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CarrierManagement.com

Winter 2014

Contents

OPERATIONAL LEADERS: Making P/C Operations Work 40 Making P/C Operations Work: From Calm Multitaskers to Maniacs With a Passion

Five leaders of P/C insurance carrier operations give their views about personality characteristics of successful operations leaders and what it takes to ascend to positions similar to those they hold.

43 Does Your Company Need a COO? 44 What Does It Take to Lead P/C Operations? 45 So You Want to Be a COO: Career Advice From Operations Executives 46 From the Front Lines to the C-Suite: Farmers’ David Travers 49 Endurance Specialty’s Catherine Kalaydjian: Thriving With Change 53 Markel’s Michael Crowley: Former Broker COO Deepening Carrier Sales Culture 56 RLI’s Michael Stone: Managing People Is the Key to COO Role 59 QBE’s Sue Harnett: Leading a Transformation www.carriermanagement.com

Winter 2014 | 3


Features Winter 2014

11 15 12 17 20 24 27 62 64 70 74 4 | Winter 2014

TECHNOLOGY & ANALYTICS/ TALENT

Winning the War for Talent to Harness the Full Power of Predictive Analytics

Manuel Rios, the CEO of American Modern Insurance Group, lays out four steps his company is using to win the war for analytics talent. By Manuel Rios, President & CEO, American Modern Insurance Group

The Race to Secure High Impact Analytics Talent Strong executive sponsorship of data projects and initiatives is helping some P/C insurers in the race for analytics talent. By Margaret Resce Milkint, Managing Partner, The Jacobson Group

TECHNOLOGY & ANALYTICS

82% of P/C Insurers Using Predictive Analytics: Earnix/ISO Research Predictive Analytics: Bringing Price Elasticity Concepts to P/C Insurance

By incorporating consumer price elasticity of demand into price determinations, insurers can enhance revenues and profits, according to three analysts. By Deepak Ramanathan and Ed Combs, Fractal Analytics; William Wilt, Assured Research

The Challenges Around Big Data and the Lessons to Be Learned

The P/C insurance industry is adapting slowly to data superabundance and instant information access. By Martina Conlon, Principal, Novarica

Designing a UBI Program to Fit Your Business Strategy

Usage-based insurance for auto is not a “one size fits all” solution. By Jim Weiss, Manager, Verisk Analytics

Avoiding the Pitfalls and Pratfalls of a UBI Product Launch

Concrete actions for the successful rollout of a usagebased auto insurance product launch are described. By Robin Harbage, Director, Towers Watson

TALENT

Workforce Considerations in M&A

Best practices for cultural integration success in M&A deals. By Stephanie Gould Rabin, Partner, Aon Hewitt

Saint Joseph’s University Research Shines Light on Gender Diversity in Insurance

Research reveals differences in the gender mix of carrier C-suites between P/C segments. By Michael E. Angelina, Executive Director, Saint Joseph’s University

Talent Management Risk: A Killer Torpedo?

An employee who is a “mastermind” or a growth-inducing “rainmaker” can actually be a killer torpedo that sets an organization on a course to implosion, ERM expert Sim Segal reports. Conference Report

Do You Have the Vision to Innovate?

Hiring outside of the box may spur insurance innovation. By Erin Hamrick, Partner, Sterling James

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For over 36 years, the National Insurance Industry Council has raised $22 million for City of Hope’s mission to provide innovative treatments for people facing life-threatening diseases. Steve DeCarlo, CEO of AmWINS and City of Hope’s 2014 Spirit of Life® honoree, encourages you to continue Insurance industry executives gathered for the 2013 City of Hope tour.

StEvE DECArlO CEO, AmWINS

2014 Spirit of Life Honoree

your legacy of support by participating in industry activities, large and small.

Your participation does make a difference!

GET INVOLVED 2014 Event Calendar

Pasadena, CA City of Hope campus Duarte, CA

Thursday, March 27 Hoops for Hope Philadelphia, PA

Friday, March 28 Hoops for Hope Des Moines, IA

Monday, April 7 Hoops for Hope Los Angeles, CA San Francisco, CA

Sunday, April 27 to Wednesday, April 30 RIMS National Annual Conference Tristar Booth Denver, CO

Monday, July 14 City of Hope Golf Outing Sponsored by NIIC West Coast Committee Annandale Golf Club Pasadena, CA

Wednesday, August 20 Strike Out Cancer

Saturday, September 13 Spirit of Life Gala Honoring Steve DeCarlo, CEO AmWINS Atlanta, GA

Wednesday, October 15 Strike Out Cancer Splitsville Tampa, FL

Saturday, October 18 Los Angeles Wine Auction Jonathan Club Los Angeles, CA

300 Atlanta Atlanta, GA

To learn more, visit cityofhope.org/niic or call 800-272-2310, ext. 26370

DEV 22113 SL

Wednesday, March 12 City of Hope Dinner Reception and Tour Hosted by NIIC Langham Huntington Hotel & Spa


Features Winter 2014

29 30 32 36 67 76 80 84

TECHNOLOGY

BYOD: Benefits and Risks of Personal Mobile Devices in the Insurance Workforce

Risk management steps related to employee use of personal mobile devices reviewed. By Timothy C. Francis, Travelers

P/C Executive Viewpoints: Data Security Strategies AIG P/C CEO Peter Hancock and Kishore Ponnavolu, President of MetLife Auto and Home, describe how their firms are managing cyber exposures. Conference Report

Cyber Threats Targeting Insurers Mount; Carriers Not Keeping Pace

PwC security expert explains how insurance industry leaders— those with a lower rate of security incidents and lower average cost per incident—approach cyber security. By Joseph Nocera, Partner, PwC

What Makes a Successful P/C Carrier CIO— and How to Know If You Have One

In today’s ultra-competitive P/C marketplace, CIOs need to be more than just technical wizards. By Frank Petersmark, CIO Advocate, X by 2

LEADERSHIP

Inga Beale: The Backstory of Lloyd’s CEO

Lloyd’s CEO Inga Beale talks about life-changing events that gave her the strength to persevere when times looked bleak during her tenure as leader of struggling Converium in the 1990s and also helped her to recognize that she had the desire to be “top boss” of insurance organizations. Conference Report

‘Fish ‘n’ Shoes’ Thinking and the Disruptive Power of ‘Just One Change’

An innovation consultant offers up a new strategic menu classic for insurance executives: “fish ‘n’ shoes” thinking. By Karen Morris

Pacific Specialty’s CEO: Working Within Limits, Re-engaging Independent Agents

The CEO of Pacific Specialty explains how to generate growth even with limited advertising dollars and other budget restrictions. Brian Cohen, Pacific Specialty CEO, Interviewed

Energi Insurance CEO McCarthy: Plugged Into Energy Revolution Through R&D

The CEO of Energi Insurance explains why his firm puts research and development and loss control first in their efforts to serve the energy sector. Brian McCarthy, Energi Insurance CEO, Interviewed

VOLUME 1, NUMBER 2

WINTER 2014

www.CarrierManagement.com Critical Information for P/C Insurance Company Executives & Directors CARRIER MANAGEMENT EDITORIAL Senior Editor Susanne Sclafane | ssclafane@carriermanagement.com Vice President of Content Andrew Simpson | asimpson@wellsmedia.com Copy Editor Kimberly Tallon | ktallon@carriermanagement.com CARRIER MANAGEMENT DESIGN Vice President of Design Guy Boccia | gboccia@wellsmedia.com Audience Developement Elizabeth Duffy | eduffy@wellsmedia.com CARRIER MANAGEMENT ADVERTISING/MARKETING Vice President of Sales & Marketing Julie Tinney (800) 897-9965 x148 | jtinney@wellsmedia.com National Sales Manager Laurel Metz (800) 897-9965 x173 | lmetz@carriermanagement.com Design & Marketing Executive Derence Walk | dwalk@wellsmedia.com Marketing Administrator Gayle Wells | gwells@wellsmedia.com Advertising Coordinator Erin Burns (619) 584-1100 x120 | eburns@wellsmedia.com CARRIERMANAGEMENT.COM WEB Vice President of Technology Joshua Carlson | jcarlson@wellsmedia.com Web Developer Chris Thompson | cthompson@wellsmedia.com Web Developer Jeff Cardrant | jcardrant@wellsmedia.com New Media Producer Bobbie Dodge | bdodge@wellsmedia.com Videographer/Editor Matt Tolk | mtolk@wellsmedia.com WELLS MEDIA GROUP Wells Media Group includes Carrier Management print and web publications, Insurance Journal and Claims Journal print and web publications, the MyNewMarkets.com online directory, and the IJ Academy of Insurance. Chairman Mark Wells | mwells@wellsmedia.com Chief Executive Officer Mitch Dunford | mdunford@wellsmedia.com Chief Financial Officer Mark Wooster | mwooster@wellsmedia.com SUBSCRIPTIONS: Please subscribe or change your address online at: www.carriermanagement.com/subscribe Carrier Management, which provides Critical Information for P/C Insurance Company Executives and Directors, is published quarterly by Wells Media Group, Inc., 3570 Camino del Rio North, Suite 200, San Diego, CA 92108-1747. Phone: 1.800.897.9965. Periodicals Postage Paid at San Diego, CA and at additional mailing offices. DISCLAIMER: While the information in this publication is derived from sources believed reliable and is subject to reasonable care in preparation and editing, it is not intended to be legal, accounting, tax, technical or other professional advice. Readers are advised to consult competent professionals for application to their particular situation. Copyright 2013 Wells Media Group, Inc. All Rights Reserved. Content may not be photocopied, reproduced or redistributed without written permission. Carrier Management is a publication of Wells Media Group, Inc. POSTMASTER: Send change of address form to Carrier Management, Circulation Department, 3570 Camino del Rio North, Suite 200, San Diego, CA 92108-1747. ARTICLE REPRINTS: For reprints of articles in this issue, contact us at 800.897.9965x148 or advertise@carriermanagement.com

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Register Today! Make your plans now to attend one of the

IICF Women in Insurance Regional Forums Chicago | June 3, Holiday Inn Chicago Mart Plaza Los Angeles | June 12, Westin Bonaventure New York City | June 17, New York Hilton

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Dallas | June 19, Hyatt Regency Dallas

2014 IICF Regional Forums: Building on the Momentum Following the overwhelming success of the 2013 Women in Insurance Global Conference, IICF is hosting four regional one-day forums in 2014. The 2014 regional conferences provide easier access to interested individuals around the country and will focus on leadership, the changing workforce of the future, and the male perspective on gender diversity. Speakers of the highest caliber will once again be featured at all four conferences, and there will be enriched opportunities for building strong regional networks and individual connections.

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Features Winter 2014

87 89 93 106 97 102 104 110 8 | Winter 2014

REGULATION & COMPLIANCE

3 Ways FIO’s Report Could Impact Core Insurance Functions and Corporate Governance

Potential consequences on the Federal Insurance Office’s Modernization Report discussed: federal scrutiny of risk classes used in insurance underwriting, downward pressure on reinsurance prices, state qualification standards for directors and officers. By Molly Lang and Susan T. Stead, Partners, Nelson Levine de Luca & Hamilton

The FSB Objective: Never Waste a Good Crisis

The Geneva Association’s John Fitzpatrick reviews the FSB’s march toward a global capital standard, explains that the omission of a global capital standard did not cause the financial crash of 2008 and reviews the essential regulatory questions for policymakers to consider in 2014. By John H. Fitzpatrick, Secretary General and Managing Director, The Geneva Association

RISK

That ’70s Show: Obamacare Takes Federal Black Lung Claims Back in Time

The new health care law has taken casualty insurance carriers back to the past— removing some 1981 restrictions to Black Lung Act benefits and reopening claims that workers compensation carriers thought were finalized long ago. By A. Judd Woytek, Shareholder, Marshall Dennehey Warner Coleman & Goggin

The Current Scientific Consensus on Climate Change and Hurricanes—It May Surprise You

According to scientific consensus, there is no detectable link between human activity and hurricane activity, says Karen Clark, interpreting the IPCC’s most recent report. By Karen Clark, President, Karen Clark & Co.

REINSURANCE

Integrating Reinsurance Management System With Core Systems Reduces Risk

Carrier considerations for selecting a reinsurance management system, components of a preliminary implementation study and key steps in the integration process explained. By Joseph Sebbag, CEO, Effisoft USA

Consolidating Reinsurance Towers to Gain Efficiencies

How carriers can benefit from reinsurance-buying strategies that consolidate multiple reinsurance towers into one contract. By Mike Schnur, Partner, TigerRisk

Reinsurance CEOs Speak Out: What Alternative Capital Means to the Traditional Industry

CEOs of General Re Corp. and Transatlantic Holdings share different perspectives on what the entrance of alternative capital means to the reinsurance business. Conference Report

INVESTMENT MANAGEMENT

Market Turning Point: Considerations for Investment Portfolio Repositioning

Insurers should consider measured approaches to investment portfolio repositioning in 2014, taking advantage of the income lift from good underwriting results to help them exert control over the timing of their decisions to realize embedded gains. By Joshua A. Magden, Vice President, Sage Advisory Services

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What You Need to Know in 15 Seconds International, National, Regional Delivered Daily to Your Inbox

Carrier Management Daily Headlines All the news and analysis a P/C leader needs, without the distractions of unimportant reporting.

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From The Editor Unsung Heroes

F

aced with the assignment to report on the inner workings of property/ casualty companies—“insurance company operations”—for this edition of Carrier Management, my first inclination was to profile the C-suiters charged with leading P/C operations. Chief operating officers, I thought. I ventured online to see what had been written about COOs in other industries, searching first for “COO magazine.” I found some comprehensive research articles, including a Harvard Business Review article published in 2006. It turns out, however, that there is no COO magazine or website. In fact, the only mention of such a publication turned up in a corporate recruiter’s blog item, in which he reported the same information—that despite the fact that there are entire magazines dedicated to CEOs, CFOs, CIOs, CMOs and other CXOs, COOs have been left out. “Why does such an important role in growing organizations get so little attention?” the blog author wonders. In this edition, we put our central focus on the unsung heroes of the C-suite, relying mainly on information from five people who fill the roles in the P/C insurance industry. The first fact we uncovered: They don’t all carry the title “chief operating officer.” Two, for example, are chief operations officers. And while the “operations officers” have roles somewhat different from the “operating officers,” the magnitude of what all five accomplish in a given day, week or month is similar no matter what titles they carry. It is staggering. The enormity of their tasks is one of the few common threads we found among the five leaders we profiled: three men and two women—two experienced in claims, two in nonclaims insurance customer-facing roles, and one whose experience comes from outside the P/C insurance industry. Underwriting operations, claims, finance operations, service centers, project management, real estate, technology and talent are just some of the functions sprinkled across the roles, with no two having the same set of responsibilities. The diversity bears out prior research. “When you examine COOs as a class, one thing [is] immediately clear: There are almost no constants,” says the HBR article, “Second in Command: The Misunderstood Role of the Chief Operating Officer.” But for almost every other finding in that research study, we found at least one P/C leader who broke the rule—including the “second in command” idea of the title, and a related rule suggesting that COOs simply “execute” strategies of CEOs. Our P/C operations leaders say they collaborate fully on strategy. They are “first in command” for hundreds or thousands of operations employees. And the job is its own reward. Order of command and titles are not their focus. Other areas of agreement: You have to be a “people person” to be a good operations executive, and you have to be able to adapt to ever-changing situations. Dealing with change and people, operations leaders connect to two other areas driving the engines of P/C insurers: technology and talent. The “gear movers” on our cover bring all three into focus: operations, technology and talent—the nuts and bolts making P/C carriers work.

Susanne Sclafane, Senior Editor

10 | Winter 2014

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Technology/Talent Winning the War for Talent to Harness the Full Power of

Predictive Analytics

Executive Summary: Manuel Rios, the CEO of American Modern Insurance Group, lays out four steps his company is using to win the war for analytics talent, after explaining why it’s important for insurance executives to accelerate and leverage the power of data and predictive analytics across all of a carrier’s business units.

By Manuel Rios

www.carriermanagement.com

T

he reputation of the insurance industry has long been that it follows behind other industries in the use and implementation of technology. Across numerous other industries, big data and analytics are profoundly altering the business landscape. Until recently, however, only a handful of the largest insurers were using them to their fullest. According to a recent Earnix/ISO survey polling insurance professionals, of the

companies with more than $1 billion in gross written premium (GWP), 51 percent either currently use big data or are evaluating or implementing big data initiatives, compared with 30 percent of the companies with less than $1 billion GWP. (See related article, “82% of P/C Insurers Using Predictive Analytics: Earnix/ ISO Research,” next page.) Now, it’s in the hands of insurance executives to effectively leverage the

continued on next page

Winter 2014 | 11


Technology/Talent continued from page 11 power of analytics to more precisely understand markets, enhance productivity and mitigate losses—all of which ultimately benefit and help better serve the premiumpaying customer.

of analytics in insurance:

• Pricing Segmentation

For nearly two decades, data and analytics have been used in pricing segmentation, optimization and by-peril ratings to establish more Manuel Rios is the Leveraging Data Analytics effective rating plans. This Across Business Units President & CEO of use of data and analytics American Modern In the last several decades, remains one of the hottest Insurance Group. the methods for effective spaces in insurance analytics. decision-making have shifted The same Earnix/ISO from qualitative decisions on survey found that 81 percent individual risks to quantitative, dataof respondents use predictive modeling driven decisions on a broader portfolio. for pricing either “always” or “frequently.” But the true value of analytics is It helps insurers develop prices that offer realized only when it’s not presented in a a fair return, are reasonable for the vacuum. Instead, analytics should be used customer and are more in line with the to help inform decisions across all customer’s behavior. functions within insurance companies. • Geo-Spatial Rating and Underwriting With continuous advances in The use of geo-spatial rating and technology and quality of data, here are underwriting analytics at the point of sale some of the ever-expanding applications

Role of Big Data in Modeling Initiatives

is also on the rise. Data can be used in this area to help insurers develop digital rating territories and also more precisely assess factors such as the distance to coast, potential wildfire exposures and floodzone perils. Further, predictive analytics can be leveraged in catastrophe risk management by using models to assess exposure to hurricanes, severe storms and

82% of P/C Insurers Using

A

survey of North American insurance professionals reveals widespread use of predictive analytics in the property/casualty insurance industry, with as many as 82 percent responding that they use predictive modeling in one or more lines. Earnix, a provider of integrated pricing and customer analytics solutions for banking and insurance, and ISO, a source of information about P/C insurance risk and a member of Verisk Insurance Solutions group at Verisk Analytics, in November released the results of their joint 2013 Insurance Predictive Modeling Survey. The firms compiled responses collected online in September from 269 insurance professionals representing

Source: Earnix Inc. and ISO (2013 Insurance Predictive Modeling Survey) Fifty-one percent of companies with more than $1 billion in gross written premium are currently using big data or are evaluating or implementing big data initiatives, compared with 30 percent of the companies with less than $1 billion in gross premium. 12 | Winter 2014

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earthquakes, among other risks, on a very granular level. In fact, geo-spatial analytics are expected to positively affect both residential and recreational product loss ratios—a win for both company and customer.

• Customer Retention Improvement

As all business professionals know,

retaining an existing customer is tantamount to success. Analytics can support this by using customer behavior and preferences to target individuals who may be interested in buying additional products. Analytics can also be used to develop predictive models that establish which customers are most at risk and which have the highest lifetime value to your company.

This sort of data is essential in determining how much to invest in retaining specific customers and when that investment is most warranted. On a larger scale, this use of analytics can help companies better align product offerings and language with the needs and behaviors of customers across different product segments.

continued on next page

Predictive Analytics: Earnix/ISO Research companies that sell personal and commercial coverage in Canada and the United States. While only 18 percent of the professionals surveyed said their companies did not use predictive analytics in any line of business, the most common line for the remainder was personal auto (49 percent). Lines like commercial property and even workers compensation and general liability were also indicated by some survey respondents. Professionals surveyed are mainly involved in actuarial, underwriting or product development functions. Based on the survey results, Earnix and ISO report that larger insurance companies are more likely to make use of predictive modeling than smaller ones. In fact, 100 percent of the respondents from companies that write more than $1 billion of gross premiums in personal insurance use predictive modeling, compared with 69 percent of the smaller personal lines writers. The gap is narrower for commercial lines, where 75 percent of respondents for smaller companies (those writing less than $1 billion) and 88 percent of respondents from larger companies (those writing more than $1 billion) said they use predictive models.

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81% of respondents said they always or frequently use predictive modeling for pricing. 52% always or frequently use it for underwriting. The most common uses of predictive modeling are in pricing (loss cost modeling and tiering) and underwriting, while analytics are used to a lesser extent for marketing, claims (fraud investigation, claims forecasting and triaging) and reserving. Benefits cited by survey respondents are: • Driving profitability, 85 percent • Reducing risk, 55 percent • Growing revenue, 52 percent • Improving operational efficiency, 39 percent Top challenges mentioned by respondents include lack of sufficient data and limited numbers of skilled modelers. The survey also revealed that companies spend considerable time on

data preparation and deployment before and after actual modeling work. More than half of survey respondents (54 percent) spend more than three months on data extraction and preparation, and more than two-thirds of the respondents (69 percent) take more than three months to deploy new models. The complete survey report also includes responses to questions about whether external or internal resources are used to develop models (broken down by company size), primary functions responsible for modeling, the number of people devoted to the effort (by size of company), the extent to which external data are used (and type of external data used), and popular data extraction and software tools.

carriermag.com/qj2sk

Winter 2014 | 13


Technology/Talent continued from page 13 • Property Inspection Selection Insurers are continuously looking for

the right balance between trimming operating costs in their underwriting programs and adequately managing risk assessment. In the area of property inspections, predictive analytics can be invaluable in making accurate pricing and risk selections by helping determine the optimal number of inspections to maximize benefits. Investment in this type of analytics saves insurance companies millions of dollars a year in potential expenses and ultimately in the cost of their products.

informed decisions, it’s easy to see why insurance executives should consider implementing or expanding their use. This requires hiring and retaining the right talent, which presents an entirely new set of challenges. In the insurance industry, there is a limited talent pool of people who are knowledgeable about analytics and big data. Also, many potential candidates are recent college graduates who lack professional and insurance industry experience and perspective. Another challenge is the perception that there are limited opportunities in the insurance industry. The common refrain we hear at recruiting and career fairs is that candidates “don’t want to sell insurance or settle claims.” We need to find ways to more broadly tell the story of risk management, its complexities and the variety of skills it takes to do the job, including analytics. In order to win the war for analytics talent, the following tactics should be considered: 1. Develop a close collaboration with Human Resources to bolster your company’s ability to compete for scarce analytics talent. Building comprehensive programs to attract, develop and retain talent is essential. Competitive salary and benefits are obvious requirements, so we have to show how the work is meaningful and satisfying as well. To that end, American Modern has established an Associate Talent Council that approaches this issue through crossdepartmental collaboration because this is a strategic issue that requires diversity of thought. The council offers input,

American Modern

has established an Associate Talent Council that

approaches the

issue of acquiring analytical talent through cross-

• Claims Analytics Claims analytics can be

departmental

collaboration. This is

an effective tool for streamlining claims operations and also identifying anomalies to detect and prevent fraud. The Insurance Information Institute estimates that insurance fraud costs property/ casualty insurers more than $30 billion annually. Whether a loss is deliberately planned or invented in a “hard” fraud, or is a “soft” fraud, where the size or scope of legitimate claims is exaggerated, analytics offers a cost-effective way to detect these issues. Also, during major storms or other widespread events, insurers using analytics that incorporate geographic data can improve service and speed for customers by proactively advising them on mitigation measures, managing field adjuster staffing and helping triage claims by priority.

a strategic issue that requires diversity of thought.

Investing in Analytics Personnel

With the clear benefits of analytics, including the potential for better-

14 | Winter 2014

analyzes existing programs and helps build new ones to shape a culture of learning and development that encourages curiosity where everyone is invited to ask questions in support of the mission. 2. Create an environment that values the skills of analytics professionals by providing continual access to the latest and greatest technology and training. 3. Highlight opportunities candidates will have to solve difficult and compelling problems critical to the company’s success. While analytics talent will likely learn most of their data and analytics skills in school, many do not have business acumen. Emphasize how your company can make them better insurance professionals and teach them how to clearly communicate and tell a story through data, which is an extremely valuable and rare skill. 4. Tap into standout analytics programs that offer degrees in the big-data discipline of machine learning. American Modern has developed a relationship with the University of Cincinnati, Center for Business Analytics. We provide assistance in the development of coursework and projects and have also utilized UC MSBA students in real-world projects. Through these types of programs, insurance companies can help educate students on job opportunities, help to direct the type of coursework universities are offering and build a talent pipeline for the future. Analytics is the future of the insurance industry. One of the biggest mistakes insurance executives can make is ignoring the potential business value of analytics, both now and especially over the next five to 10 years. It’s up to today’s insurance executives to accelerate and leverage the power of data and predictive analytics across all business units, helping them better serve their markets and ensure the success and future of their companies.

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Technology/Talent The Race to Secure

High Impact Analytics Talent

Executive Summary: Strong executive sponsorship of data projects and initiatives, often by leaders in the C-suite, is helping some property/casualty insurers win the race for analytics talent, says Margaret Resce Milkint of The Jacobson Group. She explains why such sponsorship is meaningful to qualified job seekers and provides other recommendations for employers seeking to attract potential candidates for analytics roles.

B

By Margaret Resce Milkint ig data is making a huge impact on the insurance industry and fueling this red-hot talent market. As an insurance industry megatrend, analytics impacts every aspect of an insurance organization: IT, claims, underwriting, marketing, actuarial and even human resources. In IBM’s latest big data study (register here to view the study: www-935.ibm.com/ services/us/gbs/thoughtleadership/bigdata-insurance/), 74 percent of insurance companies reported that the use of information and analytics is creating a competitive advantage for their organizations, compared with 63 percent of cross-industry respondents. Insurance organizations are using analytics to do more than just differentiate themselves. They are taking advantage of big data to build their brands, enhance profitability and gain a competitive edge in the marketplace. Along with the race to harness big data

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and achieve a competitive edge comes the need for strong analytics talent to facilitate these initiatives. According to The Jacobson Group and Ward Group’s 2013 Insurance Labor Market Study, the demand for actuarial talent was surpassed for the first time ever by analytics talent. (See related article, page 11, for P/C Carrier CEO’s viewpoint.) Jacobson has seen firsthand that the demand for analytics talent has skyrocketed at all levels, including entrylevel and staff roles, as well as middlemanagement and executive posts. Our clients are also bringing in top analytics talent on a contract basis for special projects and interim roles.

Finding Analytics Talent

Fortunately, the search for analytics talent does not need to be focused solely within the insurance industry. This is one area where property/casualty insurers can and should look beyond insurance-specific talent. Broadening the search to other industries enriches the talent pool and leads to finding the best candidate for the role. All cutting-edge industries are exploring the advantages of big data. Key areas insurers should consider when looking to bring in out-of-industry talent include

broader financial services, health care, Internet-based technology and retail. Insurers should focus their search efforts on high-impact organizations in consumerdriven markets.

Vetting Skills for Analytics Talent

The best candidates will possess a well-developed range of skills and experience in the key areas of IT, quantitative analysis and management. Important competencies Margaret Resce Milkint is to seek include Managing Partner of The exceptional analytical, Jacobson Group, the conceptual and problemleading global provider of solving abilities, as well as talent to the insurance technical architecture and industry. She may be technical support reached at mmilkint@ documentation expertise. jacobsononline.com. Especially significant are stand-out communication and presentation capabilities. Speaking the language of business is a key differentiator that separates a strong candidate from an exceptional candidate. Necessary experience will vary

continued on next page

Winter 2014 | 15


Technology/Talent continued from page 15 Defining the Role of the Data Analytics Leader

In response to the race for big data, insurance organizations are adding a new role to their ranks: the data analytics leader. While duties and responsibilities vary depending on the organization and its overall goals, the role is typically made up of a combination of the following: • This emerging leadership position will be a visible and high-impact role, tasked with leading analytics initiatives for optimal business growth and critical decision-making. • This individual will manage data assets by strategically designing and implementing data warehouses, data marts and data stores, as well as delivering high levels of data availability and data integrity. • Defining data standards and models for warehouse architectures may be required, as well as evaluating and recommending infrastructure components such as software, hardware and database management systems. • This analytics leader will educate, mentor and develop a clear understanding and framework to create an information edge. • Building synergies and fostering integration across the enterprise to increase delivery, support, communication, profitability and growth is essential for success.

dependent on the level and proposed responsibilities of the role. Insurers should look for talent with hands-on experience in areas including data architecting (structuring and managing databases), data mining, data modeling, and data gathering and analysis. Crucial “soft skills” to combine with this rigorous technical pedigree are robust collaboration and relationship-building expertise. Interviewers must provide opportunities for candidates to reveal their ability to analyze business opportunities, develop solutions and provide the company with practical, timely applications that will improve results. Specifically, interviewers should ask candidates to describe the most successful projects they were involved in and what role they played, as well as a project that did not go well and why. Consider asking questions designed to uncover critical skills like communication.

16 | Winter 2014

Asking candidates to describe their communication strategy and process on a major project— highlighting both obstacles and successes—will provide great insight. If candidates can identify communication hurdles and explain how they overcame roadblocks, it shows an ability to influence decision-makers and propel initiatives. Interviewers should also uncover how the candidate helped solve a business problem or provided insight to a business leader that made a difference to the bottom line.

Attracting Talent

to candidates that opportunities exist to use their highly specialized skills to the fullest extent and that their talents will support and enhance the strategic path and the P&L of the organization. For analytics candidates, the ideal potential employer displays a culture where data and analysis are embedded in each function and where they play a central role in decision-making. Executive sponsorship, often by leaders in the C-suite, is a great way to attract potential candidates. Strong executive sponsorship shows candidates that the organization is fully committed to its analytics initiatives. Support from the C-suite also lends credibility to the analytics initiatives and can act as a cover for analytics talent working on high-risk/high-reward projects. Job security will be particularly important to potential analytics candidates, especially in organizations in the initial phases of their data efforts. The race to attract and secure impactful analytics talent is on, and insurers must make it a focus in order to keep pace and ultimately outshine their competitors. Securing leading-edge analytics talent enables insurers to compete, create and thrive in the dynamic, global P/C insurance carriermag.com/vc7me marketplace.

The way an employer communicates the role is critical to ultimate success. Sharing an exciting vision and an Joyce Dunn, VP and Engagement Director at earnest “analytics story” creates a The Jacobson Group, contributed to this article. recruiting edge—what has the company done, what is it doing now, and what is the What is data architecting? future state? Top talent While data architecting means different things at must be able to envision different organizations (and in different roles), some a role as star player and recurring responsibilities we’ve seen include development driver of the analytics of data architecture road maps, definition of data journey. management standards, support of data warehousing A clear yet creative and provision of guidance for analytical reporting analytics career path initiatives. will be a powerful tool to entice candidates. What experience do the most qualified candidates have? Transformation, The most qualified data architect candidates will operational excellence possess a combination of the following: knowledge of and innovation are modeling tools; experience designing and implementing crucial agenda items, information solutions; technical experience designing, and the role of analytics building, installing, configuring and supporting data in achieving success warehouses; project management experience; and strong must be highlighted. communication skills. Insurers need to prove

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Technology & Analytics

Predictive Analytics:

Bringing Price Elasticity Concepts to P/C Insurance Executive Summary: Many industries have harnessed the power of big data and predictive analytics to enhance revenues and profits by incorporating consumers’ price elasticity of demand into their price determinations. Like these other industries, insurers need not remain stuck in the cost-plus pricing grind any longer, experts at Fractal Analytics reveal in this article, which describes the obstacles that have been holding insurers back.

By Deepak Ramanathan, William Wilt & Ed Combs

www.carriermanagement.com

T

he concept of price elasticity of demand (PED) has not received enough attention in the world of property/casualty insurance. Regulatory hurdles, a tradition of costplus pricing and maybe even an outright aversion to the word “discrimination” combine to hold insurers back from reaping the full benefits of applying some of the basic economic principles that are commonly used in other industries— industries that charge consumers different prices for the same product or service. Microeconomic theory teaches us that thoughtful selection of prices, or price discrimination, is key to maximizing revenue and profit. Our research, in fact, reveals that if P/C insurers adopt advanced pricing strategies that consider customer

elasticity differences, they can boost their revenues by roughly 3 percent and returnson-equity by 1 percent, on average. PED essentially refers to the responsiveness—elasticity—of a customer in terms of the quantity of a product he or she will buy when the price of that product changes. The airline industry provides a recognizable example of how a pricing strategy can be developed based on an understanding of price elasticity. Airlines get higher prices from business travelers with inelastic demand than from vacationers who shop for deals and show flexibility on departure times. Likewise, all types of retailers offer discounts to senior citizens for their

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Winter 2014 | 17


Technology & Analytics continued from page 17

Big data and predictive

products, because seniors with more flexible schedules are price-elastic. Some P/C insurers exploit the relative inelasticity of policyholder demand (on a limited basis). Insurers, for example, may account for elasticity differences when applying singledigit discounts to multiyear auto policyholders, even when their loss experience suggests steeper discounts are possible. Business insurers also may offer modest package discounts when the data suggests their loss experience could support a more substantial package-policy bonus. In other words, they’re increasing their own revenues and profits rather than sharing savings with customers. Such practices, however, are intuitionled and not typically based on rigorous analytics. We believe that big data and predictive analytics offer new avenues for research and application of PED concepts in insurance. In addition, we will propose one way in which P/C insurers can make PED concepts work within the existing regulatory framework.

discriminatory.” Outside the United States, practices incorporating price differentiation are more advanced than the package and multiyear discounts discussed. In fact, in the U.K., car insurers are permitted to change rates at will—on a daily basis if they so desire. Only race and gender are considered off limits, although insurers can and do market by gender. One British insurer is even called “drive like a girl.” Despite regulatory hurdles, we are pleased to report that PED does have a role in the U.S. personal and commercial insurance marketplace. Measures of PED cannot be applied to the individual as they might in the U.K. market—for instance, where the time of day a purchase is made might result in different rates for otherwise identical risks. In the United States, we must apply these principles at the cohort level in a manner consistent with accepted rating variables.

analytics offer new

avenues for application of price elasticity

concepts in a way that fits within the existing

regulatory framework of the P/C insurance industry.

Price Discrimination

“Discrimination” is a loaded word, but what we're discussing here is segmenting consumers based on their behaviors—not by characteristics that insurance regulations identify as unfair, such as race or religion. Still, P/C carriers are rooted in a cost-plus pricing world—borne from the data we capture, the relative size of variable costs over fixed costs, and most notably from actuarial and regulatory principles that emphasize rates that are “reasonable and not excessive, inadequate or unfairly

18 | Winter 2014

The Power of Big Data

To begin to understand their customers’ price elasticity, insurers will need to capture new data. While it is true that most insurers today don’t have the same robust customer-behavior data that an online retailer might have, that picture is

changing as more consumers buy—or at least shop for—their auto policies online. The data now being captured at insurer websites can provide useful insight into consumer behavior. Once it is captured, price elasticity will manifest in at least two traditional ways: • Switching behavior exhibited when inefficiencies in pricing enable customers to find lower premiums or more favorable combinations of prices and coverages. • Reduction in consumption in response to a change in price. A policyholder who raises his deductible or lowers his limit in response to a price increase is revealing something about his price elasticity. We refer to this behavior as “rate avoidance.” Readers will recognize the latter as a common aspect of the propertycatastrophe reinsurance market, where insurers regularly change their propertycatastrophe program in response to rate changes. Many insurers already have grasped these concepts. But through the power of predictive analytics and our ability to marry these behaviors with other forms of data, we can systematically look for patterns and correlations that can provide insights not visible through intuition or informed judgment alone. Another benefit available to insurers that study PED on their own books of business relates to improved business and financial forecasting. Underwriters may reason that a 10 percent rate increase, for instance, will drive away some business. But predictive analytics may help to refine the likely percentage, or even to examine the impacts of other changes that may mitigate policy attrition.

Regulation Doesn’t Preclude PED Application

It is possible to use PED concepts while working within the limits established by insurance regulation. We turn to the example of personal

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auto insurance pricing to illustrate how price elasticity principles can be applied. Most auto insurance rates are derived by applying rate relativity factors to a base rate. Those rate relativity factors will vary based on gender, age of driver, credit score and so on. Importantly, the statistical analysis used to estimate the relativity factors produces a range of outcomes that within a certain confidence interval should be equally acceptable to the regulator. We believe that auto insurers will benefit by applying PED in their relativity selections. Our work shows that PED relativity selections from relativity ranges estimated with 95 percent confidence can improve revenue and profit outcomes by single-digit percentages. Assume that through careful study of an insurer’s data, we can determine that females of a certain age exhibit less price

elasticity than male drivers of the same age or females in adjacent age categories. Without being overly prescriptive, we could tweak the established rating relativity variables—within their accepted confidence intervals—to arrive at a different rate for those drivers. In other words, carriers can apply PED at the cohort level—working within the existing framework to incorporate PED into already accepted pricing categories. For a business, attributes including credit score, the industry it competes in and the number of years it has been in business are among those that might provide insight into PED. In turn, these could be used in rating algorithms to improve an insurer’s revenues. Beyond switching behavior and rate avoidance, there are many more measures of price elasticity than can be used. We believe the incorporation of PED

principles into insurance ratemaking is an idea whose time has come.

carriermag.com/i47r3

Deepak Ramanathan is Vice President of Fractal Analytics and a leader in their Insurance practice. He consults with leading insurers in areas of pricing, loss modeling, claims analytics, price elasticity and customer lifetime value in the insurance domain. Reach Ramanathan at deepakr@fractalanalytics.com. William Wilt is President of Assured Research LLC, a research and advisory firm focused exclusively on the P/C insurance industry. Reach Wilt at william.wilt@ assuredresearch.com. Ed Combs is an Insurance Adviser to Fractal Analytics with more than 30 years of experience in the P/C insurance industry, including executive positions at Progressive and 21st Century, where he was Senior Vice President of Marketing and Product Management. Reach Combs at ed@combsconsults.com.

Price Elasticity Debate:

Dangerous Discrimination or Replacing Judgment With Science?

D

eepak Ramanathan, William Wilt and Ed Combs, the authors of the accompanying article, are not the only experts who weighed in with Carrier Management on the subject of price elasticity of demand or price optimization techniques. In one of the most popular articles featured on the Carrier Management website last year (“Price Optimization: A Dangerous Method?”), actuary J. Robert Hunter, who is also director of insurance for the Consumer Federation of America, says the price optimization technique is actuarially unsound and unfairly discriminatory. (carriermag.com/gmqx6) “Price optimization must be recognized for what it is: the rejection of actuarial standards for the sake of increased profits at the expense of

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unwitting policyholders,” he writes. “Buying insurance is not like buying first-class plane tickets or jewelry, where willingness to pay may reasonably be used in price setting,” he adds. Separately, in a video interview, Serhat Guven, a director at Towers Watson, responds to such criticism by noting that predictive analysis of customer demand adds science to an existing competitive process. Traditionally, insurers have selected rating formulas—to combine costbased indications with surcharges and discounts— based on actuarial judgment. “We've said, ‘Here's what my cost model says the formula should be, here's what my competitors say the formula should be, and here's what my current rates are.’ “The optimization is

basically saying, ‘How do I better blend these together?’ “As opposed to doing hand-waving, we're putting science into that process to remove biases,” Guven says.

The entire video interview, “Towers Watson’s Serhat Guven Explains the Use of Price-Elasticity Models in Insurance,” is available at www.insurancejournal.tv/.

Winter 2014 | 19


Technology & Analytics

Big Data The Challenges Around

and the Lessons to Be Learned Executive Summary: The property/casualty insurance industry is adapting slowly to an environment of data superabundance and instant access to information, with early adoption of big data initiatives typically limited to the actuarial and finance functions, reports Novarica’s Martina Conlon. Here she discusses lessons to be learned from other industries that have successfully leveraged big data in product design, marketing, distribution and risk assessment.

By Martina Conlon

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T

he hype around big data is focusing ever more attention on insurers’ data management and analytics capabilities. Analysis of data, creation of predictive models and the ability to take action based on the outcome of those models stand at the core of the industry and will continue to be a source of competitive advantage for insurance companies large and small. The growing use of third-party data comes on the heels of the proliferation of data providers in both quantity and quality.

A supplement to government, medical and business data, new data gathered from credit scores, consumer databases, social networking analysis, geographic information services and satellite photos offers enriched context for all things insurance. While this new data is proliferating, internal data is more accessible and moving faster with the wide adoption of service-oriented architectures and open, relational databases. When new data and existing internal data are coupled and

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deployed on big data technology, information becomes increasingly more accessible, sophisticated and insightful. (See related textbox on following page for information on big data technologies.) A recent survey by Novarica reveals that 1 in 3 carriers is currently using third-party or geospatial data to improve analytics and operations. However, adoption and use of big data is taking a similar path as other data technologies—early adoption in actuarial and finance, with slower adoption by other

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functional areas. A recent Novarica survey reveals that the usage of analytics is far less advanced in marketing, underwriting and claims departments when compared to usage across various actuarial and financial areas. Large insurers are more aggressively moving forward in deploying big data and related analytics across the board, while smaller insurers often lag behind with a wait-and-see attitude. The industry’s inability to fully leverage big data is generally attributed to the following reasons: fragmented data environments, lack of attention due to higher-priority core system transformation efforts, lack of investment in advanced technology and tools, lack of access to experienced data scientists, and a lack of understanding of the overall benefits resulting in a lack of sponsorship for new data initiatives. While the insurance industry slowly adapts to an environment of data superabundance and instant access to information, there are lessons to be learned from other industries and from the few insurers that have publicly revealed how they have successfully leveraged big data in product design, marketing, distribution and risk assessment. Case studies have demonstrated the benefits of big data in the creation and modification of products in many industries. Organizations are using big data to better inform and validate product development, especially when offering a customized product. Related to the insurance industry, for example, The Climate Corp. developed a crop insurance-related offering customized to the individual farmer, where a custom policy type is created using farmers’ crops, soil types, seed maturity and location information. This is combined with geospatial, geological and climate-related big data to develop personalized weather risk assessments. The Climate Corp. used big data when making decisions about product development in order to best meet the needs of individual policyholders. (Editor’s Note: The Climate Corp., which

also helps farmers improve profitability by predicting crop yields, was acquired by Monsanto in October 2013.) For retail organizations, the use of Martina Conlon is a Principal big data—specifically in Novarica’s insurance location analytics—leads practice focused on the P/C to better location market. Conlon is the primary selection and improved researcher and author of profitability of market-leading reports on distribution centers. agent portals, insurance Additionally, big data billing, business intelligence, proves critical in the big data and IT staffing design of marketing strategies. She provides programs, promotions, advisory services on brand loyalty and crossinsurance core systems, IT selling campaigns. best practices, organizational For instance, Target design and staffing strategies, analyzed consumer and strategic technology retail purchasing and planning. Her insights on demographic data and insurance and technology concluded that pregnant have appeared in a wide shoppers are a segment range of press publications, that is highly susceptible and she is a regular speaker to marketing efforts that at industry events such as can drive high-volume ACORD, IASA and PCI. Novarica purchases and long-term research is available at store loyalty. Target www.novarica.com/research/. subsequently developed Conlon may be reached in-store loyalty directly at mconlon@ programs, designed a novarica.com. purchasing profile targeting pregnant women, and used retail big data to select targets for promotional materials with baby-related ads and coupons. The company became so good at gathering, validating and analyzing internal and external data that it can successfully predict when a young woman is pregnant before her family even knows. (Described in a Feb. 16, 2012 New York Times article, “How Companies Learn Your Secrets.”) Insurers can gain similar benefits in distribution management and marketing. If an insurer is focused on growth through the expansion of the agent channel, it may make

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Technology & Analytics continued from page 21

Big Data Sources

New data is proliferating for insurers to tap into, according to Martina Conlon, principal for Novarica. Some types of big data available to insurers include: • Credit scores and details • Consumer and business data • Social networking analysis • Geo-spatial information • Weather data • Satellite photos • Purchasing history • Health and prescription data • Industry specific policy and claims data • Competitive filings • Public records (properties, competitive filings, lawsuits, crime rates, census data, etc.) • News services During a presentation at the SAP Financial Services conference in September 2013, Conlon noted that Novarica uncovered more than 90 vendors offering different types of information for insurers when conducting some research two years ago. better decisions in agent appointment, management and compensation with insights gleaned from big data analysis. Demographics, business data, population and business growth statistics, purchasing data, and public property records can be

analyzed to determine the potential risk, demand and profitability for the location the agent services. Likewise, personal lines writers that are trending toward direct sales are using big data to better engage prospects. Web usage,

social media and third-party data can be used to anticipate life events or purchases that accurately predict insurance needs, such as auto comparison and real estate sites, thereby enabling early prospect engagement. After the sale, consumer, claims, location and risk data can be leveraged to design loyalty and retention programs that deliver the right information to policyholders at the right time via the preferred communication channel. Finally, big data types can prove invaluable in basic risk assessment and pricing. Consider the ocean marine insurer that covers container ships where underwriters commonly price accounts based on historical pricing and loss history. What if the underwriter also has access to the weather conditions and piracy activity along the route, or crime and political statistics for the ports of call? With the competitive pressures in commercial lines today, price accuracy can have a big impact on the close ratio of an insurer. Big data can provide enhanced perspective to help ensure optimized pricing, and big data analysis can uncover dependencies and insights to define better

Netflix’s ‘House of Cards’ and Other Big Data Case Studies

H

ow did program developers at Netflix know that viewers of the BBC television series “House of Cards” also enjoyed movies starring Kevin Spacey and directed by David Finch? They analyzed big data to identify the overlaps, Martina Conlon reported during a presentation at the SAP Financial Services conference last year, going on to describe more of the big data insights Netflix gathered to produce its own online remake of “House of Cards.” Conlon said that examples of big data applications are harder to come by in the insurance industry. “The insurance industry is a little bit slow on the uptake except for the very, very large organizations in both commercial and personal lines.” In

22 | Winter 2014

addition, “there aren’t many insurers willing to share their successes. They view it as their special sauce,” she said, explaining why she looked outside the industry for big data case studies. Continuing her Netflix example, she noted that behavioral analysis of the big data gathered on viewing habits revealed that the likely viewers of “House of Cards” are addicted to viewing marathons—a data tidbit that prompted Netflix to release all the episodes at once. Conlon also drew an example of an underwriting application of big data from outside the insurance industry, noting that Zest Finance, a small consumer loan company, used big data to determine that the way in which a loan applicant fills out the application really matters. All small letters or all capitals may be bad, while

those using mixed letters may have a lower likelihood of default. Within the insurance industry, Climate Corp. (discussed in the accompanying article) provided Conlon’s only example of using big data for product development, but she offered two examples related to underwriting and risk assessment—one from American International Group and the other from Florida-based commercial lines writer FCCI. AIG, she reported, bought all the data on lawsuits against executives across the country since 1996 and analyzed it to find six predictive factors of the likelihood that an account in the executive liability line will be unprofitable. At FCCI, predictive models developed from data mining challenged the existing assumptions of underwriters and revealed

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What Are Big Data Technologies? Description

Examples

Appliances

Hardware devices designed and optimized for acquiring, organizing and storing unstructured data.

IBM Netezza Oracle’s Big Data Appliance

Databases/ File Systems

Storage and processing software optimized for processing large amounts of unstructured data.

Hadoop NoSQL

Analysis and Parsing Tools

Software designed to decipher and extract meaning from data in any encoding and format, then process it to look for analytic patterns.

HParser Data Quality Manager Trillium

underwriting rules while improving risk selection. Big data provides an opportunity for insurers to gain a deeper understanding of the context around customers, risks, markets, industries and distribution, which in turn drives better decisions. Data continues to be a strategic asset in our industry. As the types and volume expand and ease of access improves, insurers that have the expertise and infrastructure to leverage it will be well positioned in the competitive market carriermag.com/qu8ih ahead.

that it’s not just class code that matters but that account size is important as well. During her presentation, Conlon suggested other potential uses of big data that could be tapped by insurers—one related to marketing, for example. In Massachusetts, for automobile insurance sales, it is illegal to use credit scores for underwriting and pricing, she noted. But there is no law against using them in marketing campaigns. “Who you send a market mailer to or who you proactively contact as part of a marketing program” are actions you could take to “technically pre-underwrite in the marketing phase”—only reaching out to prospects the carrier wants to target. Separately, Milliman early last year demonstrated a way in which carriers can use unstructured data for claims analysis.

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What Is Big Data?

There are many definitions out there for big data. Big data is characterized by “the three Vs,” says Martina Conlon, principal for Novarica. • Volume: Individual data items are very large—such as a large image or telematics output record. • Velocity: Data is produced rapidly—such as telematics records that are created every few seconds. • Variety: Data may be structured or unstructured—such as structured telematics records or unstructured social media content. Big data is internal and external data, structured and unstructured, collected in enormous volumes at a rapid velocity. Big data is sometimes defined as data that is too large to be processed by traditional technology.

Philip Borba, a principal and senior consultant in the economics consulting practice of Milliman, led an analysis of narrative information related to nearly 7,000 auto accidents, uncovering a statistically significant relationship between descriptions of drivers’ drug use and the severity of accidents. In an article published last year on CarrierManagement.com, “Text-Mining Analysis Links Drug-Impaired Driving to Higher Injury Rates” (carriermag.com/ ekgt5), Borba discusses the process Milliman used to turn unstructured text strings from claims adjusters’ notes into

structured data for analysis, which he believes can be used for hundreds of thousands of accident records.

carriermag.com/fq27z

(Related podcasts are available on the Carrier Management channel of www.insurancejournal.tv: “Drug-Impaired Driving & Auto Insurance Severity” and “Text-Mining, Drug-Impaired Driving & Auto Insurance Severity”: Milliman Analysis.)

Winter 2014 | 23


Technology & Analytics Designing a

UBI PROGRAM

to Fit Your Business Strategy Executive Summary: Usage-based insurance for auto is not a “one size fits all” solution. Each insurer must design a UBI program specifically geared toward its problems to maximize return on investment and probability of success.

U

By Jim Weiss

provide a useful road map, informing the business decisions necessary to make money on UBI. In this article we’ll examine three case studies of hypothetical insurers that exhibit a common symptom—combined ratio deterioration—ostensibly treatable by UBI. While the symptom is the same, the underlying problem varies by insurer: • Underdog Assurance is a single-state writer that is growing rapidly and unprofitably. • Midsize Mutual is a well-established regional whose business is shrinking as policyholders flock to competitors with UBI. • Ubiquitous Insurance Co. (Ubico), a national writer that reached its growth potential, now seeks new revenue streams. By designing UBI programs specifically geared toward its problems, each insurer can maximize ROI and probability of success.

sage-based insurance (UBI) for auto is often presented as a “one size fits all” solution to insurers’ business problems. Tiny telematics devices that can be installed in policyholders’ vehicles have great potential for areas such as pricing, loss control and customer service. But the idea that a single approach to UBI can solve any problem great or small ignores a simple reality: All insurers are not the same. Every business faces a unique set of issues, and designing a UBI program with the right fit involves careful specification Case 1: Eliminate Unwanted Growth of business objectives. Underdog has recently been the victim The cost of telematics technology of a cruel prank by its competitors, which required to support UBI can significantly have been gifting Underdog exceed other innovations large volumes of unprofitable such as insurance credit business. scoring. Luckily, one metric But what Underdog lacks in from Finance 101 accurately the advanced analytics to describes the success (or identify risky business, it failure) of any capital makes up for in the agility to venture: return on bring new programs to market investment (ROI). quickly and in the expert In a UBI setting, gains arise knowledge of its domicile’s out of loss reduction, reduced regulatory environment. premium leakage and new Jim Weiss, FCAS, MAAA, That gives rise to a revenue streams. Costs CPCU, is Manager of proposed UBI program called include technology, program Personal Automobile “UnderDriven,” which offers a discounts and logistics. Actuarial, ISO Insurance 5 percent premium discount Analyzing each of those Programs and Analytic to any policyholder who factors and their Services at Verisk Analytics. agrees to install a telematics interdependencies can

24 | Winter 2014

device and report monthly mileage over a one-year period. Underdog plans to require all new customers to enroll in the program. Universal UBI is unconventional, but Underdog believes regulators, looking to get tough on premium fraud, will receive it favorably. Underdog also cites recent surveys showing that 89 percent of consumers would be open to UBI if their premiums would not increase. (For more on the survey, see related CM online article, “University Researchers Question RouteTracking Potential of UBI Devices.”) Let’s delve into the economics of the proposal. Insurers typically front the costs of telematics, and the cost of devices that merely record and communicate odometer readings should be relatively minimal. For example, estimate $50 per device for hardware and $2 per month for wireless data transmissions. Assuming a three-year

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useful life for the devices (that is, each unit can be deployed for one year each in three different vehicles before it goes kaput), technology costs represent approximately 2.5 percent of premiums collected from the UnderDriven book. (In developing these estimates, average annual premiums per vehicle before UBI discounts are assumed to be consistent with recent industry averages. UBI premiums refer to those collected from enrolled policyholders, before discounts, between the device installation period and the eventual discontinuation of the program, which is assumed to continue throughout the service lives of the technology.) On the surface, spending on technology simply to offer discounts doesn’t seem like an advisable recommendation. However, Verisk Insurance Solutions estimates that more than $3 billion in auto premiums are lost each year because of mileage rating errors, which is about 2 percent of industry premiums. (Source: June 11, 2012 press release, “QPC Mileage Calculator Provides Auto Insurers with Real-Time Estimates of Annual Miles Driven”) Underdog believes its own recoveries will be closer to 5 percent of premiums through use of authenticated mileage. Beyond reducing premium leakage, Underdog notes that in the fleet sector,

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Multiband Corp. estimated “the psychological effect of monitoring” to be a robust 16 percent reduction in accidents. (Source: “Managing Driver Behavior with Fleet Telematics,” Sept. 25, 2012, http://analysis.telematicsupdate.com) If UnderDriven can replicate even a quarter of those improvements through the temporary installation of in-vehicle technology, then gains will outpace technology costs and premium discounts. It’s questionable how much behavioral improvement could be effected by only monitoring mileage, but even without applying any analytics to the telematics data, and with minimal technological spending, Underdog has the ability to legitimize steps to address its unprofitable growth problem through UBI.

Case 2: Turn Policyholders Into Risk Managers

Midsize Mutual has cultivated profitability and loyalty over the years through a combination of accurate pricing and a commitment to customer service. However, recently it has seen preferred risks departing for the allure of UBI discounts, and combined ratios are creeping up. Rather than fundamentally changing its strategy, Midsize decides to leverage the power of telematics to build on its core competencies. Management believes that policyholders who demonstrate safe driving patterns should be able to earn substantial discounts, and those who don’t should be given feedback and the opportunity to improve their safety record. Midsize has the analytics and the relationships to deliver on both fronts. The result of Midsize’s internal business analysis is a proposal it calls “Daylight Savings,” which involves offering any interested policyholders premium discounts between 5 and 25 percent for operating their vehicles during less risky times of day over a one-year period, as demonstrated using telematics. The estimated average discount would be 10 percent. Midsize’s technological spending per

vehicle will exceed that of Underdog’s program because it requires a greater level of data collection. Assume the technology necessary to support Daylight Savings costs $75 per device and $3 per month in wireless—that will consume approximately 4 percent of UBI premiums collected. Best-case scenarios for UBI have shown accident reductions significant enough to cover both discounts and technology costs under Daylight Savings. The Automobile Association of America (AAA) estimates that the risk of deadly accidents doubles at night for youthful operators. (Source: “AAA Analysis Finds Seven of Top Ten Deadliest Days for Teens Occur During Summer Months,” June 11, 2011, http://newsroom.aaa.com) Recognizing that, a U.K.-based insurer once offered discounts similar to Midsize’s to youthful operators—a traditionally highrisk group—for staying off the roads during riskier times of day and was able to effect a 20 percent reduction in accidents. However, the technology was costlier at that time, and the insurer eventually discontinued the program. Telematics is less expensive now, but to avoid a comparable fate, Midsize should consider incorporating cost-cutting measures where possible. For example, an observation period of less than one year would stretch the technological investment by allowing devices to be redeployed in several different vehicles. However, reducing the length of monitoring might curtail loss reductions and defeat the purpose of the initiative. The company may wish to experiment with a more conservative discount plan instead.

Case 3: Change the Game

Ubico has earned its place as an industry leader through best-in-class analytics and an aggressive countrywide growth strategy. But the well of potential policyholders has begun to “tap out,” and Ubico’s heavy acquisition expenses are starting to take a toll on combined ratios. After some soul searching, management

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Winter 2014 | 25


Technology & Analytics continued from page 25 Smartphone data would be insufficient to support UnderDriven (which requires odometer interaction) or Daylight Savings (which policyholders could outsmart by powering off during risky hours of driving), but UberRoads doesn’t require data sufficient to support insurance rating.

“One Size Fits All” Revisited

The bar graph illustrates the ROI trade-offs of each proposed UBI program. The right-hand bar for each company represents program costs, while the left-hand bar represents best-case gains under the program. More ambitious implementations such as Midsize’s Daylight Savings and Ubico’s UberRoads present greater advantages but also carry greater technology costs. decides to revert to the entrepreneurial culture that got the company where it is today and to create a new revenue stream using telematics. Under its proposed “UberRoads” program, Ubico plans to offer policyholders one year of value-added services, such as roadside assistance and access to an online portal where they can view their driving habits and seamlessly post routes and locations to social media. Ubico believes consumers will pay $8 per month for those services, meaning UberRoads customers would generate new income equivalent to approximately 6 percent of their UBI premiums. However, Ubico requires even more sophisticated devices than Underdog or Midsize, costing $100 per unit and $5 per month for wireless. Even excluding discounts, those costs will almost completely negate new revenues. UberRoads could conceivably produce loss reductions, although it lacks the

26 | Winter 2014

“psychological impact” of UnderDriven or the robust incentives of Daylight Savings. The Monash University Accident Research Center, for example, estimated that access to automated crash notification reduced accident fatalities 11 percent. (Source: “The potential for automatic crash notifications to reduce road fatalities,” www.ncbi.nlm. nih.gov/pubmed/19026225) If roadside assistance can effect improvements even by a fraction of that number, it will move UberRoads toward profitability—and save lives. There are various ways to further improve the ROI prospects of the proposed program. For example, smartphones contain many of the same technological components as the dedicated telematics devices used in many UBI programs. Ubico could eliminate hardware costs from the equation by developing a smartphone application to collect the information required for the portals.

Figure 1 compares the expected discounts and technological spending of each insurer along with the expected loss reductions and new revenues (if any) created. All seem to present reasonable prospects for positive ROI. (Note that there are many costs besides technology associated with setting up a UBI program that, for simplicity, are not considered in this article. One such cost is securing appropriate intellectual property protections on proprietary systems and methods used in rating.) Midsize and Ubico lack the agility and niche dominion to steer all new business toward UBI with a flat, judgmental discount, as available through UnderDriven. Similarly, Underdog and Midsize lack the capital and R&D teams to launch a high-stakes risk management platform such as UberRoads. Finally, Underdog and Ubico lack the local relationships and perseverance of Midsize to effect best results under Daylight Savings. Each insurer can learn from its competitors. Investing in more capable technology may allow Underdog to perform more in-depth analytics, stretching the investment and leaving options open for the future. Midsize should not rule out simple defensive measures such as Underdog’s on analytical principle or declare vehicle services beyond its capabilities. And Ubico shouldn’t necessarily be so quick to eulogize its core revenue growth. Each company’s options with UBI are virtually unlimited. But with an increasing number of insurers deeming UBI financially viable, the one option companies may not be able to afford—if they are to avoid adverse selection and keep pace with the competition—is to do carriermag.com/b4ngm nothing at all.

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Technology & Analytics

Avoiding the Pitfalls

and Pratfalls of a UBI Product Launch

A

Insights | September 2013 Insights | September 2013

Executive Summary: Towers Watson’s Robin ny usage-based insurance (UBI) of telematics devices into cars and Harbage outlines concrete actions for the product launch is vulnerable to gathering data. successful rollout of a usage-based auto common reversals that can slow We highly encourage some testing to Auto Insurance insurance product launch, suggesting that Decommoditizing or even derail the project. Some “Consumers learnwant about value-added telematics devices and services, Decommoditizing Auto Insurance “Consumers services, which which want value-added insurers collect data beyond the one or twoThe demandsimply cause delays, while others have cost socialize the telematics process within an to fordemand value-added services presents anpresents The for value-added services an presents an opportunity for auto insurers presents an opportunity for auto insurers to opportunitythe for insurance companies to decommoditize opportunity forsignificant insurance companies to decommoditize predictive elements identified by a telematics clients real-dollar outlays insurer. However, with several hundred their auto insurance incorporating valuedecommoditize their offerings.” their autoproducts. insuranceBy products. By incorporating valuedecommoditize their offerings.” service provider. He highlights the need foradded service and opportunities. telematics vendors in North America into their offering, insurance added service into their offering,companies insurance companies can cater their value proposition to theinsurers specific needs cater their value proposition to the specific input and buy-in from all affected operational canSince many other will be needs offering a wide variety of products and to approximately 80% for the80% broader population. In to approximately for the broader population. In of their target market. If this is done effectively, of their target market. If this is done it effectively, it areas of the insurer and the potential to could lead following down this road, it may be addition, our survey found that 81% ofthat parents that services, using this as a fundamental addition, our survey found 81% of parents that to greater new business growth and higher could lead to greater new business growth and higher in UBI are willing to for value-added areapproach interested into UBIexploring arepay willing toUBI pay for value-added decommoditize insurance offerings with valuevaluable to share a few of the most are interested will lead to a renewal retention. renewal retention. services, which compares 72% of the broader services, which to compares to 72% of the broader added services made possible by telematics. common issues we’ve seenpopulation.population. long tedious process with For example, parents areparents a high-potential Forconcerned example,recurring concerned are a high-potential Only 6.9%and of parents not want any Only 6.9% would of parents would not no wantguarantee any market for during insurers offering UBIoffering programs. market for insurers UBI Many programs. safety services their children, anchildren, unsurprisingly safety services for their an unsurprisingly Towers Watson’s work onMany nearly 40 offorsuccess. value-addedvalue-added services, such as automatic services, such as emergency automatic emergency low number.low Bynumber. bundlingBy safety services with their with their bundling safety services By Robin Harbage product launches. Unfortunately, we’ve met with insurers response, are related are to increasing Interest in Interest response, related to safety. increasing safety. in offering, insurance can increase their value offering,companies insurance companies can increase their value these safety services spikes safety services spikes parents propositionproposition and offerhave a and highly differentiated product to product to offer a highly differentiated these Topping theamong list isparents a among problem we call that spent several (Figure 2b).(Figure Interest2b). in automatic Interest in emergency automatic emergency concerned parents. concerned parents. “widget paralysis”—the decision by an years testing telematics response among parents is above 90%, compared response among parents is above 90%, compared insurer to explore UBI by installing a series devices and still haven’t found the right technology. of parents that are interested Figure 2a. Percentage of respondents that are that are Figure 2b. Percentage Figure 2b. Percentage of parents that are interested Figure 2a. Percentage of respondents The key question is: Right in teen safety services interested interested in value-added services services in teen safety services in value-added Ordered by interest Ordered by interest Ordered by interest Ordered by interest for what? 0% 20% 40% 60% 80% 100% 40% 60% 20% 0% 80% 0% Towers 20% 40% 60% 100% 40% 60% 20% 0% 80% 100% Watson suggests a 80% 100% firstdispatch step is todispatch begin with an trackingtheft tracking Vehicle theft Vehicle Automatic emergency Automatic emergency 83 91 83 91 understanding of the critical Automated emergency Automatedcall emergency call Accident notification Accident notification business problems you 82 82 91 91 Robin Harbage specializes hope to solve with UBI, and Vehicle wellness reports Vehicle wellness reports Safe-driving notification Safe-driving notification 79 79 then formulate your 91 91 in UBI for Towers Watson’s Breakdown notification Breakdownservice notification service P/C risk consulting and strategy to solve those Lower premiums with safer driving Lower premiums with safer driving 78 78 90 90 software practice. Harbage problems. A sound strategy Fuel-efficiency tips Fuel-efficiency tips Driver coaching tools Driver coaching tools brand and can be reached at that fits your 75 75 89 89 robin.harbage@ value proposition offers you Navigation Navigation Vehicle location notification notification 59 Vehicle 59 thelocation clarity to focus on the 86 towerswatson.com. 86 Real-time driver feedback Real-time driver feedback telematics technology that 58 58 Safe-driving incentives iTunes (e.g., voucher) Safe-driving(e.g., incentives iTunes voucher) 86 complements your plan. 86 Safe-driving tips Safe-driving tips 55 55 gamification Ofsafe course, it can still take a considerable Social gamification of driving Social of safe driving 77 77 Journey logs Journey logs period of time to review the capability of 48 48 the many telematics service providers Geo-fencing notifications Geo-fencing notifications (TSPs). A TSP can look great on the surface, 46 46 with a polished website and a capability to Gamification Gamification of driving behavior of driving behavior 24 24 make a few dozen devices operate

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Source: Towers Watson

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9

9

8 3 towerswatson.com 8 3 towerswatson.com

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8

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Technology & Analytics continued from page 27 efficiently for a period of time, but you will need to dig deeper to understand: • Whether the solution offered is automated and scalable. • What data to collect. • Whether data provided are accurate. • Whether the TSP is a capable partner that will advance your UBI program as new technology platforms emerge. A second and related step is to understand how your UBI product’s value proposition will attract and retain customers. Ideally, it will be a value proposition that fits with your brand and corporate identity. Most UBI products initially focus on price and risk segmentation. UBI is ideally suited to address these issues because the lowest-risk drivers select UBI products and vehicle operation data has proven highly predictive of expected loss costs. However, the long-term value will likely go well beyond a simple discount. Leading insurers are beginning to realize that the technology is ideal for offering valueadded services that help engage customers beyond simple price promotion. This will ultimately provide safety services and behavior modification that truly differentiate the insurer and decommoditize auto insurance. In fact, a Towers Watson consumer survey conducted in early 2013 revealed that 72 percent of consumers interested in UBI said they would pay extra for valueadded services, and 60 percent would change their driving behavior if they knew it would make them a safer driver. (See related graph on prior page for list of valueadded services of interest to consumers.) As noted earlier, many of our clients identify the type of UBI data to collect as a third issue. The unfortunate truth is that most approach this question by asking TSPs what data they typically collect and provide from their devices. The limitations to this approach are the almost universal lack of TSP experience in setting insurance rates and the absence of loss cost models to predict expected losses. Many TSPs also have a conflict of interest since they compete largely on price, and

28 | Winter 2014

A first step is to begin with an understanding of the critical business problems you hope to solve with UBI, and then formulate your strategy to solve those problems. A second and related step is to understand how your UBI product’s value proposition will attract and retain customers. the less data transmitted from the vehicle, the lower the TSP program costs. Even if the TSP identifies one or two predictive elements by defining an arbitrary threshold to measure a common vehicle operation, an enormous amount has been invested for a small return by limiting your data collection to these elements. Your database will never serve as a source of research data for defining new vehicle operations and testing those against actual loss costs to determine potential additional predictive power. A recommended best practice Towers Watson has used successfully is to collect precise vehicle movement in as granular a fashion as is practical. We have also solved the issue of data-transfer costs by implementing a lossless data compression algorithm, which reduces the size of the transmitted data to roughly the same size as the simplest event-counter data sets. (Some vendors save data transmission costs by throwing out most of the data. A lossless data compression algorithm preserves all of the data but compresses it for transfer and storage, retaining all of the original detail for subsequent analysis.) Given the significant investment, insurers are well served to collect the data they may ultimately need—not the data they are given by default.

One last issue facing insurers is that they tend to underestimate the complexity of launching a UBI product. This is understandable given the nature of what they hear from many vendors in the telematics field. Insurers are told that the telematics vendor has a simple plugand-play solution. But vendors, unaccustomed to insurance product development, fail to understand that any product launch touches almost every operational area of an insurer and involves many moving parts. A lot of preparation, careful planning and training are needed to ensure a wellconceived product that is nearly flawless for the consumer and reflects well on the insurer. While it makes perfect sense not to overinvest in a pilot product, it is fair to say that a poorly designed product launch of any scale will not only reflect badly on the insurer but ultimately lead to poor perception and an unfair assessment of the acceptability of a UBI product by customers. In initial product launches, it is very acceptable to have some manual processes in place and not to invest in a fully automated IT solution. After all, the final product is likely to be changed and improved based on knowledge gained from the pilot, but it is clearly a weakness to not create a well-documented and comprehensive plan with input and buy-in from all affected operational areas of the insurer, including underwriting, actuarial, customer service, sales, policy administration, marketing, claims and legal. In the initial stages, some areas will be involved to greater and lesser extents, but they clearly need to understand and be ready to participate as needed. Ultimately, it is this coordination under strong leadership that will result in the success of a UBI product—not the technology. Technology will change as improvements are made and costs are brought down. But technology is not product; it is only a tool to provide a product that meets the customers’ needs and fills a niche in an increasingly competitive and innovative market.

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Technology

BYOD:

Benefits and Risks of Personal Mobile Devices in the Insurance Workforce Executive Summary: Timothy Francis of Travelers outlines some of the risk management steps P/C insurance carriers can take to manage risk exposures related to employee use of personal mobile devices.

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By Timothy C. Francis yber crime continues to be among the world’s fastest growing criminal threats. This poses a challenging decision for companies considering adoption of the “bring your own device” (BYOD) trend, where employees use their personal mobile devices such as tablets, phones and laptops to conduct company business. Allowing employees to use personal devices has both benefits and drawbacks, particularly in industries such as insurance where many employees are out in the field and have sensitive information. On the one hand, allowing the use of personal devices for work can be cost effective, efficient and streamline employee access to information. On the other hand, it may create several potential challenges and risks. However, putting a smart risk management strategy in place can help protect against the exposures associated with the BYOD trend.

Driving the Bottom Line

There are a variety of benefits to insurance providers that allow employees

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to use their own devices for work purposes—each of which can help impact the company’s bottom line. Allowing employees to use their personal phones, laptops and tablets eliminates a potential cost to the company. The organization does not need to provide these items to employees who are traveling, or those who regularly attend offsite meetings or even work remotely. The ability to stay connected creates higher productivity and makes it easy to stay on top of work and important issues despite being away from the office. Being able to use personal devices also supports better customer service. Employees and agents alike will be able to respond to client needs in real time.

Escalating Risks & Challenges

The threat of cyber crime is a reality all companies face today—regardless of whether or not an organization has embraced BYOD. Cyber criminals can get through a company’s firewalls, send viruses, and hack into companywide or individual accounts. However, organizations can put certain protections in place to minimize the likelihood of a breach—and monitor those protections closely. With personal devices, companies have much less control over how or where the device is used and lack the oversight that exists with in-office technology. The lack of oversight can translate into

increased likelihood of personal mobile devices being hacked. Typically, insurance companies will require employees to use sophisticated passwords and will ensure any confidential information is also kept secure by password protection and limited access. Employees today are also commonly storing information in their personal cloud to access it from their mobile devices. According to data from network security firm Fortinet, 89 percent of young workers have personal cloud storage. Timothy C. Francis is the Seventy percent of Enterprise Cyber Lead and those individuals use Second Vice President for that storage for workTravelers Bond & Financial related files, and 33 Products. percent store customer data on their personal cloud, allowing them to gain access to it from their mobile devices. (“Fortinet Global Survey Shows Generation Y’s Hardening Stance Against Corporate BYOD/Bring-Your-Own-Cloud Policies As Emerging Technologies Enter the Workplace,” Oct. 21, 2013.) Hacking and viruses aside, an equally damaging threat is simple theft. Roughly 1 in 3 robberies in the United States involves mobile phones, according to the FCC.

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Winter 2014 | 29


Technology continued from page 29 (Source: “U.S. Officials to Meet Over Cellphone Thefts,” by Terry Collins, Associated Press, June 5, 2013.) Laptops and tablets are also frequent targets for criminals. Once a criminal has a physical device, any information contained within it—or available through it—is at risk of exposure. When criminals secure confidential information, it puts the company at risk for not only corporate data and information being exposed but also for clients’ personal information to be compromised or stolen, allowing criminals to potentially commit identity theft.

P/C Executive Viewpoints:

Managing BYOD Risk

Providing best practices for employees who choose to use their own devices can be one way to help manage exposures. Simple steps can go a long way in minimizing risks for hacking and theft, such as enabling auto-lock on devices; adopting passwords that combine letters, numbers and symbols; and ensuring employees keep the devices in a safe place at all times. In addition, requiring employees to engage with the corporate IT department not only can help them understand the exposures their mobile devices present but will also give them the resources they need to put the best possible protections in place. In the event a laptop is stolen, a phone misplaced or an account hacked, cyber risk insurance policies can serve as a safety net. From providing the resources needed to stop and investigate an incident to delivering necessary financial support, cyber risk coverage can help companies minimize both their financial and reputational risks. As BYOD becomes more prevalent, insurance organizations will have to take a stance on the use of personal devices for work-related activities. While BYOD provides both benefits and challenges, insurers should also keep in mind the power of smart, strategic risk management through best practices and relevant carriermag.com/ insurance solutions.

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“Broader MetLife has to worry about espionage and intellectual property protection, as any other large financial institution does. We have a really coordinated effort there.” Kishore Ponnavolu, President of MetLife Auto and Home Photo: Don Pollard

A

By Susanne Sclafane s cyber attackers continue to menace businesses in all industry sectors, property/ casualty insurers are working to provide network security and privacy coverage. But how are insurers managing cyber exposures within their own organizations? Leigh Ann Pusey, president and CEO of the American Insurance Association, posed the question to executives participating on a panel at the Property/Casualty Insurance Joint Industry Forum in January. “We’re rounding up the usual suspects,” said Stuart Henderson, president and CEO of Western National Insurance Group. “We have intrusion protection, [and] we hire somebody from the outside to try to break in.”

Henderson notes that because Western National is a smaller company, some systems are outsourced along with related security processes. Michael Sapnar, president and CEO of Transatlantic Holdings, said his company also hires people to try to hack in. Noting that the reinsurer has international operations and that privacy standards in Europe are very high, he said Transatlantic also encrypts certain claims data. “We have high security levels in terms of who can access it internally. And then you have the basic shut-off,” he said, referring to controversies discussed in all industries surrounding employee use of personal computers that have company information and software on them. “We have software installed that allows us to shut down that PC or that laptop, if it’s stolen,” he said.

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Data Security Strategies

“At the end of the day, one of the most prevalent vulnerabilities is human error. So focusing on social engineering and vulnerability to how employees behave is key.” Peter Hancock, CEO of AIG’s global property/casualty business Photo: Don Pollard Kishore Ponnavolu, president of MetLife Auto and Home, characterized his company’s approach as “more complicated” than the others. “The P/C business is a small division in a much bigger MetLife. Broader MetLife has to worry about…espionage and intellectual property protection, as any other large financial institution does. We have a really coordinated effort there.” Beyond that, MetLife is also watching for “coordinated attacks on financial institutions,” he said, noting that not only are internal resources devoted to the effort but that there is also a great deal of coordination with law enforcement. Peter Hancock, CEO of AIG’s global P/C business, said that like any large company, AIG is “under constant attack, [facing] hundreds of attacks a day.” “Increasingly, the method of

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counteracting it is to let the attack penetrate a certain [amount of the] way so that we learn about the attacker rather than just try to breach it at the first level,” Hancock said. He stressed that “at the end of the day, one of the most prevalent vulnerabilities is human error.” “So focusing on social engineering and vulnerability to how employees behave— and the fact that they don’t follow procedures—is key,” Hancock said. “We’re looking at it from an end-to-end perspective, [with] a combination of the software, the hardware and training people to actually follow procedures. [And we] recognize perfection is impossible. But if you don’t think about [risk management] comprehensively, you’ll overoptimize on one part of it and then you’ll just leave yourself a huge and wide-open door for

somebody to go through,” he concluded. Pusey also asked the executives about take-up rates for network security (cyber) coverages they’re providing to customers. “This is a market we’ve been involved in for over a dozen years, but we haven’t seen a pickup in demand like the last two years. It’s definitely shown excellent growth,” AIG’s Hancock reported. He said AIG saw 30 percent growth in the last year overall, including a 70 percent spike in demand from nontraditional sectors— sectors other than financial services and other “hyper-aware” sectors that had previously understood the risk of cyber breaches. “Prudence suggests that limits remain small until we determine what works and what doesn’t in terms of risk control,” he added, noting that AIG gets roughly 300400 claims under its cyber policies each year. “So each year we learn a bit more about it. But technology is progressing so fast—both in terms of defense as well as offense—that maintaining a sensible risk profile in terms of concentration is important,” he said. Sapnar said his company estimates the U.S. cyber insurance market is $1.6 billion in premium, making it larger than environmental impairment liability, with roughly 40 primary markets participating. “From a reinsurance standpoint, the interesting thing would be a clash cover. If you’ve get somebody like a Target” experiencing a security breach, there will be others that have problems stemming from that breach. “It’s not just Target; it’s a lot of their vendors, their security people, their software people.” On the primary side, Dan Glaser, president and CEO of Marsh & McLennan Cos., said Marsh has seen placements as large as $300 million. “We think market capacity is probably around $400 million, although when you throw business interruption into it, it cuts it in half,” Glaser carriermag.com/k8xpy said.

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Technology

CYBER THREATS TARGETING INSURERS MOUNT Carriers Not Keeping Pace

32 | Winter 2014

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Executive Summary: Even though insurers’ security budgets were at an all-time high in 2013, they still experienced more security incidents than ever before, according to PwC. Here, PwC Partner Joseph Nocera summarizes the characteristics of insurers that lead the pack in thwarting cyber attacks and minimizing their costs. He then outlines a framework for defending against emerging cyber threats, highlighting six new security capabilities for insurers to invest in going forward.

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By Joseph Nocera hile insurers have made significant security improvements, they have not kept pace with today’s determined cyber adversaries. As a result, many rely on yesterday’s security practices to combat the threats of tomorrow. We describe below some of the highlights of PwC’s recent “Global State of Information Security” report, which summarizes key cyber threats for insurers— both life and property/casualty—and the insurance industry’s response to them. Cyber attacks on insurers are nothing new; the industry has been heavily targeted for years. Moreover, information security is an area of focus for insurance regulators, privacy regulation and a variety of auditors. As a result, insurers’ information security budgets are at an all-time high. In 2013, security budgets were 3.6 percent of IT spend, or just over $10 million on average. Yet, at the same time, insurers experienced more security incidents than ever before—5,469 per company on average, up 54 percent from the year before. Likewise, 22 percent of insurers— also more than ever before—did not know exactly how many incidents had occurred. There is good news, however. The average losses from security incidents appear to have dropped significantly and are down 77 percent from the prior year. Insurers are highly connected with their customers, agents and business ecosystem. They employ technology and ubiquitous connectivity to share a huge volume of

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information with customers, agents, suppliers, partners, employees and regulators. Their reliance on sophisticated technologies enables them to perform business tasks with unprecedented speed and efficiency, but it also tempts adversaries who would exploit these technologies and processes to disrupt operations and commit financial fraud. Accordingly, security threats have become a critical business risk for most insurers. Today’s cyber security risks require organizations to treat information security threats as enterprise risk management issues that can critically threaten business objectives. In comparison to other industries, insurers’ security programs tend to focus on regulatory compliance. In fact, 61 percent of insurers identified regulatory compliance as a key driver of their program, in contrast to just 30 percent of all industries. Likewise, the protection of personably identifiable information is vital. Thirtyeight percent of insurers identified this as a security driver in comparison to just 17 percent of respondents in all industries. Interestingly, while cyber attacks by specific nation states receive a great deal of press, insurers said they believe that only 7 percent of their security incidents were the result of nation state attacks. In contrast, a far greater risk for most insurers continues to be the insider threat. For example, 36 percent of insurers identified current employees as the source of a breach. Former employees were identified as the source 26 percent of the time, and trusted business partners/suppliers were identified 22 percent of the time.

Learning From the Leaders

In order to determine how insurance industry leaders approach cyber security, we took a closer look at the data in our survey and performed a regression analysis against it to identify organizations with a lower rate of security incidents and lower average cost per incident. We found that they share a common set of attributes: • They all have an overall information security strategy.

• They all employ a chief information security officer (CISO) or an equivalent who reports to top leadership: the CEO, CFO, COO, CRO or legal counsel. Ninetyfour percent also have a chief privacy officer or equivalent. Joseph Nocera is a Partner • They all have at PwC. Nocera has more measured and reviewed than 14 years of security the effectiveness of their and risk management security measures within experience ranging from IT the past year. auditing to security There are several other systems implementation. areas in which leading Nocera leads PwC’s insurers stand out from information security, IT risk their peers, including: management and IT • 211 percent more likely governance practices for to perform employee the Midwest. background checks. • 89 percent more likely to use behavioral profiling and monitoring solutions (see related text box for explanation of behavioral profiling). • 86 percent more likely to justify security spend by return on investment. • 85 percent more likely to include coordination with third parties in their incident response plans. • 81 percent more likely to conduct penetration tests. • 81 percent more likely to inventory and classify sensitive assets. • 77 percent more likely to involve security

continued on next page Behavioral profiling technology monitors user activity to identify a pattern of activity that may look suspicious either because it matches a known bad pattern or because it does not match the user’s standard pattern of activity. Some examples may include activity originating from known bad IP address ranges or user login hours at nonstandard times (e.g., between 2 a.m. and 5 a.m.) or geographies (e.g., Eastern Europe or Asia when 99 percent of all the user’s activities come from the U.S. Midwest).

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Technology continued from page 33 in technology projects at inception. • 72 percent more likely to utilize patch management solutions. • 71 percent more likely to have processes for cross-border data exchanges. • 70 percent more likely to conduct risk assessment of third parties.

Framework for Response

Based on the results of the survey and our experience with clients, we believe that an effective cyber security strategy starts with an understanding of which assets are most critical to the business and how they flow throughout the organization and broader business ecosystem. Likewise, insurers must understand how various threats—cyber criminals, nation states, hacktivists, trusted insiders—value the insurer’s assets and the specific techniques that each group might use to compromise the insurer’s information. This serves as the foundation of a more informed risk assessment process that can enable the organization to focus its cyber security investments on its most critical assets and the most likely techniques malicious actors may use against the company. Armed with this understanding of the risk landscape, cyber security executives then must engage with business leadership to understand how cyber security can support, protect and enable the organization’s objectives. Then parameters can be set for rationalizing and prioritizing further investments in the program, as well as allocation of resources. Accordingly, we advocate a cyber security approach that is informed by knowledge of threats, assets and adversaries, and that treats security incidents as a critical business risk that may not always be preventable but can be

managed to acceptable levels. Insurers must build upon the foundation security program components (e.g., policies, standards, risk assessments, access management, etc.) they already have established. In order to effectively meet current and future challenges, insurers should enhance their focus on new capabilities, including: • Strategic threat modeling, which analyzes current and potential human and strategic threats to the security of business operations, corporate reputation and sensitive data within the context of the corporate ecosystem and business objectives. • Technical threat intelligence, which collects, analyzes and normalizes system events, technical vulnerability alerts and threat information, and makes data available to other processes in order to create actionable cyber security intelligence. • Proactive breach indicator analysis, which proactively identifies indicators of past or current compromised or nefarious activity. This analysis identifies indicators of intrusion (e.g., extraneous registry entries or unusual system processes) before attackers can infiltrate sensitive information and thereby gives organizations a chance to stop attacks at an earlier stage. It also provides organizations the opportunity to gain and maintain awareness of network and system topologies.

We advocate a cyber

security approach that treats security

incidents as a critical

business risk that may not always be

preventable but can be managed to

acceptable levels.

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• Enhanced monitoring and detection capabilities, which

build upon traditional security operations and monitoring capabilities by creating a toolset that facilitates proactive, heuristic analysis of network traffic and security event logs. This also includes advanced analytics and the use of certain big-data principles to proactively identify security threats in an ever-growing volume of security data. • Enhanced incident response, which can ensure that the plan includes full engagement from key business executives, such as general counsel, corporate risk, marketing and HR, and closer coordination with third parties in the business ecosystem, such as law enforcement, government agencies, outside counsel and Internet service providers. It will be necessary to test the response plan through simulations, table-top exercises and fullscale tests, recording and incorporating any lessons learned. • Insider threat analysis, which combines monitoring, awareness and education programs to protect employees and data assets against human threats. Some of the advanced capabilities described above already exist within many cyber security organizations. However, based on our experience, most insurers need to further invest in and develop these capabilities in order to respond to today’s rapidly changing threat landscape. The risks of tomorrow, which are likely to be even more pernicious than current ones, will demand greater information security programs. Insurers will need to be diligent, aware of potential new threats and have the proper people, processes and culture in place to maintain and enhance carriermag.com/xj75k cyber security.

Joe Calandro, Managing Director at PwC, also contributed to this article.

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Technology

What Makes a Successful P/C Carrier CIO and How to Know If You Have One

Executive Summary: In today’s ultra-competitive P/C marketplace, CIOs need to be more than just technical wizards, says X by 2’s Frank Petersmark.

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By Frank Petersmark riumphant Mutual and Victorious Insurance Co. seem like two peas in a pod. They’re similarly sized property/casualty insurers that write personal lines and small-business insurance. But take a closer look. Victorious is growing while Triumphant stagnates. Agents and customers are leaving Triumphant because its website is dated and doesn’t allow self-service. In addition, its phone reps don’t have client information at their fingertips. What’s the difference? Victorious Insurance has a CIO who knows how to leverage technology and process for competitive advantage. Triumphant Mutual doesn’t. In today’s ultra-competitive P/C marketplace, CIOs who know how to help their company achieve competitive advantage are worth their weight in smartphones. But such CIOs are few and far between, and without them, it becomes difficult for carriers to chart the right course through the turbulent waters of the rapid technological changes that threaten to swamp some carriers. So, how can today’s P/C CIO become a valued

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contributor to, if not leader of, the strategic success of the company? And how do CEOs and boards know if they have the kind of CIO they need to guide their companies to a blissful technological future? Let’s start with the basics. Today’s business realities are shaping the characteristics CIOs need to bring to the table. Among those realities are: • The struggle for revenue and profit. • The need to mitigate financial and market risk. • The continual push for efficiency and expense management. • The ever-increasing demand for IT services and capabilities. • The changing face of the customer, from lowest common denominator to customer of one. • The need to modernize business processes and systems. • Lots of data but little actionable information (data swamps). • Increased governance, compliance and regulatory oversight. • An industry culture of risk aversion. Now let’s combine this with the fact that most IT shops inside P/C insurers have their own set of realities, including: • Lack of a workable/sustainable IT talent acquisition and retention strategy. • No comprehensive data strategy for business

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Frank Petersmark is CIO Advocate at X by 2, a Farmington Hills, Mich.-based technology company specializing in software and data architecture and transformation projects for the insurance industry. He may be reached at Fpetersmark@xby2.com.

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Ultimate success as a CIO will depend mightily on the energy put into really listening to those who need support, guidance and who have issues that need attention. www.carriermanagement.com

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Technology continued from page 36 intelligence, advanced analytics and predictive modeling. • Problematic/antiquated program management processes. • Disjointed systems architecture. • Lack of business involvement and ownership in IT initiatives. And those are just the short lists. Today’s CIOs need to acknowledge the reality they find themselves in and understand that they will not be able to control everything—either inside or outside their IT shops. The ability to come to terms with this will allow them to focus their attention on a few things that really matter. Implicit in this admission is the CIO characteristic of valuing learning over controlling—by hiring people they can learn something from and who can independently execute the corporate and IT mission. The second characteristic every successful CIO possesses is the ability to create, sustain and enhance key relationships over time. This is much easier said than done, as relationship building doesn’t always come naturally to CIOs. CIOs, like most IT people, are analysts and problem solvers at their core, and the mistake many CIOs make is to treat relationship building like a problem that needs to be solved. It’s not a problem; it’s a skill, and a critical one at that. It’s important for CIOs to remember that there are no shortcuts to building relationships with peers, staffs and bosses. The key is to build them a layer at a time and to base them on mutual respect for what each other does. If a CIO is having some difficulty with a business colleague, it’s a pretty good bet that the CIO hasn’t invested the time required to establish and build the relationship. Next, CIOs have to evolve into consummate communicators. This doesn’t mean the constant recitation of status reports, service-level metrics and budget targets. Rather, successful CIOs have learned to communicate in the language of the organization, leaving the technical jargon in their offices to be used only with their own staff. However, the most effective CIOs

38 | Winter 2014

understand that communication is a twosided coin and that the most important thing about communicating isn’t the talking part—it’s the listening part. There’s an old adage about learning more from listening than from speaking, and that is especially true for today’s CIO. Ultimate success as a CIO will depend mightily on the energy put into really listening to those who need support, guidance and who have issues that need attention. It’s critically important for CIOs to listen, process and effectively communicate what they can and cannot do. Another crucial characteristic for today’s CIOs is to have “double vision.” And it’s not the kind of double vision that occurs when you’ve misplaced your glasses or had one too many martinis. Nor is it the kind of vision usually associated with corporate strategic planning, although that is an element of it. Double vision here is something closer to the ground. It’s the ability not to be mesmerized by every “next big thing” but to instead be focused in one eye on only those next big things that have the potential to create a beneficial intersection with the organization’s strategic goals and objectives. That’s double vision, and it’s not easy. A good example of this is infrastructure and application virtualization, which first gained popularity several years ago. Many organizations leveraged the technology as a way to manage and reduce infrastructure costs—think avoiding costly hardware refreshes and the software licensing woes that go along with it. That was fine, but for CIOs with double vision it became an opportunity to rethink the way applications were delivered to employees and customers, test the waters in a secure way with bring-your-own devices, and create a bridge between legacy platforms and native Web-based applications and services. CIOs also need to be comfortable with disruption, and in some cases to even be the disruptor. Being comfortable with disruption starts with asking the tough questions, which are usually the simplest questions. Never underestimate the power

of a simple question at just the right time: Why are we doing this? What is the benefit? What could we do differently? The key point is to become comfortable with disruption because innovation and clarity often come out of the chaos that follows. As counterintuitive as it sounds, it is nevertheless true—successful CIOs tend to ask more questions than they answer. The best CIOs understand that it’s not their job to answer everybody’s questions but to instead have the ability to ask the kinds of questions that lead others to the best answers for the organization. Technological and process disruption are going to occur no matter what a CIO does. So the key question that all successful CIOs must answer is whether they want to be the disruptor or the disruptee. Finally, the most successful CIOs have learned that success is dependent on understanding that the ‘I’ in CIO stands for much more than just information. It also stands for such things as innovator, instigator, imaginer, inspirer, inquisitor, invigorator and insurer. Today’s most successful CIOs tend to be sums of many parts, as it’s no longer enough just to be the kind of CIO who is good at keeping the trains running on the tracks. While by no means an exhaustive list, the above characteristics are part of what constitutes today’s most successful CIOs. It’s not an accident that these characteristics have little to do with technology itself or being a technical wizard of some sort. If you’re a CIO and don’t recognize some of these characteristics in yourself, fear not, for these all can be learned with practice. Consider getting a little coaching; it can be a game-changer. On the other hand, if you’re a colleague of a CIO and don’t recognize any of these characteristics in him or her, it might be time to start asking a few of those simple but powerful questions listed previously. No matter what, the most successful CIOs have learned not to take themselves and their roles too seriously, and to even have a carriermag.com/ little fun with it.

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Exclusively on CarrierManagement.com More articles on topics featured in this print edition, along with articles on additional management topics, are available on our website, CarrierManagement.com, including these:

MORE ON TECHNOLOGY & ANALYTICS Investment in Mobile Agent Tech Lags as Carriers Focus on Gen Y

By Pat Speer and Stephen Applebaum Executive Summary: Analysts at Aite Group reveal what they see as the top three technology-related trends in P/C insurance for 2014, including carrier moves to win over Gen Y customers with mobile apps. The lack of investment in mobile technology for intermediate customers—captive and independent agents—may force carriers to recalibrate the Gen Y strategies going forward, they say. carriermag.com/u3ejb

MORE ON TALENT MANAGEMENT

RLI Takes LEAD on Succession Planning With Formal Talent Program Executive Summary: RLI COO Michael Stone describes his company’s internal initiative to develop future leaders. carriermag.com/svwyt

MORE ON OPERATIONS

What It Takes to Be a P/C Insurer COO: Executive Recruiter Views Executive Summary: Executive placement experts Gregory Jacobson and Erin Hamrick discuss the qualities they look for when placing COOs at property/casualty insurance companies. carriermag.com/48kfr

MORE ON LEADERSHIP

Everything You Always Wanted to Know About Knitting and Gender Bias in the Insurance Industry By Karen Morris Executive Summary: Innovation consultant Karen Morris stitches together clues that reveal her own unconscious gender bias and explains why the “stick to your knitting” axiom should not apply to insurance industry leadership. The industry’s future resilience and power to innovate cry out for a rich and varied fabric of talent, as well as a broad array of leadership models, she says. carriermag.com/an8mc

From Lawyer to Carrier CEO: Charting a Career Course Executive Summary: Pacific Specialty CEO Brian Cohen describes his unusual career path from accountant and lawyer to the C-suite of the California-based specialty personal lines insurer. carriermag.com/gusk4

Endurance Building ‘Relevance’ Through Leadership Changes, CFO Says Executive Summary: Endurance Specialty is gaining relevance in the specialty insurance market as it adds new underwriter leaders, some specifically tapped by CEO John Charman and others attracted to the underwriting culture Charman is building, CFO Michael McGuire says. carriermag.com/vitdq

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Winter 2014

Cultural Change Emerging at QBE NA, CEO Duclos Says Executive Summary: During a December conference call on which QBE executives described details of an expected bottom-line loss of $250 million for 2013, Dave Duclos, CEO of the North American operations, said cultural changes are emerging to right the ship. Duclos spoke about a developing culture of transparency, an operational redesign and plans to diversify the underwriting portfolio. carriermag.com/rx2jc

MORE ON REINSURANCE

Reinsurer Downgrades Ahead, S&P Says; A.M. Best Says Sector Stable Executive Summary: Almost half of the global reinsurers rated by Standard & Poor’s are “materially exposed” to competitive pressures, the rating agency said in a January report, warning of negative rating actions to come for some. Stuart Shipperlee, analytical partner for Litmus Analytics, reviews S&P’s new rating method and takes some guesses about the potential downgrades. carriermag.com/pgesv

MORE ON RISK

21 Insurers, Brokers Launch Oasis ‘Open Source’ Cat Model By Charles E. Boyle, Insurance Journal Executive Summary: Oasis Loss Modeling Framework unveiled what it says is “the most significant development in the modeling of natural catastrophe losses for 20 years”—the launch of an independent, global, open framework for use by any party interested in creating a cat model. carriermag.com/qjdw2

Flooding and Flood Models Explained By Karen Clark, Karen Clark & Co. Executive Summary: Catastrophe risk expert Karen Clark explains different types of floods and contrasts the challenges of modeling storm surge and inland flooding. Catastrophe modeling for storm surge associated with hurricanes is straightforward, although detailed data is required. By contrast, a lack of data and the absence of a predictable occurrence pattern suggest that scenario-based approaches will provide more meaningful results for inland flood risk. carriermag.com/gybnh

Can We Fix Earthquake Insurance in California? By Bill Churney, AIR Worldwide Executive Summary: For a California earthquake that causes $20 billion of residential property damage, insurance recoveries would amount to less than $2 billion, according to AIR Worldwide. The low level of coverage is “a systemic failure,” writes AIR COO Bill Churney, who argues that models now are more adequate for risk assessment than in 1994 when Northridge occurred. carriermag.com/ui4s6

Winter 2014 | 39


Operations

Making P/C Operations Work:

40 | Winter 2014

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From Calm Multitaskers to Maniacs With a Passion

www.carriermanagement.com

Winter 2014 | 41


Operations

T

By Susanne Sclafane

See related online article, “What It Takes to Be a P/C Insurer COO: Executive Recruiters’ Views,” for more perspectives from Hamrick and Jacobson at carriermag.com/48kfr.

42 | Winter 2014

he leaders of operations at property/casualty insurance companies carry various titles and have a wide range of responsibilities—they are so different, in fact, that even industry executive placement experts have a hard time defining this category of professionals. Erin Hamrick, a partner with Sterling James, a New York-based insurance industry executive search firm, attempts one categorization—putting operations

executives in two buckets. “In organizations where you have a CEO who is ‘Mr. External,’” then complementing that CEO may be a chief operating officer, or “Mr. Internal”—someone who “will almost be a de facto president.” That type of operating officer may have the business units reporting to him or her but not the back office, Hamrick says. In a second company model, the operations leaders run shared-services teams, commanding all the back-office

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functions. “They can actually have HR, technology and sometimes finance reporting to them. So they're running the internal workings of the insurance company.” The second group is the one that sometimes carries the title chief operations officer, she agrees. But some P/C insurance organizations have neither a chief operating officer nor a chief operations officer, instead relying on the CEO to fill the role. “Whether or not you need two separate and distinct people depends largely on the size of the organization, the complexity of the organization and the maturity of the organization,” says Greg Jacobson, co-chief

executive of the Jacobson Group, a provider of insurance talent based in Chicago. Delving deeper into the subject, Hamrick and Jacobson repeatedly respond to questions about the qualities to look for in an operations leader by saying that “there is no blanket answer” or that “it’s very dependent” on the organization. “There really are no two COOs alike in the insurance industry. It depends on the class of business, the mix of business, the size of the organization and the personality of the CEO,” says Jacobson. The variations in the roles and the people who fill them come through clearly in our interviews with the two placement professionals and with five executives who

actually fill the operational leadership roles in their companies. In the profiles that follow on pages 46-61, we ask the leaders to talk about their career paths and their day-to-day responsibilities. In addition, they share their views on three key questions: 1. When does a P/C carrier need an operations leader in the C-suite? 2. What are the most important qualities of an operations officer? (See page 44.) 3. Does a P/C operations leader need a background in insurance? (See related article, “Beyond a Sense of Humor: What Does It Take to Lead P/C Operations?” on carriermag. CarrierManagement.com.)

com/48kfr

Does Your Company Need a COO?

S

ome P/C insurance companies have chief operating officers; some have more than one. Others have chief operations officers. All are C-suite positions. But does every carrier actually need a leader of operations? Leaders offer these views: Michael Crowley, co-Chief Operating Officer, Markel Corp., says: In some companies, it may be that the chief executive officer has all the operational skills that are needed and has surrounded himself or herself with a team that can do pieces of the chief operating officer role. It depends on the talent and the expertise that you have on board, how you structure the company. I don’t think you should get caught up on the CEO role or the COO role. Those are just titles. First, decide what you have to do. You have to set a strategy and execute it. In order to execute it, you’ve got to have a team that understands the underwriting piece, the technology piece, the sales piece, the actuarial piece. And you have to count the dollars. You have a strong finance team that can do that. Those pieces can either be inside the COO role, some of them, or they can be outside of it. They can be outside the

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CEO role. It depends on the individual company and the talent that you have. Sue Harnett, Chief Operating Officer, QBE North America, says: Having a COO

lets other people do what they’re best at. Business leaders should be best at serving customers, growing premium, etc. Let somebody else worry about the day-today—did the policies go out on time, were bills sent out on time, those types of things. Have it focused in another way. You have to create a focus on like things. A chief operating role is someone that is a business partner and is capable of working with business leaders and understanding how the various functions in an operating group can best support the business. Catherine Kalaydjian, Chief Operations

Officer, Endurance Specialty Holdings, says: I personally think it’s a role that’s

important…The right person with the right skill set can drive some real success and real efficiencies within an organization, [while] the business leaders—the CEOs of your businesses—need to be totally focused on building your business. We all know there’s a whole bunch of other things that go on under the surface to support them. Should they really be distracted when they just need to be out

there trying to focus on writing possible business or finding niches? Although companies define operational areas differently, I think having a person dedicated to operations and leading that, if it’s done right, brings synergy to the organization. In some companies, marketing and communications, for example, are left with the underwriters. They’re supposed to be doing deals. They’re not necessarily experts at marketing. They’re not experts at finding new offices. [At some carriers], when the company expands its base, they put an underwriting team in the city, and it is up to the manager of that underwriting team to go out and find real estate, get an office together, put furniture in it, figure out how to buy computers. Here, we manage facilities and real estate under operations. We’ve got a team; we have much more of a corporate plan on real estate. We set global contracts on how we buy furniture; we set standards. The company saves money doing that. There’s a real economic benefit to having an operations officer wear those hats. [At carriers that] don’t do that, you have a lot of individual businesses that start to feel like companies, as opposed to one company with many businesses.

Winter 2014 | 43


WHAT DOES IT TAKE to Lead P/C Operations?

Sue Harnett, COO, QBE North America, says:

“You have to be supportive. You have to be able to deal with ambiguity and complexity. “How do you set a direction and how do you make sure people within the organization feel that they’re supported in the work that they do are two main questions for the COO to deal with. “Understanding processes is important. Understanding financials and key drivers of financials is important. And I would never underestimate the ability to partner with other people in the organization. It’s vital. “You have to be willing to work hard. I think women are very collaborative, which is a good skill for a chief operating officer. “You have to be decisive.”

Michael Stone, COO, RLI Corp., says:

“You have to have the patience to think through problems without being too deliberative. You’ve got to decide— but a little bit of patience goes a long way. “You want to make sure your people understand and feel like you’re in control without being controlling. “People are looking for leadership, and they watch how you behave and how you manage through situations. “It’s how you keep your cool—keep your head while other people are losing theirs.”

44 | Winter 2014

Catherine Kalaydjian, Chief Operations Officer, Endurance Specialty Holdings, says:

“You have to be a good listener to really get past some of the noise. There’s a lot going on. “A lot of people are very impassioned, but you have to be able to be listening and taking in the big picture—and not making decisions that are only going to help one team. “You have to have a very wellrounded understanding of the business. You can’t just be an expert in one area. You need to understand how the whole operation works. “You have to be agile. You have to be able to work on multiple things at once. “Operations leaders also need to be good communicators. The lack of clarity around the area of operations by its very self, I think, concerns people. “You have a lot of people demanding your time. They need you to make decisions. You have to try to make them as fast as possible while staying as informed as you can. “You have to be able to think fast on your feet; you have to try not to get too stressed. And you have to be able to be as even-keeled as you possibly can but be very focused and results-driven. “Insurance professionals who like routines—who need to come to work at the same time and eat lunch at the same time every day—aren’t likely to do well in operations roles. “If all this sounds like too much noise for a person, they would fail at this job. They would actually just drown.”

David Travers, Chief Operations Officer, Farmers Group, says:

“If you’re a person who likes to come to work every day and get out a playbook and say, ‘Here are all the things we’re going to do,’ and then your reduce it to spreadsheets,’ then this wouldn’t be a good job for you. And you probably would find that the team might not be engaged. “You’ve got to like people, and you’ve got to like interacting with people at all levels of the organization. And I thrive on that. “We’re paid to be on our game, to manage relationships, and to do it in a way that gives comfort and security to the people that are counting on us. “It’s a people job.”

Michael Crowley, co-COO, Markel Corp., says:

“You have to have a passion for what you’re doing. I think you need to show passion. If you don’t, then you should be doing something else. “I think you have to be calm under fire, but I don’t think you have to be a calm personality. “Things only get done when you have a maniac with a mission. “I enjoy getting up every day. When I wake up, my feet are moving. I’m ready to go. “There has to be an energy about what you’re doing. You need to energize the team.”

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Operations

So You Want to Be a COO: Career Advice From Operations Executives

F

By Susanne Sclafane or junior-level professionals who see glimpses of their own personalities in the profiles contained in the following pages, the operations leaders offer some words of advice about climbing up to similar C-suite positions. “The way to move ahead is to do the job that you have very well,” says Markel’s co-COO Michael Crowley. “Don't be looking to the next job. If you do the job you have, doors will open for you.” Ultimately, though, Crowley, whose background is on the brokerage side of the business, agrees that it’s important for COO hopefuls to broaden their bases. “Just because I didn't grow up on that [carrier] side doesn't mean somebody shouldn't spend time understanding process, understanding continuous improvement, but also understanding sales and product development and all the other critical things that go into a role at an insurance company. You should be exposed to those things.” Sue Harnett, COO of QBE North America, advises that “understanding processes is important. Understanding financials and key drivers of financials is important. “And I would never underestimate the ability to partner with other people in the organization. It's vital,” she says.

Any special advice for women looking toward a C-suite role in operations?

“You have to be willing to work hard,” Harnett says. “I think women are very collaborative, which is a good skill for a chief operating officer.” Catherine Kalaydjian, chief operations officer at Endurance Specialty Holdings, notes: “Women are much more adept at change management. They're much more

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accustomed to waking up in the morning and having a day go to hell or things just go crazy. They don't get quite so bent out of shape about it. “Whether it's operations or whether it's administration, this is an area of [carrier management teams] where women should search out roles—where they can be managers,” Kalaydjian says. Like Harnett, she also sees women as consensus-builders. “In operations, you're dealing with so many different parts of an organization, different constituents—a procurement person and a PMO [project management] person, a claims person. They’re all very, very different people. A marketing individual is creative; an underwriting operations person is in the weeds and very detailed.” Kalaydjian highlights the value of participating in industry organizations, having spent more than a decade volunteering for the Association of Professional Insurance Women, ultimately serving as president, and also becoming president of the International Association of Claims Professionals.

What about experience in P/C insurance—is that necessary for a future carrier operations officer? Of the group interviewed by

Carrier Management,

only Harnett doesn’t have that background. “I have good, solid business leadership skills. Those can serve you

well in any industry,” says the former executive of Citigroup. “I can go direct movies. The opportunities are almost limitless.” Kalaydjian, whose entire career has been in P/C insurance, doesn’t think it’s a necessary requirement but offers reasons why it may be helpful. “I do believe that you could be probably very accomplished in operations [and] surround yourself with managers who actually know the industry.” Still, there’s something to be said for understanding the business needs of the various P/C areas, she says. “If they're asking you to create something that is so bespoke that it can only be used by them, a good operations person needs to step back and say, ‘Let's go to the 80/20 rule and build it for everybody.’ “You do have an advantage if you come from any role within the industry,” she reasons. Crowley has a similar view. “It would take a special person, and I think they would need to come in and spend a little bit of time in the business before they took on that role. “If you've never sat at an underwriting desk, or if you've never sold an insurance policy, I think it's difficult to understand the dynamics of the business.”

Winter 2014 | 45


Operations

From the Front Lines to the C-Suite: Farmers’ David Travers

Executive Summary: David Travers, the chief operations officer of Farmers Group, explains how his earliest experiences donning a headset and his annual excursions into the Utah back country prepared him for the position he has today. He also explains how a service professional can wrap his head around unfamiliar technology issues by getting IT team members to use backyard barbecue terms and to focus on how IT initiatives help Farmers’ customers.

W

By Susanne Sclafane

For more of Carrier Management’s interview with David Travers, including his thoughts on managing IT projects and a summary of some operational changes that have occurred at Farmers during his tenure, see the online version of this article at: carriermag.com/cmnpb.

46 | Winter 2014

hen he was taking policyholder phone calls as a customer representative for a direct writing carrier 26 years ago, David Travers did not have designs on a position in the C-suite of an agency writer. In fact, the chief operations officer of Farmers Group, who has now carved out a new career path to carrier leadership for countless customer-facing employees to follow, isn’t terribly wrapped up in the chief officer title today. “If you were to spend time here [and] just walk with me [on] the operations floor, or interact with the workforce, you would discover…the culture that we're operating in—and that the title, which might seem really important to some, to me is just a title,” he says. “I would never disrespect it because I know those things really matter in corporate scorekeeping. But as it relates to my career satisfaction, and what really matters to

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me [and] my team, that title is a license to get things done and to be in a position to get things done for the workforce.” Travers counts his early roots working in USAA’s contact center among the experiences that have given him an ability to really connect with the folks he leads on the policy service team at Farmers. When “I look in the eyes of an employee, we can have a conversation that is mutually beneficial. They know I understand the reality of what they're doing,” he says. “I can walk away from that conversation confident that they are comfortable enough with me to tell me what's really going on—what I really need to know.” In a recent interview, Travers explained how the credibility he has gained from his headset-wearing days and the leadership training he’s had from organized classes and from annual excursions into the Utah back country have groomed him for the chief operations officer role he holds today.

Q: Tell us about your background. Travers: I was with USAA for 26 years. I

started my career wearing a headset, talking to customers, and did that for about five years. I worked my way up through the service side of the business. I was in training, in project management roles and then ultimately was senior executive over all nonclaims customer-facing operations. When I came to Farmers, I joined them in a similar role. I was brought here to transform their nonclaims customer-facing operations. At that time we were going to consolidate physical locations, modernize the technology platform. Then fastforward to last year—I became the COO and now have the service operations still reporting to me, and then all the other things that go with the COO role.

Q: In some companies, the COO title refers to chief operating officer, but your title is chief operations officer. Is there a difference between the two roles in your view? Travers: Structurally, it depends on the

company. The COO role can have finance associated with it; it may have more control

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“We’re paid to be on our game—to manage relationships, and to do it in a way that gives comfort and security to the people that are counting on us. It’s a people job.” David Travers, Chief Operations Officer, Farmers Group over some aspects of P&L. At Farmers, this is truly an operations role. I don’t have oversight over finance from the CFO’s perspective. But I have a team that manages the operational finance component, and they interact with the CFO’s team. I manage real estate and fleet and procurement, [as well as] the customer-facing function, which includes in our model both agents and our end customer. I also have [responsibility for] the IT organization. IT, in our world, is a fairly sophisticated place. [We] deploy technology supporting the agents running their small businesses. We also support their technology footprint that’s customer facing so they [customers] can interact with us in a way that complements what the agent is doing.

Q: Did you always want to work in insurance—to wear a headset?

Travers: I can’t say that I always wanted to,

[but] joining USAA was a really good fit. If you walked in their contact centers, you wouldn’t believe you were in a traditional boiler room sort of contact center. USAA is in the relationship business, and they know that. So the kinds of things you’re held accountable for are not how many phone calls did you take and how many seconds did each call last… They’re really focused on why did the customer call, what did you do about it and is the issue resolved. That really shaped my philosophy. So when Farmers approached me about joining the organization, the entire interview process was my belief about what it is we do in contact centers. There was a great deal of alignment in our thinking, [which] made it easy for me to want to join this team, do the kinds of things I had been taught at USAA, and then work to expand that and take it to a new level on a different operating platform—because this is an agency-based organization, and USAA was not.

Q: Can you talk more about your experience at USAA? Travers: When I joined USAA, policy

service was like it was in many organizations—sort of an asterisk to other parts of the business. They weren’t really sure where it belonged. At different times it was part of communications, or it would be attached to underwriting. As I moved up in that organization, I became the first senior executive whose sole responsibility was running the policy service function. The kinds of things I was able to do created a reason to legitimize that role differently in their minds. To be able to take a career from the headset and shape it into something the organization’s investing in, and then have another company look at that and say, “We’d really like to talk to you about what you’re doing there,” has been fun.

continued on next page

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Operations continued from page 47 Q: Do you think other frontline customer representatives can follow a similar career path? Travers: Almost everyone on my team

started as a frontline rep, either here at Farmers or at another company. It gives us credibility when we [interact with] the workforce, knowing that they know we’ve done that job and we understand that job— we understand the complexity of it. And, most important, we respect that job.

Q: What qualities do you think are required to be a chief operations officer? What types of people aren't cut out for the role? Travers: I believe with all my heart that you

should never take this job if you do not like interacting with people. Within my organization, we have a philosophy that says you're really going to be defined by how you treat the “least important” person in the room—putting least important in quotes because everybody in the room is important.

Who Leads the Operations? Chief Operations Officer David Travers Company: Farmers Group Inc. Prior Experience: • 26 years with USAA, starting in an entry-level customer service position and ascending to the position of Senior Vice President of P/C Operations. • Prior positions at Farmers include: Senior Vice President of Service Operations (2006-2010); Executive Vice President of Service Operations (2010-2013).

What has happened during Travers’ tenure? • Consolidation of regional contact centers, started in 2006. • Relocation of Los Angeles headquarters in progress.

What he thinks:

“Within my organization, we have a philosophy that says you’re really going to be defined by how you treat the least important person in the room.”

48 | Winter 2014

We're paid to be on our game—to manage relationships, and to do it in a way that gives comfort and security to the people who are counting on us. It's a people job.

Q: Is there training that can help someone learn some of the skills necessary to be a successful COO? Travers: Certainly there's a level of technical

capability that you need to have. For example, I'm not a real estate expert, but as I got into this role I have put myself in a situation where I'm interacting with real estate professionals and making sure I have a working knowledge of what's happening in that industry and how to think about real estate as it relates to a corporation this size. The same thing with IT. But probably the things that have influenced my success the most have been the leadership training I've had over the years and exposure to really great leaders. You can synthesize different inputs from different great leaders [and] create your own personal brand from that. Working at USAA is a very unique experience because the senior leadership there is comprised of a mix of industry folks and retired military executives. There was a standout guy for me there who was a four-star general when he was on active duty, and then he became president of a P/C company. If you've been a four-star general in the military, [it’s] the kind of role where you could get all caught up in your own ego and importance. [But] I learned more from him about how to be humble and approach the frontline employees with a level of regard and respect, which really took my game to a new level. At Farmers, I’ve had a succession of leaders—starting with Paul Hopkins, who was the CEO when I got here—who are all very integrated into the social fabric of this organization. They do not stand apart from it. They do not run it at arm's length.

Q: You also have what you refer to as a hobby that you believe helps develop leadership skills. Travers: There's a group of us that goes out

to Southern Utah every year, and we go

into the back country, and we go Jeeping and hiking. This is probably my 35th year participating. That is a leadership experience because you put yourself in a situation where you don't really know what's going to happen. You're going to have to make decisions on the fly, and you're going to have to build consensus with a group that doesn't always agree on everything that's going to need to be done. At times, you have very unexpected scenarios happen—complete vehicle failure and you have to figure out how you are going to get out of there, or no cellphone coverage.

Q: You mentioned that you're involved in strategic planning. It’s commonly thought that COOs execute the strategy of the chief executive. Do you see the COO role evolving in the P/C industry? Travers: I would say that it's not unique to

the property/casualty industry. The CEO of this company has got a team that works on strategy. And I report to him. I'm part of that team. I don't think it's realistic for any of us to believe somebody else is responsible for all of the strategy, and then I'll just execute on everything that comes in here. The functions that report to me—the team and the CEO—are counting on me to be thinking about what does the future state need to look like. And one of the things I've learned throughout my career that's an absolute certainty is that the problems we have faced in the past are not going to be the problems we're going to face in the future. Part of my strategy is making sure I've got a team that is learning-agile and that they can basically walk into an empty room, be handed a bunch of problems that they've never seen before, and figure out how to navigate and get it done. That's not just executing on an agreedupon strategy. That is defining, developing and helping evolve the strategy as we go. I really believe that a role at this level demands that. You can't hide from the strategy. You have to participate. You have to be accountable for helping shape it.

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Endurance Specialty’s Catherine Kalaydjian: Thriving With

Executive Summary: Honing her abilities to assess situations and make decisions quickly during a career as a claims professional, Catherine Kalaydjian brings that experience and a prior background in management roles to her new position as chief operations officer of Endurance Specialty Holdings. As the leader of operations, Kalaydjian has been tackling an efficiency mandate handed down from new CEO John Charman in an environment of rapid change and growth since July 2013.

J

By Susanne Sclafane ust six months after John Charman took the reins of Endurance Specialty Holdings in May 2013, he announced to the investor community that the management team had been completely restructured. In addition, he said during a November 2013 conference call that the underwriting culture was being refocused and underwriting talent greatly expanded while total headcount and corporate costs had been slashed. “In short, we’ve been really busy,” he concluded. Odds are that Catherine Kalaydjian was too busy to hear Charman’s remarks.

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Last July, Endurance announced that Kalaydjian would assume the role of chief operations officer, giving her oversight of IT, insurance and reinsurance underwriting operations, procurement, and project management. Those responsibilities came in addition to the ones she had taken on when she accepted the role of chief administration officer just six months earlier—managing HR, marketing, communications and facilities. And that December 2012 promotion had added onto the responsibilities she previously had on her plate for more than five years as chief claims officer. Heralding Kalaydjian’s latest appointment, Charman, who spent his first 60 days in the CEO spot commanding an overhaul of the organizational structure, said: “Endurance will truly differentiate itself over the next five years by achieving one of the lowest operating expense ratios in our industry. Cathy will be instrumental

See related articles at CarrierManagement.com: • ‘Neutral-to-Challenging’ Markets Ahead: Endurance CEO Charman • Endurance Building ‘Relevance’ Through Leadership Changes, CFO Says

in helping us realize that goal.” What has prepared Kalaydjian for such a tall order? The new operations executive, who started in the industry—right out of college—as a claims adjuster and worked her way up into different levels of insurance and reinsurance claims management roles over a 30-plus-year career, says the claims side of the business is an appropriate proving ground for operational leadership. The “talent and art” of good claims analysis lies in having “an ability to assess situations quickly” and to make rapid-fire decisions based on those assessments, Kalaydjian says. “Whether you're on the eve of a trial or making a decision about what a claim is worth, there's no book or manual that gives you those answers. You have to know it in your gut. You have to be able to immediately assess information from a variety of sources, and you [can’t be] afraid to make decisions. “Claims people have to make decisions every single day. It forces you to not be afraid. You have to be willing to fail, and you have to know that you're going to pick

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Winter 2014 | 49


Operations continued from page 49 yourself up and move on.” Her new role as chief operations officer is similar, she says. “It's all about execution, organization, reaching conclusions quickly. You can't think about things for six months. “You have to collaborate with the right people—bring the right people to the table. But at the end of the day, you have to make decisions and accomplish things. In claims, you accomplish something every day,” she says. Sprinkling in some lessons learned from her managerial positions, Kalaydjian adds, “Being in a senior capacity in those roles has really helped me realize that nothing is as complicated as everybody thinks it is, that you can just get to the facts [and] make the right decisions, and that the company will benefit from a more streamlined organizational process.” During a recent interview (excerpted below), Kalaydjian discussed her background and her thoughts on operational leadership generally.

Q: Your college degree was actually in marketing management. Why did you ultimately choose an insurance career? Kalaydjian: I like the idea of marketing. I

like selling things [and] improving things. In addition, I like bringing a lot of enthusiasm to projects. I really believe in that front-facing thing. Going all the way back to my days in college when I was a manager of a McDonald's, I also really like managing things [and] bringing things to conclusion. I like getting things done [and] motivating people. But when I got out of college [in] 1981, I could not find a job in marketing or management. I saw an ad for a job as a claims adjuster, and it came with a car. It sounded like a private investigator, which was intriguing. I never looked back.

Q: Tell us about the organizational structure of Endurance. Also, what services are shared throughout the enterprise? Kalaydjian: We have a shared-service model at Endurance. We went to that

50 | Winter 2014

“When you’re hiring new teams of underwriters, they need to underwrite. They need to be able to produce business. We want to make it as easy for them and as seamless for them as possible.” Catherine Kalaydjian, Chief Operations Officer, Endurance Specialty Holdings many, many years ago because we believed we could get more economies to scale. Instead of having four CFOs, for example, we had one. Instead of having five CIOs of different divisions, we had one. If managed properly, we felt [that] in the ebbs and flows of the business, those shared services could be more efficient with less headcount… Certainly my goal is building toward a very streamlined and efficient operation, where we are really putting all of our focus on our core business. Decisions on how those shared services are going to work and be used within the organization, however, are not made in a vacuum at my level. I may be managing it and I may be the leader of it—[and] I'm making recommendations. But the executive team of our company is

collectively making those decisions together. [And] we have functional leaders running our functions. So the CFO runs finance; I run claims. But I don't just do what's good for claims. I do it as part of understanding what the businesses need and then work to support the businesses. In terms of the organizational structure, what falls under “operations” at our company is a little bit [different] because of who I am. So in some companies maybe claims is not part of operations. HR is in operations today in Endurance, but it will not be in 2014. HR will be run by its own executive as part of the executive team. Underwriting operations is part of operations. This is not the actual underwriting. It's everything once the underwriter underwrites and that information then has to come back into the organization. How is it managed? How is it coded? How do we build the products? How do we build the policy forms? IT in our company is also in operations. IT could report directly to the CEO and the chairman of a company, or in some companies, IT reports are split in two—there's insurance IT and reinsurance IT. I believe that having it as one cohesive group with a leader, who is the CIO, but also working with [the operations leader], allows me to speak for IT in a much better and broader sense and to make technology decisions that are the right platform for the company, as opposed to making the right technology decisions for individual lines of business. At some companies, actuarial is part of operations; it’s not at Endurance. The pricing actuaries are actually part of the business, and reserving actuarial work and the risk management actuarial work is part of the chief risk officer's role and her area of responsibility at our company. Accounting, at Endurance, is also not part of operations. It's part of our finance team. That said, though, as part of

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operations, as part of my role and my team's role, we would be looking for efficiencies in process and procedures around the company. We can facilitate a more streamlined view of how we do our processes within the organization, and that would ultimately affect all of the departments within the company. So, if we can get some economies to scale in efficiencies in finance, or in claims, or in legal, or in any area of the company, operations is looking to do that.

Q: We have been asking operations leaders to describe the most significant operational change of their tenure. But you’re new to the role, so what are you working on? Kalaydjian: We really have gone through a

lot of transition [in 2013]. The primary focus initially was IT—making sure we have the right structure within our IT operation to support our business growth going forward. While we did bring in a new CIO, last May, he was relatively new at his job. My number-one focus when I took over was to work with him very closely for at least a month and help him land on his organizational structure and bring in those gaps in leadership that he needed to be successful. We've accomplished that with all of his new direct reports. [My next area of focus involves] putting more parameters around our project management work and making sure we've got toolsets to actually report on projects consistently. My head of project management had already started to put that together, and we were able to roll that out as a first look for the executive team— something they have never been able to see before, all the timelines for the projects. [Another] focus is on our real estate and facilities because we are in the course of opening our new corporate headquarters in the spring of 2014, [and we’re in the midst of] a new office move outside of New York City for our IT and finance and other members of our team. We needed to open a new office in Atlanta for our growth in our underwriting, a new office in New Jersey

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and to manage a relocation in Chicago. The largest [task] right now is really underwriting operations. What is that supposed to be? Where are there gaps? Do we have any weak areas in supporting the businesses? And then identifying what those are. Are there areas where we could potentially reorganize to make ourselves more supportive? Do we have any gaps with our technology to support some of the businesses? Did we have the right training tools in place for the underwriting businesses? Are we able to roll out new products quickly? Again, these are not solely my responsibility. It’s a collaborative effort. But I wanted to focus on areas where I thought we needed to shore up resources or move some people to different places so we could get things done as quickly as possible—because when you're hiring new teams of underwriters, they need to underwrite. They need to be able to produce business. We want to make it as easy for them and as seamless for them as possible. Instead of focusing on all the things that were working really well, I needed to focus on the things where the demand potentially outstripped the resources or where we didn't have the tools to support them, and to try to quickly see what we could do to help the [new] businesses get up and running. There are some other things I've been working on as well, but they weren't as mission critical as making sure our underwriters that are joining the company are coming in and very quickly having the tools they need to underwrite the business—being able to issue policies, being able to be out in the marketplace marketing the business and the company.

Q: Among your new areas of responsibility is the Project Management Office. Kalaydjian: At any given moment, we could have anywhere from seven to 15 projects happening. We have some significant projects that

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Who Leads the Operations? Chief Operations Officer Catherine Kalaydjian Company: Endurance Specialty

Holdings

Prior Experience:

• Before joining Endurance in 2003, Kalaydjian served in senior claims and administrative roles covering a range of reinsurance and direct property/ casualty lines, including Senior Vice President, Head of Claims for QBE the Americas and Senior Claims Officer for Resolute Management Corp. • Prior roles at Endurance include: Senior Vice President, Head of Claims for the U.S. reinsurance operations (2003-2007); Chief Claims Officer (2007-present); Chief Administrative Officer (2012-present).

What’s going on?

• John Charman became CEO in May 2013 and quickly restructured the management team. Charman also set his sights on hiring new teams of specialty underwriters throughout the global organization while creating efficiencies and slashing corporate costs. • Ongoing projects involving physical locations include the opening of a new corporate headquarters in the spring of 2014, as well as setting up new offices in Atlanta and New Jersey and office moves in New York City and Chicago. • Other significant projects include a large transformational claims project, the ongoing rollout of Endurance’s policy-issuing system to new lines of business and a straight-through processing finance project.

What she thinks:

“Claims people have to make decisions every single day. It forces you to not be afraid. You have to be willing to fail, and you have to know that you’re going to pick yourself up and move on.”

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Operations continued from page 51 are underway and also part of our 2014 budget. For example, we are going to be doing a large transformational claims project and putting in a brand-new claims system at the company for the first time since our inception in 2001. We are continuing to roll out our policyissuing system to new lines of business that we are planning on doing at the company…Also, currently, we have a straight-through processing project happening. That is really a finance project that allows our clients and customers and brokers to report to us electronically and then have the receipt of premiums and cash application happen automatically to the system.

Q: In your opinion, what are some of the qualities that make a good chief operations officer? Kalaydjian: A lot of people overengineer

operations. I think if you look at things very simply, you will get to your answers much quicker and they'll be better answers. If you overengineer it, it will look great and you'll have a great presentation, but you'll never get to a conclusion. If that's your personality—to be very, very detail-oriented and very meticulous, I think you also will fail as an operations person [because] you won't have the adaptability to be successful.

All in the Family For Catherine Kalaydjian, chief operations officer of Endurance Specialty Holdings, schedules of meetings and appointments in the office can be so hectic that she often doesn’t find a lot of quiet time to think through the operational problems she needs to tackle. “I have to do that at night or at home on the weekend—or in the car driving into the city with my husband.” Kalaydjian’s husband, she reveals, also works in the insurance industry—in operations as well. “He works at AIG, and he’s been invaluable to me,” she says. “I’ve been able to get some of the acronyms defined, or I’ve been able to say, ‘Hey, this is what I’m seeing and feeling. Is it typical? Is this unique to Endurance? Is it how big companies run their operations?’” Kalaydjian notes that the two don’t

discuss deals that are happening within their individual companies. “We don’t share management discussions. It’s more theoretical…It’s more about organizational structure or understanding how was IT structured in this part of AIG or how other operations are structured at carriers. “This isn’t confidential information. It’s more best practices. It’s just like reading in a magazine, trying to understand industry information.” During our recent interview, Carrier Management asked Kalaydjian what types of resources are available for someone new to operations to learn about the role. “There’s a lot on the Web, and resources like E&Y, PwC and Deloitte as well. We work with these [consulting] companies,” she says, characterizing her discussions with her life partner as similar to these best practices guides.

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(For more of Kalaydjian’s views, see related article, “What Does It Take to Lead P/C Operations?” page 44.)

52 | Winter 2014

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Operations Markel’s Michael Crowley:

Former Broker COO Deepening Carrier Sales Culture

M

By Susanne Sclafane ichael Crowley had been in the chief operating role of property/casualty insurance organizations for nearly two decades when he signed on to be an executive for Markel Corp. in 2009. But for all of those years—in fact, for his entire career in the insurance industry dating back to 1974—Crowley had been on the retail brokerage side of the business. So how did his friend, Vice Chairman Anthony Markel, convince the broker executive to accept what Crowley knew would be a challenging role as president of Markel Specialty, and later the position of co-COO of the carrier? “If I can do it, you can do it,” Crowley recalls Markel saying, referring to the fact that the company’s longtime former president and COO never worked in insurance underwriting. Lack of hands-on experience at an underwriter’s desk didn’t stop Markel, along with his brother Steven and cousin Alan Kirshner, from growing a company that now has an $8 billion market capitalization from one that was a fraction of the size when it went public in 1986, Crowley notes, revealing his clear admiration for the threemember executive team. Like Tony Markel, Steven is also a vice chair, while Kirshner has the title chair and CEO. Titles, however, aren’t all that important at Markel Corp., Crowley suggests, describing his

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Video Bonus: For more of Carrier Management’s

recent interview with Michael Crowley, captured on video, visit the Carrier Management channel of www.insurancejournal.tv. Segments include: “How Markel Is Writing More Business With Fewer Submissions” and “From Five Silos to OneMarkel.”

Winter 2014 | 53


Operations continued from page 53 own position on a three-man operating leadership team alongside co-COO Richie Whitt and Chief Investment Officer Tom Gayner. In fact, another aspect of the Markel leadership team that makes the ex-broker chief entirely secure these days is the fact that Whitt, Gayner and Crowley work together running the day-to-day operations, responding interchangeably to situations as they arise when one or the other isn’t available, but also primarily playing to their strengths—Crowley in sales and people management, Whitt in finance, and Gayner in investments. “I've been in a chief operating officer role, in one fashion or another, since 1991. So that piece fit nicely,” Crowley adds. Still, thinking back on his earliest days, Crowley admits, “It took me a long time to get comfortable and to understand the metrics on the underwriting side of the business. When I was running a brokerage firm, my focus was on growing the top line and managing expenses to that top line.” For Crowley, the learning experience has been a welcome one. “It’s not a bad idea to have to get up every day and have to re-earn your stripes and learn a new profession or a new division or a new capability that you didn’t have before. “For a considerable period of time at Markel, I felt like the dumbest guy in the box. Even the terminology I didn’t understand that well,” referring mainly to actuarial concepts, loss reserving issues and capital models used to price products going forward. “Running a brokerage firm, you know what the metrics are. You know what rent should be, what payroll should be. You know what everything else should be as a percentage of revenue. “On the other side, it’s all about underwriting profit. It’s not about top line,” Crowley says. “It’s the same business, but it’s a different game. You play it differently. It’s not about volume—it’s about writing business with profitable margins and reserving conservatively. “During my first year at Markel, we

54 | Winter 2014

“When I wake up, my feet are moving. I’m ready to go. There has to be an energy about what you’re doing. You need to energize the team.” Michael Crowley, co-Chief Operating Officer, Markel Corp. shrunk the top line 14 percent in a tough market but grew the book value of the company 28 percent,” he reports. While learning the rules of the underwriting game, Crowley clearly brings some welcome skills to the operating team at Markel, developed while he earned his stripes at retail brokerage firms, along with a passion for selling. During a recent interview (excerpted below), he spoke about that passion, his career and the role of COOs generally.

Q: What experiences from the retail brokerage side helped you in your position as co-COO at Markel? Crowley: First, I understood coverage. I

learned coverage early on. I grew up on the property side of the business basically. I understood doing deals and putting policies together. It’s like putting a puzzle together. And, obviously, I had to deal with the underwriting side of the business every day when I was placing coverage as a producer [and] in my role as a leader in other firms.

Q: Tell us more about your background. Crowley: I started with Johnson & Higgins

in 1974. I’m in my 40th year in the business. I served as president and COO and then vice chairman of a large, privately held brokerage firm, Palmer & Cay, for 12 years, and then served as president and COO of Hilb, Rogal & Hobbs prior to it being acquired by Willis. I was with Willis for a short time [before] I joined Markel in February 2009, [and I] moved into the co-COO role in May of 2010.

Q: Were you always in management positions? Crowley: I started as a trainee. I

had to start somewhere. I can remember sitting at a desk and reading insurance policies to learn insurance, and comparing insurance policies. I learned that way and then progressed through the organization. I became a manager, but I spent most of the time in sales.

Q: How do you divide up the day-to-day COO responsibilities with Mr. Whitt? Crowley: He runs international and the

reinsurance piece, as well as some of the admin and finance functions. I take the U.S. specialty, the chief underwriting officer reports to me, the wholesale division and global insurance. HR also reports to me because I have a passion for the people side of the business. If I’m not there, he makes decisions in those areas. And if he’s not there, I make decisions in the areas that he deals with on a daily basis. It’s not as simple as I’m doing this and Richie is doing this—that there are silos and they don’t cross. Everything we do every day crosses and interacts.

Q: What is the typical day like? Crowley: Primarily one of the things I have focused on at Markel is building a sales culture. Tony Markel and Alan Kirshner are both great salespeople, but I think we didn't go far enough down into the organization in

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terms of instilling in people that we can't sit and wait by the phone for a broker or agent to call us to write a piece of business. We've got to be out in front of them, articulating what our underwriting appetite is, what lines of business we want to write, and really spreading the gospel about what Markel's about. We have a strong balance sheet. We're in a strong financial position. We're going to be there to pay the claims when that happens. So I spend a lot of time on the branding, marketing and sales side. Marketing reports to me. Also, from my brokerage background, I have a passion for talent and recruiting talent. So human resources reports to me. I asked for that. I spend a lot of time attracting talent and interacting with the talent of the company to make sure that we have the right people in the right positions and that we also are spending a lot of time on succession— making sure that we have backups in our key positions. And then, I am dealing with the results of the company. I see on a monthly basis how we’re doing, and where I see issues— where somebody’s off budget or off what their results were in prior years… I put a lot of emphasis on year-over-year results. And I spend my time focusing on those areas where year-over-year results might be slipping, either in the profitability of a line of business or in the revenue of a line of business. And then, [with] Richie and Tom and Alan Kirshner, we’re spending a lot of time right now setting the strategic direction of the company for the next five years.

Q: So as a chief operating officer, you’re not simply executing the strategy of the CEO as might be the case at other companies? You are also involved in setting the strategy. Crowley: It's clearly different at Markel.

Richie [Whitt] and I and Tom [Gayner] are heavily involved in setting the strategy for the company with Alan Kirshner and the Markels. Our role is more than just executing the strategy. It's developing the strategy and then executing the strategy.

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Q: You talked about instilling a sales culture, and the fact that previously it wasn't low enough down the chain. How do you, as the chief operating officer, instill that? Crowley: I get kidded about saying all the

time that nothing happens till somebody sells something, but that's true.... Fortunately, from being on the brokerage side of the business, I know a lot of people. I've called on those people and opened doors for underwriters to go visit them and to articulate what we're about, what we're trying to do and what our product offering is. I think that's been helpful. I spend a lot of time with our agents and brokers, and having been on their side of the business, I understand what their needs and wants are. I can help our people on the underwriting side, who have never been agents or brokers, to understand that we need to respond quickly. And that a “no” is not always bad as long as you give it to the agent or broker quickly. Actually, a couple of years ago, for the first time, we instilled a growth component in our underwriting compensation plan. So, while underwriting profitability is still the driving factor in [the underwriters’] compensation, we've put a component in there for growth to get them to understand that we can't sit on a book of business. We need to grow. We need to be a dynamic company and to provide opportunities for people. We doubled the size of the company in the last four-and-a half years. If you aren't a dynamic company, if you aren't growing, then you can't create as many opportunities for people—career opportunities, bonus opportunities, growth opportunities, educational opportunities. We're committed to that.

Q: One of the biggest recent headlines for Markel—and for the industry—was the closing of the $3.1 billion acquisition of Alterra Capital. We haven’t talked about your role in integrating Alterra with Markel. Crowley: I've been heavily involved in that,

as have Richie and Tom and others. In our due diligence prior to the acquisition of Alterra, there were two key

litmus tests. One was we snuck away, before we announced that we were willing to do the deal, with about 40 of their top key people and 40 of our top key people, for three days outside Washington, D.C., and under the cover of darkness spent three days together, just seeing if people could work together [and] if it was a culture fit. We left there feeling really good about it. We also did a deep dive into their reserving practices—were their reserves conservative enough for us to do the deal? We felt they were. We paid a fair price for Alterra. We didn't buy it cheap, but I don't think we overpaid. We'll see, five years down the road. Alterra was not a fixer-upper in our minds. We have done acquisitions in the past that were. We're delighted with the people. Hopefully they're delighted with us. The cultures seem to be meshing carriermag.com/ey4cs extremely well.

Who Leads the Operations?

Co-Chief Operating Officer F. Michael Crowley Company: Markel Corp. Prior Experience:

• 1974-1991: Johnson & Higgins; positions included Senior Vice President. • 1991-2004: Palmer & Cay; positions included President, COO, Vice Chair. • 2004-2008: Hilb, Rogal & Hobbs, positions included President & COO (acquired by Willis in 2008).

What’s going on with Markel’s operations?

• In 2009, Markel implemented its OneMarkel strategy, reorganizing siloed insurance companies into one cohesive wholesale division with five regions in the country. • In 2013, acquired Alterra Capital Holdings for more than $3 billion.

What he thinks:

“Nothing happens till somebody sells something. If you aren’t a dynamic company, if you aren’t growing, then you can’t create as many opportunities for people.”

Winter 2014 | 55


Operations

RLI’s Michael Stone:

Managing People Is the Key to COO Role Executive Summary: At RLI, a company that has recorded 18 consecutive years of underwriting profits, operational challenges revolve around growth initiatives—integrating new products and acquired teams of people, says COO Michael Stone. The former claims executive says people management skills are critical to success in the COO role.

By Susanne Sclafane

Online bonuses at CarrierManagement.com:

• COO Michael Stone talks about RLI’s LEAD program, a formal program devoted to the career advancement of RLI employees, in a related article, “RLI Takes LEAD on Succession Planning With Formal Talent Program.” • RLI CEO Jonathan Michael explains RLI’s track record in a related video: “How to Make an Underwriting Profit? RLI’s CEO Jonathan Michael Explains.”

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I

f you can keep your head when all about you are losing theirs…”

With apologies to Rudyard Kipling, you might finish that sentence with the phrase “you can be the chief operating officer of a property/casualty insurance carrier.” At least, that’s how you might finish it after talking to one: RLI Corp.’s Michael Stone. Stone used Kipling’s line when we asked him about some of the defining characteristics of chief operating officers. “People are looking for leadership, and they watch how you behave and how you manage through situations. You want to make sure that they understand and feel like you’re in control without being controlling,” he adds. With RLI declaring an extraordinary cash dividend for holders of the company’s common stock the day before Carrier Management’s interview with Stone— tangible evidence of the specialty insurer’s ongoing record of financial performance—it

doesn’t seem like there’s much for anyone to be losing their heads about at RLI. But with more than a decade in the COO role under his belt, the 37-year veteran of the P/C industry says that combining the skills to manage people with an ability to be patient yet decisive has helped him rally the troops through times of stress. Here, Stone talks about the situations that a P/C COO has to control and his own path to the C-suite.

Q: What has been the toughest challenge you had in the role of chief operating officer? Stone: I don’t know if there’s any one, but

those that stand out are all similar. They revolve around people—either disciplining people or promoting people, and how the organization manages through that. How you communicate, how you carry yourself, how you steer the organization through it—those are tough. The tough problems revolve around people. And at the end of the day, this is a people business.

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Q: Given your view—that the COO role is about managing people—does it follow that you don’t think someone needs to have experience in the P/C insurance industry to be COO of a P/C carrier? Stone: No, I think the insurance

background is very important. I’m not saying that a good manager can’t manage anything. But I think you’ll find that most good managers had, in their career, some technical expertise and some technical depth. They know something about the product that they’re selling. It would be hard for an aircraft engine guy to come to RLI and be a good P/C COO. I’m not saying he couldn’t be, or she couldn’t be. I just think there’s something about feel for the business. There’s something about gut for the business, instinct, whatever the right word is that comes from experience [and] technically understanding how the business works. All businesses work the same, by and large. You’re trying to make a profit, you’ve got expenses, etc. But…property/casualty insurance has its own peculiar complexities. Understanding those takes some knowledge and typically experience. To try to do the job without that would be very, very difficult.

Q: Tell us about your background. Stone: I spent my career until I moved to

RLI in 1996 with Travelers, most of the time in Hartford. I came up the claims side of the business. I’m a lawyer by education but an insurance claims professional by trade. I held a number of positions at Travelers with increasingly more responsibility. I was running the casualty claims department at Travelers when I got a call from RLI to come run their claims department as a vice president. At the time, the company [RLI] was quite a bit smaller, but we’ve had a good run over the 17 years that I’ve been here. When our chief underwriting officer left to take a position with a different company, I combined those two roles. I took charge of underwriting in our branch offices. We do our underwriting out in the field and those field product [leaders] reported to

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“Trying to influence people at all levels— customers, employees, regulators, investment community. That’s what the job is about.” Michael Stone, co-Chief Operating Officer, RLI Corp. me, as well as the claims department, the home office underwriting department and our operations staff. So I was running the technical insurance functions as a senior vice president. Then I came to this current role shortly after [former COO] Jon [Michael] stepped up to be the CEO and Jerry Stephens, our founder, became the nonexecutive chairman…It wasn’t a big change. In a lot of ways it was a title change to recognize what I was doing.

Q: Your first transition from claims was to take on the responsibilities of the CUO. Was that difficult? Stone: It’s obviously a different technical

skill, but it’s still insurance. And it wasn’t like I was underwriting individual risks. I was managing people, which is a skill a bit apart from the technical skill. I had been managing people for quite some time. At RLI, we have product heads who are really responsible for the underwriting of their particular products. My role was to provide oversight from a corporate

perspective and to make sure they weren’t running us into any brick walls or over cliffs—trying to manage the aggregate risks. Managing a department and managing these people who were experts in their field is not something from which I was that far removed. I won’t say the transition was easy. At my age it was a challenge, but a welcome challenge.

Q: Beyond managing people, is there any other way in which a career in claims helped to prepare you for the COO role? Stone: At the end of the day, what we’re

selling as an insurance company is financial security and management of those customers after a loss. I saw that up close and personal. I was day-to-day involved in that. Most senior executives in insurance don’t come up that side. I think that gives me a bit of insight that helps across our senior management team that most companies don’t have.

Q: What is your typical day like? Stone: Like most management jobs, you’ve

got people in place directing their functions who have technical expertise. So I’m really making sure everybody understands our strategy—that we’re all pulling in the same direction. Everything isn’t always working perfectly, so you’re spending more time in one area than another to try to help get things going in the right direction or fixing something that’s a bit broken. My day is one of going to meetings by and large, talking with people, traveling, going up to visit our branch offices…I also spend time with the investment community. I’m trying to influence people. I’m trying to get them to understand the RLI story, the competitive advantages we have, the value creation we provide. It’s really trying to influence people at all levels—customers, employees, regulators, investment community. That’s what the job is about.

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Winter 2014 | 57


Operations continued from page 57 Q: What areas have commanded most of your attention recently? Stone: We’ve gone through a complete

building renovation, so managing to keep our people working throughout that and keeping them focused on the customers. We’ve expanded quite a bit over the last five years. We had to integrate a surety company in the West Coast into our operations. We’ve integrated a medical malpractice company into our operations. We’ve had a number of startup products over the last four or five years. It’s integrating them, getting them up and running, getting their systems developed and implemented so that they can write business.

Q: How do you learn to manage people? Or is it just an inborn skill? Stone: Like most things, it’s a bit of both. Some of it you gain through experience, some of it you gain through a simply

Who Leads the Operations? President & Chief Operating Officer Michael J. Stone Company: RLI Corp. Prior Experience:

• 1977, started with Travelers as a claims professional by trade. • 1996, joined RLI as VP of Claims. • Later took positions as Chief Underwriting Officer, SVP Operations, before becoming COO.

What’s going on?

• In January, RLI reported its 18th consecutive year of underwriting profit. • Recent office building renovation. • Several recent acquisitions, including a West Coast surety company, a medical malpractice company and startup product launches.

What he thinks:

“This job is really about people. Do we have the right people in the right places? How are we motivating them? How do we get them to be as productive as they can be and keep them interested in RLI and the RLI way?”

58 | Winter 2014

technical training of some sort or another, and some of it is your personality. It’s how you keep your cool—keep your head while other people are losing theirs [and] manage through issues and chaos. I’m experienced, so I’ve been through a few situations. I think that helps. I think there’s a place for somebody who’s been around for quite a long time and there’s a place for younger people who are moving up and have got a lot of energy and a lot of drive.

Q: Do you have any mentors in the business or role models? Stone: I’ve had people down through the

years in various positions that I relied on as a mentor, or at least a friend or colleague in the business that I could seek advice from who wasn’t my boss, which I think is important. It’s important in the corporate world to have tentacles throughout the organization no matter where you sit. It’s not just the org chart that [determines] the way information flows or the way things get done. It’s having relationships with people at all levels— either for information or for technical expertise, or just for relaxation or release. It’s important to have an organization and the proper structure, but you also need to have an informal network.

Q: Let’s talk some more about the organizational structure of the operations of RLI. Which functions are centralized at RLI, and which are delivered at the underwriting products division? Who’s making decisions about staffing and technology at the product level? Stone: The people who run our individual

products participate in everything that has to do with their products. But we do the financial function in a centralized way; we do our human resources in a centralized way. Likewise for our IT and actuarial work. Our claims department is separate organizationally. We have claims people who sit with particular products and are experts in particular products, but they report to the claims department and not to the underwriting function.

We centralized the things that are efficient to centralize, or that need to be centralized from a separation of authority or responsibility basis. Everything else, we want the underwriting product expert—the product leader—to be driving.

Q: What’s the best decision you’ve made in your tenure? Stone: The best decision I made in my

business life was to work for RLI—and I don’t say that lightly. I was with a big company, and I was at a stage in my life, age-wise and experience-wise, where I was either going to become a lifer or I was going to leave. Not that Travelers isn’t a great place. But you can have a much bigger impact in a smaller place, and a much bigger impact in a shorter period of time.

Q: What about the biggest lesson learned? Stone: The more experienced I’ve become,

the more tolerant I’ve become—of different styles, different walks of life, and different ways that people approach life and therefore approach their work. Then there’s the patience to really understand and deal with people and with situations. Anybody can make a decision; it’s trying to make the right one. So it’s having the patience to think through things without being too deliberative.

Q: What are some of the top goals that you set for RLI over the near-term horizon? Stone: The biggest challenge we have is to

keep our performance up. Our performance has been very, very good, and to continue at that level of performance is difficult. And we have to grow. That’s true for any company. You don’t have to grow evenly, and you probably shouldn’t grow evenly or consistently. But over time you’ve got to grow because your expenses are going to increase, people are going to want more, and you’ve got to provide opportunities. The way you provide opportunities is to grow. You grow, and new jobs are created, new needs are developed, and that’s how people get new opportunities and get growth and advancement in their careers carriermag.com/k4pr2 and their lives.

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QBE’S SUE HARNETT:

Leading a Transformation Executive Summary: Operational transformation is a central activity at QBE these days, and leading the effort in North America since late 2012 has been Chief Operating Officer Sue Harnett, a 30-year veteran of Citigroup. In a recent Carrier Management interview, Harnett described how her background in change management in the financial services industry prepared her for QBE’s challenges and what transformations are in motion at the company today.

O

By Susanne Sclafane perational transformation is a central activity at QBE these days, and leading the change in North America since late 2012 has been Chief Operating Officer Sue Harnett, a 30-year veteran of Citigroup. The COO role was new to QBE North America when she joined, Harnett reveals, explaining that while individual disciplines like claims, IT and legal previously reported directly to the CEO, an “agenda of activity” that included “transformation initiatives across every part of the organization” prompted the decision to create the position. Harnett, who is unique among the executives of property/casualty operations interviewed by Carrier Management in that she has no previous background in the insurance industry, is up to the task. The 80/20 rule applies, she says. “About 80 percent in any senior leadership role is the same. The 20 percent that's different is what you have to really make sure you understand or have someone near you who understands it very well. “I admit what I don't know. Oftentimes, leaders, particularly at a senior level, don't

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want to admit that they don't know everything. But my general nature is very probing,” she says. Having spent her entire career in financial services, Harnett has moved from product to product and country to country, finding that there were different skill sets required for each environment. “You figure out what is the same and what is different and then manage accordingly,” she says. Beyond that, Harnett finds commonality across the insurance and other financial services segments. “Financial services has been almost on the leading edge of innovation, cost reduction, use of data, process design—all the things that help drive efficiency,” she says. “It's just their nature. They’re very

transaction-heavy businesses. The [financial services] industry lends itself to that type of expertise,” she says, adding that being involved in regulatory compliance activities is also a transferable skill. Does Harnett think her unique background gave her an edge in landing her position at QBE? “I'm a firm believer that a fresh pair of eyes is always a good thing. So even within financial services, from time to time we would bring people in from different industries with different backgrounds. “And I have good, solid businessleadership skills. Those can serve you well in any industry. I can go direct movies,” she says. “The opportunities are almost limitless.” Harnett, who says that her company is still in the middle of its transformation movie, answered more questions about her background in change management in the financial services industry, QBE’s challenges and the transformations in motion at the company today.

Q: Tell us about your background before you joined QBE as COO at the end of 2012. Harnett: I basically was born and raised

professionally at Citi. I worked with the firm for a little bit more than 30 years. In the course of that, I worked both domestically and internationally. I ran businesses. I was always just involved in the change management of one version or another. I moved back from a stint in Europe at the very end of 2007 just so I could have

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Winter 2014 | 59


Operations continued from page 59 a front row seat for the financial services crisis. I arrived in December, and things really started to heat up in March of '08. I was involved in a lot of restructuring and re-engineering in the consumer bank at that point. I started talking to QBE in the middle of 2012, and what fascinated me about the opportunity is the history of the firm. It’s been built based on a series of acquisitions, and we haven't yet integrated the way you would in financial services. Many of the businesses were allowed to run completely independently. So there was a lot of inefficiency as a result of that.

Q: You've said that your responsibilities include overseeing claims, legal, IT and the transformation initiatives. But tell us what your typical day is like. Harnett: I spend a lot of time in meetings—

[ranging] from the strategic, very highlevel meetings way down into the weeds. At the leadership-level meetings, we're setting the strategy of the firm. Then, also, because of the transformational activity, we have a series of work streams. It’s a lot of oversight—how do I facilitate the success of the rest of the people in the organization for the initiatives that they are undertaking? I do a lot of project reviews. I do a lot of skip-level, one-on-one type of meetings, where I'm trying to get the pulse of the organization. And then I try to interact with my colleagues in other geographies as well. [Also], the regulatory aspects of the [COO] role should not be underestimated. In the era of corporate governance, the chief operating officer, chief risk officer and chief financial officer all play important roles in making sure we're onside with the regulators and the governance structures that we have in place. Here, the legal group that reports to me deals with the NAIC insurance exams, tracking outstanding corrective actions to

See related article online:

“Cultural Change Emerging at QBE NA, Duclos Says” carriermag.com/rx2jc

60 | Winter 2014

“Never underestimate how much work change takes. Alignment of the leadership behind the change is vital.” Sue Harnett, Chief Operating Officer, QBE

make sure they are brought to a successful conclusion. We support all the board activities in terms of preparation of materials, minuting the meetings, etc. A good board is as effective as the material presented to them.

Q: Let’s talk more about the transformation that's going on at QBE. Throughout the year, we’ve heard QBE CEO John Neal and QBE North America CEO Dave Duclos talk about an “operational transformation.” What does that refer to? What services are shared? What is being outsourced? How were the operations structured, and how are they changing? Harnett: The organization was [previously]

structured to support the various business lines. So we would have a finance organization that supported the program business or [one that supported] the property/casualty business, etc. Same thing with claims. We were very much focused on aligning against the business. Any shared-service function has to support the needs of the business very definitely. But you need to combine like

things in order to get efficiency. That's essentially a lot of what we're doing. The other thing is admitting where you'll never be as good as a third party—assessing the skills of the organization, the capabilities of the organization, and then saying, “How does that match versus my strongest competitor? And is there a third party that can provide the same service for me? Can I do offshoring?” QBE has a facility in Manila. So can we use our own affiliate to help get a better cost dynamic? All of those levers are considered, and then you have to look at the complexity of the implementation as well.

Q: What functions have you transferred to the Manila organization, which opened at the beginning of this year, or to true outside third parties? Harnett: We publicly announced

that we're partnering with Sedgwick for some of our claims activity. That was done Oct. 1 for low-value, high-frequency claims. We're partnering with Accenture on application development and maintenance. And we are partnering with mPhasiS for quality-assurance testing.

Q: What is application development and maintenance? Harnett: It's for your technology. When

you run a series of systems, you always have major projects. Accenture would do the work; QBE would direct their activity. They're able to bring to bear resources from around the globe. They have very strong disciplines on project management and execution. Quality-assurance testing is [also] technology related. Before I put a system into production or it changes into production, I have to test it to make sure that it works effectively.

Q: Why did you think those three areas were better served by outside providers? Harnett: The answer is three different

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answers, depending on the function. In the case of Sedgwick, it’s a scale player in claims processing. It has better technology, better cost per claim—better, better, better. In the case of application development and maintenance, Accenture has partnered with two other regions within QBE to do the same thing. And we felt that it was an upgrade in our capabilities that we were gaining. In the case of quality assurance, we just didn't do it very well. A third party with the reputation of mPhasiS can do a much better job at that. I could build it myself, but it would take a lot of time and energy. This way, I can just go to a third party and get the benefits in a relatively short time.

Q: You mentioned earlier that your role started out with the oversight of the changes in claims and IT but that there were other operation transformations going on throughout the company. What else are you looking at? Harnett: We're looking at just the core operations for underwriting, policy issuance, agent support. We're looking at our lender-placed business in terms of how they manage their processes. We've looked at how we procure various services—how we spend our own money, basically. For human resources, we have a call center that answers questions from employees on benefits and their paychecks. That is now housed in our facility in Manila.

Q: So that's a recent change in the human resources area. Are any of the other areas you're reviewing ripe for change? Do you foresee those functions being handled in Manila or by a third-party vendor? Harnett: It's definitely within the realm of

possibility. When we do a transformation exercise here, we look at: What is the business model? How does the business model conform with our strategy? Are there adjustments that can be made? Are there things that can be shared across various

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businesses that would make us more efficient and effective? Then, how do you measure the progress that you're making? How do you measure the quality of the process that you have?

Q: What do you view as maybe the biggest accomplishment or the biggest change of your tenure so far? How do you measure the success of it? Harnett: I do think one thing we've done

very well is worked across the organization to make sure that the leaders are leading the change. So while I technically have reporting responsibility for the transformation, each one of the business leaders has to be involved and participating to make sure we're doing the right things. Transformation [means] you used to do a process this way [and] now we're going to make these four changes. So it's a little bit disruptive, and we need the help of all the leaders in the organization to manage through the changes. I think we've done those steps very well.

Q: What's been the most difficult decision so far? Harnett: I do think the implementation of

the claims model was difficult because it was a pretty radical approach.

Q: What's the biggest lesson learned as you're going through the changes? Harnett: Never underestimate how much

work change takes. The other thing is that the importance of alignment of the leadership behind the change is vital.

Q: During your tenure, the CEO in North America has changed. Mr. Duclos wasn't the CEO that was onboard in the company when you joined. How does that affect your role? Harnett: Two different leadership styles

but both understanding the importance of improving the efficiency of QBE in North America. In that regard, that was consistent. Dave has been through this type of transformation before, where his predecessor had not been. He's very much of an advocate, which is very helpful.

Q: Are there lessons you learned at Citigroup that guide you in your role today? Harnett: You have to maintain your sense

of humor—absolutely. And you have to create good, solid working relationships across the organization and a good team to carriermag. implement the change.

com/pfags

Who Leads the Operations? Chief Operating Officer Sue Harnett Company: QBE North America Prior Experience Highlights:

30 Years with Citigroup: • Head of Local Consumer Lending, which includes Citigroup’s Global noncore consumer mortgage, commercial real estate, auto loan, student loan and credit card businesses. • Head of Citigroup’s Global Business Performance Management, where her focus was on driving efficiencies, bestpractice sharing, improving productivity and customer satisfaction for businesses located in 40 countries and revenues of $32 billion. • Director of Retail Operations. • COO for Retail Banking. • President of Citigroup Canada. • CEO of Citibank Germany, Citi’s thirdlargest consumer business.

What’s going on?

• An operational transformation is in progress at QBE around the world, including its North American operations. Some services are being shared; others are being outsourced. QBE opened a shared-services facility in Manila at the beginning of 2013. • New leaders, including Harnett and Dave Duclos, who became CEO last year, are driving the changes in North America.

What she thinks:

“Good, solid business leadership skills…can serve you well in any industry. I can go direct movies. The opportunities are almost limitless.”

Winter 2014 | 61


Talent Management

How to Successfully

Merge Cultures in M&A Deals Executive Summary: As M&A activity continues to rise in the P/C insurance industry, it is critical for companies to carefully consider the role that cultural integration plays on the success or failure of a deal. In this article, Aon Hewitt’s Stephanie Gould Rabin provides 10 best practices for cultural integration success, noting that senior leadership must develop a process, an action plan and measurable goals early in the M&A process.

T

By Stephanie Gould Rabin he level of merger and acquisition activity is projected to rise in 2014, and while most M&A transactions are driven by growth opportunities for property/casualty insurers, nothing can derail integration like poor cultural synergy. For decades, most management teams have been acutely aware that culture and people issues are the most significant challenges during M&A transactions. According to Aon Hewitt’s Culture Integration in M&A survey, 87 percent of organizations report that cultural integration was important or critical to transaction success. Unfortunately, cultural integration was also cited as one of the top three reasons for transaction failure. While countless studies indicate that lack of focus on organizational culture correlates strongly with underperformance from a shareholder value perspective, most management teams do not have dedicated expert resources assigned to address

62 | Winter 2014

cultural integration. Further, many organizations do not even have a wellhoned process or an established action plan for addressing culture alignment.

Organizational Culture

Culture is an organization’s operating environment or, more simply, how work gets done. Culture is primarily leader-generated. It manifests itself in behaviors and beliefs about what is important to the organization. An organization’s culture should be abundantly clear to all stakeholders, embedded in all initiatives and directly support key business objectives to create a sustainable competitive advantage. Organizational culture is best understood through three critical domains: behaviors, values and norms; strategy,

structure and goals; and decisionmaking and governance. In a merger integration context, confusion around decision-making and governance can result in delays of product or services to clients. Confusion around strategy, structure and goals can similarly cripple a company. One company may promote customer intimacy as a critical strategy, while the other may promote financial discipline. Neither is right or wrong, but understanding how they promote different behaviors and harmonizing them is critical. Similarly, one company may have a very informal decisionmaking protocol and promote accountability, while the other may be extremely hierarchical and very disciplined around all decision-making and governance. Getting two culturally different workforces to work together without a good road map is hazardous.

Best Practices to Manage Culture Integration

Aon Hewitt’s 2011 Culture Integration in M&A survey finds that top-performing organizations dedicate strong resources to own and drive integration around people issues. Companies that successfully merge organizational cultures during M&A are focused on five key interventions:

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• Clarity around the behaviors, actions and rules of the road that drive growth. • The right leadership and talent in place to drive the go-forward business plan. • Performance rewards that drive the right behaviors and deter bad behaviors. • Clear governance that enables responsiveness and clear decision-making and also defines accountabilities and authorities for employees joining the organization. • Effective change management and communication capabilities and practices that help sustain engagement around the growth imperatives. (Editor’s Note: The full report on Aon Hewitt’s survey findings, “Culture Integration in M&A,” is available on Aon’s website at www.aon. com/human-capitalconsulting/thoughtleadership/m-and-a/ reports-pubs_culture_ integration_m_a.jsp.)

called upon to be primarily accountable for cultural integration and harmonization and, when tasked with this accountability, it is on a part-time basis. However, cultural integration cannot be solely an HR initiative; it has to be leader-led. Given the importance of a transaction in the life cycle of a company and the significant erosion in shareholder value that a poor integration can generate, integration success should not be left in the hands of busy part-time resources that have other critical responsibilities. Additionally, business leaders should focus on the following best practices to ensure deal success: • Define the desired culture. Clearly describe the operating environment that will lead to success and identify cultural characteristics that will help drive success in the future. • Manage people risk. Identify key individuals who are negatively impacted by the transition and develop plans to mitigate risk, such as high turnover. • Align leaders. Individual leaders must recognize their responsibility for transition integration, establish the need and urgency for change, and model desired behaviors. • Ensure leadership direction. Ensure leadership is taking charge of the organization, sending powerful messages about what is important and what behavior is acceptable or unacceptable. • Develop organizational

In a merger integration

context, confusion around decision-making and

organizational structure to define the specific opportunities each individual has within the combined organization. • Manage talent. Companies must define and set the criteria for selecting, promoting, rewarding and exiting talent to shape the organizational culture.

governance can result in delays of products or

Not Just HR Traditionally,

services to clients.

integrating business cultures during M&A activity is considered to be an HR responsibility. Business leaders are rarely

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design and identify decision-makers. Create

• Implement rewards

and consequences.

Companies should put a focus on rewards messaging to reinforce behaviors to become the norm. • Communicate. Communications should Stephanie Gould Rabin is convey facts, inspire, a Partner for Aon Hewitt, present required actions Aon Merger and and address emotional Acquisitions. She may be responses to the change reached at stephanie. as a way to inspire rabin@aonhewitt.com. organization connectivity and decision-making. • Set management policies and procedures. It is important to set management policies and procedures, as this level of detail defines the parameters for required behavior. • Evaluate the workplace environment. Consider that the workday structure and dress code communicate expectations in terms of formalism, hierarchy, information flow and decision-making.

Measuring the Success of Acculturation

Addressing culture in M&A is highly measurable. Employee engagement is a strong barometer of cultural integration success. It is highly correlated with total shareholder return as well as net income growth and earnings per share. Interestingly, most acquired companies’ engagement results lag pre-merger results as well as acquirer engagement results for several years post-merger. Given the strong correlation with total shareholder return and other shareholder metrics, this means that acquirers that fail to prioritize cultural integration are suboptimizing their returns. As M&A activity continues to rise in the P/C insurance industry, it is critical for companies to carefully consider the role cultural integration plays on the success or failure of a deal. To properly address cultural alignment, senior leadership must develop a process, action plan and measurable goals early in the M&A carriermag.com/cv37d process.

Winter 2014 | 63


Talent

Saint Joseph’s University

Shines Light

on Gender Diversity in Insurance

Executive Summary: While gender diversity is significantly lacking at the most senior levels across the insurance industry, research by Saint Joseph’s University reveals there are differences in the gender mix of carrier C-suites observable between segments of the property/ casualty insurance industry.

T

By Michael E. Angelina he insurance industry has long suffered from a “brand identity” crisis on many fronts. Often accused of improper

64 | Winter 2014

sales and marketing of our products and poor handling of policyholder claims after a major natural catastrophe, the industry has a negative image and lacks public trust. With regard to the issue of gender diversity, the industry performs no better— although to be fair, insurers are not much worse than other industries included in the Fortune 500 or Russell 2000. The Saint Joseph's University study found that gender diversity is significantly lacking at the most senior levels within the insurance industry. Our study also highlights the major

Out of 100 companies analyzed, 85 percent had no females in their top executive positions.

differences in gender diversity that arise within market segment and type of leadership role (business-facing versus functional). While our results are disappointing, our discussions with executives in the industry did find signs of hope for progress. Saint Joseph’s University undertook its study to analyze demographics in senior positions within the insurance industry. The study was focused on overall

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demographics and not initially specific to gender diversity. Using publicly available information, we analyzed the directors, inside officers and top executives at 100 U.S. insurance companies along the dimensions of age, gender, compensation, stock ownership, board retainer and tenure. We also studied the differences by leadership role or corporate position. We found wide gaps in compensation among market-facing (i.e., businessproducing) roles, such as CEOs or division presidents, versus the more functional roles, such as accounting, actuarial, claims, finance or legal—regardless of gender—with the top C-suite executives commanding $3 million more, on average, than executives in functional roles. In addition, we found significant differences in gender diversity for the two types of executive positions, which seems to highlight differences in compensation levels for men and women holding executive titles in the insurance industry. As we began to analyze the data and review the results, the issue of gender diversity quickly emerged and could not be ignored. In addition to the disappointing gender grades across the industry, there were

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some other surprising results of our study. We noticed significant differences between the various market segments of insurance companies in that brokerage firms, carriers that predominately write personal lines and life insurance companies scored high marks on gender diversity relative to their counterparts in the financial, offshore and primary carrier space. (Company size did not explain the differences, which persisted for both large and small-to-midsize carriers.) We also found a genuine concern and strong willingness to assist from many senior executives in the industry. The first observation will require more investigation as to the root cause of the difference. The second bodes well for change yet requires leadership and action.

Lack of Gender Diversity Is Significant

The results of the Saint Joseph's University Study of 100 U.S. insurers show that females hold: • 12.6 percent of board of director seats (128 of 1,017 total seats). • 8.4 percent of inside officer positions (42 of 498 total positions). • 6 percent of top executive spots (15 of 250 total spots).

Our study analyzed 100 U.S. insurers (91 publicly traded and nine mutual companies) and focused on the most senior-level positions within their organizations. The data included 2,185 records in total and was based on what companies report publicly in SEC documents or NAIC filings. The top executive spots include the CEO, CFO and sometimes an additional executive (president, COO, etc.). Since not all companies reported a third executive, our data points resulted in 250 persons for the 100 companies. The distribution of the 100 companies in our study by market segment is: 36 percent primary, 7 percent personal lines, 18 percent offshore, 5 percent broker, 6 percent financial lines, 7 percent large primary and 21 percent life. Our study also showed that across these companies, a surprising number lacked females in any of the three leadership positions. Specifically, for the 100 companies analyzed, 28 percent had no female directors; 65 Michael E. Angelina, percent had no female ACAS, MAAA, CERA, is the inside officers; and 85 executive director for the percent had no females in Saint Joseph’s University their top executive Academy of Risk positions. Management & Insurance. We did find that 34 Prior to assuming his role percent of the companies at Saint Joseph’s, Angelina we analyzed had at least had more than 25 years of two females on their professional experience in boards, with more than the property/casualty half of the brokerage insurance industry as a firms, personal lines practicing actuary. Among carriers and life companies his positions, he served as having two or more chief risk officer of females on their boards.

Market Segments Matter

The study uncovered significant differences by market segment across many categories, including gender diversity within the three

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Endurance Specialty Holdings Ltd. and as a principal and head of the Philadelphia office of the consulting actuarial firm Towers Watson (then Tillinghast Towers Perrin). He may be reached at michael.angelina@sju.edu.

Winter 2014 | 65


Talent continued from page 65 leadership levels, board retainer and tenure, compensation, and leadership role (business-facing versus functional). In particular, the market segmentation across the seven types demonstrates strong differences with regard to gender diversity, top officer compensation and leadership role. As we looked at the percentage of women in leadership roles across the seven market types, we found that the brokerage firms, personal lines carriers and life companies consistently demonstrated more gender diversity than their financial, offshore and primary company counterparts. (See chart below.) As we inquired further, a few hypotheses emerged. The brokers, personal lines carriers and life companies are traditionally more customer facing and as a result face a more diverse consumer base. Their leadership positions reflect this diverse group. Other suggestions include the idea that the underlying employee base of these companies is more diverse and that leadership positions are more reflective of this type of workforce. We also found that while gender diversity is more prevalent in these consumer-facing companies, a major driver

of the greater percentage of women in the inside-officer position is a higher percentage of women in functional roles. While the brokerage firms, personal lines carriers and life companies show twice the level of gender diversity in the businessfacing roles (resulting percentages are 6 percent versus 3 percent), they show more than three times the level (25 percent versus 7 percent) for the functional roles.

Senior Leaders Care

After analyzing the data and reviewing the results, we shared them with a group of senior executives to gain additional insight and solicit their input. The executives we interviewed found the study to be useful— and needed—as it provides an unbiased view of the facts and data highlighting the current state of the industry. As we update the study, we can better utilize the results to measure progress and track success. The executives were both surprised and disappointed by the results. They were surprised as they had hoped the industry would have been further along, and disappointed in that the current initiatives have not shown more favorable progress. As the underlying customer demographics are changing, the industry will also need to respond to this shift in the

consumer base as more females are making purchasing decisions. While the business case will dictate a need for change, the executives are also committed to diversity in their leadership ranks and boardrooms, and we are seeing some changes in behavior and thinking.

What Next?

While the Saint Joseph’s University study has shed light on the demographics in the industry with regard to gender diversity, we believe that we have just skimmed the surface. We are already underway in updating the Saint Joseph's University study with more recent information and expanding the scope to incorporate additional data with more granular information. As our initial study provided the industry a baseline against which we can measure progress, the updated study will be able to analyze changes and movements in the metrics. The additional detail at a more granular level will allow us to probe further and potentially discover leading indicators and progress at other levels of management. Like anything, progress on this front requires both insight and the ability to measure results. More importantly, the industry requires leadership to embrace the willingness to change at the executive level. Our study and analysis has not only shed light on the important issue of gender diversity but has also prompted a discussion at the executive level of companies and at a macro level within the carriermag.com/f4vbt entire industry.

(Editor’s Note: Saint Joseph’s University undertook its study at the suggestion of Erin Hamrick from Sterling James to analyze demographics in senior positions within the insurance industry. Hamrick and Angelina presented the results at the IICF Women in Insurance Global Conference in June 2013. A copy of Angelina’s presentation is available on the SJU website: Saint Joseph’s University Study on Insurance Industry Demographics at www.sju.edu/int/academics/hsb/special/ armi/thoughtleadership.html.)

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Leadership

INGA BEALE: The Backstory of Lloyd’s CEO

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Winter 2014 | 67


Leadership continued from page 67 Executive Summary: During the IICF Women in Insurance Global Conference last year, Lloyd’s CEO Inga Beale entertained attendees with personal stories of her career and her year off from the industry, also delivering some tips to underwriters who aspire to be leaders.

O

fficial biographies of Inga Beale, who became the first woman to lead Lloyd’s as CEO on Jan. 1, reveal her prior leadership of a struggling Converium in the 1990s as a milestone of her career. But to understand where she gained the strength to persevere when times looked bleakest at Converium—and what gave her the desire to be “top boss” of several insurance organizations—you’d have to hear Beale talk about her adventures with an ultra marathoner in Australia or her lifechanging encounter with the office manager at a broadcasting company. “She changed my life,” Beale said, referring to the latter—a manager in an office of the British Broadcasting Co., where Beale worked as a receptionist in the 1980s after leaving her first job in the insurance industry. Having left a male-dominated workplace, the future insurance leader could not help but notice that everyone in the BBC office treated this woman like a boss. “And she wore trouser pants to the office,” Beale exclaimed as she recalled the lifealtering assignment outside the insurance industry. “It gave me some sort of extra confidence that I’d never had before,” Beale told more than 400 women who attended the Inga Beale is the Chief IICF Women in Insurance Executive Officer of Lloyd’s. Global Conference in New York City in June last year, recounting some of the unpublished personal experiences that shaped her career. “I thought, ‘I’m going to go back [to the insurance job], and I’m going to be me, and I’m going to wear pants to the office,’” she

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reported, noting that she eventually went back to London and reclaimed the underwriting job that she had left a year earlier—but with “a totally different mindset.” “I’m never going to worry about posters on the wall for two weeks,” she added, referring to an incident that precipitated her departure from her first insurance job. The posters were depictions of scantily clad women on Jamaican tourism posters that had initially been hung to decorate the insurance company office for some broker parties. Beale, who was working with 30 male underwriters at the time, explained that the parties coincided with a big cricket competition taking place in the Caribbean. Since the wife of one of the underwriting managers worked for the Jamaica tourism board, they created an office theme complete with the posters, Jamaican curry and Jamaican Red Stripe beer. Two weeks after the party time was over, everyone was back to work. But those posters remained hanging around the office, prompting Beale to call this to the attention of her manager, who vowed apologetically to have them taken down. The posters were removed from the walls the next day, but Beale found her entire workstation—chair, computer and desk— wrapped in the posters. She ultimately left and took a year off to go backpacking in places like Bombay, Hong Kong, Thailand, Taiwan and Australia. When her money ran out, she turned down a job offer from Swiss Re, signing on to odd jobs like the BBC receptionist stint rather than return to what was at the time a “chauvinistic insurance industry.” “There have been a few interesting moments in my career,” she told the IICF attendees, going on to describe another experience from her year of travel that shaped the leader she is today.

It was during that trip to Australia, “when I met this crazy guy on the beach,” she said, continuing to reveal parts of her life story in an entertaining way. The tall, tanned, hairless man was an ultra marathoner who set out to run 3,000 miles around Australia and convinced the backpacking Beale to join him. He ran, and she cycled, Beale reported. Even though the pair did not make it all the way to their goal, “what it taught me is how strong women can be,” she said. Although the marathoner had to urge her forward at the beginning of the trip, “after about 1,500 miles, he was getting tired. So then I had to find the strength to motivate both of us. “I would never do it again in my entire life, but it [revealed] the strength that we have. This came really to life when I was in the Converium situation,” she said, referring to the period when Converium was fighting a hostile takeover by SCOR. “During a crisis, you have to be able to show such leadership. You have to communicate, communicate, communicate. All your people are so nervous, and you really have to be strong for them and show them your strength.”

“During a crisis,

you have to be able

to show leadership. You have to

communicate.”

Easy As PIE

Beale led off her IICF presentation by describing her path into the insurance industry as “slightly unconventional” in that, unlike other speakers at the conference, she wasn’t very studious. Rather than pursuing university degrees, Beale took a position as a trainee underwriter for Prudential 31 years ago. “I wasn’t focused on my career at all,” she added, highlighting another difference from prior speakers.

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“For the first 10 years, I didn’t really care about the job. I just made money and continued to do my sport,” she said, noting that she competed in rowing and rugby at the time. It was “absolutely vital to get to River Thames in London and do my training during the day and my competing on the weekend.” Beale said it wasn’t until she joined GE Insurance Solutions (then called Employers Reinsurance) in 1992 that her approach to her career changed. Moving away from a very traditional, old-fashioned, maledominated workplace, she said: “Joining GE changed my life. They gave opportunities regardless of your age, class, gender or race.” An important opportunity came in 2001 when she was offered the job of leading the risk management function in the insurance headquarters in Kansas City. “I was in London [doing] front line underwriting,” working with brokers and customers directly. “I spent my time negotiating deals. “Why would I move from London to Kansas City—and from this front-line exciting role [into] some headquarters job?” she thought at the time. “The best thing I ever did was to say yes,” she told the IICF audience. “The reason is because of the exposure I got from being at the center, dealing with the CEO, having meetings with all the key leaders in the business,” she said, going on to list “exposure” as one of the three keys to forward into leadership roles. Beale uses the acronym P-I-E to spell out the three success factors: performance, image and exposure. “You have to perform your role. There’s no way you can get away from that. It’s a given,” she said. “You also have to work just as hard on your image, how you’re coming across, your brand,” she added, explaining that the only way you know

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how you’re coming across is by asking other people. “Make sure you’re getting the exposure— whether it’s inside the organization or in the industry,” she added. “Ask for exposure. Demand it.” Beale described her subsequent appointments to lead operations in Continental Europe for GE from Paris and then Munich, tracing the opportunities back to that Kansas City move. “When you do have the courage to make these difficult decisions and take these big steps, they do pay off,” she said. After GE sold its insurance business to Swiss Re, Beale took another big step, agreeing to become CEO of Converium. “They got in a bit of trouble,” she said, understating the desperate situation that included rating agency downgrades and the firing of a previous CEO. It took a week to make the decision, she reported, noting that it meant leaping from operating a division within GE to running an entire company that was in crisis and dealing with angry shareholders and other constituents. Beale left Converium when SCOR won the hostile takeover battle, but the chance to lead a unit of Zurich Group came quickly. She joined Zurich to head up the M&A unit, even though she had never done a merger or acquisition in her life. Later, she became chief underwriting officer. Beale said she made her next move—to become CEO of Canopius—when “things changed a little bit at the top of the organization” at Zurich. “I didn’t feel it was the place for me, so I left,” she said. “I took some time to think [and] realized that I’d actually loved my time at Converium. I loved running the company,” she said, countering remarks by earlier speakers at the conference who had told the women in the audience that you don’t really have to be the top boss to make your mark. “Actually, I really like that,” Beale said in a mock whisper, months before Lloyd’s announced that she would leave Canopius to become the CEO of the centuries-old carriermag.com/43qac London market.

Inga Beale’s Career Path 1982 - 1992:

Prudential Assurance Co. Ltd., London, UK • Underwriter - Reinsurance Treaty

1992 - 2006:

GE Insurance Solutions / GE Frankona Re • 03/1992 – 03/1995: Underwriter - Reinsurance Treaty, London, UK • 03/1995 – 03/1996: Head of Underwriting - UK Treaty, London, UK • 03/1996 - 04/1999: Underwriting Manager - Property Treaty, London, UK • 04/1999 – 05/2000: Marketing & Six Sigma Leader, London, UK • 05/2000 – 10/2001: Underwriting Manager, London, UK • 10/2001 – 07/2003: Global Underwriting Leader, Kansas City, USA • 07/2003 – 10/2004: Continental Europe Manager, Paris, France • 10/2004 – 01/2006: Continental Europe CEO, Munich, Germany

2006 - 2007:

Converium Ltd., Zurich, Switzerland • Group Chief Executive Officer

2008 - 2011:

Zurich Insurance Co. Ltd., Zurich, Switzerland • 01/2008 – 05/2009: Head of M&A, Organizational, Transformational and Internal Consulting • 06/2009 – 11/2011: Global Chief Underwriting Officer

January 2012 to Dec. 31, 2013:

Canopius Group Ltd., London, UK • Group Chief Executive Officer

Starting January 2014: Lloyd’s of London • Chief Executive Officer

Source: Lloyd’s

Winter 2014 | 69


Talent Management

Talent Risk: A Killer Torpedo? Executive Summary: Is the unique expertise of a superbright professional increasing the value of your company? Risk expert Sim Segal explains how an employee who is a “mastermind” or a growth-inducing “rainmaker” can actually be a killer torpedo that sets an organization on a course to implosion, and how a value-based ERM program can mitigate talent concentration risks.

T

By Susanne Sclafane he most gifted professionals in property/ casualty insurance organizations can also be the ones to bring those organizations down if carriers don’t employ valued-based enterprise risk management processes to manage talent risks, an expert suggested recently. Although he didn’t state his case in quite those words, and talent-related risks weren’t his only examples of commonly neglected risks that are leading indicators of potential carrier collapse, Sim Segal, president of SimErgy Consulting, put three talent-

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centered risks at the top of a list of “killers” he presented during a recent industry meeting. Speaking at a gathering of the Casualty Actuaries of Greater New York (CAGNY) during a session titled “Killer Risks: Torpedoes in the Water,” Segal identified “masterminds” with unique expertise, “rainmakers” with the magic touch to grow revenues and “arrogant” individuals (and business units) on his list of eight killer risks for all types of organizations. Segal, an expert in ERM who is also the author of the book “Corporate Value of Enterprise Risk Management,” explained that “masterminds” are individuals who are paid highly for mastery of a particular topic. They are widely respected throughout their industries and internally within their organizations, he said. “Everybody talks about them and says, ‘Wow, isn’t it great that they have him or her in the organization,” Segal noted. But “that can be a leading indicator of high-severity risk,” he said, explaining that masterminds create a large vacuum when they leave

continued on next page

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Winter 2014 | 71


Talent Management continued from page 70 an organization. Think Steve Jobs, he said, mainly providing examples of super-talents from outside the P/C insurance industry but highlighting traits that attendees could readily recognize in insurance experts. “They are very difficult to replace. They also tend not to share information,” he said, suggesting that the brightest talents are often somewhat insecure and deliberately choose not to share their expertise or to develop others. At Apple, Jobs set up Tim Cook as his successor, Segal said, noting that Cook does not possess the level of creativity or genius so often ascribed to Jobs. “Maybe he didn't want [Apple] to succeed after he was gone. If they fall right afterward, it was all him, right? There's not necessarily alignment between him and the company.” When masterminds are poached by competitors, “that's doubly dangerous for the organization,” which may or may not realize that it doesn’t have a strong bench. In addition to Jobs, Segal gave an example of a chief financial officer of a large financial services company, reporting that it took the company five years to recover after he retired. “He had weak people under him, sycophants, and he would do everybody's job. He didn't want anybody smart or capable around. So the entire department imploded, and they had to replace almost everyone over the next three years. “They couldn't get anything done. It was a huge loss.” Masterminds can also be very difficult to work with, Segal said, noting that when they are disrespectful to co-workers, companies tend to look the other way. Segal said that masterminds and other killer risks have three common characteristics: • They are politically difficult to discuss. • Everyone is aware of them. • They are often leading indicators of high-severity risk events. The first characteristic makes them difficult to mitigate, Segal said. But he suggested that a first step in mitigation is to raise the idea of dealing with “rare talent

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concentration risk” as a talentmanagement issue. “Diffuse the responsibility,” he said, noting that it isn’t something that should be handled by an individual talent or risk officer but by a committee. Once the committee has pinpointed various groups of rare talent within the organization, then the company can institute enhancements, such as a strong succession plan for the mastermind to protect the firm, Segal said. “This is the list that we want to be on, right? You want to be selected to be the most precious commodity of your organization,” he said. In addition to succession planning, other talent management steps include developing a supporting cast. “Get that transfer,” he added, referring to the need to institute policies for documentation and sharing of critical information, as well as the need to define key relationships among the support cast members. Masterminds may not want to do that, “but if you have a policy, it's a little easier to make that happen,” Segal said.

constraints of other operational guidelines. A lack of scrutiny and accountability may lead to bad behaviors, excessive perks, and often even theft and fraud, Segal said. Among the examples he offered was that of David Sokol, the once heir-apparent to Berkshire Hathaway's Warren Buffett. Sokol, who was able to turn around Berkshire’s Johns Manville and NetJets subsidiaries, abruptly resigned in March 2011 after inappropriate trades in shares of a company called Lubrizol came to light. Sokol had bought 100,000 shares of the company while Berkshire was in talks to buy the company on Sokol’s recommendation. “There were several preexisting signs of abuse that were known about internally,” Segal reported at the CAGNY meeting.

Flood Barriers for Rainmakers

automatic scrutiny of high

Segal had similar advice about mitigating risks created by a second class of killer talent risks: rainmakers. “These are people who make it rain. They bring in the money. They make growth happen,” he said. Like masterminds, they’re easily identifiable. “They tend to strut around, and they're heavily compensated. Everybody knows who they are.” Their presence is also a leading indicator of high-severity risk events, Segal said. The typical progression of events is “recognition of talent, massive rapid growth and then implosion,” he said, noting that things come crashing down as the rainmaker’s moneymaking activities go unscrutinized and as a consequence of pressure on the rainmaker for continued growth. “Organic growth is really tough, so if you find somebody who can actually grow organically, [then] they tend to get bushels of money thrown in their direction, and they get all obstacles moved out of their way”—including corporate audit and the

“Risks and returns go together. So if we have massive growth, we shouldn’t look the other way,” Segal says, recommending growth. He cited Sokol’s “bizarre firing of a subsidiary CEO.” Sokol also “tried to offer a CEO $1 million in cash for a one-way nondisparagement agreement where he could criticize the CEO but the CEO couldn't criticize back,” Segal said. (Editor’s Note: Online sources refer to the agreement with former NetJets CEO Richard Santulli as a mutual nondisparagement agreement.) Segal also recalled that in April 2010, when Sokol was still considered a likely successor to Buffett, a judge ruled that Sokol “acted willfully and intentionally to manipulate profit calculations” to deceive certain minority stakeholders out of profits when he was CEO of Berkshire subsidiary American Energy Holdings. “This all went on, [and] it was ignored because he could turn things around. He was a rainmaker,” Segal suggested, noting

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Sim Segal defines killer risks as those that are:

that NetJets made a $207 million profit during the first year that Sokol took the helm after posting $157 million in aggregate losses in the decade before. Segal also said the pressure heaped on rainmakers to continue to work their magic to increase revenues and generate profits creates “an addictive type of situation” that can precipitate a meltdown, pointing to the example of hedge fund Long-Term Capital to illustrate his point. Recalling that the speculative hedge fund earned 40 percent returns on investments in its first three years, he said the fund collapsed when a massive inflow of investors provided funds to the speculators in expectation of the same level of returns. But by that time, the arbitrage opportunities that fueled their fortunes had evaporated. They initially started shrinking when they recognized that the window of opportunity was closing, but then they started to get all this extra money from investors. “Do you think they said, ‘Thank you for the money, [but] we really can't deliver those kind of returns anymore. Here's your money back’?” Instead, the partners took highly leveraged positions, and ultimately the fund collapsed, Segal said, providing a simplified history of the events in order to get to his main point—suggestions for mitigating the potential for disastrous consequences of rainmaker activities. He recommends having an ERM policy to automatically enhance scrutiny when there is abnormally high growth emerging. “Risks and returns go together. So if we have massive growth, we shouldn't look the other way,” he said, noting that the automatic nature of this ERM mechanism will avoid flagging a particular individual for scrutiny. Instead, the policy kicks in routinely under specified growth conditions and confrontation with the rainmaker can be avoided. Importantly, Segal also espouses a valuebased ERM approach that focuses on connecting risks and returns. While not providing all the specifics, Segal said this approach starts out with a dynamic

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1. Politically difficult to discuss. 2. Easily identifiable. 3. Leading indicators of high-severity risk events.

valuation of the organization (based on a discounted cash flow approach) and then analyzes risk scenarios and how they shock the value up or down. “You end up with the ability to have a distribution of all the possible outcomes of the value of the organization. You’ve got upside and downside; you've got risk and return together. So you can evaluate not just the current value of the company but [also] the volatility of achieving that value under very different what-if scenarios.” In the past, risk folks and strategicminded return folks have been very far apart—with the return folks eyeing the money-making opportunities, and the risk folks stressing the downside, he said. “They're both right. They both need to be considered,” Segal said, noting that a valuebased ERM model blunts the rainmaker argument that the value to be generated overwhelms any risk concerns. “This gives you a numbers way” to sort it all out.

Put ERM in the Strategic Plan

Segal also suggested integrating ERM into strategic planning during his discussion of another killer risk that destroys value: arrogance. “This is an attitude of invincibility,” he said, here describing a risk that may be tied to an individual or to an entire business unit or company. Like the other killer risks, it’s easily identifiable. “We know it when we see it,” he said, noting that arrogant businesses have an insular attitude. The cultural message is: “Everything is great here. We don't need any ideas from the outside,” Segal said, explaining that volunteering to take part in industry activities is frowned upon by leaders of arrogant business units. They believe that “if it's good, it started here.” He provided the example of Swiss watchmakers to underscore the risk.

Although the Swiss captured 50 percent share of the global market between World War II and the 1950s, when Japan’s Seiko introduced quartz watches in the late 1960s, they had an arrogant attitude about it, refusing to see the trend toward cheaper, lightweight, less expensive watches. About 20 years after the quartz came out, the Swiss had lost more than two-thirds of their global market share, Segal reported. As he spoke, Segal displayed a simple curved line graph illustrating the typical trajectory of arrogant companies—first sloping upward to show movement from a period of struggle, up to a period of competition, then excellence, followed by dominance and then arrogance at their peak, and finally plummeting to sudden collapse as they fail to see potential vulnerabilities and overestimate strengths. A lack of self-criticism and a resistance to negative constructive feedback is also typical here, Segal said. Arrogant organizations and individuals “tend to be overly praising of themselves, have lavish parties [and] massive perks, which can lead to some bad behaviors,” he said. “Can you think of anybody that you know in the industry—a company, a business executive, individuals—that exhibits this type of behavior?” he asked the actuaries in attendance. “They may be headed for some disaster if it hasn’t happened,” he said, going on to suggest corrective actions. “Focus on the weaknesses resulting from the behavior, not the behavior itself,” Segal advised. Unrealistic strategic plans are one weakness, he said, essentially recommending that companies work to integrate strategic planning into ERM.

carriermag.com/8j4ds For the complete list of eight killer risks, see related article, ”More Torpedoes: Inadequate Shareholder Disclosure and Other Killer Risks,” on CarrierManagement.com.

Winter 2014 | 73


Talent

Do You Have the Vision to Innovate? Executive Summary: How can you innovate when you are tired of hearing the word? Given the challenges of today’s insurance market, carriers and brokers know that their future success is tied to innovation. But when setting up the whiteboard and brainstorming aren’t getting it done, maybe different perspectives are needed, says Erin Hamrick, an executive recruiting specialist for the insurance industry.

G

By Erin Hamrick oogle the term “insurance innovation” and you’ll get more than 42,000 results. Probably not surprising, and as you would expect, the results cover everything from an actual domain name to consulting groups espousing their ability to transform an insurance company to be innovative. Will following a “six-step process” get an

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insurance company to be innovative? It’s clear that companies want innovation and that consultants are armed to sell their innovation services. The confluence of advanced technologies providing cheaper and easier platforms to facilitate transaction ease and greater client connectivity, combined with marginsqueezing price and product commoditization, is most likely behind this consulting push. However, my sense is that innovation goes well beyond “faster, cheaper, smarter.” If the supply of consultants meeting the demand of the companies doesn’t get you innovation, then what does? Get out the “whiteboard” and let’s “flush out” what we can do to be innovative. Sound familiar? There is no doubt that both brokers and insurers are feeling compelled to be innovative because the status quo is not an

acceptable business strategy. Don’t misunderstand me. I think many insurers would still view an enhanced “click and bind” as innovative, but I’m thinking about broader innovation. As the industry is known for its “herd mentality,” companies can no longer wait to see what tweaked product and rate their competition has filed so that they can follow suit. Was this ever really product innovation? Is creating a product for exposure to identity theft considered innovative? On one level the answer is yes, but I think the industry now understands, desires and recognizes the need for something more.

Using Intangible Assets

By some measures, the largest tangible asset in both the insurance and technology industries is human capital (even though

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it’s not itemized on the corporate balance sheet), and intellectual capital is their largest intangible asset. If human capital defines both of these industries, then why is innovation so difficult for the insurance industry but arguably not for technology? Consistently, when an insurance company is looking to the outside for talent, aside from desiring all the standard qualifications, the request is “in addition, we want someone who thinks outside the box” and “who is innovative.” The demand is there. But where are these people, and how do you find them? Think about Progressive, with a history of innovation that stands apart from the “me-too” dynamics in the insurance industry described above. Progressive was built on a line of business no one wanted with the goal of being the “consumers’ choice for auto insurance.” How did Progressive develop the idea of being the first to offer customer and claims service 24/7 in the early 1990s? What gave the company the confidence to launch a website in 1995 and then transact to buy a policy online in 1997? How did Progressive understand the power of advertising with consumers? The answer can be boiled down to Progressive’s investment in its human capital assets. With visionary leadership at the top, Progressive was hiring top-10 MBA school graduates who had previously been in consumer products but often had very unconventional backgrounds. The company placed these recent MBAs in virtually every discipline: product, claims, customer service, finance, etc. To Progressive’s credit, it was understood that there were plenty of insurance content experts to protect the fundamentals of the business. The

influence and confluence of all the experiences of those hired from outside the insurance industry continued to push and drive Progressive to be a leader and innovator in the industry. Turning to technology, think about Apple. Steve Jobs had a vision of what he wanted his products to be—and as we all know, he wasn’t a technologist. He had no degree and couldn’t write code. But Jobs was a “visionary” because he applied his love and knowledge of art and design developed in his formative years and pushed his technologists to create heretofore never-conceived products. The confluence of his background and experiences applied to the technology sector provided an unwavering, crystalclear vision. Jobs felt the need to demystify how to use technology through “fun consumer experiences,” and Apple’s customers became passionate advocates. Can you imagine insurance buying being described as a fun experience?

Have you considered putting a musician on your staff?

Hamrick advocates hiring

outside of the box to spur insurance innovation.

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Same Scene, Different Lens

If you think about Progressive, Steve Jobs and other visionaries, is there a common denominator? The one that strikes me is that in order to be innovative, you need the ability to look at the same thing through a totally different lens. Keep that thought and now think about insurance innovation. The industry was trained to look through a single riskmitigation lens. How can you expect people who have been rewarded their entire career for not taking risk and containing risk in a box to now think outside the box? Progressive understood this premise: Combine great insurance talent with great noninsurance talent and you will get innovation. We all know that innovation at

Apple was Steve Jobs, and he wasn’t a technologist. Strong leaders recognize their own limitations and look to those who are not like themselves to push a company to be innovative. It’s the old adage: “Dare to be different.” Take the risk to hire someone who might not be a direct reflection of your own thoughts and ideas. There is a caveat—you need to hire more than one individual outside of the usual mold, and these hires need support and protection at the top. This industry of ours has a way of killing good talent by a thousand bites. New ideas prompt change, and change can make people who have been in their box feel insecure and threatened. Think about what it is you are trying to achieve. Hire creatively at different levels of the organization. Good musicians tend to be strong analytically. I know of one property/casualty insurance company that has hired a great musician as part of a product development team—and that individual doesn’t know insurance. But you can’t expect one person to innovate. Erin Hamrick is a Partner Progressive and Steve with Sterling James, a New Jobs certainly didn’t. So York-based global this company augmented specialist in executive the musician with a search and leadership graphic design artist. advisory services for the These are all nuances insurance sector, which she that ultimately will founded in 2011. Hamrick challenge a company’s has 18 years of experience norms. You’ll be surprised serving the insurance what the insurance industry. Early in her industry looks like viewed career, before becoming an from a different lens. executive recruiter, she If you have a strong served in both line and staff leader at the top who is roles at The Hartford and at willing to invest in the brokerage firm nontraditional human Hamilton Dorsey Alston. capital solutions, the Reach Hamrick at result will lead to ehamrick@sterlingjames. something innovative.

carriermag.com/z5t9u

com.

Winter 2014 | 75


Leadership

‘Fish ‘n’ Shoes’ Thinking and the Disruptive Power of ‘Just One Change’

Executive Summary: Innovation Consultant Karen Morris offers up a new strategic menu classic for insurance executives: “fish ‘n’ shoes” thinking. By swimming against the current of industry assumptions and slipping into different pairs of shoes to navigate changing business terrains, carriers can join the likes of shoe designer Christian Louboutin, who found a competitive advantage in the most unlikely place—on the bottoms of signature stilettos, or the leaders of online shoe distributor Zappos, who offer better customer experience as a differentiator.

76 | Winter 2014

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By Karen A. Morris

Shoes matter. This is a universal truth. And they particularly matter to me. Some may remember when “Sex and the City” protagonist Carrie Bradshaw was mugged and exclaimed: “Please, sir, you can take my Fendi baguette, you can take my ring and my watch, but don’t take my Manolo Blahniks!” She was speaking a language I understand. Ask anyone who knows me. I have been fortunate, frazzled and frustrated to have traveled the world in my career—and my shoes came with me. When it comes to shoes, I laugh in the face of excess baggage charges. You see, I believe that as we embrace the many changes through our multifaceted, iterative careers, we need a change of shoes. As we grow personally and professionally, life urges us to step into new shoes—literally and metaphorically. As leaders and innovators, we need something more—a range of shoes. By this I mean the ability to adapt intellectually and physically to different kinds of business terrain and working environments. The exigencies of shifting contexts, where our fast-moving business plateaux increasingly slip and glide like ice-floes, force us to tackle steep gradients of learning, maneuver high-velocity change, speed up to grab advantage, and decelerate to assess and navigate risk. We need a rich array of mental footwear to perform this complex choreography and get to where we need to be.

Giving Meaning to Products

Celebrated shoe designer Christian Louboutin likens a girl’s first pair of high heels to the rite of passage from girl to woman. Remember the shoes you wore at

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your wedding? On your first day at work? When you ran a marathon? Shoes commemorate transition and change. They also have something to say about innovation strategy and management. My beloved Monsieur Louboutin tells his rite-of-passage story for a reason: It makes shoes matter more. It imbues shoes—his product—with meaning. Crafting a strategic narrative uses the socializing power of storytelling to inject meaning, relevance and purpose into your strategy in a way that can be immediately understood by all of your stakeholders. But a good story is not the only means by which businessman and innovator Louboutin was able to make his name synonymous with sexy, exquisitely expensive shoes. How did Louboutin become “the” designer shoe in a surprisingly crowded marketplace of thousand-dollar-plus shoes, inspiring reverential, eclectic tributes to his iconic impact, such as an eponymous single composed by Jennifer Lopez, a “Louboutin Barbie,” a David Lynch exposition and a Disney short? Yes, his designs, raw materials, craftsmanship, distribution and premium pricing are outstanding. But so, one posits, are those of competitors Manolo Blahnik, Christian Dior and Jimmy Choo. These albeit indispensable determinants of best in class do not put you in a class of your own. It is a dilemma all already excellent businesses face and ambitious businesses want to anticipate early. Here’s my theory: Louboutin made the sole of the shoes—historically the unseen,

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Karen A. Morris is a consultant to the insurance industry, specializing in all aspects of innovation strategy and execution. She is a member of the faculty of the ILO Institute founded by Dr. Peter Temes and an adjunct professor at Fordham University in New York teaching Innovation as part of the MBA program. She serves on the board of the Global Sourcing Council. Reach her at karen. morris2@yahoo.com.

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Leadership continued from page 77 least vital part—narrate his brand. He made the soles red.

Just One Change

This is innovation genius. The disruptive power of “just one change” lies in the inversion of conventional thinking about what matters and why. We typically classify product and service attributes—in this instance shoes—into those that matter from a utilitarian perspective, such as quality and durability, or from an emotional perspective, such as design, elegance, fashion statement or unabashed sexiness. By going against the segment’s assumption that the sole is a utility and function player and making it instead the quintessential aspect of the offering, immense competitive thrust is delivered. This, to adapt a culinary classic of my native Yorkshire, is “fish ‘n’ shoes” thinking. Fish, because you swim upstream against the force of industry assumptions. And shoes, because as already indubitably established, shoes are a better metaphor for strategic leadership than are French fries. “Fish ‘n’ shoes” thinking abounds in businesses that demonstrate the “change one thing” strategy: • Apple, by putting design above function. • Whirlpool, with the idea that it doesn’t have to be white, makes the washing machine furniture. • Macy’s, by offering “risk less” insurance for furniture—agreeing to refund the insured’s premium (in the form of a refund to be applied to the next furniture purchase) if no claim is made on the policy. (“Risk free” insurance is oxymoronic to a traditional insurer.) • Argyle Mines, by delivering industrialgrade brown diamonds, increasing the price by a thousand percent and creating desire for the previously undesirable brown—now champagne, cognac and hazel—rocks. • “The Sopranos,” which could have been another absolutely typical family-centered drama series in a legacy tradition. But changing the dad’s profession to Mafioso

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created a television icon. In these paradigms, the “one thing” becomes a great deal more than the sum of its sole part, which returns us conveniently to the red Louboutin sole, affectionately termed “Sammy red-bottoms.”

Barriers to Exit and Free Advertising

The litigiously hard-won intellectual property right protection of exclusive rights to the use of that red-bottom color code (Pantone 18-1663 TPX) on shoes cemented the commercial advantage of Louboutin’s differentiator and created an impermeable barrier to entry. It also created that elusive competitive advantage—a customer barrier to exit— because the proclamatory red sole of sensual extravagance simply is not available anywhere else. The red soles then deliver value far beyond the aesthetic design innovation; they go to work on brand promotion as “free” advertising. Marketing, I heard a Harvard business school professor quip, is the price you pay for not having a good enough product. We are accustomed to admiring utility brands whose functional excellence or brand ubiquity makes their brand inseparable from the product’s performance: Jacuzzi, Xerox, FedEx, Escalator, Hoover, Google, Kleenex. In this case, the emotional “story” of the luxury glamorous shoe renders the brand inseparable from the product and the product literally a walking promotion for the brand. The flashing red sole in turn becomes a unique value proposition to the consumer, a motive to purchase, a fashion and status statement, an

advertisement of how expensive the shoes are. The historically unconsidered sole becomes the soul of the consumer experience. This is the essence of a desire-driven sales strategy. Your customers are “head over heels” in love with your product. And this is exquisitely commercial head-overheels success: Three years straight leading the Luxury Brand Status Index; three years awarded Most Prestigious Women’s Shoes; and the “real” Carrie Bradshaw, fashion doyenne and trendsetter par excellence Sarah Jessica Parker, chose to get married in them.

Changing the ‘How’ Instead of the ‘What’

This kind of “fish ‘n’ shoes” thinking about differentiation in a crowded marketplace is not limited to $4,000 shoes. But since we’re on the topic of shoes, let’s look at another shoe-led business model innovation: Zappos. A parallel pattern emerges in the components of the strategy: • Question conventional assumptions. • Change one thing. • Build a platform around the innovation. • Socialize the strategic story. • Make the “product” integral to the buyer experience. The Zappos story also begins with an inversion of the “rules.” Conventional thinking about call centers obsesses about cost and efficiency with emphasis on control and consistency. U.S. call centers have had notoriously high turnover rates. We have all had

The disruptive power of “just one change” lies in the inversion of conventional thinking about what matters and why.


dispiriting experiences trapped between the tyranny of the technology (press 73 if you would like your blood pressure to reach dizzying heights in frustration) and the disembodied and disengaged script reader on the phone. This constipated experience is the antithesis of the storied, connected, empathetic customer experience. But that’s call centers for you—and unlike books and sundry hardware, some things just don’t fit the online model because fit is important, in shoes for example. Zappos founder Nick Swinmurn and CEO Tony Hsieh did not conform to those assumptions. Swinmurn’s vision to build a retail empire online began with the unlikely proposition of shoes. Like many bright ideas, it now seems obvious with 20/20 hindsight but on inception looked improbable, even to initial venture investor Hsieh. I was surprised that even in 1999, the startup year of the future Zappos, $400 million worth of shoes were being ordered from mail-order catalogs—and that was a mere sliver of a then $40 billion U.S. market. Zappos’ shoe inventory replicates other online and physical store retailers. Zappos did not change the what but instead the how of its model. Product-centricity was supplanted by people-centricity. In its brief and occasionally tumultuous 10-year history before hitting more than a billion dollars in sales and being acquired by Amazon, Zappos had a number of  “fish ‘n’ shoes” moments, such as its decision to walk away from drop shipping, which represented 25 percent of revenues and sorely needed cash flow, because control of the customer experience necessitated control of inventory. But the bold, transformational “change one thing” that excites me in this peoplematter-as-much-as-product story was their reinvention of the call center. Through a dramatic salmon-upstream leap of faith and imagination, Zappos effectively repurposed the call center from servant of the organization’s efficiency and expense management to servant of customer experience. Of course, for the “one changed thing” to

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have resonant and sustainable business impact, the organizational ecosystem must be redesigned around it. Operationally and culturally, Zappos built the platform around its core idea. Thus it became a business in the business of exceptional, memorable customer experience. The then prototypical accoutrements of the call center—scripts, time restrictions, de minimis discretionary decision rights, impersonal and fungible hourly staffing, keystroke counts, command and control— were booted out in favor of intensive training, trust and empowerment. The first step to customer centricity is often misunderstood as customer focus. But the quintessential first focus if we seek differentiation in customer experience must be on the employee. Recruitment training and retention methods and tools were reinvented to support the preeminence of customer experience. New recruits were paid during intensive training programs, building skills to communicate with customers empathetically and authentically. All new hires to the company at every level were inducted into the customer-centric culture by working for an initial period in the call center. The story goes of a newly appointed senior executive officer who was disinclined toward the immersive call center experience; the company was disinclined to continue the relationship. The organization made cultural fit and shared values the defining characteristics of employees and created and sustained employee engagement as the sine qua non of the delivery of customer experience. Making the grade technically is irrelevant if the cultural dimension is lacking. After partial training, prospective hires are offered a $4,000 “bonus” to quit (as a way to make sure employees are committed to more than just a paycheck). If you want a great ecosystem, investing in weed killer makes sense. Moreover, employees enjoy the benefits of the people-centric culture, which they are accountable for sustaining operationally as well as socially. Zappos offers free health care, lunches and

vending machines as well as a library. Significantly, these are positioned as cultural rather than economic benefits. The bottom-line benefit is not red bottom but black. Zappos’ vibrant viral reputation for customer service again creates a barrier to exit. People love being treated like people by people. If that’s trite, I make no apology, since it seems to elude the imagination and execution of far too many organizations. Constant storytelling and exchange and “goofing around” underscore the unique values and positioning of the company, which publishes unedited its annual “Culture Book,” an anthology of employee descriptions of the company’s culture. These are not ubiquitous traits of servicecenter environments. Clash with convention. Create culture. (Louboutin’s employees, by the way, are known as “Loubi’s Angels.”) These leaders have re-imagined the businesses they are in. As Hsieh puts it, they are not in the business of selling goods online but of “delivering happiness,” just as Louboutin is less in the business of shoes than in the business of celebrating the mystery and mythology of shoes. So this “fish ‘n’ shoe” combination is my invitation to you to think differently and make the inquiries: 1. What conventional assumptions can we invert? 2. What one thing can we change? 3. What platform can be built upon this innovation? 4. How can we socialize our strategic story? 5. How do we make our product the soul of the customer experience? Finally, if cynicism still has you under its heel and these ideas seem abrasive because your business is “different,” remember Golda Meir’s advice about confrontation: Before you race to dispute someone with a different perspective than yours, walk a mile in their shoes. Then, if the dispute should materialize, you are a mile away and you have their shoes. If you are really blessed, they will be your size and have red soles.

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Leadership

Pacific Specialty’s CEO: Working Within Limits, Re-engaging Independent Agents

Executive Summary: Scarce resources? No problem. Speaking from past experience, Brian Cohen, the CEO of Pacific Specialty, explains how to generate growth even with limited advertising dollars and other budget restrictions. At PSIC, independent producers are a key part of the strategy, he says.

W

By Susanne Sclafane hen employees of Pacific Specialty Insurance Co. bemoan the fact that they don’t have a ton of money to spend on sales and marketing to generate growth, the chief executive does not promise to find more resources. Instead, Brian Cohen directs his staff to work within the limits they’re facing. Drawing on his own past experiences as an executive at a much larger company, Farmers Insurance, Pacific Specialty’s CEO knows it’s possible to look beyond the boundaries to find hidden opportunities. “When I was at Farmers we complained that we didn't have enough money to spend on marketing and advertising, and we spent 20 times as much as we spend at

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Pacific Specialty,” he says. “Every situation you're in has its advantages and disadvantages. As a business leader you have to learn how to exploit the advantages and minimize the disadvantages,” he says, noting that for Pacific Specialty, the advantage is being small. “There aren't layers and layers of bureaucracy that independent brokers— our predominant distribution source—have to deal with.”

At the time, Farmers had roughly 15,000 captive agents selling mainly traditional homeowners and auto, with some selling commercial and life insurance as well. “That was when Citigroup and Sandy Weill were talking about the financial supermarket and the [idea that the] only way financial companies were going to survive was…to get multiple

Catching the Bug

Back at Farmers, Cohen, who rose to the position of chief marketing officer and chairman of the budget committee for the whole group in the late 1990s and early 2000s, says that it was his first job there— leading a floundering new-products division—that led to his insights about finding success with seemingly inadequate tools to do the job. Adding a few more tools, including some rented yellow Volkswagen Beetles, Cohen and a colleague drove around the country to generate agent support for the new products—a home warranty product and mechanical breakdown insurance.

products inside a customer's home, all branded,” Cohen recalls, referring to the time when banks were expanding into brokerage and insurance. “The way Farmers reacted was to sell products that were complementary to our core automobile and homeowners insurance product lines,” he says.

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Leadership continued from page 80 “But I was told I wasn't going to get the resources to build my own factory to make these products,” Cohen says. “I couldn't hire hundreds of people and build a whole internal capability. I had to do it through joint ventures and relationships,” he says, noting, for example, that a joint venture with Sears Roebuck was part of the answer for the home warranty product. They had appliance repair people all over the country, he says, explaining that the Sears Repairs network became the claims staff. “We basically underwrote the risk and put it on our paper.” Cohen tackled the distribution hurdle in a number of ways—targeting Farmers’ best agents first, and then publicizing their success to everyone else. “It was a very simple sales approach: ‘Look at what this top agent's doing. Why aren't you?’ Next came middle-of-theroad agents. “‘Not only are our top agents doing it, but our middle-of-the-road Brian Cohen agents are. Why aren't you?’" Cohen says that an unorthodox publicity campaign stressed how easy it was to sell the products and how good it was for their agencies. “We called these products valueadded products—value-added for your customer and value-added for the agency,” he explains. The campaign was called “Catch the Value‑Added Bug.” Cohen and his co-worker drove out across the country in VW rentals giving out key chains with replicas of differentcolored VW Bugs on the end of them, and they auctioned off additional giveaways that were all VW Bug‑related, ultimately giving away three actual VW Bugs. “Our district managers got a kick out of the excitement created when we came to town. So they got behind it,” he says. “We built bottom‑up excitement that generated an incredible amount of publicity for us within the Farmers distribution channel— and ultimately sales.” Cohen stresses that this was possible with inadequate resources and inadequate

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staff. “What I realized was that you’ve got to work within the boundaries you have to make a successful business,” he says. Cohen used his newly discovered marketing talents again when he was asked to train Farmers agents to sell more sophisticated financial products, including mutual funds. “None of them had ever done that. None of them were licensed to do it.” Leading a much larger unit, “we trained 10,000 Farmers agents to sell these products. We became one of the largest broker-dealers in the United States. More importantly, we became the fastest growing business unit at Farmers,” he reports, noting that outside experts came in to do the training. Using the value-added product strategy again, Cohen set out to send a message to Farmers’ internal distribution channel that they could sell these products, that their customers wanted to buy the products from them and that selling them would help the agents as well. Cohen generated excitement by ordering annual subscriptions of Money magazine for every agent and asking the publishers of Money to create a separate cover for Farmers. “Every month for 12 months we profiled an agent [and] we put one of our agents on the cover of Money magazine." Everybody wanted to be on the cover, but to get there they had to embrace the idea of selling sophisticated financial products, Cohen says. “I took the same approach to our core business of auto and homeowners,” he says, noting that innovative sales approaches ultimately propelled him to the role of chief marketing officer at Farmers, focused on these core products. Although the Internet was in infancy and access was made with dial-up modems, he started developing an idea that Pacific Specialty uses today— essentially using online lead-generation tools to make agents more efficient. “Everyone was talking about something called direct marketing, which was really telesales. They were distinguishing direct marketing from what I'd call captive distribution sales approaches, which is sitting around the kitchen table.

“What I realized was you could merge the two, and that the Web was going to enable that,” he says. At Farmers, Cohen reports that the “agent‑focused lead generation direct marketing program” that he put in place produced more than $500 million of new premium in one year.

Growing Pacific Specialty

After Farmers, and four years after a subsequent executive position leading the turnaround of a financial services software company, Cohen signed on at Pacific Specialty. An interim role as an executive with Altamont Capital Partners, a private equity firm that invests in insurance businesses, introduced him to the carrier in 2012. “I saw a great company that was at the point where it could really grow to the next level. That's really what I was asked to do by the board of directors, and that's what I've been doing since.” Cohen stresses that the personal lines specialty company has been growing profitably, noting the company’s third annual ranking as a Ward's 50 Top Performer in 2013. “Our disadvantage is our advantage. We're small in that we only write a little under $200 million in premiums a year. But our size allows us to go after niche markets that other companies would find too small,” Cohen says of the carrier, which writes product lines like motorcycle and personal watercraft insurance in addition to homeowners. The size and focus on personal lines products allows the carrier not only to serve existing agents but also to have other insurance companies as clients. “For whatever reasons, [they] don't want to offer some of the products that we offer— because they don't understand the risks, or they don't think [the business] is profitable enough.” Giving an example, he says some large carriers believe that selling homeowners insurance in California is too risky—a state where Pacific Specialty has been for decades.

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Cohen confirms that Allstate is among them. “We're one of a handful of carriers in California that offers a homeowners offering to Allstate agents," he says, noting that Allstate deals with third-party relationships through its Ivantage unit. Pacific Specialty also signed a deal with Insurance America in the Southeast to sell motorcycle and powersports products last year, and earlier in the year the company inked a deal with Infinity Insurance, which sells auto insurance, to offer Pacific Specialty’s homeowners and motorcycle products through their distribution channel.

The Age of the Independent Agent—and SEO According to Cohen, however, these relationships are not the main avenue of growth for the company. “We're very committed to the independent broker channel. And, frankly, when I joined the company I didn't think we were engaging enough with our independent brokers. “I think actually this is the age of the independent broker,” Cohen asserts.

Growth for Pacific Specialty, he says, is not simply about forming new broker relationships. “We're re-engaging with brokers we already have relationships with.” And the carrier isn’t simply waiting to take the agents’ business when it comes. “We’re showing them how they can use our products to generate more business.”

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In particular, Cohen refers to leadgeneration programs now being launched by the carrier to help independent brokers get new business. “Our view is if you produce for us, and if you're committed to doing business with Pacific Specialty, then we're going to help drive business to you." The carrier CEO went on to explain the use of search engine optimization strategies in conjunction with social media. “Commercially, what social media means to me is the opportunity to interact with someone at the time that they're looking to make a purchase,” he says, noting that today’s consumer does a tremendous amount of research, whether sitting in front of a computer or from a smartphone. “We literally have a firm that we've engaged with that surfs the Web for us and identifies people that might be looking at insurance options,” he says. “If we build our algorithms correctly, we're popping up on the pages that they're looking at to let them know that we're out there to help answer some of the questions they have,” he says, explaining the SEOtype concept that Pacific Specialty is now using. Cohen stresses that the carrier is not “popping up” in the traditional way with a tease that says, “Click here and get a cheap price on your auto insurance.” Instead, “it's ‘Click here and we'll help explain to you what you need,’” he says. Giving some more details of a pilot program just launched in some parts of California, he notes that a co‑branded icon appears with a link and information about a local independent producer that's close to where the consumer is located. “Insurance is the kind of purchase where it's complicated for people to understand if they have what they need. But it's not something people want to spend their time figuring out. “That's why I believe the independent

“Every situation you’re in has its advantages and disadvantages. As a business leader, you have to exploit the advantages and minimize the disadvantages... You’ve got to work within the boundaries you have to make a successful business.” broker is really going to experience a real renaissance over the next decade.” (Cohen also wrote about his views on using social media in an article for our sister publication, Insurance Journal: “Become a ‘Brand Behemoth’ by Seizing the Digital Moment,” in the Dec. 2 edition.) Before Cohen joined Pacific Specialty, the company had a direct-to-consumer website. “You can't make money like that,” he asserts. There are a lot of people out there who just want to find the cheapest auto policy. Then six months later, they’ll search again to find a cheaper carrier. “There's no customer‑centric value proposition. If you can't create value beyond price, then you're not going to create a lasting customer relationship that's going to be profitable,” Cohen says. So while a consumer typing motorcycle insurance and California into an online search engine might return results including Progressive or GEICO, the competitive advantage for Pacific Specialty lies in the next step. “They'll give you a price, but you've got to know answers to questions like, ‘What kind of limit of liability do you want?’" For most people, that’s confusing—and they don’t want to spend time researching what it means, Cohen believes. He says the pilot program currently involves 30 agents, but the goal is to roll it out to all of the producers that sell on a regular basis with Pacific Specialty.

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Leadership Energi Insurance CEO McCarthy:

Plugged Into Energy Revolution Through R&D Executive Summary: Former independent agent Brian McCarthy, the CEO of Energi Insurance, explains how his firm is capitalizing on the failure of others in the insurance industry to put research and development and loss control first in their efforts to serve the energy sector.

J

By Andrew Simpson ust as there are best practices for managing today’s energy risks, there are also best practices for managing a company that specializes in insuring those risks. According to Brian McCarthy, best practices in the fast-changing energy insurance sector begin and end with a commitment to research and development (R&D). It was the insurance sector’s lack of R&D on the energy sector that drove McCarthy’s 2006 launch of Energi Insurance in Peabody, Mass.—and that commitment to R&D continues to define the company that specializes in North American energy risks. McCarthy is a former independent agent, the former CEO of Conifer Insurance Agency and Conifer Energy, and an Internet pioneer. He was one of the first to offer an agency system for buying and selling insurance online. Energi, however, is less about pioneering a new way to do business than it is a return to some old-fashioned best practices, albeit with a modern interpretation. “Back in 2002, we were an independent

insurance agent and broker. We specialized in the energy industry. Our policyholders became very frustrated with the limited number of insurers in the energy sector. But in addition to that, the carriers [were] not providing meaningful loss prevention, safety and really aggressive claims management,” he says.

Back to Basics

According to McCarthy, there was a time when insurers serving the energy sector took R&D and loss control seriously. “When I first came into the business, we had the little Aetnas and the Insurance Companies of North America, Aetna Life & Casualty, Travelers. There was a real emphasis back then on engineering loss control, an emphasis on underwriting.” Then the business changed, with financial approaches to underwriting taking hold, he says. The energy sector, however, still “needs to have an engineering approach to it, an extensive research and development approach where you ensure that you really understand the sector before you go in and insure it.” “You approach it the same way as HPR [highly protected risks] and boiler machinery…It’s very critical to do that because of the catastrophic risk exposure,” says the veteran of the market. He and his energy insurance customers were tired of having insurance companies entering and exiting the market, writing energy firms that did not implement best practices and, perhaps most upsetting, not offering serious loss control assistance.


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Energi leaders and some fuel distribution customers decided to take matters into their own hands. They brought in actuarial and reinsurance consultants. “We went back to basics, back to basic underwriting. To do basic underwriting, that was critical—to understand the risk exposures, understand the industrydefined best practices and make sure that you selected the right risk from the get-go,” McCarthy says.

Business Model

Energi was incorporated in 2005 and began operations in 2006 as a group captive. It operated that way until 2009, when it merged with Conifer Insurance Agency Inc. and became an industrial reinsurance company. Energi looked to two insurers— ACE and XL—for its business model, McCarthy says. They both started out as group captives before evolving into industrial reinsurance companies and then into insurance companies. That's the track that Energi is on. Energi is probably the only industrial reinsurance company in the U.S. today, according to its founder. An industrial reinsurance company is one where policyholders are owners of the company along with management. Insurance company partners act as the insurance company, and these insurance companies cede a portion of the business to Energi’s reinsurance operations. Energi’s strategic insurance partner is Hannover Re. “Today, we're really a virtual insurance

company. We don't issue policies today because we don't have primary paper or a primary insurance company. We don't own one,” says McCarthy. Energi’s core programs include fuel distribution, fuel transport, energy construction, agricultural cooperatives, renewable energy, energy efficiency, utilities, and oil and gas exploration. It does not handle manufacturing. Energi contends that its in-depth knowledge of the various energy sectors and their best practices not only drive its underwriting process but also give it the tools to provide “differentiated safety, loss prevention and claims management services” for each energy sector. These services reduce loss costs and enhance productivity for policyholders over the long term, the company promises. “Really, what we developed was a new way to do engineering loss control. We call it a ‘compliance audit’ to determine if risks are in compliance with industry-set best practices.” McCarthy highlights the importance of this audit, explaining that “if companies do not implement industry-set best practices, you're going to have to defend against those in court. They're going to be a critical determination of liability.”

Available on the Carrier Management channel of www.insurancejournal.tv: • Fracking and Other Energy Risks • How a Specialty Insurer Handles Hiring and Training: Energi’s McCarthy • A Specialist in Energy Risks: Energi’s McCarthy • State of Market for Energy Insurance “It was in manufacturing, moved to technology, moved to biomedical, and now it's moving to our own natural resources, with oil and gas and other renewables that we have in the United States. I think the oil and gas sector is really the driver in our ability to become energy-independent by the year 2020.” Two areas of this revolution where Energi has focused some of its own energy are renewable energy/conservation and the oil and gas exploration method known as fracking. According to Energi’s founder, energyefficiency projects in the United States are primarily done by major energy service companies like Johnson Controls and Honeywell, which guarantee that the measures they install are going to reduce energy consumption by a certain amount. Most of these guarantees are done on municipal and federal projects. But now, energy-efficiency projects are gaining popularity in the private sector, and there is a growing need there for warranty products. “What this policy does is it backstops the guarantee that secondtier contractors are now able to provide to the end building owner to guarantee [reduced] energy consumption,” says McCarthy. “The finance lenders need the reliability that if the energy savings don't occur, there is an ability to repay those loans.”

“The end result of

shortcuts in catastrophic risk exposure industries is you have these

catastrophic losses that occur.”

Brian McCarthy, CEO, Energi Insurance

Energy Revolution

One of the reasons McCarthy is so attracted to the energy industry is because it is undergoing tremendous change that is shaping the country’s future. “I think the most exciting thing for Energi and for our people is that we're seeing the next industrial revolution occur in the United States,” he says.

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Leadership continued from page 85 McCarthy says that his company put a lot of R&D into understanding the risks and developing the policies with Hannover Re.

Fracking

Just as it has researched the energy savings market, Energi has also done its homework in the fracking segment of the oil and gas industry and determined the method is safe when best practices and regulations are followed. The industry (American Petroleum Institute) has developed best practices for fracking that minimize the impact to the environment, according to McCarthy. But even more important, in his view, is government's role in safety and loss control. “States like Pennsylvania, Ohio, North Dakota and Oklahoma are taking the lead in establishing regulations to enforce these best practice standards, to ensure that it won't have an impact to the environment. “As in any industry, we have good actors and we have bad actors. This will allow the regulators to ensure that they can regulate those bad actors, those companies that just don't want to implement practices that are best.” The regulations also mean “that we can have our fracking done safely in the United States—so that it doesn't have an impact to the environment and the air quality,” he says.

‘Get It’

While too many insurers enter the energy sector without the necessary commitment to R&D, a few insurers in addition to Energi do it the right way, according to McCarthy. He cites Travelers

Recruiting for Specialty Insurance

and W.R Berkley as two that “get it.” “They've done a good job. They've spent the money on Any specialist insurance company faces a research and development, and recruitment and training challenge. In Energi’s they've got boots on the ground— case, it needs people who know not only engineering loss control insurance but also energy. professionals that really understand McCarthy believes a solid education and the sector, no different than what training program is key to getting the right Energi has done today,” he says. people for a specialist company like his. But there are still some insurers “When we onboard new employees, we have that do not get it. The marketplace an extensive education and training process, not is less stable because of them. to just understand what our set policies and “I've been in this business long procedures are but to really understand these enough to see companies come into industry sectors—understand how they operate, the marketplace, and they don't understand the best practices.” make that investment in research This is true for employees at all levels—from and development, don't look at it as client services to underwriting—but especially an industry that has to be highly for Energi’s people that are out in the field, engineered and loss controlled. In McCarthy says, referring to loss prevention and turn, they suffer the losses.” safety professionals. After these insurers get burned Energi looks for people who have either by losses they might have avoided insurance expertise or energy expertise and had they taken R&D and loss then trains them in what they lack. control seriously, they exit the market, McCarthy notes. “The end result of shortcuts in In addition, he says that “the sector does catastrophic risk exposure industries is you need some increase in pricing, and we've have these catastrophic losses that occur. seen that over the last two years.” “We've seen some real hardening of For insurers like Energi that are firmly pricing with insurers withdrawing from the committed to the market, that reduction in marketplace—again, those carriers that capacity is not necessarily bad. “It gives us didn't invest in research and development, more of an opportunity because of our didn't do solid underwriting, didn't invest approach of understanding the industry in loss prevention and safety. We've seen sectors and making sure that we some of those carriers have to withdraw underwrite the risks that want to from the marketplace,” he reports. implement best practices,” according to McCarthy says that reduced capacity carriermag.com/qm7tf McCarthy. always results in increases in overall pricing.

About Energi Energi is probably the only industrial reinsurance company in the U.S. today, according to founder and CEO Brian McCarthy. An industrial reinsurance company is one where policyholders—including energy distribution companies, in Energi’s case—are owners of the company along with management. Energi’s strategic insurance partner, Hannover Re, cedes a portion of the

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business to Energi’s reinsurance operations. Energi may not be an insurance company in the full sense, but it has most of the operations of an insurance company. It acts as a program administrator and reinsurer, providing underwriting, distribution management, loss prevention and claims oversight. The Energi business model has two main revenue components:

• Energi earns fee income for services it provides for its third-party insurance partner as an administrator of insurance programs. These services include product development, marketing and sales, risk selection, initial underwriting, safety and loss prevention, and claims management. • Energi earns underwriting income and investment income by providing reinsurance on a portion of the casualty business placed through its core insurance programs.

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Regulation & Compliance 3 Ways FIO’s Report Could Impact

Core Insurance Functions and Corporate Governance Executive Summary: As the regulatory landscape evolves in the wake of the FIO’s Modernization Report, potential consequences for P/C insurers include federal scrutiny of risk classes, downward pressure on reinsurance prices, and state qualification standards for directors and officers.

I

By Molly Lang and Susan T. Stead n its report, “How to Modernize and Improve the System of Insurance Regulation in the United States” (Modernization Report), the Federal Insurance Office (FIO) concluded that a combination of reforms to the state-based system of regulation and federal government actions are necessary. The insurance regulatory landscape is destined to evolve as states respond to the pressure of federal monitoring and involvement. If and when action is taken to modernize insurance regulation, insurers

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could be impacted at the highest levels in at least three ways.

1. Underwriting practices could be scrutinized by the federal government.

In the Modernization Report, the FIO addressed the fundamental insurance concept of risk classification. Recognizing that technological advances have rapidly expanded the accessibility of personal information, the FIO recommended that states develop standards for the appropriate use of such data in pricing personal lines insurance. This recommendation may not be surprising given insurers’ increasing interest in using big data. What was unexpected was the FIO’s suggestion that binding, uniform federal standards may be appropriate for risk classifications, especially to the extent insurance scoring methodologies involve factors that implicate rights secured under federal law. Although the FIO did not expand upon these rights in detail, certain protected classes under the Civil Rights Act of 1969 and the Fair Housing Act—including but not limited to race, sex, age and national origin—readily come to mind. Recent developments regarding the treatment of samesex spouses, including the Supreme Court’s decision concerning the Defense of Marriage Act, may have focused the FIO’s attention on the use of marital status in underwriting.

It is not uncommon for personal lines insurers to use an applicant’s age, sex and marital status in underwriting and calculating risk. The development of federal standards could force insurers to change traditional underwriting practices. The FIO committed to monitoring accessibility and affordability of insurance to traditionally underserved communities, which will likely include an assessment of existing risk classification practices. Risk classification factors such as education, occupation and credit score were identified as being correlated with race, resulting in minorities paying higher insurance prices. The FIO recognized insurance scoring and other methods of classifying risk as potentially important tools for insurers to more accurately predict and price risks but encouraged states to better understand criteria used in developing risk profiles. Insurers should expect to see increased scrutiny of their risk classification factors and methodologies by regulators and, perhaps, by the FIO.

2. A covered agreement could preempt state reinsurance collateral laws.

Consistent with a theme of the Modernization Report that there is a need for regulatory uniformity to cure certain limitations inherent in a state-based system, the FIO recommended direct federal involvement in the regulation of reinsurance collateral requirements. It specifically called for the U.S. Department of the Treasury and the United States Trade Representative (USTR) to pursue a covered agreement to preempt inconsistent state laws. Such a covered agreement could remove barriers that non-

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Regulation & Compliance continued from page 87 U.S. reinsurers face in conducting business in the U.S. Under existing law, if an insurer wants to receive balance-sheet credit for liabilities ceded to a non-U.S. reinsurer, most states require the reinsurer to post collateral equal to 100 percent of the ceded liabilities. Non-U.S. reinsurers claim this requirement results in a competitive disadvantage when compared with U.S. reinsurers, which do not have a similar collateral requirement. In 2011, the NAIC adopted a revised Credit for Reinsurance Model Law and Regulation that allows a sliding scale for reduced collateral requirements for nonU.S. reinsurers domiciled in a “qualified jurisdiction.” Only 18 states adopted the model, and there is concern that even if more states adopt it, implementation will not be uniform. The FIO recommended basing a covered agreement on the NAIC model. To the extent preemption through a covered agreement is accomplished, foreign reinsurers would likely be able to operate domestically with less than 100 percent collateral. This would free up foreign reinsurers’ capital, which could then be made available to take on additional risk. The potential for an increase in capacity could theoretically place downward pressure on the cost of reinsurance.

The FIO recommends that states develop character and fitness expectations for directors and officers in proportion to the size and complexity of the insurer. This is true to another theme in the Modernization Report—that domestic and international supervisory standards should be in alignment. It has been suggested that insurance regulators improve corporate governance standards for insurers. In 2010, the International Monetary Fund (IMF) conducted a Financial Sector Assessment Program (FSAP) evaluation of the U.S. as part of a larger effort to monitor regulation in the global financial system. The assessment included an evaluation of the U.S. insurance sector’s adherence to international insurance regulatory standards. The assessment was based upon the Insurance Core Principles (ICP) established by the International Association of Insurance Supervisors (IAIS). Two ICPs directly relate to the suitability and fitness of directors and officers, providing that supervisors should require: • Board members, senior management, key persons in control functions and significant owners of insurers to be and remain suitable to fulfill their respective roles. • Insurers to establish and implement a corporate governance framework which provides for sound and prudent management and oversight and adequately protects the interests of policyholders. The IMF found that the U.S. system of insurance regulation largely observed these ICPs. While U.S. insurers are subject to corporate governance requirements articulated in federal laws such as the Securities Exchange Act of 1933 and the

FIO’s report suggests that binding, uniform federal standards may be

appropriate for risk

classifications, especially to

the extent insurance scoring methodologies involve

factors that implicate rights secured under federal law.

3. Directors and officers may become subject to different suitability and fitness standards.

The recent regulatory focus on corporate governance standards will likely continue and become more defined in the aftermath of the Modernization Report.

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Sarbanes-Oxley Act of 2002, these laws typically apply to public companies and are enforced by federal financial regulators, but they are not specific to the insurance industry. U.S. insurers are Molly E. Lang (top) and subject to another layer Susan T. Stead (bottom) of corporate governance are partners in the regulation at the state Columbus, Ohio, office of level. State regulators Nelson Levine de Luca & review the background Hamilton. They advise and experience of insurance companies on a directors and officers and broad range of compliance obtain third-party and regulatory matters. verifications of the Reach Lang at mlang@ biographical information. nldhlaw.com and Stead at Corporate governance is sstead@nldhlaw.com. also assessed through risk-focused examinations and ongoing analysis and monitoring. Even though U.S. insurers are subject to federal corporate governance laws and state reviews, both FIO and the FSAP evaluation noted the absence of an NAIC model law for corporate governance and for what constitutes a fit and proper individual to serve as officer or director. The FIO rejected a one-size-fits-all approach to corporate governance, recognizing that standards reflect the size and complexity of the insurer. In accordance with relevant ICPs, the FIO also encouraged states to adopt director and officer qualification standards that contemplate requisite expertise to assess strategies for growth and managing enterprise risk. As states respond to the FIO’s suggestions and pressure from the IMF, current standards for suitability and fitness may be subject to change. Some degree of regulatory change is inevitable. With encouragement from the FIO, it may occur sooner rather than later.

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Regulation & Compliance

THE FSB OBJECTIVE: Never Waste a Good Crisis

Executive Summary: The Geneva Association’s John Fitzpatrick reviews the FSB’s march toward a global capital standard, explains that the omission of a global capital standard did not cause the financial crash of 2008 and reviews the essential regulatory questions for policymakers to consider in 2014.

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By John H. Fitzpatrick e have had the benefit of more than six months since the designations were announced by the Financial Stability Board (FSB), and we now also have the Oct. 9, 2013, statement by the International Association of Insurance Supervisors (IAIS) announcing its intent to develop a global insurance capital standard (ICS) by 2016 for implementation in 2019. Let's take stock of where we are. The essential facts of the July pronouncements by the FSB and IAIS can be summarized as follows: Nine insurers have been named as global systemically important insurers (G-SIIs). For G-SIIs, a “straightforward backstop capital requirement,” on which higher loss absorbency (HLA) will be based, is required to have been created by November 2014. For all internationally active insurance groups (IAIGs), ComFrame will have a “quantified capital standard (QCS),” which will be supplanted by the new ICS. When one considers these announcements in isolation, someone far from the machinations of Basel and the world's financial capitals could miss their significance to the global insurance industry. Taken together, there should be no doubt as to the significance of the FSB

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designations and IAIS pronouncements. In our view, the intent of the FSB is clear. The central bankers of the world want a global capital standard for the insurance industry, and the IAIS has committed to develop it by 2016. It is difficult for central bankers to understand how it is that banks have had Basel I, II and III, but insurers have never had a global capital standard. Central bankers have struggled with what has been viewed as the failures of global bank capital regimes and supervision—and, in particular, the failings of the most recent years that unfolded into the crisis in 2008. This experience strikes fear in a central banker's heart about an industry some do not know as well as their own and that has never had a global capital standard. One could ask, innocently, why the insurance industry needs a global capital standard when it already has local capital standards that protect policyholders. Did this omission of a global capital standard cause the financial crash of 2008? Clearly not. Five years after the crash, we finally have some agreement on the root cause of this event—government policy regarding housing in the U.S.—as well as the causes of its recessionary cousin, the 2010 banking and sovereign debt crisis in Europe. Logic suggests that the world's reform agenda would address the root causes of the crash, so we do not have to endure such a painful episode ever again. Determining the root causes of a crash and directly addressing

these would seem to be the logical priority of policymakers going forward. The evidence points to wrong-headed government policy as the root cause of the housing bubble and its spectacular bust in the United States. And government policy in Europe contributed to its own bubble and bust—a monetary union without fiscal union, which caused banks and others to flood the peripheral European markets with cheap financing. (For more background, see “A Short Digression Into the Root Cause of the Financial Crash” on page 90.) The wake-up call of the U.S. housing crash in 2008 led to the 2010 eurozone crisis, where a dramatically sharp drop in financing by banks (and others) to peripheral countries and other credits in the eurozone forced governments to provide funding with austerity attached. Generally it takes governments to originate problems measured in the trillions. Of course, such losses were absorbed, not just by banks but by savers, retirees, pension funds and those insurers without a global capital standard. They did not originate the crash, but they suffered from the “common shock” of the deflating real estate asset bubble in the U.S. and the decline

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Regulation & Compliance continued from page 89 in asset values in Europe that produced a global recession—a first for our modern world.

How the FSB Planned to Get to a Global Capital Standard

The FSB has a broad mandate from the G20 finance ministers to “assess vulnerabilities affecting the financial system and identify and oversee action needed to address them.” The FSB members do not want to have to use taxpayer money to bail out banks, securities firms or insurers ever again. In particular, the FSB wants a system where the failure of a financial institution

A Short Digression Into the

Root Cause of the Financial Crash

S

By John H. Fitzpatrick ix years after the financial crisis, there is some common understanding of the root causes of the 2008 crash in the U.S. as well as the causes of its recessionary cousin, the 2010 banking and sovereign debt crisis in Europe. First, it should be acknowledged that many actors made mistakes, including financial institutions such as banks, mortgage brokers, securities firms and insurance companies. Individuals also made mistakes, believing that real estate values only go up and taking on too much leverage in the form of mortgages, credit card debt and car loans. Banks, large and small, made some loans that made sense only in a rising economy; securities firms around 2005 started securitizing weaker credits; mortgage brokers pushed some very questionable loans into the system, etc. Some claim that it was underregulation by Republicans, or the breakdown of

90 | Winter 2014

cannot cause the failure of another financial institution, disrupt financial markets or disrupt the real economy—the essential definition of a systemic event. The mission of the FSB does not explicitly include mandating a global capital standard for insurers. And it can be hard to argue that the lack of a global capital standard for insurers, in and of itself, created or contributed in a material way to the financial crash. AIG Financial Products would still have happened if there had been an ICS. Nevertheless, not wanting to waste a good crisis, the FSB took action to get something it appears it has always wanted:

a global capital standard for insurers. And now the IAIS has committed to develop it. The FSB had chosen to focus this effort on the nine named G-SIIs, where it arguably had the power, through the usual G20 process, to encourage G20 member countries to adopt legislation required to be implemented by insurance regulators in each jurisdiction. Achieving agreement among nine companies and their regulators, in theory, ought to be easier than among 50 or so IAIGs and their larger and more diverse set of regulators or, for that matter, among all the insurers in the world and their larger set of regulators. Worth noting at the time of writing is the

Glass–Steagall, or the greed of investment bankers that was the root cause of the crisis. All these things existed and surely, taken together as a group, would have created a recession of some significance. However, the evidence suggests that the magnitude of this recession has as its root cause the longstanding U.S. government housing policies that fueled one of the greatest asset bubbles of all time—and one of the biggest financial crashes of all time. From 1938 to 1992, Fannie Mae (and since 1968, Freddie Mac) bought and packaged prime home mortgages without much financial distress through several economic cycles—no small accomplishment given the government policy of an extremely low capital requirement of 2.5 percent of held whole mortgages and 40 bps of securitized mortgages. In 1992, the U.S. Congress mandated that mortgages be bought from low- and medium-income borrowers. The purpose of the mandate was to make home mortgages available to lower-income borrowers so they could share in the American Dream of home ownership. The problem was that there were not enough prime mortgages in this sector relative to the congressionally imposed mandate. So increasing amounts of subprime mortgages started to find their way to Fannie Mae and Freddie Mac's

balance sheets and from there, through securitizations, into investor balance sheets all over the world. This extraordinary availability of mortgage financing caused all real estate values to rise—particularly lower-income housing values. These rising values allowed subprime borrowers who got into trouble the ability to sell their houses at a gain or refinance, so defaults on subprime mortgages were amazingly low compared to what institutional investors would have expected. Few investors looked beyond the amazingly low default rates, which

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application of the U.S. Federal Reserve to be a new member of IAIS. It seems clear that the Fed’s new role as a regulator of global insurance groups, such as AIG Inc. and Prudential Financial Inc. and soon others under the Dodd-Frank law, qualifies it for membership in IAIS and that its application will surely be accepted. Also important is the Fed's role as chairman of the FSB's Standing Committee on Supervisory and Regulatory Cooperation, the relevant committee with oversight on insurance, in the person of Fed Governor Daniel Tarullo. Clearly the Fed has an interest, and obligation, to set capital requirements for

convinced them to pile into these subprime mortgages in a very big way. Private market securitizations added to the enormous appetite for subprime and Alt-A mortgages by investors, causing real estate prices to rise even farther. In 2004, the U.S. Congress demanded that Fannie Mae and Freddie Mac do even more for lower-income Americans and increased the requirement to purchase even lower-income mortgages. This fueled a great and final phase of the asset bubble as home prices in America marched ever upward into 2006. When real estate prices started their

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global insurance groups and a leadership role on the FSB. Will this new power at the IAIS push the association’s agenda closer to FSB objectives? We think, yes, it will. What does the FSB want? Ultimately, no companies that are “too big to fail.” We actually think the FSB will succeed in insurance, but not because it crushed large insurers with sanctions involving enhanced supervision, expensive recovery and resolution plans, and an excruciatingly high level of HLA. Instead, it will be because the FSB will ultimately apply the right policy mix of regulation and supervision to the large insurers in the world—a world that needs

balance sheets that can absorb the world's risks, both insurance and investment. We foresee a world where no G-SIIs exist because, with the right policy mix, they do not represent a systemic risk to the world. The FSB has mandated that the G-SIIs carry HLA, a capital requirement over and above existing prudential capital requirements designed to protect policyholders. It is clear that the FSB could simply ask the IAIS to develop HLA equal to a percentage add-on of the existing capital requirements of the activities that are considered systemically risky—activities

descent in early 2006, investors, analysts and policymakers failed to recognize the severity of the problem. Federal Reserve Chairman Ben Bernanke famously testified on Feb. 15, 2006, that “housing markets are cooling a bit. Our expectation is that the decline in activity or the slowing in activity will be moderate, that house prices will probably continue to rise.” Actually, real estate prices in the U.S. went on to decline by 42 percent as measured by the Case-Shiller Index. Lowincome real estate and subprime real estate dropped by much more. One of the reasons investors, analysts and the Federal Reserve chairman got it so wrong was that Fannie Mae and Freddie Mac's disclosures of their subprime exposure was materially understating their real exposure. Witness the following excerpt from a U.S. Securities and Exchange Commission December 2011 news release: SEC Charges Former Fannie Mae and

approved of misleading statements claiming the companies had minimal holdings of higher-risk mortgage loans, including subprime loans…The SEC's complaint against the former Fannie Mae executives alleges that when Fannie Mae began reporting its exposure to subprime loans in 2007, it broadly described the loans as those “made to borrowers with weaker credit histories,” and then reported…less than one-tenth of its loans that met that description.

Freddie Mac Executives With Securities Fraud Washington, D.C., Dec. 16, 2011—The Securities and Exchange Commission today charged six former top executives of the Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Corporation (Freddie Mac) with securities fraud, alleging they knew and

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Clearly, Bernanke had bad information, as did the rest of the marketplace. This is what caused such a large, sharp downward market adjustment to asset prices due to the reported rise of real subprime defaults in 2008. In summary, while many actors made mistakes that would have caused a recession of some significance, wrongheaded government policy was the root cause of the housing bubble and bust in the United States. Generally it takes governments to originate problems measured in the trillions. Of course, such losses were absorbed not just by banks but by savers, retirees, pension funds and those insurers without a global capital standard. They did not originate the crash but suffered from the “common shock” of the deflating real estate asset bubble.

Winter 2014 | 91


Regulation & Compliance continued from page 91 that are subsets of the nontraditional, noninsurance (NTNI) classification that regulators have created for this purpose. But that is not what they pursued. The current strategy is to pursue the creation of an entirely new capital standard not in use anywhere in the world—a new base level of capital, referred to as a “straightforward backstop capital requirement” now known as BCR. This is to have a common, globally consistent base on which to calculate the HLA for nine global insurers. And by 2016, the IAIS intends to develop the ICS, which will presumably replace the BCR as a base for HLA and be a new worldwide capital standard to be applied to all IAIGs—and which could in the future apply to insurers everywhere through the Insurance Core Principles (ICPs) of the IAIS. (Editor’s Note: The ICPs were developed by the IAIS to provide a globally accepted framework for the regulation and supervision of the insurance sector.) The BCR has variously been described as a “minimal minimal” level of capital, “lower than most jurisdictions’ current capital requirements,” and “somewhere between Europe's Solvency I and proposed Solvency II.” The FSB mandate to the IAIS is to develop the BCR by November 2014, which, from a practical perspective, means the IAIS must approve the BCR by September 2014. We struggled with this timetable when it was first announced and, months later, we are more convinced that a new capital standard for insurers cannot be developed and proposed, impacts assessed, adjustments made and agreement reached by insurance regulators—and by insurers—

all in time for consideration by the FSB and individual finance ministries by the G20’s November 2014 meeting. This would set a land-speed record for a brand-new capital standard to be set for any financial industry, much less an industry that has never had a global capital standard before. Getting agreement on a BCR, in any time frame, is not an inconsequential matter. What could be the substance of a straightforward capital requirement? It will require the best talents in capital management from both insurers and regulators—with all attention, focus and best intent—to develop and agree on a standard that is fit for this purpose. Assuming agreement can be reached at some point on BCR, attention then focuses on the application and calibration of HLA, also not an inconsequential matter to the named G-SIIs, which may then include reinsurers, if any are named in June 2014. Running closely behind is ComFrame, which must now include the ICS, replacing the QCS, which will apply to all IAIGs. Although no direct link between the BCR and QCS existed when announced in July, it may have been clear to policymakers that it would be dysfunctional for there to be no commonality between them. When announced, the QCS was not intended to replace existing local capital requirements. Apparently someone saw the serious complexity of the current multiple existing and proposed capital standards for insurance and concluded it was time to simplify this system. So now it is clear that the intent of the FSB was to drive the development of a global capital standard for insurance. And, of course, while all this attention is paid to capital standards of BCR, HLA, QCS and ICS, attention will need to be paid to the other consequences and measures to be applied to G-SIIs: enhanced supervision, recovery and resolution plans,

If no insurance company failure caused the

failure of another financial institution, then the

higher capital requirement for G-SIIs may just be a tax for being big in a business where the law of large numbers reduces risk. 92 | Winter 2014

systemic risk management plans, and the new discussion on macroprudential surveillance and supervision in insurance. While we will respond to this prodigious pile of policy in a careful and John H. Fitzpatrick is thoughtful manner, we Secretary General and will also focus on what Managing Director of the really matters for Geneva Association, an policymakers: international insurance • Do insurance think tank for strategically company resolutions important insurance and from around the globe risk management issues. evidence disorder, or are He has spent his entire they orderly? Did an career in insurance and insurance company financial services, serving failure cause the failure as CFO of two publicly of another financial listed corporations, institution or disrupt Kemper Corp. in the U.S. financial markets or the and Swiss Re Group in general economy? Switzerland. Fitzpatrick is a This matters hugely to nonexecutive member of whether any insurer, the board of directors of doing insurance business, American International can ever be systemic. And Group Inc. and also serves if not, the case for as the Chairman of Oak designating insurers as Street Management Co., “systemically important” Oak Street Partners LLC crumbles to a point and of the firm’s Investment where no legitimacy Committee. exists for sanctions such as HLA. • What is the right policy mix of supervision and capital and liquidity requirements to minimize the risk of another AIGFP-like situation? It is clear the world needs precise answers to these important questions so that there is an insurance industry that can perform its traditional function—enabling global growth by taking on insurance and investment risk in a sustainable fashion.

carriermag.com/4cuq2

(A version of this article was originally published in the October 2013 Insurance and Finance newsletter of The Geneva Association.)

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Risk

That ’70s Show:

Obamacare Takes Federal Black Lung Claims Back in Time Executive Summary: The new health care law has taken casualty insurance carriers back to the past—removing some 1981 restrictions to Black Lung Act benefits and reopening claims that workers compensation carriers thought were finalized long ago.

T

ucked into amendments to the Patient Protection and Affordable Care Act (PPACA) are two unexpected provisions that put casualty insurance carriers on the hook to pay federal Black Lung benefits on claims that were closed many years ago.

The Black Lung Benefits Act (BLBA) is Title IV of the Federal Coal Mine Health and Safety Act of 1969 that was passed by Congress to address unsafe and oftentimes deadly working conditions in the nation’s coal mines. The stated purpose of the BLBA is to provide specified benefits to coal miners who are totally disabled due to pneumoconiosis, also known as Black Lung—a chronic lung disease caused by the accumulation of coal dust in the lungs. The BLBA also provides benefits to surviving spouses or dependents of coal

miners whose death was caused or hastened by pneumoconiosis. The BLBA has been amended several times since its enactment: • Amendments in the 1970s made it easier for claimants to be awarded benefits. • Amendments in 1981 restricted eligibility by changing several provisions of the act. • Then, on March 23, 2010, the PPACA was signed by President Obama. The amendments to the PPACA were proposed by now deceased Senator

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Winter 2014 | 93


Risk continued from page 93 Robert Byrd of West Virginia. The amendments are applicable to claims for federal Black Lung benefits filed after Jan. 1, 2005 that were pending on or after March 23, 2010. The PPACA revived two provisions of the BLBA that had been eliminated in the 1981 amendments to the act. The first provision resuscitated by the PPACA was the provision known as the “15-year presumption.” Under the 15-year presumption provision, a coal miner who has established 15 years of qualifying underground coal mine employment and is able to prove that he suffers from a totally disabling

respiratory condition is entitled to a rebuttable presumption that his total disability was caused by coal workers’ pneumoconiosis. The miner is entitled to this rebuttable presumption even if the X-ray evidence submitted by the parties is negative for the presence of coal workers’ pneumoconiosis. The burden of proof then shifts to the employer to rebut this presumption by showing that the miner’s respiratory disability is not caused by pneumoconiosis. (Section 411(c)(4) of the act, 30 U.S.C. Section 921(c)(4)) The other provision of the BLBA that was revived by the PPACA pertains to survivors’ or widows’ claims. Prior to the 1981 amendments to the act, a coal miner’s surviving spouse or other dependent only had to provide evidence that the deceased miner was collecting federal Black Lung benefits prior to his death in order to receive an automatic continuation of his benefits. The 1981 amendments changed all that. From 1981 until 2010, a surviving spouse or dependent had to file his or her own claim for survivor’s benefits. Within the claim, he or she would have to prove that coal workers’ pneumoconiosis caused, contributed to or hastened the deceased coal miner’s death. In other words, the automatic award to the surviving spouse or dependent was eliminated in 1981. Hop in your DeLorean, turn on the flux capacitor and time travel

forward to 2010 when the PPACA reinstitutes the automatic award provisions of the act for survivors of deceased coal miners who were collecting federal Black Lung benefits at the time of their death. (30 U.S.C. Section 932(l)) This reinstatement of the award provisions is not good news for insurance carriers. Since the 2010 PPACA amendments apply retroactively to claims filed after Jan. 1, 2005 that are pending on or after March 23, 2010, it has caused the proverbial floodgates to open. The change has brought about a flood of new claims being filed on behalf of surviving spouses and dependents and has burdened insurance companies with huge benefit payments for claims they thought were closed and finalized years and years ago.

What Has Changed

The BLBA allows a claimant (miner or survivor) to file multiple claims over the years because pneumoconiosis is a progressive disease. So under BLBA, if a claim is denied today, the miner could refile in a few months and allege a worsening of his condition. However, BLBA’s provisions pertaining to survivors’ claims indicate that a subsequent survivor’s claim shall be denied on the basis of the prior denial because the survivor cannot prove a change in condition since the prior denial. In other words, the miner cannot be more dead than he was before. Therefore, since 1981, when a widow or other survivor filed a claim and was denied benefits due to an inability to prove that pneumoconiosis caused, contributed to or hastened the miner’s death, the insurance carrier could rest assured that the matter was final and that the widow or survivor could never come back to refile and be awarded benefits. The “subsequent” claim would be summarily denied based upon the prior denial. All that changed under the PPACA.


Recent case law from the United States Court of Appeals for the Third Circuit (Marmon Coal Co. v. Director, OWCP, 726 F.3d 387) has held that a survivor/widow whose prior claim had been denied can now pursue a new claim for benefits under the PPACA and be entitled to an automatic award if her husband was collecting federal Black Lung benefits at the time of his death. The court rejected the employer’s argument that res judicata (claim preclusion) would apply. The court held that the PPACA created a new cause of action by resurrecting the automatic award provisions of the act. Widows or other survivors of coal miners who had previously filed claims for survivor benefits under the act and were denied can now refile for benefits and receive an automatic award of benefits provided that the deceased coal miner was collecting federal Black Lung benefits at the time of his death. This automatic award of benefits is retroactive to the month after the effective date of the prior denied claim and can result in tens of thousands of dollars in back-due benefits being paid to the survivor of the coal miner even though his death was not in any way caused by pneumoconiosis. For example, Coal Miner Joe is receiving federal Black Lung benefits. He dies in a car accident in 2002 (death clearly not due to

pneumoconiosis). His widow files a survivor’s claim. Her claim is denied in July 2003 because she cannot prove that her husband’s death was due to pneumoconiosis. Under the PPACA, the widow can now refile for benefits in 2013 and be entitled to an automatic award of benefits going all the way back to the month after the denial of her prior claim became final. In other words, she is entitled to an automatic award of benefits going back to August 2003. The United States Courts of Appeals have spoken, and both the Third Circuit and Fourth Circuit have upheld this change to the act.

The PPACA reinstitutes automatic BLBA award

provisions for survivors

of miners who had been

collecting benefits at the time they died.

The flood of widows’ and survivors’ claims will continue. Any surviving spouse or dependent of a coal miner who was collecting benefits at the time of his death is now entitled to an automatic award of benefits. The PPACA has not taken us back to the future but back to the past. Coal miners and their surviving widows and dependents have been given an unexpected gift under the new health care law. Employers and insurance carriers are the ones paying the price into the carriermag. future.

com/xnd4a

A. Judd Woytek is a shareholder in the Workers Compensation Department at Marshall Dennehey Warner Coleman & Goggin. He focuses his practice on the defense of federal Black Lung claims on behalf of insurance carriers and coal companies. He may be reached at ajwoytek@ mdwcg.com.


Risk Five Insurers Lead P/C Industry to 8th Year of Reserve Takedowns:

Fitch Ratings Analysis

H

eadline reserve charges for Tower Group, Meadowbrook Insurance Group and QBE Americas in 2013 didn’t interrupt an eight-year trend of overall prior-year reserve takedowns for the property/casualty insurance industry overall, according to Fitch Ratings. But while Fitch estimates that overall favorable prior-year loss reserve development for the industry will shave 2.6 points off the industry combined ratio for 2013, rating agency analysts also report that just five large carriers accounted for three-quarters of the favorable development for the industry overall. Fitch reviewed loss reserve experience for 100 of the top U.S. P/C insurers, representing approximately 88 percent of industry aggregate loss reserves, as of Sept. 30, 2013, using data from SNL Financial to complete the analysis. The number of companies reporting significant favorable prior-year development has fallen regularly over the last five years, Fitch reports, identifying State Farm Mutual Automobile Insurance Co., National Indemnity Co., The Travelers

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Cos., The Chubb Corp. and United States Automobile Association as the five contributors to the bulk of the overall industry takedown. Fitch’s special report, titled “Property/ Casualty Loss Reserve Development: Five Insurers Carry Trend,” also reveals that Fitch’s estimate of favorable development for the industry overall—2.6 percent of earned premiums—is higher than the 2.4 percent figure tallied for 2012. Measuring prior-year reserve movements against the dollar amount of carried loss reserves, the figures are 2.0 percent for 2013, compared to 1.8 percent in 2012. The analysis finds: • Fewer companies in total with favorable reserve development. • Reduced levels of favorable reserve development among leading companies. • Modestly higher levels of unfavorable reserve development relative to beginning reserves for the worst performing companies. Fitch believes this pattern is indicative of a weakening in the industry reserve position over time and expects more modest favorable development for the P/C industry in 2014. Fitch notes that loss reserves from more recent accident years do not exhibit the same level of redundancy as the hard market years 2003−2007, anticipating reduced favorable development as

those hard market years pay out. Fitch also suggests that “given recent improvements in core underwriting results from a hardening pricing environment, insurers may be more inclined to strengthen reserves from older accident years and latent asbestos exposures in the near term.” The report lists prior-year reserve takedowns for the 10 carriers with the largest declines, including the five identified above. Although carriers like State Farm and National Indemnity each released more than $2 billion of reserves for prior accident years, for several carriers in the bottom five of the top 10 group, takedowns represented higher percentages of earned premiums. For example, for sixth-ranked Old Republic, $326 million of prior-year releases represented 19.3 percent of earned premiums. Eighth-ranked Markel took down $173 million, but this represented nearly 15 percent of carried reserves. Focusing on insurance groups with unfavorable development, Fitch revealed that American International Group and Liberty Mutual actually reported higher levels of prior-year reserve boosts by dollar amounts—$486 million and $454 million, respectively—than Tower, QBE or Meadowbrook. Meadowbrook, in fact, did not make the top 10 list of companies with unfavorable development in Fitch’s report. See related online article, “Top 5 Reserve Boosts in 2013; Fitch Reveals Carriers With Unfavorable Development.” The full Fitch Ratings report is available

on Fitch’s website at www.fitchratings.com (under the Insurance tab of the Ratings and Research section).

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Reinsurance Integrating Your

Reinsurance Management System

With Core Systems Reduces

Executive Summary: Effisoft’s Joseph Sebbag explains some of the initial carrier considerations for selecting a reinsurance management system, components of a preliminary implementation study and key steps in the integration process to ensure a smooth handoff of information between the PAS and reinsurance management systems.

I

By Joseph Sebbag nsurers’ numerous intricate reinsurance contracts and special pool arrangements, countless policies, and arrays of transactions create a massive risk of having unintended exposure. Inability to ensure that each insured risk has the appropriate reinsurance program associated with it is a recipe for disaster. Having disjointed systems—a combination of policy administration system (PAS) and spreadsheets, for example—or having systems working in silos are sure ways of

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having risks fall through the cracks. The question is not if it will happen but when and by how much. Beyond excessive risk exposure, the risks are many: claims leakage, poor management of aging recoverables and lack of business intelligence capabilities. There’s also the likelihood of not being able to track out-of-compliance reinsurance contracts. For instance, if a reinsurer requires a certain exclusion in the policies it reinsures and the direct writer issues the policy without the exclusion, then the policy is out of compliance, and the reinsurer may deny liability. The result is unreliable financial information for trends, profitability analysis and exposure, to name a few. Having fragmented solutions and manual processes is the worst formula when it comes to audit trails. This is particularly troubling in an age of stringent

standards in an increasingly internationally regulated industry. Integrating the right solution will help reduce the aforementioned risks to an absolute minimum. Consider vendors offering dedicated and comprehensive systems as opposed to PAS vendors, which may simply offer “reinsurance modules” as part of allencompassing systems. Failing to pick the right solution will cost the insurer frustration and delays by attempting to “right” the solution through a series of customizations. This will surely lead to cost overruns, a lengthy implementation and an uncertain outcome. An incomplete system will need to be customized by adding missing functions.

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Reinsurance continued from page 97 Common system features a carrier should look out for are: • Cession treaties and facultative management • Claims and events management • Policy management • Technical accounting (billing) • Bordereaux/statements • Internal retrocession • Assumed and retrocession operations • Financial accounting • AP/AR • Regulatory reporting • Statistical reports • Business intelligence

Study Before Implementing

Picking the right solution is just the start. Implementing a new solution still has many pitfalls. Therefore, the first priority is to perform a thorough and meticulous preliminary study. The study is directed by the vendor, similar to an audit through a series of meetings and interviews with the different stakeholders: IT, business, etc. A study typically lasts one to three weeks depending on the complexity of the project. A good approach is to spend a half-

Preliminary study/ (gap analysis) sample: 1. Introduction • General introduction and description of project objectives and stakeholders • What’s in and out of scope 2. Description of current business setting 3. Business requirements • Cession requirements • Assumed and retrocession requirements 4. Systems environment topics • Interfaces/hardware and software requirements 5. Implementation requirements 6. System administration • Access, security, backups 7. Risks, pending issues and assumptions 8. Project management plan

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day conducting the scheduled meeting(s) and the other half drafting the findings, and then submitting them for review the following day. The study should at least contain the following: • A detailed report on the company’s current reinsurance management processes. • A determination of potential gaps between the carrier reinsurance processes and the target solution. • A list of contracts and financial data required for going live. • Specifications for the interfaces. • Definitions of the data conversion and migration strategy. • Reporting requirements and strategy. • Detailed project planning and identification of potential risks. • Repository requirements. • Assessment and revision of overall project costs. A sample of preliminary study contents is presented in the accompanying textbox. The preliminary study report must be submitted to each stakeholder for review and validation as well as endorsement by the head of the steering committee of the insurance company prior to the start of the project. If necessary, it should be revised until all the components are adequately defined. Ideally, the report should be used as a road map by the carrier and vendor. All project risks and issues identified at this stage will be incorporated into the project planning. One of the main reasons why projects fail is poor communication. Key people on different teams need to actively communicate with each other. There should be at least one person from each invested area—IT, business and upper management must be part of a welldefined steering committee. A clear-cut escalation process must be in place to tackle any foreseeable issues and address them in a timely manner.

A Successful Implementation Process

Let us focus on key areas and related

guidelines that are essential to successfully carry out a project.

Data Cleansing

Prior to migration, an in-depth data scrubbing or cleansing is recommended. This is the process of amending or removing data derived from the existing applications that is erroneous, incomplete, inadequately formatted or replicated. The discrepancies discovered or deleted may have been originally produced by userentry errors or by corruption in transmission or storage. Data cleansing may also include actions such as harmonization of data, which relates to identifying commonalities in data sets and combining them into a single data component, as well as standardization of data, which is a means of changing a reference data set to a new standard—in other words, use of standard codes.

Data Migration

Data migration pertains to the moving of data between the existing system (or systems) and the target application as well as all the measures required for migrating and validating the data throughout the entire cycle. The data needs to be converted so that it’s compatible with the reinsurance system. It’s a mapping of all the data with business rules and relevant codes attached to it. This step is required before the automatic migration can take place. An effective and efficient data migration effort involves anticipating potential issues and threats as well as opportunities, such as determining the most suitable datamigration methodology early in the project and taking appropriate measures in order to mitigate potential risks. Suitable data migration methodology differs from one carrier to another based on its particular business model. Analyze and understand the business requirements before gathering and working on the actual data. Thereafter, the carrier must delineate what needs to be migrated and how far back. In the case of long-tail business, such as asbestos

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coverage, all the historical data must be migrated. This is because it may take several years or decades to identify and assess claims. Conversely, for short-tail lines, such as property fire or physical auto damage, for which losses are usually known and paid shortly after the loss occurs, only the applicable business data is to be singled out for migration. A detailed mapping of the existing data and system architecture must be drafted in order to isolate any issues related to the conversion early on. Most likely, workarounds will be required so as to overcome the specificities or constraints of the new application. As a result, it will be crucial to establish checks and balances or guidelines to validate the quality and accuracy of the data to be loaded. Identifying subject-matter experts who are thoroughly acquainted with the source data will lessen the risk of missing undocumented data snags and help ensure the success of the project. Therefore, proper planning for accessibility to qualified resources at both the vendor and insurer is critical. You’ll also need experts in the existing systems, the new application and other tools.

between primary insurance systems, general ledgers, BI suites and reinsurance solutions most likely has already developed such interfaces for the most popular packages and will have the knowhow and best practices to develop new ones if needed. This will ensure that the process will proceed as smoothly as possible. After the vendor (primarily) and the carrier carry out all essential implementation specifics to consolidate the process automation and integrations required to deliver the system, look to provide a fully deployable and testable solution ready for user acceptance testing in the reinsurance system test environment. Formal user training must take place beforehand. It needs to include a rolebased program and ought not to be a onesize-fits-all training course. Each user group needs to have a specific training program that relates to its particular job functions. The next step is to prepare for a deployment in production. You’ll need to perform a number of parallel runs of the

existing reinsurance solutions and the new reinsurance system and be able to replicate each one and reach the same desired outcome before going live. Now that you’ve installed a modern, Joseph Sebbag is CEO of comprehensive Effisoft USA, an reinsurance international reinsurance management system, software vendor based in you’ll have straightDallas. He was previously through automated Assistant Vice President of processing with all the Reinsurance at SCOR, checks and balances in where he played a key role place. You will be able to in the development of reap the benefits of a SCOR’s global reinsurance well-thought-out system. Sebbag may be strategy paired with an reached at jsebbag@ appropriate reinsurance effisoft-group.com. system that will lead to superior controls, reduced risk and better financials. You’ll no longer have any dangerous hidden “cracks” in your reinsurance program.

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Interfaces

Interfacing in a reinsurance context relates to connecting to the data residing in the upstream system, or PAS, to the reinsurance management system, plus integrating the reinsurance data to other applications, such as the general ledger, the claims system and business intelligence tools. Integration and interfaces are achieved by exchanging data between two different applications but can include tighter mechanisms such as direct function calls. These are synchronous communications used for information retrieval. The synchronous request is made using a direct function call to the target system. Again, choosing the right partner will be critical. A provider with extensive experience in developing interfaces

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Reinsurance

Consolidating Reinsurance Towers to Gain Efficiencies

Executive Summary: TigerRisk’s Mike Schnur explains how a carrier can benefit from a reinsurance buying strategy that consolidates multiple reinsurance towers into one contract and why reinsurers are willing to sign onto such contracts now even though they’ve resisted such moves in the past.

By Mike Schnur

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I

n addition to raising capacity and lowering reinsurance prices, the influx of new capacity from the capital markets is driving more flexible reinsurance terms and efficiencies that primary insurers and their brokers have been seeking for years. Multiyear programs, once a rarity, are now becoming commonplace, and private

placements with bespoke terms and conditions that address specific client needs are gaining traction. Another trend being ushered in by the flood of new money is the shift of reinsurance buyers to consolidate multiple reinsurance towers into one contract. Insurers have long complained that the use of multiple towers instead of just one is

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inefficient and results in a poor return on their investment. For example, an insurer may buy separate programs for individual regions with each program having its own limit. In a portfolio of five programs, the chances of making a reinsurance recovery is lower than when consolidating all of the programs into one. Besides the additional administrative issues involved with managing multiple programs (including determining appropriate retentions and limits for each), a ceding company is better able to address its risk tolerance levels by managing its placements on a more cohesive basis. For reinsurance buyers, consolidating multiple programs into one program makes sense in other important ways: • Buying a single reinsurance program requires less overall limit than the aggregation of multiple programs. Indeed, multiple programs usually result in redundant protection. • Reinsurers often institute a minimum capacity premium for exposing any limits. By combining programs, these minimum capacity charges for each program can be reduced significantly. • By combining diverse programs with low potential for correlation under a single cover, further efficiencies can be achieved. Naturally, reinsurers have resisted the trend of reinsurance buyers rolling several programs into one. That is until now.

Nontraditional Players Enter

“Nontraditional” is an apt term for the capital markets players who have entered

In a portfolio of five programs, the chances of making a reinsurance recovery is lower than when consolidating all of the programs into one. the reinsurance market of late. For them, reinsurance is just another asset class. They are not tied to previous conventions but are looking at reinsurance transactions with a fresh pair of eyes and have shown a willingness to do things differently. You can be sure they will make use of every advantage. Meanwhile, the additional reinsurance capacity has also made buyers bolder. They realize that it’s a buyer’s market, and they expect to see a better return for their reinsurance dollars. In the face of nontraditional competition and more demanding clients, traditional reinsurers have become more flexible. One result is a new willingness for consolidating multiple towers. Regional programs are being combined into national programs. U.S. and international covers are being merged. Even business units of insurers are now combining property and casualty under one cover.

Aggregate

In addition to a movement toward single-tower, per-occurrence covers, and because buyers have growing capital positions, they want aggregate-type covers

Why Carriers With More Capital Want Aggregate Reinsurance Protection Since 2013 was a light catastrophe year, most insurance companies were able to

grow their capital. As their capital bases have grown, they have been able to increase their retentions and buy reinsurance at a higher attachment point. One potential negative outcome of keeping larger retentions is that an unexpected frequency of smaller losses—those that don’t exceed their retentions—could negatively impact their results. As a result, companies are looking to buy aggregate covers which would respond to a higher frequency of small events.

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to improve the efficiency of their reinsurance. Until recently, carriers concentrated on protecting themselves from large singleoccurrence losses. Now, thanks to a more flexible marketplace, they are also buying coverage for a higher-than-expected frequency of smaller events. While aggregate protection was previously available, the scope of coverage has greatly expanded. Carriers can now combine very disparate types of coverage (think highly divergent lines of business—conventional P/C, marine/energy, assumed reinsurance, etc.) into one program. Mike Schnur is a Partner at And it can be done on a TigerRisk with more than multiyear basis.

Other Benefits

30 years of experience in the industry. Before joining TigerRisk he held EVP positions at Benfield and Guy Carpenter. He began his career as a reinsurance underwriter, first with General Re and then with F&G Re.

In addition to improving efficiency, reducing required capacity and lowering premiums, large single covers are also just plain easier for carriers to manage. However, there could be some potential downsides to single covers. Single covers, especially in the case of very large programs, may make cedents more reliant on specific reinsurers that may end up with a much larger share of the program than when participating on individual towers. Should market conditions change, reinsurers with larger positions could end up in a more favorable negotiating position. Similarly, if a reinsurer with a larger position should change its risk appetite and decide to no longer participate (or to reduce its share) in a specific program, meaningful shares might need to be replaced.

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Reinsurance continued from page 103 Reinsurer Perspective

From the reinsurer perspective, there are reasons they prefer not to support single covers. First, it increases their exposure, as losses can suddenly accumulate from multiple sources. In addition, the margin on a big single cover is likely lower than what it would be on five smaller covers. Reinsurers have their own capacity to manage. When covers are combined (and aggregate covers are purchased), reinsurers often find it much more difficult to

Reinsurance CEOs Speak Out:

What Alternative Capital

Single covers, especially in the case of very large programs, may make cedents more reliant on specific reinsurers. The reinsurers may end up with much larger program shares than when participating on individual towers. internally allocate their capacity. As a consequence, reinsurers are forced to become much more conservative in their underwriting. In the end, that means delivering a lower return on risk. For the time being, reinsurers will need to adapt to the trend for single covers. The flow of new capacity is not about to abate. Indeed, in the short term we can expect the capital markets players to be even more aggressive. It’s only a matter of time before they become more interested in casualty reinsurance. Despite the fierce competition, doing business with traditional reinsurers still has many advantages. Reinsurance is their business, not just an asset class, so they are much better equipped to design and administer reinsurance programs. And they are in it for the long haul.

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Michael Sapnar, president and CEO of Transatlantic Holdings Inc., shares his views with a Forum participant after speaking on a panel of CEOs about the influx of alternative capital. Photo: Don Pollard.

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By Susanne Sclafane he hottest topic in the reinsurance world was on the agenda at the Property/Casualty Insurance Joint Industry Forum in January, where two reinsurance executives gave different perspectives on what the entrance of alternative capital means to the business. Speaking on a panel of chief executives titled “A View from the Inside Looking Out,” Franklin “Tad” Montross, chair and CEO of General Re Corp., and Michael Sapnar, president and CEO of Transatlantic Holdings Inc., both said that the impact of capital from hedge funds, pension funds and other third-party capital providers is undeniable. Sapnar, however, saw more

positives for the traditional reinsurance industry than did Montross. Sapnar first noted the tremendous amount of consolidation that has taken place in the reinsurance industry in the past 20 years. “When the RAA [Reinsurance Association of America] has gone from 120 reporting reinsurers down to less than 20 today, what you see is an industry that is basically an inverted pyramid. You’ve got all your risk protection going to your insurance companies, which then funnel their tail risks onto the same 25 balance sheets. “When you do that, the next dollar of risk is going to naturally be more expensive.” Bringing in more diversified capacity from the capital markets turns the

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Means to the Traditional Industry

Panel discussion at the Property/Casualty Insurance Joint Industry Forum, featuring Transatlantic’s Michael Sapnar (second from right) and Gen Re’s Franklin “Tad” Montross (second from left). Photo: Don Pollard. inverted pyramid into an hourglass, Sapnar said. “You will get a lower charge as that risk is spread because it is not accumulating.” This is good for reinsurers because it gets the market back to “demand driving product,” he said, using the example of Florida catastrophe business to explain. “Florida should be buying $300 billion of coverage—not $100 billion. If we can diversify to make it priced reasonably enough, if we can get the buckets spread widely enough to make that viable, then they will buy $300 billion, and we’ll have properly rated risk on our balance sheets.” Sapnar also noted that as the capital comes in from alternative providers, much of that is actually managed by insurers or reinsurers. “I’d argue over half,” he said.

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Montross said there was roughly $7 billion of new deal issuance during 2013, with more than $2 billion in the fourth quarter alone. “This is a very real phenomenon. There have been estimates that it equates to about 15 percent of the nonproportional catastrophe marketplace. “From the clients’ perspectives, it’s great that they have an alternative. If I were a reinsurance broker I’d be thrilled because it gives me two things: I’m bringing a new capability to my client; and I’ve got a twoby-four that I can beat the traditional markets back with. “We clearly saw that at June 1 with the Florida renewals; and we saw it even more explicitly at the Jan. 1 renewal,” he said, referring to average 1/1 reinsurance price declines that brokers put at 15 percent for

the United States and low-teens worldwide. “The ongoing question is just how committed is this [alternative] capital,” Montross said. “The investment bankers would say it’s totally committed” because this is a noncorrelated asset class and just a small portion of pension funds’ investable funds are being allocated. But Montross is skeptical. “If we were at a pension convention 10 years ago, we’d all be talking about mortgage-backed securities. We’d be talking about CDOs and CD-squareds. And we’d be saying, ‘Yields are so attractive. And it’s a noncorrelated asset class. “I’ll leave it at that,” he said. Leigh Ann Pusey, president and CEO of the American Insurance Association and panel moderator, asked about price and product changes in the traditional markets. “Competition works,” said Dan Glaser, president and CEO, Marsh & McLennan Cos. “It refreshes. It keeps you on your toes. It drives innovation,” he said, noting that reinsurers’ competitive juices are flowing. “All of a sudden there are quota shares available where [they] weren’t in the past. There are multiyear arrangements [and] better reinstatement provisions,” he said, adding that coverage enhancements such as broader hours clauses and extended cyber limits are also available this year from traditional reinsurers. Sapnar responded: “Brokers and underwriters have different definitions of innovation. To me, aggregate cover, threeyear deals and lower price is not necessarily innovation. “We’ve done that. I’ve done that. I’ve gotten killed at it,” Sapnar said. “Short-term, there may be attractive innovations on the table, but if they’re not sustainable, [then] it’s going to give the industry a black eye.” Montross warned.

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Risk

The Current Scientific Consensus on Climate Change and Hurricanes— It May Surprise You Executive Summary: According to scientific consensus, there is no detectable link between human activity and hurricane activity, says Karen Clark, interpreting the IPCC’s most recent report. Looking ahead, however, anthropogenic climate change could lower the frequency of storms. And with wind speeds of hurricanes jumping 2-11 percent, insurance losses for each storm will be higher, she notes.

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By Karen Clark hile “scientific consensus” on climate change may sound like an oxymoron, there is consensus on three key questions about climate change and hurricanes, as demonstrated by recent reports from the Intergovernmental Panel on Climate Change (IPCC). The IPCC, the scientific body under the auspices of the United Nations that reviews and assesses the scientific, technical and socio-economic information produced by thousands of scientists around the world, has recently released its fifth assessment report. The summary of the report (reference 1, p. 109) along with an earlier Special Report on Extreme Events (ref 2) contain a synthesis and distillation of the current science, the climate model results, and the global scientific opinion on climate change and its likely impacts.

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Because of the potential impact on losses, insurers and reinsurers are keenly interested in the relationship between global warming and hurricane activity, but there is a lot of misinformation. This article reviews the current scientific consensus on whether human activity has already had an impact on hurricanes, what impacts anthropogenic warming are likely to have on hurricane activity in the 21st century, and what it means for insurers and insured losses.

Has human-induced climate change already impacted hurricane activity?

Despite popular belief that recent events are “proof” that anthropogenic climate change is causing more hurricanes, the scientific consensus is the opposite. Given the current state of knowledge, scientists cannot conclude that human activities have had any influence on

continued on next page

Scientists conclude that observational biases explain what seems to be an increasing trend in tropical cyclones when annual numbers are simply plotted on a graph.

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Winter 2014 | 107


Risk continued from page 106 hurricane activity to date. According to the IPCC, “There is low confidence in any observed long-term increases in tropical cyclone activity (i.e., intensity, frequency, duration) after accounting for past changes in observing capabilities.” While simple plots of the annual number of tropical cyclones since 1851 seem to indicate a significantly increasing trend, scientists have concluded that there is no real trend and that observational biases are responsible for the apparent increases in the number of storms. In other words, scientists are now detecting more storms using aircraft and satellite technology than they did decades ago under a ship-based observation network. These conclusions are consistent with the data on hurricanes as well as U.S.-landfalling hurricanes, neither of which show upward trends over the past century.

What about storm intensity?

While the data seem to suggest that we’re experiencing more major (Category 3, 4 and 5) hurricanes over the past few decades, there is scientific disagreement over what is causing the increase—internal

Losses increase exponentially with wind speeds, so even a 2 percent change in maximum wind speeds can lead to a 10 percent increase in losses. variability, human influences (anthropogenic forcings) or natural forcings. (See related textbox, next page.) For example, according to the IPCC, for the North Atlantic basin there is medium confidence that a reduction in aerosol forcing (versus greenhouse forcing) has contributed to the observed increase in tropical cyclone activity since the 1970s. With respect to hurricane losses, there is scientific agreement that, to date, the most significant driver of increasing losses is increasing property values in hazardous coastal areas. According to the IPCC, “Increasing exposure of people and economic assets has been the major cause of long-term increases in economic losses from weather- and climate-related

Scientists agree that the most significant driver of increasing losses is increases in property values in hazardous coastal areas.

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disasters (high confidence).” Karen Clark & Co. recently conducted a study of historical U.S. hurricanes and what they would cost today given current property values. The results shown in the chart below confirm there is no increasing trend in losses over time, which is consistent with scientific opinion. Globally, there is low confidence in the attribution of changes in tropical cyclone activity to human influence. We cannot rule out human influences, but if human activities have had an impact, it’s not yet detectable in the data.

Karen Clark, the President of Karen Clark & Co., is internationally recognized as the founder of the first catastrophe modeling firm and as an expert in the field of catastrophe risk assessment and management. She may be reached at info90410@ karenclarkandco.com.

What impact will climate change have on future hurricane activity in the 21st century?

Here again, part of the answer may be surprising. Based on results from the most sophisticated climate models, it is likely that the global frequency of tropical cyclones will either decrease or remain essentially unchanged. The reason for this counterintuitive result is that even though sea surface temperatures (SSTs) are likely to warm dramatically during the 21st century, the upper tropospheric temperatures are likely to warm even more. Additionally, most of the climate models project increasing levels of vertical wind shear over parts of the tropical Atlantic. Increased warming of the upper troposphere relative to the surface and increased vertical wind shear are both detrimental factors for storm development and intensification.

Why does increased warming of the upper troposphere relative to the surface inhibit hurricane formation?

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In the lower troposphere, air spirals inward toward the center of the hurricane, then upward in the eyewall and then outward at the top of the troposphere. The air eventually sinks back toward the lower troposphere and the circulation continues. This secondary circulation works like a heat engine and requires air to flow into the hurricane in the lower troposphere at a higher temperature than it exits the hurricane at the top of the troposphere. Fast, upper tropospheric winds can also create high values of vertical wind shear, a change in wind direction or speed at different altitudes. With respect to storm intensity, the scientific consensus is more intuitive. “Average tropical cyclone maximum wind speed is likely to increase, although increases may not occur in all ocean basins.” This is more likely to occur in the latter part of this century—2081 to 2100. According to the climate models, hurricanes could be more intense by the end of the 21st century, with maximum wind speeds 2-11 percent higher than the current reference period. Anthropogenic warming over this century may also lead to an increase in the number of very intense (Category 4 and 5) hurricanes in some basins. The climate models also project substantially higher rainfall rates than present-day hurricanes.

What is the likely trend in insured hurricane losses?

Over the past century, the primary driver of increasing insured hurricane losses has been rising property values along vulnerable coastlines. Over the past few decades, U.S. hurricane losses have about doubled every 10 years due to demographic factors. It is very likely that if unmitigated,

Internal variability is caused by natural processes within the climate system such as El Nino Southern Oscillation and Atlantic Multidecadal Oscillation. Natural external forcings include changes in solar radiation and volcanism.

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According to the climate models, hurricanes could be more intense by the end of the 21st century, with maximum wind speeds 2-11 percent higher than the current reference period. these demographic trends will continue to drive up insured losses well into this century, and the most effective ways to control the rising costs of hurricanes would be to implement and enforce better building codes and land-use planning strategies. By the end of the 21st century, climate change will likely be having a significant impact on hurricane losses. Losses increase exponentially with wind speeds, so even a 2 percent change in maximum wind speeds can lead to a 10 percent increase in losses. An 11 percent increase in peak winds would result in expected losses more than 50 percent higher than today. All projections are for continued sealevel rise that will subject coastal properties to higher wind speeds from landfalling hurricanes along with making the properties more vulnerable to stormsurge flooding. In summary, according to the most recent scientific consensus, human activity has of yet had no detectable influence on hurricane activity, though anthropogenic climate change is likely to impact hurricane activity later in the 21st century. The frequency of storms is likely to decrease or remain the same, but hurricanes are likely to become more intense—possibly with maximum wind speeds 2-11 percent higher by the carriermag.com/ end of the century.

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References: IPCC, 2013: Summary for Policymakers. In: Climate Change 2013: The Physical Science Basis. Contribution of Working Group I to the Fifth Assessment Report of the Intergovernmental Panel on Climate Change [Stocker, T.F., D. Qin, G.-K. Plattner, M. Tignor, S. K. Allen, J. Boschung, A. Nauels, Y. Xia, V. Bex and P.M. Midgley (eds.)]. Cambridge University Press, Cambridge, UK, and New York, NY, USA. The full report of the Working Group I contribution to the IPCC Fifth Assessment Report was published online Jan. 30, 2014 and is available at www.climatechange2013.org or www.ipcc.ch. IPCC, 2012: Summary for Policymakers. In: Managing the Risks of Extreme Events and Disasters to Advance Climate Change Adaptation [Field, C.B., V. Barros, T.F. Stocker, D. Qin, D.J. Dokken, K.L. Ebi, M.D. Mastrandrea, K.J. Mach, G.-K. Plattner, S.K. Allen, M. Tignor, and P.M. Midgley (eds.)]. A Special Report of Working Groups I and II of the Intergovernmental Panel on Climate Change. Cambridge University Press, Cambridge, UK, and New York, NY, USA, pp. 3-21.


Investment Management Market Turning Point:

Considerations for Investment Portfolio Repositioning

Executive Summary: Sage Advisory’s Josh Magden explains why insurers should consider measured approaches to investment portfolio repositioning in 2014, taking advantage of the income lift from good underwriting results to help them exert control over the timing of their decisions to realize embedded gains.

U

By Joshua A. Magden nlike any other time in modern market history, the early months of 2014 present a period of opportunity for insurers to position their investment portfolios ahead of upward interest rate changes. As 2013 wound down, December proved to be an eventful month. Most relevant to the bond markets, the Fed began to taper its asset purchases in December, reducing monthly purchases from $85 billion to $75 billion ($40 billion in Treasuries and $35 billion in mortgage bonds). We are told by the Fed that further reductions will be measured, and based on its communication to date, the Fed is telegraphing its intent now more than it ever has before.

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Not surprisingly given how far in advance Ben Bernanke and the Fed talked taper before actually making a decision, investors seemed psychologically prepared and appeared relieved when it was announced, and equity markets actually rallied on the news. In fact, the S&P continued its climb over the last two weeks of December and finished 2013 with its best performance since 1997—a nearly 30 percent increase over the course of the year. Insurers face a few important decisions with the taper underway, no sign of inflation and a stock market that seems to have the capacity to climb further. A constant conversation with property/ casualty companies is what to do with respect to portfolio repositioning in an environment with the potential for rising interest rates. It is important to remember that tapering (reducing the Fed’s purchase of bonds) is not the same as tightening (raising benchmark interest rates). We look at the timeline and transition as one occurring in three parts (see the chart on next page). The biggest unknown is the length of

Joshua A. Magden is Vice President of Insurance and Institutional Marketing at Sage Advisory Services Ltd. Co. in Austin, Texas. He works with a variety of insurance clients, including general carriers, captives, risk retention groups and risk pools, to build regulatory- and liabilitysensitive investment portfolios. He writes regularly on insurance asset management topics and innovative approaches to some of the challenges faced by insurers in the current interest rate climate. Reach Magden at jmagden@sageadvisory.com.

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each of these stages. Given the large contingent of P/C insurers whose portfolios are run according to a book yield approach, a looming question at the start of 2014 is whether such portfolios should sell particular fixed income holdings; realize the capital gains and reinvest in shorter maturities (or hold additional cash) and thus shorten the overall portfolio duration while preparing for the Fed to raise interest rates; or perhaps allocate additional capital to equities. This decision hinges on one’s view of when and how much rates might increase. Despite a book yield portfolio’s predilection to buy and hold, suppose an insurer rides down its current book yield over the next 12-18 months, accumulating cash from maturities and coupons but not redeploying into new, equivalent duration bonds. In 12-18 months, what if inflation is nowhere to be seen, unemployment is reasonable (in the Fed’s opinion) and rates continue to stay low? Then sitting in cash may prove to be quite costly in terms of the income give-up over the time frame. The opposite choice—maintaining duration and credit quality—may mean an insurer’s book yield drops less over the same time frame but that a larger portion of its portfolio is “locked in” to a particular duration and yield when policymakers begin to raise rates. This could prove most problematic were the Fed to raise rates very quickly, in a 1994-type scenario, and an insurer had a loss event that required substantial portfolio liquidation. In such a circumstance, the liquidity profile of the portfolio will be vital. Not all “AA”- or “A”-rated bonds are created equal, whether within municipal bonds, within corporate bonds or comparing a muni to a corporate. It’s good to regularly remind oneself that capital quality and liquidity are not the same thing. Favorable underwriting experience means that most insurers’ hands have not been forced with respect to the duration positioning or liquidity of their investment portfolio. Indeed, ISO recently reported

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The Federal Reserve began to taper its asset purchase program Dec. 18, and Sage sees a threestage transition from taper to eventual Fed Funds rate increases, with the latter unlikely until 2015 or later. that through the first three quarters of 2013, the P/C insurance industry’s combined ratio had improved to just shy of 96 percent from above 100 percent in 2012 over the same period. ISO also notes that investment income from interest and dividends fell (by 2.9 percent in the first nine months) but realized capital gains more than doubled (see related CarrierManagment.com article, “Nine-Month Results Show P/C Industry Headed for Best Post-Crisis Year,” Dec. 23, 2013). Given the choice over how and when to reposition its fixed income portfolio, and taking into account the fact that any such repositioning will likely have an impact on book yield, how should an insurer proactively assess whether to realize embedded gains? It can be a trade-off. Going from higher book yield to lower book yield will impact future income, but the insurer captures some of the capital gain from the bond sold. It would seem ISO’s data suggests that many insurers chose this route through the first three quarters of 2013. This analysis requires some economic and interest rate assumptions and may ultimately involve trade-offs driven more by tax considerations, rating agency goals or competitive pressures. However, the alternative involves loosening one’s rating requirements or moving out the curve in continuous pursuit of yield. While the risks are obvious, market conditions continue to oblige the unwitting (see “Minding the Gap: Investment Risk Management in a Low-Yield Environment,” April 25, 2013). As risk managers first and

foremost, insurers need look no further than the record issuance of high-yield debt globally, led by Europe and the U.S., in order to understand that investor thirst for yields and still-low interest rates is enticing less creditworthy borrowers to float debt while there are willing buyers. As 2013 closed its doors, some insurer portfolios certainly reflected more lenient fixed income parameters brought on by a quest for yield. Let us assume, however, that the focus of most insurers will be the sustainability of the credit quality and liquidity of the fixed income instruments generating their cash flow. Yield will be preserved as best as it can be in the current rate environment but is likely to continue along the downward trend. If and when the Fed actually does begin to raise rates—whether in 12 months or 24— the exit trade out of longer duration positions may become a crowded one, and that canoe can tip rather quickly. In taking a measured and methodical approach, an insurer can mitigate some of the portfolio pain that may be inevitable when rates rise. Insurers are better off exerting control over the orderliness and timing if they choose to realize embedded gains, particularly while underwriting results are helping to positively drive operations. In 2014, insurers can resolve to take stock of their investment goals and the risks in their portfolio in order to carve and craft with precision, positioning their portfolio to robustly continue supporting their underwriting risks in a variety of carriermag.com/ market conditions.

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