles (1990) examined the role of relationship marketing on
whole life sales by analyzing the effect of the quality of the buyer-seller relationship (as
perceived by the buyer) on future sales. Based on data received from 296 returned
questionnaires, the paper found that relationship quality was related to the buyer’s
anticipation of future interaction with the seller (salesperson). However, the paper did not
determine much of an effect between relationship quality and sales effectiveness. Thus,
high relationship quality provides the opportunity for the seller to identify customer needs.
Whether these opportunities will be captured depends on the seller’s “attractiveness and
competence.” The seller behavioral factors which tend to impact favorably on the buyer’s
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perception of relational quality are high contact intensity, mutual disclosure, and
cooperative (as opposed to competitive) intentions.
B1. Forms of distribution -- Life
Towers Perrin (Berry and Heath, 1993) recently estimated that in a typical agency
company in the life insurance industry, two-thirds to three-quarters of total annual company
expenses are distribution related. They also calculated the average ROI for the industry to
be about 10% with career companies under 8% and multiline companies approaching 12%.
These poor results and competitive pressures from outside the industry make controlling
distribution expenses a strategic imperative. Vice presidents Berry and Heath (1993) argue
that senior management needs to treat agency distribution as a business not a function. In
order to diagnose problems and exploit opportunities, agency distribution must be
separated from the business of product manufacturing. Ben-y and Heath claim that poor
productivity is the root cause of agency companies’ weak financial returns. Management
should take responsibility for this issue rather than delegating costs to field managers who
typically do not manage them effectively and who obscure compensation and expense
management. Firms need to increase production without a commensurate increase in fixed
costs. In conjunction with this, they need more marketing discipline and focus.
Towers Perrin consultant Rick Berry predicts that insurers will begin considering
radical changes in their field distribution as they realize that they cannot grow out of their
productivity problems. In response to the realization that reducing home office personnel is
not sufficient to ensure success, that insurers will be analyzing their total distribution in
order to determine what is and is not working. The real emphasis on change will relate to
productivity improvements in agent distribution. ” Changes considered will include more
disciplined marketing, better development of customer relations, alternative distribution
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approaches and new compensation arrangements. Implementing these changes will require
insurers to actively manage agents and agencies. (King, 1993).
Some consultants are predicting an end to the life insurance industry’s traditional
agency distribution system. To quote Michael Chandler who is president of a company that
develops insurance/securities profit centers for independent community banks, “the career
agency distribution system may not be dead yet, but with some old industry giants
obtaining growing amounts of business through alternative sources, including bank
‘partners,’ the funeral may not be far away.” An example of a bank partnership is that of
Prudential with Citibank. This marketing unit distributes its products through the Citibank
distribution system where commission structures are asset-based and do not require high
frost-year commissions. Chandler goes onto say that success will be determined by the
ability to hurdle the traditional thinking of the past and assume the risks of leadership. He
then asserts how distribution is changing and lists some advantages of alternative
distribution methods. For example, in the 1960s, large insurer shops which housed
dozens of agents and which carried on systematic recruiting and training dominated the
industry. These shops were characterized by large fixed costs and were managed by tiered
organization structures. Today, most companies have distribution systems which are
multi-channelled. The new distributors include stockbrokers, financial planners, general
agents, and financial institutions. Advantages of using these new, alternative channels
include lower distribution costs, variable as opposed to fixed expenses, lower front-end
commission costs, and the opportunity of selling the products in conjunction with other
investment-related products. (Chandler, 1994).
In the United States, the Glass-Steagal Act prohibits inter-company ownership of
bank and insurance businesses. In Europe, on the other hand, there is no such restriction.
Instead there is pressure on banks and insurance companies to adopt a strategy toward
“bancassurance” which is the combined offering of banking and insurance products. Both
insurance companies and banks find bancassurance appealing. For insurance companies, it
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provides an opportunity to open additional distribution channels for their insurance
products. Banks can sell higher margin insurance products and provide a fuller array of
products to their customers through their branch networks. (Howard, 1993).
Duff and Phelps (King, 1992) have recognized the importance of distribution by
explicitly incorporating distribution-related characteristics in its ratings. The following five
criteria are used in addition to its usual financial analyses of asset quality, cash flow,
liquidity, market value assessments, callability, retention, and risk profile:
• Does the company pay reasonable but not excessive compensation?
Ž Does the company market its own name and reputation?
Ž Does the company emphasize quality service and client relationships?
Ž Does the company have some defined market niches where it has strengths?
Ž Is the field force comprised of experienced and loyal agents and brokers with a
successful history of distributing the company’s products?
Larry Brossman, a vice president of Duff and Phelps indicated that his company is
not inclined to favor any kind of distribution system indicating that “We have seen good
and bad in all of them.” (King, 1992) Notwithstanding the prophets of doom, it seems
that a variety of distribution systems can simultaneously exist in the insurance industry.
B2. Forms of distribution -- P/C
An example of re-evaluating traditional P/C distribution relationships exists in the
breakup between excess and surplus lines companies and the wholesalers they have been
doing business with. “There used to be a tremendous partnership feeling [between the
two] . . . There was a real commitment and support, almost a ‘til death do us part’ feeling.”
“That close relationship . . . has deteriorated to the point where wholesalers are passing over.
E&S carriers and going to standard carriers with business.” (Calise, 1992).
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Some select distribution systems are described and related observations are cited:
1a. Independent agents -- Life
An independent agent is an insurance agent who, typically, carries lines for a
variety of companies. The independent agent assists buyers by selecting the agent which
best suits the customer’s needs. The number of independent agents and agencies has been
declining. According to the president-elect of the Independent Insurance Agents of
America, the period 1987-1992 witnessed a 14 percent loss of independent agents and
from 1978 to 1992 the number of independent agencies declined from 70,000 to 46,500.
(Dauer, 1992).
Despite the market share decline and high costs associated with independent agents,
these have a significant advantage in selling to consumers who are unable or disinclined to
independently determine their insurance needs. In the case of P/C, independent agents also
can resolve some kinds of agency problems such as the company/buyer conflict. Thus, in
some cases the higher costs are justified. For insurers who choose to use independent
agents, it is important that they be able to evaluate the marginal costs and benefits of this
distribution, and develop a synergistic relationship with the agency as it pertains to the
marketing and management of getting and keeping customers. (Berry and Heath, 1993).
Agents are being encouraged to employ technology more effectively. This
includes, for example, expanding the service function from direct mail to the phone and
through personal computers. “We’re in the mailbox now, . . . Now we’ve got to get inside
the house.” (Dauer, 1992). In today’s marketplace agents need to be aggressive and able
to understand marketing and promotions (Downey, 1992).
lb. Independent agents -- P/C
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Independent agents have been finding opportunity in property and casualty personal
lines as the major national companies are abandoning personal lines and redeploying their
resources on commercial lines. This has led non-traditional companies such as John
Hancock Property & Casualty to contract with independent agents for personal lines. The
appeal is summarized by John McDonald, vice president of John Hancock P&C: “It’s far
less costly for us to add independent agencies than to subsidize a direct writing agent.”
(McGhee, 1991). John Karanik, Atlantic Mutual’s senior vice president for personal,
suggested that due to pressure from direct writers, the best strategy in personal lines is to
focus on the upscale market. (Karanik, 1990).
The managing general agent can serve as an important link between retail insurance
agents and insurance companies. The advantage for the insurer of operating through a
managing general agency is that products in broad areas can be made available without the
added cost to the retailer or consumer that a branch office system entails. The independent
agent is provided with a wide variety of products from several suppliers allowing programs
to be customized. The independent agent is also supplied with a full range of support
services, including technical support services. (Rogan, 1992).
lc. Independent agents -- Life & P/C
In a Marketing Department working paper at the Wharton School, Ross, Anderson,
and Weitz (1993) analyze the effect of perceived asymmetry of commitment to the
relationship between insurance agent-insurance provider dyads for life and
property/casualty insurers. They find that perceives’ rating of their performance is
inversely related to their perception of relative commitment to the relationship. For
example, perceives rate their performance outcomes from the dyads highest when they
believe they are less committed than their counterpart and lowest when they believe they are
more committed than their counterpart, In the insurance industry, over-committed agents
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may foster “reverse” opportunism. That is, insurers who initiated the building of close
relationships in order to discourage agent opportunism against them may exploit this
relationship at the expense of the agent. Managing the degree of commitment becomes a
challenging task.
2. Stockbrokers -- Life
Stockbrokers are agents who are licensed to sell shares of publicly traded equities.
Stockbrokers can work for large national firms such as Merrill Lynch, regional firms,
banks, or be self-employed. The use of stockbrokers to sell life products is increasing.
The attraction to stockbrokers is the much higher remuneration for selling life products than
for selling equity shares. According to David Ferguson of Sun Life of Canada, brokers
who write a second-to-die policy may receive compensation of $10,000 to $12,000. This
compares favorably to the $150 they may earn on a securities transaction. The deterrence
to stockbrokers is the six to eight week delay for payment and the need to place multiple
sales calls to the same customer. To allure stockbrokers to this market it is important to
make life products simple and easy-to-sell. Variable annuity products are sold successfully
by stockbrokers at a number of firms. (Crosson, 1993).
3a. Salaried sales force -- Life
Salaried sales personnel are sales personnel who are not compensated primarily on
the basis of product sales. Thus, they are incented to provide customers with accurate
product information efficiently and pleasantly. Consumers are demanding a greater role in
selecting life and health insurance products. The smaller premiums and higher cash values
of low-load products appeal to the consumers. A salaried sales force which responds
through a call center and gives immediate, personalized service and advice is a non-
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traditional approach to these consumer demands. This form of distribution is cost-efficient
and focused and is beneficial to price-conscious consumers. In order to succeed, the
following four elements are required:
Ž The company must offer excellent products at competitive prices
Ž The company needs to research, develop, and market the products in order to reach a
targeted niche.
Ž The company must hire and train a top-notch sales force.
Ž The company must gain and maintain the trust of consumers.
USAA Life has deployed a salaried sales force with success as measured by lower than
normal lapse rates and higher than normal productivity per salesperson. (McClure, 1992).
3b. Salaried sales force -- P/C
Motivated by a search for greater efficiency and economy, a number of insurance
companies are using telemarketing to expand market penetration while maintaining a control
on sales costs. Telemarketing is particularly effective at:
Ž lead generation/qualification;
Ž follow-up to direct mail programs;
Žcross-sales of products, and
Žnew product introduction to both agents and customers.
Companies are finding that they can reach more prospects and attract new business without
expanding staff. The key to successful telemarketing is implementation. In order to keep
costs in check, more and more insurance companies are using reputable telemarketing
service agencies for support. (Weber, 1990).
4. Recent distribution choices -- Life
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The fact that there is no evidently dominant distribution choice can be seen from the
next two recent examples:
a. AIG’s agency launch
Typically, new entrants to the life insurance field employ brokers or personal
producing general agents. However, American International Group (AIG) has announced
that it intends to be among the top 20 life insurance markets in the next five years and will
accomplish this by employing a career distribution system. Their goal is to hire 125-130
agents by 1994 and 300 by 1995. This will be supplemented by a field underwriter
development program which is designed to attract younger people who fit the Life
Insurance Marketing and Research Association’s profile for new agents. (King, 1993a).
b. Allstate and Dean Witter partnership
Dean Witter, Discover& Co. and Allstate Corp. have forged a marketing
partnership to develop and sell annuities and other life products through Dean Witter
account executives. Capital contribution for product development and profit sharing will
be shared equally. The products will be sold by Dean Witter’s 6600 account executives
and not through Allstate’s agency distribution network. (Mulcahy, 1993).
C. Electronic data interchange in distribution -- P/C
In the context of marketing channels, the term “computer-based interorganizational
systems” refers to a system based on information technology that links distribution channel.
members for the purpose of facilitating the flow of a product or a service through the
channel. Callaghan, Kaufmann, and Konsynski (1992) analyze adoption correlates
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(likelihood of adoption) and share effects (share of business the adopting firm directs
toward the source firm) for the category of interorganizational systems called electronic data
interchange (EDI) systems. EDI in this case is a system which is based on information
technology that Links channel members for the purpose of facilitating the flow of a product
or service through the channel. The EDI system is proprietary to the initiating (“source”)
firm.
The authors studied the link between independent agents and the insurance carriers
on which they write their property and casualty policies. Data for the study was gathered
from 1242 responses received from a survey mailed to 5000 agency principals drawn at
random from the 40,000 members of the Independent Insurance Agents of America. The
study concluded that “agents would tend to favor a carrier with whom they had an EDI link
because it would be easier to do business with that carrier. ” Target firms tend to focus on
the benefits of EDI and pay relatively less attention to the expected initial costs of adoption
which, of course, need to be borne both both the developer firm and adopter firm.
The design challenge for EDI source firms is to design a system with the following
attributes:
Ž It facilitates the initial adoption.
Ž It ensures the desired postadoption business effects
Ž It ensures the long-term retention of those effects by discouraging additional linkages.
An example is the GEMINI system of Aetna which offers agents a fully integrated
proprietary system and includes an electronic mainframe linkage. This system leads to a
high initial adoption cost for the target firm (agency) and makes the adoption of additional
interfaces very costly.
D1. Market segmentation -- Life
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The distinction between financial services has blurred and like other providers life
insurance companies are facing increasing competitive threats. Customers are increasingly
reluctant to purchase the traditional life insurance products and banks and other financial
service providers are providing competitive investment products that meet consumers’ cash
flow needs. Life insurance companies have modified their product line toward universal
and variable life policies. These respond better to market needs, although they are less
profitable. The profit decline provides a need to increase sales volume and improve control
over delivery costs. Surveys of the industry’s leaders* indicates that the trend will be
toward flexible investment-based products containing shorter life spans and lower profit
margins. Also needed will be cuts in the costs of operations and delivery, and work
stations binding the agent to the company. Life insurance companies will continue to
segment and tailor their products to specific customer group needs. Agents will be used as
planners and supported by selling teams with product expertise. (Brooks, 1987).
Walter Zultowski, senior vice president of research for the Life Insurance
Marketing and Research Association indicates that “the agency system must change in order
to meet the changing needs of an evolving marketplace.” He defines the chief challenge to
be realigning distribution within tiers and defining business needs within tiers. Zultowski
predicts the emergence of a two-tier market consisting of an “advanced” (business/affluent)
market and the mass market. Needs associated with the advanced market include retirement
and distribution planning, investing inheritances, and providing for children who move
back to the nest. Mass market needs include income protection, saving for retirement, and
funding of education. (Friedman, 1993).
Market segmentation becomes most important as it pertains to direct marketing,
Due to the increased costs of reaching a household, intensified competitive pressures, and
the ineffectiveness of mass mailing, companies are attempting to nearly attain one-on-one
lArthur Anderson co-sponsored three surveys: “Strategic Issues in Banking,” “Changing Horizons forInsurance,” “Keys to a Changing Securities World.”
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marketing strategies. Thus, the need arises to build highly informational data bases, and to
cross-sell existing accounts. It is suggested that a model built on actual data specific to
buyers and non-buyers will be more predictive than a model based on averages such as
census driven overlays. (Kauffman, 1988).
John Hancock Mutual Life is a company which has responded to need to
increasingly segment the national market by significantly upgrading its market research and
product development. An example of new product development includes “more emphasis
on financial service products for the elderly; products that can adjust to lifestyle changes
such as divorce, retirement and health; products for women, such as disability income; dual
earner products, such as joint life policies; products for the growing Hispanic and Asian
ethnic markets; products targeted to growing geographical markets including Texas and
Southern California; and more emphasis on fellness. ” (National Underwater, 1987).
Dr. Kenneth Black, Jr., of Georgia State University predicted that the life insurance
industry will in the future remain highly fragmented and will not be controlled by a few
“monolithic financial services giants.” He predicted that a new role would emerge for the
financial product manufacturer. (Knowles, 1987).
It is currently easier to indentify challenges which threaten the industry’s survival
than to identify opportunities for success. The industry is predicted to thrive “if we take the
opportunity to return to explaining the product we sell best, insurance, and return to a
needs-selling basis whereby people appreciate the fact that many of the needs they have can
be filled only by insurance companies and insurance products and we help quantify for then
the amount of that need.” (Knowles, 1988).
A Chicago actuary has presented his solutions to the questions of how you would
design, market, and service a life insurance product for 2001. The key is to guarantee to
policyholders a “lifetime of assistance in planning to meet their financial needs.” The old
solutions of selling and guaranteeing contracts required too many assumptions about future
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inflation, future consumer needs, and the future cost of doing business. One result is that
premium and benefit schedules quickly became outdated. (Knowles, 1991).
Managements of life insurers are subject to the dilemma that they feel pressured not
only to offer new products at competitive prices but also to provide substantial agent
compensation, aggressive risk selection and costly service support. This approach leads to
questions about the ultimate profitability of the resulting products. Companies must
aggressively manage for desired future results instead of building profits and waiting.
“They need to work hard to obtain a share of our customer’s heart instead of focusing on
obtaining a piece of some
D2. Market segmentation
generalized market share. ” (Shapiro, 1989).
-- Life & P/C
Insurance firms face the following three major challenges in selling financial
products and services:
Ž They need to overcome the negative perceptions associated with the business.
Ž They must compete against other financial service companies such as brokerage firms
and banks.
Ž They must overcome the confusion in the marketplace which has been caused by
increased financial services advertising.
In overcoming these hurdles insurers must provide information that the consumer wants
and needs. Consumers need to be reached “with more pointed messages that elicit a deeper
understanding about what differentiates a company from its competition.” This “branding”
can be assisted by changes in media planning. An example of this is the association of
Liberty Mutual with the Legends of Golf on NBC. In addition, refining marketing
communications with segmentation research can assist companies in providing useful
information to the targeted audience. (Lancaster, 1987, 1987a).
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E. Service centers -- P/C
Company operated service centers have arisen as a result of the competitive cost
pressures from direct writers. These facilities take over service responsibilities for agents.
Clients call the customer service center using a toll-free number in order to change
coverage, report claims and transact other routine business. The service center
representative handles the call in the same manner as an in-house representative would.
For example, on a claim they take the report over the phone, file the paperwork, contact the
adjuster, and follow the claim until it is resolved. The center keeps records of its
transactions and even cross-sells coverages for the benefit of the agency, however, it does
not prospect for new business. (Hoyt, 1992). The advantage of using the service center is
that it lowers the costs of servicing and frees the agencies’ representatives to generate
additional business. For their fee, the centers typically charge 2% of revenues.
Companies employing service centers claim that their use is critical to the ability to
compete long-term in the personal lines market. According to John Karanik, president of
the Maryland Group’s personal insurance operations: “‘In order to compete, we must
change the way we do business [by utilizing] a more efficient delivery system,’ he said
noting that independent agents cannot cost-effectively service personal lines business in line
with their major competitors-direct writers. ‘I’m convinced this is the way we’ll survive.
Otherwise, we’ll go the way of Reliance, Crum&Forster and Cigna: big agency companies
who no longer write personal lines.’” (Mulcahy, 1992).
Not all companies agree with this assessment, however. American States Insurance
has taken a moderate approach to personal lines. They imposed restrictions on new
business recognizing that the loss ratios on new businesses are significantly higher, on
. average, than those on business which is already on the books. The organizational
structure of American States is also more decentralized than most. According to Peter
Browning, marketing support manager for personal lines, “Where some companies have
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gone toward consolidation of functions within the home office to achieve economies of
scale, we’ve gone the other way-opening up more offices.’ Browning says by keeping its
underwriting, claims and servicing functions closer to the communities it serves, American
States can better understand its customers and work toward long term retention of those
customers.” (McCoy, 1991).
Independent agents have expressed concern about the use of service centers. They
argue that selling and servicing are interrelated. For example: “A client calls to have a teen-
ager added to the auto insurance policy or seeks insurance for a new high-powered boat.
The agent points out the client’s increased liability exposures. The client decides to buy a
personal umbrella policy. Thus are accounts built.” (Williams, 1992).
Agents are expressing fear that the use of service centers will precipitate the loss of
touch with their clients. These risks are currently controllable since an agency retains
ownership rights and designates the level of company intervention. However, the future
structure of service centers is uncertain. ITT Hartford Group in Pennsylvania has
mandated the use of personal lines center. (Mulcahy, 1991).
A task force of the Independent Insurance Agents of America recommended that if
agents feel pressured into complying with an insurer’s wishes to use a service center then
they obtain the following contractual guarantees:
Ž Termination notice of at least 180 days.
Ž Twenty-four additional months for renewals, unless agent wrongdoing is involved.
This could be done by providing a specific run-off provision or a three-year rolling
term agreement. Such a provision gives the agent time to build a service staff or move
the business to another company. The provision should also apply if the agency is sold
and the company decides not to appoint the new agency.
Ž Twenty-four months to transfer business from the service center to the company’s
traditional processing center.
Ž Complete customer information on an ongoing basis and at termination.
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Ž Indemnification for all acts or omissions of the company service center.
Ž Ownership of expirations on business placed with the service center, sold by it for the
agent’s account or from any type of agency lead. Also, the insurer must agree that it
will not use these expirations for the sale of any additional product or service without
the agent’s approval.
Ž At least 180 days notice for contract amendments, including any increase in the
service fee.
Ž Use of the service center not being made mandatory in the future.
Ž The right to assign business to a new agency.
(Yates, 1992).
F. Point of sale policy illustrations -- Life
Policy illustrations are being used as point of sale devices in order to compete for
life insurance policies on” the basis of price. Since the values are highly dependent on
assumptions about mortality rates, lapse rates, and investment earnings, these are subject to
overly optimistic projections and are highly controversial. The use of overly aggressive
pricing assumptions tends to create false expectations in the eyes of buyers and then a
demand for accountability on the part of the policy insurer. Some members of Congress
are expressing indignation at “misleading policy illustrations. ” For example, Senator
Howard Metzenbaum claims that “Consumers . . . are not getting essential pricing
information, do not understand the costs of a policy, are being misled about projected
future values and are being persuaded to cancel policies in which they have accumulated
value to buy new and poorer products.” (Brostoff, 1993).
An area which is particularly prone to abuse is the lapse supported policies such as
second-to die. These new products lack the history to develop reasonable lapse rate
statistics and, therefore, may lead to dramatic dividend reduction if the actual lapse rate
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experience turns out to be significantly lower than what was assumed in pricing. Policies
with high explicit or implicit surrender charges and heavy penalties for skipping premiums
have weak contractual guarantees on how these “profits” will be distributed. Thus, they
are known as “trust me” policies since clients need to trust that the insurance company will
treat them fairly. (King, 1992a).
There is increasing concern that insurance agents will be successfully sued by
policy holdholders in the event of insurer default. This threat was realized by the 1987
Texas jury verdict that an insurance agent had to pay his policyholder $725,000 plus legal
fees for placing insurance with a company that subsequently became insolvent and
defaulted on a claim. Although the decision was reversed on appeal it has led to the
development of tactical planning for agents’ protection. One of the recommendations is to
use conservative policy illustrations. Payments must be earnings based and the company’s
track record is probably a better indicator of future performance than the illustration.
(Woods, 1990).
Illustrations are subject to regulatory pressures, market pressures, and client
feedback. Variable products are regulated by the SEC and NASD while for universal life
contracts, the state insurance department determines what can be shown as well as the
interest rate assumptions. Market pressures come to bear as consumers can subject a firm’s
policy illustrations to a competitor’s scrutiny. Clients receive performance information
which can be compared to the original assumptions and may become a source of contention.
(Anonymous, 1990).
Manulife Financial, Toronto, switched to a 50-year rolling average “index rate” for
all its individual participating policy illustrations in addition to showing current and
guaranteed values. A company spokesperson indicated that this was done “because it is
less affected by short-term volatility and, therefore, is more realistic than other measures
used to project future values.” Actuaries who commented on the use of this index indicated
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that it is helpful if it makes consumers aware of the uncertainty of projecting policy values
but noted that one index is not appropriate for the entire industry. (King, 1993 b).
In order to “free the life insurance industry from the need to compare policies based
on price, Beacon Co. is offering life insurers a policy illustration “verification” service.
For a price of $10,000 Beacon will match the insurer’s current experience for investment
yields, mortality, expenses, and surrenders with Beacon’s model pricing assumptions.
After verification, Beacon’s client is given permission to use the illustration with
consumers. Accompanying the verified illustration is a disclosure statement which
consumers are required to sign and which is retained by the insurer. (King, 1994).
G. Unbundling -- P/C
Fronting companies have been providing corporations with the ability to set up
insurance plans in all 50 states without becoming qualified as a self-insurer in all those
states. Recent legislation allows corporations to establish risk-retention groups (Workers’
compensation insurance is not covered by this legislation.) which can operate in all 50 “
states after being licensed in only one state. This eliminates the need to pay fronting fees
and the need for security like letters of credit to support the limits that the fronting company
is writing. Fronting companies are responding by unbundling and selling underwriting and
claims adjusting services to risk retention groups which, in turn, are acting similarly to
managing general agents. (Howard, 1987).
In an analysis of the changing broker environment, risk management consultant
John Roskopf declares that “Maintaining market share will be tough - maintaining market
leadership will be virtually impossible.” Roskopf observes that risk managers are
increasingly better educated and have a more sophisticated financial orientation. He notes
that the new risk managers are more management-oriented and less inclined to be technical
specialists. These managers are more likely to unbundle services and shop around on a
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per-transaction basis, analyzing potential service providers from a cost/benefit basis.
Consequently, the opportunities for brokers to forge broad-based long-term relationships
has decreased. (Roskopf, 1989).
H1. Innovative policies and products -- Life
Some traditional life insurance companies are increasingly using the brokerage
market as a source of individual life business. Many of these companies are finding that
product innovation is a key to success in brokerage. One such firm is Manufacturers Life
which has been targetting the upscale estate market with traditional life products and using
brokerage to do so. It introduced a new survivorship product and estate preservation rider
for this marketplace. New England is another company which has been emphasizing
broker sales. It introduced new survivorship life and multiple life products for the
brokerage market. In order to continue to expand its brokerage business, Principal Mutual
introduced a new non-qualified single premium deferred annuity and survivorship rider,
and updated its adjustable life products. (Arndt, 1989).
In order to offer a product that contains a guaranteed account and variable options
on individual annuities for the non-qualified market, Aetna Life Insurance and Annuity Co.
needed to use an innovative approach. This is because only a handful of states allow these
options in individual policies. The company developed a group deferred annuity with
variable options and fixed account (the withdrawals from which may be subject to a market
value adjustment (MVA). The product offers five variable investment options, and a
guaranteed account, which is referred to as an MVA option. The variable investments
include growth and income, bond, money market, and managed funds. Clients can make
up to 12 transfers between accounts a year, without charge. The guaranteed account offers
up to five maturities, ranging from one to 10 years. Any funds withdrawn from the
guaranteed account before maturity may be subject to an MVA. The product is registered
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with the SEC and is designed for distribution to individual clients through broker-dealers
and financial institutions. These distribution channels produce about 45 percent of the non-
qualified business nation-wide for life insurance companies. (Koko, 1993).
A recent innovative product, synthetic GIC, outsold all other GIC products in the
first half of 1993. Synthetic GICs, typically, provide a plan sponsor with title to the
underlying assets and a book value wrap that provides benefit payments at book value
(book value guarantee) to participants. Over 70 percent of the synthetic GICs issued
during the first half of 1993 contained book value guarantees only. Others contained the
book value guarantee and management of the underlying assets. (Crosson, 1993a).
H2. Innovative policies and products -- P/C
A financial innovation being developed on the Island of Bermuda has the potential
of revolutionizing the insurance business. This innovation, entitled an “Act of God” bond
would securitize property catastrophe risks and would function similarly to the way
mortgage-backed securities transferred duration risks to a multitude of new investors.
new instrument is being developed by a Centre Re joint venture, Centre Re Financial
Products, headed by former Kidder Peabody executive managing director Richard L.
Sandor, who is the principal architect of the property catastrophe futures traded on the
The
Chicago Board of Trade. This over-the-counter derivative has yet to be launched and the
precise nature of the product has yet to be revealed. However, Sandor and Centre Re
founder Steven Gluckstern have indicated that it may be a bond with interest rates linked to
the incidence of certain catastrophic events, such as hurricanes and earthquakes. Sandor
and Gluckstern claim that the new instrument has tremendous growth potential like the junk
bonds of the early 1980s. (Banham, 1993).
II. Underwriting and expert systems
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A. Life
An example of the latter use of expert systems is the in-house development of
CLUES by MONY Financial Services. CLUES which is an acronym for Comprehensive
Life Underwriting Expert System is, according to the insurer, the “first comprehensive
underwriting and policy issue system using AI technology to be fully integrated with a
company’s mainframe computer. The system was programmed predicated on the
knowledge of underwriting contained in the brain of the MONY’s chief underwriter and
veteran of 24 years in the business. This information was extracted by way of intensive
interviewing sessions which involved thousands of “what if” questions including the type
of mundane decisions that would be considered commonplace to an underwriting expert.
The underwriting system contains approximately 5000 automated steps with about 800
programmed underwriting rules. Two functions which characterize the system are:
Ž the ability to interpret the medical history on an application in conjunction with blank or
unanswered questions;
Ž the degree to which it is performing natural language processing; e.g., recognizing the
actual wording of an application, rather than requiring the coding of the information.
The operation of the system is being enhanced through the development of a
communications system called FAST (Field Application Submit Transaction) which will
allow direct input to CLUES from the field. Input will occur directly from an agency’s
computer terminal or from a laptop computer in the prospect’s home and will shorten the
issue time even more. (Jones, 1988).
John Hancock Life uses an expert system in order to eliminate a great deal of the
routine underwriting. This enables the company experts to concentrate on more complex
cases. The system is called the John Hancock Life Underwriting Expert System. It was
developed on stand-alone PCs. When uploaded to the mainframe, it will run all
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applications entered on a particular day through a nightly batch cycle and, the next
morning, print a paper referral notice which contains client information and the expert
system-derived data indicating whether the application was approved or whether an
underwriter should review the application. (Gorham and Barr, 1991).
B. P/C
A major part of the business of insurance involves the processing of information.
For example, risks need to be assessed, costs need to be predicted and contained,
fraudulent claims need to be screened out, and assets need to be managed properly. Expert
(knowledge-based) systems are computer-based systems which are used to capture the
problem-solving models used by company experts and apply them to a wide range of
problems. These systems are being used in order to process a large percentage of incoming
policy applications. Todd Loofbourow, president of an expert systems consulting firm,
reports the average cost for underwriting an application to be $250 to $300. Therefore, the
cost savings potential of expert systems is significant. Besides cost savings, other benefits
are related to improved quality and consistency of perfomance. Expert systems have the
potential to strongly impact the ability to create and enter new markets, to manage risk, and
to run businesses that are changing in the 1990s.
Expert systems first came on the scene in the early 1980s. These were oriented to
research and development and were priced in excess of $100,000. Now, the systems can
work well on mainframes and integrate with existing databases and application programs.
They can also be developed on desktop workstations and personal computers. It is the
choice of company strategy which has determined the types of systems that have been built.
One approach has been called the Dupont strategy. This approach builds many small,
simple systems and is best suited to a highly change-resistant organization. On the other
hand, the “gold nuggets” strategy looks for applications with the highest payoff regardless
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of their degree of complexity. The intent of building these high payoff systems is to build a
lasting competitive advantage. Problems like underwriting, fraud detection, and cost
containment tend to be more complex and more difficult to develop. (Loofbourrow, 1991).
According to a study of 100 mid-tier firms produced by the accounting and
consulting firm of Coopers & Lybrand, mid-sized insurers are implementing expert
systems technology in order to gain strategic advantage, become more competitive, and
streamline their operations. Expert systems are particularly well suited for D&O
underwriting for the following reasons:
Ž The underwriting problem is well structured;
Ž The problem can often be handled or solved in a relatively short period;
Ž There is a repetitive decision process involving a finite set of choices.
(Norton, 1991).
C. Life & P/C
Artificial intelligence, which mimics the human attributes of thinking, vision,
speech, and movement was supposed to have been ready for application by now. (ISM,
1989). “After 10 years of hype and unrealistic expectations, artificial intelligence is now
persona non grata.” (May, 1992). However, in order to promote better decision-making,
improve productivity, reduce expenses, and enhance service, insurers are beginning to use
expert systems in the front office areas of their operations. The area of insurance where
expert systems are most applied is underwriting. Expert systems ensure that the decision
process applied to every submission is consistent, accurate, and standardized by corporate
business plans. (Fitzpatrick, 1990).
Insurance agents may be the next to benefit from the use of expert systems. For
example, it is posited that after receiving information about a prospect, a computer could
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select the best policy offerings then print out a report which compares and evaluates these
policies according to the prospect’s specific requirements. (Waddell, 1989).
III. Data processing
Al. General -- Life
The Life Office Management Association (LOMA) surveys the life insurance
industry every two years in order to determine hardware and software use as well as
systems changes. Some of the results are:
l Local area networks are becoming more popular.
l Companies have increased their efforts in the area of systems/data security.
l Data processing operations are getting a smaller share of insurers’ annual budgets.
(National Underwriter, 1993).
A2. General -- Life & P/C
Many insurance executives have difficulty achieving operating efficiencies because
their company has not implemented an effective strategic systems plan. A business plan
should be developed that enables the company to support its informational needs and
processing requirements. Companies need to compare the capabilities and costs of current
with proposed systems and identify the steps that will move operations to the new
environment. Manual operations that can be improved through automation or by a change
in procedure must be identified. A systematic approach to development should be used. It
is recommended that a project team be put into place and that the team be assigned to the
strategic planning unit. (Lee, 1993).
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The rapidly changing world requires a company to think and plan dynamically in
order to be able to effectively manage for the future. Forming alliances with companies that
supply technology is a way of obtaining a technological competitive advantage. An
example of this is the alliance between Allmerica Financial, a fast-growing insurance and
financial services organization, and DST Systems, Inc., a leading developer of automated
business solutions and one of the financial industry’s largest information processors.
(Goldeberg and Sifonis, 1994).
B. Outsourcing vs. in-house -- Life & P/C
Firms are increasingly considering outsourcing as a strategic option allowing the
companies to meet evolving market demands. An outsourcer can help insurance companies
reach strategic objectives by:
Ž
Ž
Ž
Ž
Ž
managing existing day-to-day operations and providing objective insight while internal
data processing professionals focus on developing improved systems;
providing access to and garnering benefits from technology experts to supplement
internal skills without incurring the added expenses of hiring and retraining specialists;
reducing costs and leveraging assets by divesting some operations to the outsourcing
partner;
capturing the market value of existing assets by selling systems and software to the
outsourcing partner, enabling the insurance company to recoup some of its systems
development costs and possibly reduce operating costs;
entering an information- and technology-intensive business by leveraging the systems
and support of its outsourcing partner to enter new businesses.
In order to effectively implement an outsourcing arrangement, the following
elements are required:
Ž total executive-level commitment;
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Ž key management input;
Žtactical plan.
(Sinensky, A., and R. Wasch, 1992).
The outsourcing relationship between company and vendor should be a close
partnership with good chemistry among participants being essential. It is important that the
service firms share the insurer’s vision. The high cost of purchasing and maintaining
technology and the speed at which it obsolesces might prompt many insurers to consider
outsourcing. However, companies with extensive data processing and lettershop
capabilities might find the move difficult. An example of a company that has tried to
implement the partnership approach is Arbella Mutual Insurance Company. It selected
Output Technologies to take data processing transmissions from the company’s data
processing outsourcing partner and arrange, print, and mail the output within 24 hours.
(Palmer, 1993).
Using interim management to perform special short-term needs is a type of
outsourcing recommended by Corey and Crowder, 1992. This approach is recommended
in order to yield more flexibility, greater effectiveness, and lower staff costs. Interim
executives can:
Ž conduct special projects, especially in areas of particular knowledge beyond current
staff capabilities;
Ž assist in formulating a strategy, or implementing one, to enter a-new product line,
market segment or geographical area;
Ž conduct a “consulting” project at lower cost with interim staff under direct company
control;
Ž give a trial look at a key executive whom the company may want to hire long-term, but
whose immediate, permanent hire could pose a high initial risk;
Ž act as a key general manager for a venture capitalist or investors
industry;
who are new to the
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Ž provide a flexible, overload capacity.
Other examples of insurance firms using outsourcing include the contracting of the
data processing operation of Royal Insurance (Jones, 1994) and outsourcing the
administration of the payroll deduction business of LifeUSA (Rourke, 1992). Annuity
insurers are using outsiders for getting into or expanding their annuity business (Cox,
1992).
C. Centralization vs. decentralization -- Life & P/C
The terms centralization and decentralization refer to changes made in order to place
accountability where it belongs. In centralization, accountability resides at the head office,
whereas in decentralization, accountability resides in the field. Either organizational layout
can work well under the right circumstances. Three factors should be considered in
determining whether a move should be made toward centralization or decentralization:
Ž the organization’s informational needs;
Ž the methods and procedures used in day-to-day operations;
Ž the complexion and morale of the organization.
The decision-making process and cost/benefit analysis should consider the basic operational
and customer needs as well as the needs of the organization in the areas of informational
requirements, personnel, and methods and procedures. (Pahl, 1987).
D. Mainframe vs. mini vs. workstations -- Life & P/C
The trend in insurance data processing operations is toward downsizing; that is,
transitioning from using mainframes to using minis and microcomputers (PCs). The tasks
performed by microcomputers have moved beyond traditional word processing, electronic
mail, and spreadsheet programs. They are being applied in such mainstream uses as new
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Image networking has recently become cost effective at insurance companies.
Several factors contributing to the recent attractiveness of image networking include:
Ž reduction in the cost of storing large volumes of image data due to developments in
optical storage drives;
Ž improvement in image compression techniques;
Ž more powerful and flexible image processing systems;
Ž the ability to link image data with corporate databases;
Ž the move toward imaging applications that run on existing off-the-shelf hardware rather
than dedicated image processing platforms and workstations.
(Salamone, 1991).
Image technology has provided improvement in insurers’ productivity and customer
service. For example, locating and accessing a customer’s files takes only a few seconds
today compared to the days or weeks required due to file retrieval problems. In the future,
imaging technology is moving toward integration, for example, the development of a fully
integrated desktop terminal that can simultaneously manipulate data, image, graphics,
video, and audio information. (Graham, 1993).
F1. Technology, systems, and software -- Life
Metropolitan Life has developed an automated system that has revolutionized its
new business operation. At the point of sale, account reps use laptop computers to create
policy illustrations during customer meetings and to initiate a “fact find” through an
automated business process. A support system was developed, called LapApp, which
gathers all of the data needed to complete an application thoroughly and accurately. The
system prompts an account rep to ask the customer a question. Once the response is keyed
in, the system analyzes the response and prompts the rep to ask the customer for more
information. It operates this way until enough information has been obtained. The meeting
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is a more effective use of both the customer’s and account rep’s time because only those
questions that are relevant to the customer and policy are asked. At this point a patented
security measure is activated that locks the data necessary for the underwriting process so
that it cannot be changed. The information is electronically transmitted to the sales office
using the Sales Office Network of Intelligent Computers system.
At the beginning of the review process, the underwriters use the Paperless
Underwriting and Rapid Response (PURR) system to electronically analyze the application
and automatically send requests for any needed additional information, such as credit
reports, medical statements and motor vehicle records. The additional information is sent
through the PURR system to the underwriter. PURR tracks the case throughout the
underwriting process, flagging new information that is relevant to the applicant. PURR
allows the account reps to track their cases through the process and benefits the
underwriters by allowing them to focus on the selection process, not having to worry about
the clerical tasks of gathering information relevant to the case and then attaching it to the
file.
The systems automatically determine the policy forms and language specific to a
state’s requirements and then assemble and produce the policy package. The package is
printed on a laser printing system. (Miller, 1992).
F2. Technology, systems, and software -- P/C
In another effort to promote interface, a consortium comprised of leading insurance
companies, agency automation vendors, and user groups has formed the Alliance for
Productive Technology (APT). A description of APT can be extracted from a statement
issued by the consortium: “The new partnership will market and continue to develop
software that provides a standard structure for better data integration within agency
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agencies. The purpose of APT’s ‘open architecture’ approach is to enhance the agents’
freedom to choose companies and automation vendors, allow insurance companies to
continue their unique product requirements, and encourage competition among hardware
and
F3.
software vendors.” (Zinkweicz, 1990).
Technology, systems, and software -- Life & P/C
According to Laurence Chait, a vice president of Arthur D. Little Inc., Boston,
most of the insurance industry does not make effective use of technology. Technology
should be used in innovative ways that would make it easier for customers to do business
with organizations rather than just as a means of speeding up processes. The need to close
the gap between the potential of information technology and the use of that potential is
increasing. The reason is that the competitive landscape is changing. The area of
“insurance” is now subsumed in “financial services” and the competition is not constrained
to the United States but is global. The survivors will be those firms that can do things
faster, more flexibly, more efficiently, and more in line with rapidly changing customer
needs. Insurers need to take a new look at their processes, rather than continuing to focus
on operational problems. Management needs to intersect innovative technologies and
ideas. An example of this intersection is the use of image processing in conjunction with
client server systems, new graphical interfaces, and mass storage. Three problems that are
prevalent in a number of companies are:
Ž the entrenchment of mainframes which are viewed as too expensive to maintain, yet too
expensive to replace when the costs of hardware and human capital are factored in;
Ž the rift between the business side and technologists. The technologists contend that the
business side lacks vision, strategy, or plan which makes them difficult to support.
Business people claim that technologists deliver system enhancements either too late or
never and without the specifications they need;
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Ž the view by insurance management that technology is an expense rather than an
investment. What technology does require is staff training. Its effective use would
make their companies more competitive.
(Chait, 1994).
As the insurance business becomes more competitive, agencies are realizing that in
order to survive, they need to be able to balance efficiency in technology with effective
service. Creating this balance depends on software applications that use computing
resources efficiently and respond quickly to user needs. Given tight reporting and
processing schedules, it is critical that applications use limited computing resources in order
to complete the work quickly and cost effectively, thereby, leaving sufficient resources to
allocate to additional processing and unexpected demands. Large applications contain
hundreds of thousands to a million lines of code. If an application overruns its allotted
time, it may be due to just one or two statements. It is very difficult to locate the source of
the problem. Application “tuning” products can assist a company in locating and removing
application inefficiencies which impede processing and monopolize computing resources.
This has both immediate and strategic advantages:
Ž It can be used to uncover hidden resources that can be channeled to fill sudden changes
and demands;
Ž It allows organizations to get more from an existing system, helping to defer a costly
hardware investment until it is absolutely necessary;
Ž It can fix performance problems which result from the dynamic state of growth and
change of software. Performance problems can occur as new applications are
developed, older applications are fixed and upgraded, more users are added to online
systems, and more data is fed into the batch processing cycle.
Information systems can become inefficient and have a devastating impact on a
company’s market position and profitability. Inefficiency may occur as a result of
expansion and the piecemeal installation of programming languages, new hardware,
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software packages and procedures. In order to verify and improve the efficiency of the
systems, a review process needs to be established which evaluates the physical facility and
environmental configuration; operating systems design, configuration and management;
communication network design and management; organizational structure; data and system
security; storage management; and the installation and integration of productivity tools and
other software. (Fishman, 1991).
G. Links between mainframes and pc networks -- Life and P/C
The insurance business is information extensive. Companies are increasingly using
electronic means to transmit data. Computer systems are comprised of mainframe
computers, telephone lines, terminals, and other equipment which is used to transmit
information from location to location. Insurers want to be able to send data as quickly as
possible. However, high speed lines are more expensive and the cost of the accompanying
equipment is higher. Using data compression is an optimal solution because faster
communications equipment in conjunction with data compressors reduces the number of
necessary telephone lines. (Hoffman, 1988).
IV. Claims settlement -- P/C
The chairman of Jury Verdict Research, Phillip J. Hermann, claims that insurance
companies have paid millions of dollars in needless claims because they have failed to make
use of “actuarial verdict information” before settling claims. Hermann indicates that it is the
news about large verdicts rather than the actual verdicts which has caused the problem.
“Those who manage and evaluate claims, by failing to realize that much lower monetary
values are often assigned by jurors that are generally believed, are needlessly paying out
their companies’ funds. “ “The problem is not that jurors are out of control or, with
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exceptions; make ridiculous awards. . . . The problem is the effect that newspaper reports
of very high verdicts-which may or may not be justified by the facts-have upon the public,
the lawyers and the insurance carriers.” Hermann alleges that in order to avoid litigation
insurance companies often pay large sums in order to settle a claim even though they are
convinced that a jury would reward the plaintiff with nothing. Over the long-term, this is
very expensive business. (Brostoff, 1986).
The economics of denying insurance coverage favor insurance companies for the
following reasons:
Ž
Ž
Ž
Ž
Ž
Ž
Ž
A policyholder is out of pocket money during an insurance coverage dispute and may
experience severe cash flow problems;
Many courts do not award pre-judgment interest;
Pre-settlement interest is rare;
Policyholders generally have no experience with insurance coverage disputes;
Insurance companies are comfortable with litigation;
Litigation against an insurance company can exacerbate the policyholder’s underlying
liability problems;
Settlement means that the policyholder gets less than he/she is entitled.
V. Miscellaneous
A. Total quality management -- Life and P/C
Insurers and agencies are employing “total quality management” (TQM) in order to
provide a competitive advantage, reduce costs, and increase productivity, thereby,
improving the bottom line and improving customer service. TQM differs from ordinary
programs for improving customer service by the degree of comprehensiveness and
commitment it requires. TQM requires a cultural transformation as all processes from
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underwriting to claims handling are examined and reorganized for greater efficiency and
responsiveness to customers’ needs.
It is not necessarily true that technological improvement equate to quality
improvement. Quality improvement focuses on people and process and then automation
not making an old, inefficient process work faster. The primary expenditures involved in
TQM are not large investments in technology but modest expenditures in training. TQM is
being repeated at insurers across the country. A notable example is Zurich-American
Insurance Group in Schaumberg, Illinois. (Freedman, 1992).
Total quality management (TQM) or the process of continuous improvement to
achieve full customer satisfaction on all fronts is being incorporated by insurers into their
daily performances. “A lot of insurance companies are now seriously looking at TQM as a
way to reduce overhead costs and improve efficiency to serve customers better. ” An
example of an insurance firm implementing TQM is Zurich-American. They have
established an eight-person department which continuously monitors quality operations
within the firm’s corporate headquarters and at 40 other office locations in the United
States. (Hall, 1992).
B1. Reengineering -- Life
Reengineering can be used as a way to free hidden corporate assets such as
knowledge, initiative, and staff motivation. It can also be utilized to reduce hidden
corporate liabilities such as established work patterns, cost structures, organizational
inertia, and legacy systems. For example, recognizing the interrelationship among
products, service, and price, Lincoln Life defined a new business organization to facilitate
an increase in business volume while improving service quality and reducing unit costs.
(Edris and Kuhl, 1993).
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Connecticut Mutual Life Insurance Co. has been using reengineering to transform
itself from a paper-driven, clerical-based organization which employed a sequential,
factory-like work flow. The company has been pulling together fragmented systems,
eliminating paper, and restructuring its work processes. In order to undertake this
reengineering task, the company used a project-team approach which involved its own
engineers and architects, vendor-provided product specialists and associates who would
use the system and be responsible for its bottom-line results. For example, several
different technologies were integrated that helped combine data and paper-based
information and made it easily accessible to those who needed it. The result of the
reengineering process is that imaging and work flow technologies have eliminated much of
the manual, tedious work. Company personnel have been empowered to make more
decisions because they have all the tools and information on their command centers.
Clients are served faster and more efficiently resulting in fewer complaints. (Scites, 1993)
Connecticut Mutual relies on LAN imaging services as the underpinnings of its business
reengineering effort. (Messmer, 1993).
B2. Reengineering -- P/C
The head of a major insurance, industry systems vendor has indicated that insurance
companies need to employ a complete reengineering and re-architecture of systems in order
to be able to use new technologies effectively. The technologies which he refers to include
“imaging, advanced networking, voice-based systems, expert systems, graphic user
interface, and anew generation of desk top computers. He has advocated a redesigning of. .
organizations and has described this change as a “revolution” but not all organizations will
require the same solution. “There will not be one solution that’s the same for all
companies, ” . . . It’ll be like snowflakes. Every company will have a different, unique
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image of the system but with common architecture. ” He stresses the need for automation
as a means to increase productivity. (Knowles, 1990).
Computer simulation is starting to be used as a tool for improving processes in the
financial services sector. It has been utilized extensively in the manufacturing sector in
order to reduce work-in-progress and turn around time and to provide better and more
reliable delivery times. Legal and General have used simulation in testing new ideas to
reduce bottlenecks in the pension claims and quotations processing section. They were
able to carry out experiments in a matter of hours. Simulation demonstrated that work-in-
progress could be reduced by 75 percent, lead times reduced by 60 percent, and the need
for Saturday working eliminated. (Wood, 1993).
Systems reengineering allows for the enhancement of computer systems that
involves using an existing computer system and its code as the main source for the
functionality of an enhanced version. The purpose of this is to “unscramble years of
incremental additions and changes to the functions of a system and reconstruct it to that it
can be more easily enhanced and maintained. ” That two steps involved are:
Ž the extraction of business policy, data design, calculations, and other proprietary
information from the current system to ensure that this information is included in the
new one;
Ž the providing of this information to the team charged with building new system
components or an “entirely new one.
Systems reengineering should be considered under the following conditions:
Ž There is a shortage of users familiar with the details of system functionality;
Ž System documentation is out of date or too high level.
(Hoffman, 1991).
During the decade of the 1980s, insurers spent an estimated $12 billion per year on
information and application systems. Due to a lack of integration, these systems tend to be
aggregations of incompatible technologies which have not reduced the industry’s operating
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expense ratios. Software redevelopment can be employed to assist insurance companies
take control of technology and position themselves to take advantage of more effective
platforms, enhanced functions and new ways of doing business. The problem which
requires fixing is that applications written in outmoded programmingg languages or for
outdated operating environments cannot communicate with other programs or be ported
readily to more advanced platforms. (Garner, 1991).
to
Loss control personnel have been experiencing 10 percent to 40 percent reductions
due to mandatory staff cuts without any decline in workloads. Consequently, loss control
managements have been reengineering their loss control processes. Some of the items
being eliminated include dictation tapes, survey forms, activity reports, and paper-based
survey processing. Report mailing is being replaced by phone-links to notebook
computers carried by 10SS control representatives from site to site. Flexible report-
generation software is replacing dictation. Paper can be eliminated from the loss control
process. (Falkenburg, 1992).
As more insurers are reengineering and downsizing from mainframes to
client/server platforms, large “industrial strength: technology vendors are increasing their
marketing efforts to the industry. These vendors include firms like Digital Hewlett-
Packard, IBM, and Microsoft, which are often entering the marketplace in partnership with
existing insurance-specific vendors. (King, 1994).
The Travelers has undertaken a reengineering effort, the object of which is to add
new life to mainframe-based systems and, at the same time, cut costs. In order to
undertake this, Travelers is using a 3 person unit within the data processing organization.
This application services unit was formed to make the most of the available systems by
reengineering legacy systems and also to offer an evolutionary path from a traditional
mainframe-based insurance carrier to distributed processing. It is using reengineering tools
from Viasoft Inc., Computer Corp., and InterPort Software Corp. After competing test
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projects, the unit needs to convince DP managers for the need to renovate. (Bucken,
1992).
Units of CIGNA have benefitted extensively from reengineering. For example,
reinsurance division experienced a 1200 percent transaction time improvement and 42
percent operating cost reduction. The reengineering effort resulted in the conversion of
the
17
different computer mainframe systems to five PC-based systems. Employees were
organized into customer service teams that included underwriters, customer service
representatives and systems specialists. (Helldorfer and Daly, 1993).
The Principal Financial Group recognized that in an industry with increased
competition and slower economic growth, the firm’s good reputation and past
achievements were not sufficient to guarantee its future success. They came to this
understanding as a result of the recognition that of a growing expense gap and the
apprehension of employees inability to effectively utilize a new computer system. As a
consequence, they totally transformed their Individual Insurance Department. They chose a
goal of becoming an organization that was more responsive to customers and more creative
at solving problems and more readily embraced change. In order to achieve this, The
Principal used the following steps:
Ž establish a strategic vision
Ž disseminate the vision throughout the organization by using “participation action
teams. ”
Ž create positive dissatisfaction which involved eliminating unnecessary work,
identifying problems, and generating solutions.
Ž radically reorganize the structure of the department.
Ž reengineer ‘new jobs to fit in the new organization.
(Rohm, 1993).
Many insurance companies are rushing tore-engineer business processes that were
developed over decades. This move is prompted by competitive market pressures. “High
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loss and expense ratios on the property/casualty side can no longer be made up for by
investment returns. Life insurers investment-type products now are competing with those
from financial services firms that operate with lower expense ratios.” Processes in use at
most insurers were never engineered at the start but instead were formed by accident and
compromise, resulting in fragmentation and redundancy. “Reengineering must be linked to
business goals such as increasing market share, improving customer ratings, faster
development of new products and lowering expense ratios, . . . If the company is unclear
about its goals for reengineering, it is unlikely they will be achieved. ” (Ingrassia, 1994).
In 1992, The Travelers’ made a strategic decision to remain in the small commercial
market. Given the increase in production costs coupled with flat revenues, they decided
they had “to offer the appropriate coverages for the specific classes in which we wanted to
compete, meet our competitions’ market price, make it easier for agents to do business by
providing three-day policy delivery and reduce agency transaction costs. ” This required:
Ž reengineering the small business product delivery systems;
Ž reengineering the computer systems across all lines of commercial business in order to
achieve economies of scale and resource sharing;
Ž re-educating the data processing technical staff.
(Del Vecchio, 1994).
The only way that insurance companies can maintain their financial strength whale at
the same cut costs and increase value to customers is to reengineer the way in which they
do business. The survivors in the year 2000 will be those who are agile enough to adapt
new business approaches and technology to their advantage. Technology needs to be used
to control expenses and claims costs in areas such as managed care for workers’
compensation medical claims, direct service for personal lines, sophisticated market
segmentation, and elimination of redundancy in product distribution. (Wilson, L., 1992).
C: Downsizing -- P/C
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The insurance industry literature refers to downsizing in two completely different
contexts. The first context uses the term “downsizing” to refer to the movement of systems
support from large mainframe computers to small, networked computers. The other
context in which downsize is used relates to the reduction of the workforce. Following are
examples of each.
A trend in data processing among insurance companies is downsizing computer
hardware. Insurers are finding that small-scale hardware in conjunction with networking is
sufficient to meet their needs. They are downsizing as a matter of economics. “. . . the
economies of scale have shifted. Large computers once had a cost advantage - you could
buy a machine that was twice as powerful as another for less than twice the price. But
mass production of small systems has changed this. Personal computers can usually beat
minicomputers in price-performance, just as minicomputers beat mainframes. You must
now pay a premium to use a large system even if you have a lot of data to process. ” There
is also an extensive amount of reasonably priced software being developed for these small
systems. “Software ease of use is much higher, quality and reliability are usually good and
sometimes better, and price is near zero when compared to the price of comparable
software for use on large-scale computers. ” (Christians, 1994).
An interview with the CFO at Aetna reveals the nature of the two downsizing
initiatives that occurred:
Ž top-down reorganization which replaced a divisional structure with a strategic business
unit structure;
Ž bottom-up approach which involved a series of initiatives designed to streamline
operations and make them as cost-efficient as possible.
The ultimate goal of these downsizing efforts is to make the company more profitable and
to serve customers better. Tangible results involve consolidating claims operations and
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reducing personnel in unprofitable areas such as workers’ compensation. (Kenny
interview, 1992).
Prompted by organizational efficiency reviews, three leading carriers have
announced extensive division restructuring and staff cutbacks totalling over 1600. Cigna
P&C reduced its staff by 400 and will begin to rely more on satellite offices to obtain closer
producer/customer contact. ITT Corp. fired more than 1000 employees in human
resources, investment operations, actuarial functions and some outside services. Rather
than making across-the-board cuts, Royal Ins., eliminated 124 staff persons in conjunction
with the restructuring of several departments. (Dauer, 1993).
D. Mergers and acquisitions -- P/C
Some prominent individuals in the insurance field predict large-scale consolidation
of the industry. For example, a former president of the National Insurance Consumer
Organization predicts a 90 percent reduction in the number of insurers over the next 20
years. Consistent with this view is that of a Senior Vice President at A.M. Best Co. who
predicts that of the current 700 small county mutual insurance companies, only 200 will
exist by the year 2000. He contends that with expense ratios that are 10 to 20 points higher
than other insurers, county mutuals cannot afford to exist. The president and public affairs
associate of the National Association of Mutual Insurance Companies differ from this
viewpoint. They point out that the origins of the mutual movement was a national
consumer movement to service rural residents with the best possible insurance coverage for
a reasonable price and to be there when a claim occurs. They assert that small mutuals have
been providing this kind of service for a considerable time, indicating that more than half of
Namic’s approximately 1250 member companies are over 100 years old, and most of the
rest are at least 50 years old. They indicate that small companies have some distinct
advantages:
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Ž They have a good understanding of the risks they insure and can take prudent steps to
minimize them;
Ž They know their policy holders on a personal basis and can quickly respond to their
needs.
They acknowledge that expense ratios are greater but assert that lower loss ratios more than
compensates for this. They also indicate that although consolidations are occurring within
the ranks of small mutuals, the extent of consolidation is less than in the property/casualty
industry overall. They conclude by saying that with the appropriate regulations and
controls on fraud, small insurers will survive. (Forrester and Rader, 1994).
A study by the National Association of Mutual Insurance Companies (NAMIC)
indicates that small mutuals are doing well and should not be concerned about
“becoming an endangered species despite warnings to the contrary by industry
observers. ” In presenting their argument they cite merger and performance statistics.
(Anonymous, 1994).
According to a study of eight national multi-line companies commissioned by
Tillinghast, a Towers Perrin Company based in Philadelphia, the size of an insurance
company is not a major determinant of efficiency. “If the companies were lined up in order
corresponding to the premiums written, there was no set pattern of corresponding expense
ratios.” Some of the differences across companies could be accounted for by the difference
in lines of business and market segments. One thing that the study found was that
companies with the highest expense ratios have the highest expense ratios inmost nearly
every area of operation. In contrast, it was found that companies with the lowest overall
expense ratio did not have the lowest ratio in a number of individual areas. (Dauer, 1990).
E. Management reporting -- Life
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The intense competitive pressure of the life insurance industry is compelling
managers to adopt new approaches to financial reporting and control. Financial managers
are seeking new concepts that can be applied to their business in addition to a GAAP basis
of reporting. One of the approaches which has been successful is that of contribution-
based management reporting. The focus of contribution-based management reporting is to
manage each business operation as a separate business entity. Distinctions are made
between controllable financial results and those elements which are beyond the operation’s
immediate control. A contribution-based reporting approach ‘is particularly effective for
managing costs. Expenses are separated into functional costs incurred to support business
activities and overhead. It is necessary that all expenses be controllable by one of the
business areas for which a contribution-margin is reported. All major business units and
internal operational areas are given a contribution margin that presents each unit’s unique
contribution to the business. The goal is to provide a broad range of product, operational,
and service managers with a bottom-line-oriented set of reports that motivate and spur
managers to become entrepreneurs, thereby, assisting the organization to respond better to
their new competitive environment. (Hylas and Tiny, 1987).
VI. Financial risk management - Life
A. Overview of risk
There are five types of risk which need to be managed by insurance companies:
credit or asset quality risk, insurance and pricing risk, interest rate risk, business risk, and
liquidity risk.
Asset quality risk as it related to debt securities is the risk of default. This translates
into the risk that the insurance company will not be able to pay its policyholder claims in
full or on time. Commercial rating services rate the quality of public bonds that are part of
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life insurance company invested assets. They-also rate the claims paying ability of life
insurance companies using asset quality risk as one of several factors for assessing this.
An area of concern is how to estimate the credit quality of the commercial mortgage
investments in a life insurance company portfolio.
Insurance risk is the risk of loss that is associated with misprizing a product after
estimating and factoring in mortality risks. Generally, due to its non-systematic nature, this
risk is reduced in portfolio.
Interest rate risk relates to asset/liability management. It depends on the portfolio
duration and is a risk of loss as a function of interest rate movements.
Business risk includes the effects of technological change and the effects of
management quality. It also includes risks such as product obsolescence and the risk of
assessments to cover the insolvencies of other firms.
Liquidity risk is the risk that a company cannot raise sufficient cash to meet an
unexpected increase in volume of cash withdrawals through surrender, policy loans, or
early withdrawal of GIC funds. Sufficient liquidity is usually generated from the net cash
flow resulting from investment yield and new premiums. Sometimes, options to withdraw
funds in a short period of time are unexpectedly exercised, creating a liquidity problem.
(Reardon, 1993).
B. Risk management: a balance -- Life
Life insurance companies cannot totally eliminate risk since it is their business to
accept and manage risk. The key to successful underwriting is to price risk appropriately.
Profits will decline and business risk increase when a company either prices too high and
sells too little product or prices too low and sells too much product. In conjunction with
this, eliminating credit risk will produce returns which are too low to allow a competitive
offer rate on certain types of insurance policies. Again, immunizing its portfolio from
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interest rate risk may require the offering of non-competitive rates. Finally, increasing
liquidity reduces yield and, thus, increases business risk. (Reardon, 1993).
C. Risk management: a perspective -- Life
Life insurance companies maximize total expected return subject to several risk
constraints:
Ž Reinvestment risk must be considered as a component of interest rate risk since
minimum cash flows are required to support product liabilities. In order to facilitate
this objective, invested assets are grouped by portfolio segment.
Ž The proportion of the portfolio which is held in equity securities is regulated. State law
ceilings of 10 percent or less are common.
Ž Gains trading is subordinated to durability matching.
Ž Low quality investment is limited.
Ž Private placement lending is substantial and strictly monitored.
Ž Risk preference behavior of policy holders and fiduciaries must be taken into
consideration.
(Reardon, 1993).
The risk exposure of the insurance industry has increased in the 1980s. Based on
the case studies of seven large 1991 failures, it appears that guarantee funds provide
incentives to increase risk-taking. Life insurance companies benefit from guaranteed funds
because the guarantees, which protect policyholders in the event of insolvency, are
attractive to customers. Life insurance companies should pay for access to these
guarantees. (Brewer and Mondschean, 1993).
D. Catastrophe risk -- P/C
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A claim is made that risk managers could save their companies millions of dollars
worth of uninsured and “hidden” losses when major catastrophes strike by pinpointing the
most effective, least expensive catastrophe management strategy. This solution is arrived at
by overlaying business interruption losses with reconstruction costs. This would also
allow insurance companies to reach the fairest, least expensive claims settlement. It is
generally presumed by risk managers and their insurers that high-speed construction is
more expensive than normal construction. However, the advantages of a high-speed
response can save money by minimizing time-related business interruption costs. Business
interruption costs are high even in the case of complete business interruption coverage.
Losses which are not covered by insurance include:
Ž
Ž
Ž
Ž
Ž
Ž
Ž
lost market share;
increased costs following restart;
employee mistakes;
training costs and slowness;
decreases in employee efficiency;
lost relationships with vendors;
severance pay and increased unemployment insurance costs for employees who are laid
off .
It is mainly these hidden costs and losses which cause the following:
Ž
Ž
Ž
an estimated 43 percent of all businesses which are struck by a catastrophe never
reopen;
28 percent of those which do reopen close permanently within three years;
Many companies that do survive find that their long-term costs have increased
significantly partly as a result of greatly increased unemployment compensation
insurance premiums due to massive temporary layoffs and reduced revenues due to loss
of market share.
(Bean, 1990).
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El. Asset-liability management -- Life
Software maker BARRA Inc., Berkeley, has added an enhancement to its U.S.
Bond Analysis System software which allows insurance companies to test cash flows of
fixed-income portfolios under seven pre-defined scenarios listed in the New York State
Insurance Commission guidelines. The guidelines examine the asset and liability
relationship of life insurance company funds under various interest rate scenarios in the
commission’s Regulation 126. (Hemmerick, 1994).
Frank Russell Company and The Yasuda Fire and Marine Insurance Co., Ltd.,
developed and asset/liability management model. The model uses multistage stochastic
programming and determines an optimal investment strategy that involves multiperiods and
enables the decision makers to define risks in tangible operational terms. The model is. .
capable of handling the complex regulations imposed by Japanese insurance laws and
practices. The model’s primary function is to produce a high-income return in order to pay
annual interest on savings-type insurance policies without sacrificing the goal of
maximizing the long-term wealth of the firm. The investment strategy devised by the
model yielded extra income of 42 basis points during fiscal 1991 and 1992, the first two
years of its use. (Carino, 1994).
E2. Asset-liability management -- P/C
Much attention has been drawn to asset liability management (ALM) techniques.
Many insurers in the life/health sector have put ALM into practice, whereas, few in the
property/casualty sector have done so. It is speculated that the lack of attention on the part
of property/casualty insurers may be due to the relatively uncertain nature of their liabilities,
or to the fact that state regulators do not require it, or their belief that the market does not
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reward their efforts. A University of Texas working paper shows that interest rate risk
exposure is the strongest and most consistent predictor of insolvency among
property/liability insurers for any of the variables tested. Another working paper indicates
that at reasonable levels of interest rate risk, the market rewards the reduction of risk with
an increase in share prices and penalizes increased risk with a decrease in share prices.
(Babbel and Staking, 1991).
F. Capital budgeting -- P/C
Strategic decisions of an insurance company should be consistent with the goal of
maximizing firm market value. In this paper the surplus problem is treated as a capital
budgeting problem, and solved by a constant surplus strategy whose optimality comes
from assumptions of invariant operating conditions of companies and non-frictionality of
markets (without taxes and transaction costs). The model is developed further by taking
into account market frictions as well as the temporal changes in profit expectations.
(Pressacco, 1989).
G1. Derivatives -- Life
Collateralized mortgage obligations (CMOS) have become important investments in
life insurance company portfolios. The cash flows and principal payments of the
mortgages underlying CMOS are segmented into tranches. The tranches vary according to
maturities and degrees of subordination in terms of duration and priority of payment of
interest and principal. Insurance companies like their duration predictability for managing
the asset/liability balance backing interest-sensitive products, such as GICs, universal life
and current-assumption whole life policies. They are designed to have high credit quality,
liquidity, and low interest rate risk (A given tranche is typically overcollateralized or
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payment is guaranteed by a government agency of private issuer.). The lender incurs risk
as a result of the fact that the borrower has the option to hold the fixed-rate mortgage for a
very long time if market interest rates rise and the option to prepay the mortgage principal if
market interest rates fall. (Reardon, 1993).
In a recent report, Moody’s warned that insurers may be imperiling their financial
ratings and asset quality as a result of the interest rate risk backed securities. Moody’s is
most concerned about the use of CMOS. Insurance companies like these securities since
they yield about 50 to 100 basis points over Treasury bills and are rated triple-A because of
their Federal government backing. This makes good for asset quality and asset-liability
management. Raters are concerned that mortgage backed securities can increase an
investment portfolio’s prepayment and extension risk, especially in a volatile interest rate
environment. S&P’s Life/Health Outlook concurs and indicates that neither prepayment
nor extension risk is accounted for in insurers’ product pricing. (Friedman, 1994).
G2. Derivatives -- Life & P/C
Insurers, hungry for yield, bought $440 million of floating-rate notes. This is an
unusual strategy for insurance companies since they generally prefer fixed-income debt.
The notes were offered by Crescent Capital Corp. which plans to invest in a complex set of
buyout-related securitiess - including senior bank loans, publicly traded subordinated
bonds, privately placed subordinated bonds with warrants, and private equity. 25 to 30
insurance investors were buyers of the two tranches of notes to be secured by that pool of
investments. Other insurers invested in the $90 equity piece which is not secured. “‘I was
shocked at how big some of these orders were,’ said Chris Allick, executive vp at Jefferies
& Co., which coagented the transaction with Chase Securities. ” (Schwimmer, 1994).
H. Regulation -- Life & P/C
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Two accountants with KPMG Peat Marwick said that the SEC is increasingly
scrutinizing insurance industry accounting practices. The SEC is requesting more
disclosure in the areas of investments, reinsurance, derivatives, real estate, and
environmental liability. Currently, the interest from the SEC stems from its chairman
Arthur Levitt Jr., who is a friend of House Energy and Commerce Committee Chairman
John Dingell. Dingell has shown a great deal of interest in insurance accounting matters.
(Brostoff, 1994).
There are a number of regulatory and legislative measures under development or in
effect to protect the public in those instances in which economic incentives are not sufficient
to motivate optimal behavior. These measures include the valuation amendments to the
Standard Valuation Law, a required “risk based capital” estimate, the “asset valuation
reserve/interest maintenance reserve” requirements, and a new model investment law.
The valuation actuary amendments require the designated valuation actuary to
express a professional opinion on the life insurance company’s reserves, including an
analysis of the insurer’s assets in determining reserve adequacy. The process requires
rigorous cash flow testing to be applied to all products under several interest rate scenarios.
Several states have already developed these amendments.
The risk-based capital model being developed requires many categories of liability
and asset risks to be weighted in order to calculate required capital. This capital figure is
then compared to the actual amount of capital in order to determine capital sufficiency.
The “asset valuation reserve” will replace the “Mandatory Securities Valuation
Reserve” (MSVR). The new reserve will cover mortgages, owned real estate, and other
assets in addition to fixed income securities and stocks. The “interest maintenance reserve”
will smooth capital gains and losses into income over a number of income periods.
(Reardon, 1993).
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As a result of the slide in the US junk bond and real estate markets, regulators,
especially the National Association of Insurance Commissioners, have been tightening
requirements for reserves and pressuring insurers to boost capital levels. Some US
insurance companies are responding to this pressure by packaging their commercial
“mortgage holdings into securities with the intention of selling the riskiest parts to investors.
For example, New England Mutual Life Insurance is securitizing $1 billion of it $3.3
billion real estate mortgage portfolio. This deal is structured as a senior/subordinated
securitization. It intends to keep the two top quality, investment-grade tranches worth $800
million and sell the remaining $200 million, consisting of a junk-quality, BB-rated tranche
and an unrated fourth trance, through a 144a private placement. (Bergsman, 1993).
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