Future of the Insurance Industry

May 6, 2011

© 2011 TransUnion LLC All Rights Reserved

KEYNOTE ADDRESS

Future of the Insurance Industry

Bob MoretteSenior PartnerBain &Company

Future of the P&C Industry?

• Slow growth

• Mediocre profitability

• Commoditization

• Traditional channel decline

• Consistent growth

• Strong returns

• High performing companies

• Dynamic innovation

© 2011 TransUnion LLC All Rights Reserved2

or

Agenda

P&C industry overview Lessons from

otherindustries New rules of

the gameFinal thoughts

3 © 2011 TransUnion LLC All Rights Reserved

P&C industry has experienced slow growth over the past 30 years

Note: NPW: Net premiums writtenSource: A.M. Best; ISO; Insurance Information Institute


1978

1980

1982

1984

1986

1988

1990

1992

1994

1996

1998

2000

2002

2004

2006

2008

Average = 8%

Average = 4%

Consistent profitability has been elusive

Note: Median Cost of Capital for the P&C Industry was ~10% (2010)Source: ISO; A.M. Best (2009F); Insurance Information Institute; Cost of Capital is Median Cost of Equity Capital for SIC code 6331 in 2010,

from the Ibbotson Cost of Capital yearbook (Morningstar)


Relatively consolidated, but…

Source: AM Best; SNL Financials


…significant share change.

Source: Credit Suisse 2008

-10

-5

0

5

10%

Share point change by channel

84-89

-6.6

1.4

5.2

89-94

-3.7

0.8

2.9

94-00

-3.0

6.0

-3.1

00-06

-0.7

4.5

-3.7

Captive agentsDirect responseIndependent agents

“Donor” channel now captive agents


Commoditization: Price! Price! Price!You could save hundreds

in minutes on your auto insuranceSave on your auto insurance.Find out how much now.


Select few players are outperforming

Note: Companies shown are the top 10 highest NPW in 2010; dashed lines represent top quartile growth and outperforming ROESource: SNL Financials, Return on Average Equity data for specified P&C divisions of each corporation or holding group


Agenda





Other industries have faced similar challenges

Airlines

Credit Cards

Gambling

Defense

Challenging returns?

Stagnant or declining revenue?

Disruptive threat?(technology, new entrant,

etc)

Personal LinesInsurance


Airlines: Legacy carriers faced significant challenges in the late 1990s

….and was under attack by low-cost competitors

Industry consistently struggledwith profitability…

-10

-5

0

5

10%

US Airlines Net Margin

1980 1990 2000

Required margin for >15% ROE

Note: ROE calculation estimated based on selection of leading airlinesSource: ATA, company financials


Continental met this challenge by ruthlessly reconfiguring its footprint…

*LCC growth in New York attributable to introduction of Jet Blue hub at JFKSource: SEC Filings, DOT Form 41, Analyst reports, Annual Reports; Bain Analysis

“Cut” “Fix” “Keep” “Add”

-20

-10

0

10

20%

Percent reduction in non-fuel expenseper ASM (post 9/11)

Contin

ental

-18%

United

-9%

America

n

-8%

USAir

-5%

Delta

14%

Legacyaverage

Year filed for bankruptcy:

N/A 2002 2005N/A 2002

Continental optimized route network by exiting unattractive hubs

And reduced overall non-fuel expense by 20%


• Shifted mix to higher revenue customers- Grew premium business revenues >20%, through excellent customer service and

NPS implementation- Expanded international footprint through partnerships and JVs to >40% of global

revenue base (e.g. Star Alliance)- Developed new suite of travel products and services targeting international and

business class customers (e.g. airport fast tracking/seating upgrades, lounge access)

• Unbundled the product to create revenue opportunities- Phased out amenities once included in the price of the ticket, generating an

incremental ~$30M per year in ancillary revenues (e.g. food/beverage services)- Implemented new fees for baggage checking services ($25 per item)

Source: DOT Form 41, Analyst reports, Annual Reports; Bain Analysis

…and fixing the revenue side.


Credit Cards: The 1980s credit card market was booming, but fragmented and simplistic

• Virtually unregulated industry

• Simple decision metrics: – Debt-income ratios– Unadjusted credit scores

• Uniform pricing:– 19.8% interest– $20 annual fee

• Dramatic growth:– Share of consumer spending

doubled– Accounted for 70% of revolving

debt in 1989

Source: HBS Case Study: “Capital One Financial Corporation” May 2001


Fairbank and Morris believed credit cards offered a unique opportunity


1. Ability to record every interaction with a customer

2. Ability to customize products to each customer

3. Ability to turn a business into a scientific lab where every decision could be systematically tested via thousands of experiments

4. Ability to roll out products nationally after they have been proven to work, without incurring brick-and-mortar costs

5. Potential to reinvent the entire economics of a business

6. No other competitor recognized this opportunity

1

2

3

4

5

6


Capital One’s success was driven by an information-based strategy

Source: HBS Case Study: “Capital One Financial Corporation” May 2001 (quote from page 7); BCG Case Study “Customer Relationship management at Capital One (UK)”

1 price for each customer:Each customer carries a specific credit risk that drives an optimal price

Test and learn:Understand correlation between behaviors and level of risk

Product proliferation:Wide range of products, targeted to narrow customer segments

+

=


Constant testing created a virtuous cycle of improved segmentation and profitability

Source: Graphic from Case Study “Customer Relationship management at Capital One (UK)”http://www.authorstream.com/Presentation/rakesh208-709520-customer-relationship-management-capital-one-uk/


0

10

20

30

$40B

Market capitalization, Capital One

1995

5

1999

34

As a result, Capital One experienced monumental growth

0

100

200

300

$400M

Capital One Net Income

1995

127

1996

155

1997

189

1998

275

1999

363


Net income grew 185% in 5 years…

… and market capitalization increased by 600%


Gambling: In the 1990s, Harrah’s was faced with intense competition as others innovated

The Mirage Hotel, Las Vegas

The MGM Grand Hotel, Las Vegas

Harrah’s had to determine how to defend their position and grow in existing markets

Source: HBS case study “Harrah’s Entertainment” by Rajiv Lal, June 2004


• Competitors began introducing flashy, themed properties

• No new jurisdictions were planning to legalize gambling

Marketing Experiment Example:

Harrah’s “Total Rewards” cardTiered based on the expected

value of each customer

In response, they focused on customer loyalty… and harvested data to do so

$125 in hotel room and

steak dinner

$60 in free chips

vs.

Despite the reduced value, customers of the same segment preferred the chips



• Harrah’s CEO hired a Harvard professor to turn marketing into a quantitative, data-driven strategy

• Launched a loyalty card to gather customer data

• Mined that data and built statistical models to predict customer lifetime worth

• Segmented customers based on expected worth and behavior

• Conducted marketing experiments to determine the most effective approach for each customer segment

As a result, Harrah’s growth outpaced the marketby 3x



Defense: General Dynamics faced dramatic declines in its revenue base in the early 90’s

Source: Bain analysis, company reports


GD identified and prioritized bright spots in their portfolio where they could win…

24

Mar

ket a

ttrac

tiven

ess

Invest and growMaintain

Manage for cash

StrongWeak

High

Low$800M

ArmoredVehiclesMilitary

Aircrafts

Space Launch system

Electronics

Aircraft Components

MissilesSubmarines

SmallCommercial

Aircraft

Exit

Competitive position

Fit with core competencies

High

MediumLow

Assessment of GD businesses

Source: Bain analysis, company reports

“We have adopted a 'plan of contraction' that reflects our intention to place our non-core businesses in other hands as their markets permit and appropriate transactions can be negotiated.”

William Anders, CEO, 1992


… by divesting 70% of their revenue but setting the stage for substantial, refocused growth

Source: S&P Industry Overview; Prudential; company reports

Operating margin

GD refocused its business and shrunk from $10B to $3B, while improving operations within

its core

Divested…• Space systems (Martin Marietta)

From a strong base, GD grew aggressively by adding two new cores

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

Divested…• Tactical aircraft (Lockheed)• Cessna (Textron)• Missiles (Hughes)• Electronics (Carlyle Group)


Agenda





Which new rules of the game do you live by?

Rule with lowest costsDifferentiate on

brand/value and/or customer niche

Data/analytics/insights

Loyalty and advocacy


0

1

2

3

4

$5B

P&C industry advertising spend

1996

0.9

1997

1.1

1998

1.3

1999

1.7

2000

1.7

2001

1.6

2002

1.7

2003

1.9

2004

2.3

2005

3.0

2006

3.4

2007

4.1

2008

4.4

10%

(96-03)CAGR

18%

(03-08)CAGR

Brand-building is driving massive growth in advertising spend

Source: SNL Financial (2008)


Ad spend moving from simply “price” to differential brand and customer propositions

Differentiate on quality/service…. …or emphasis on segments

Focus on value“Lowest price for you”

“We’re here for you” “We understand your special needs”

Plays to the advantage of larger incumbents29 © 2011 TransUnion LLC All Rights Reserved

0

5

10

15

20

25

30

35

GEICO

17

ProgressiveDirect

Taxes

General Expenses

Other acquiring

21

Expense ratio (2010)

Captive Agents comparable

Ind. Agents comparable

Costs will remain an important battleground

Source: AM Best, SNL, Company Financials

How low can direct costs go?

How low do costs need to be to stay

competitive while outperforming

on value?


Information (and the ability to commercialize) will be an increasingly potent weapon

Per

cent

of l

osse

s

Population (sorted by predicted risk)

Source: Progressive Investor Relation Meeting, June 2010


Product or service meets basic needs

Product or service works as expected

Problems are resolved as

expected

80s and 90s: Satisfaction

The basics: “Eliminating nuisance

factors”

Ordinary services delivered

exceptionally

Exceptional services/ features

delivered well

2000+: Loyalty/AdvocacyDifferentiators:

“Creating the wow-factor”

Capturing new customers is only part of the battle, long-term success will depend on keeping them loyal


The payoff from investing in loyalty is significant

~30% higher profits

Profit for given volume of total agency book; indexed

~5.4x higher NPV

Lifetime profit from new policyholder (NPV); indexed

Agency Value of Loyalty Policyholder Value of Loyalty

Source: Bain Analysis; Bain & Co Ind’t PH Top-down Survey; Policyholder satisfaction survey; JD Power; Dec 2009 Agent satisfaction survey; salesforce.com


USAA

Am

ica

Erie

AAA

Sta

teFa

rm

Auto

-Ow

ner

s

Am

eric

anFa

mily

Har

tfor

d

Mer

cury

Nat

ionw

ide

Alls

tate

Prog

ress

ive

Farm

ers

Alli

ed

Saf

eco

Trav

eler

s

Enco

mpas

s

Liber

tyM

utu

al

Han

over

-Citiz

ens

AIG

Extraordinary range in client satisfaction exists in both property…

2010 Net Promoter Score, Property Insurance Provider

Industry Avg (7)

Source: Top-down policyholder NPS survey, N=129,662. Note: All competitors shown collected more than 200 responses.


…and auto.U

SAA

Am

ica

Erie

AAA

Sta

teFa

rm

Auto

-Ow

ner

s

Har

tfor

d

GEIC

O

Sta

teFa

rm

Prog

ress

ive

Am

eric

anFa

mily

Alls

tate

Nat

ionw

ide

Merc

ury

Han

over

-Citiz

ens

Trav

eler

s

Saf

eco

Alls

tate

Farm

ers

Alli

ed

Trav

eler

s

Liber

tyM

utu

al

Enco

mpas

s

AIG

2010 Net Promoter Score, Auto Insurance Provider

Industry Avg (18)

Source: Top-down policyholder NPS survey, N=129,662. Note: All competitors shown collected more than 200 responses.


Source: Bain & Co Ind’t Agent Top-Down NPS Survey, 4/20/10. N = 1215; Individual company names have been disguised

There are also opportunities with agents2010 Net Promoter Score (Independent Agents)

Industry Avg = 22


Agents that are promoters quote more, close more, and have higher share of agent book

Source: Bain analysis, Dec 2009 Agent satisfaction survey

Average 2009 close ratio(New Policies / Quotes);indexed

Median quotes written (2009); indexed

Likelihood to Recommend Carrier to a Customer

Company share of Agent’s book2009 Average;indexed


Agenda





Final thoughts: Key questions to consider• Where is my competitive advantage?

-Today/tomorrow?– Pricing/selection? – Brand? – Loyal/Advocacy?

• Do I have a distinct (enough) value proposition?– Against what segments? – Which agents?

• How competitive are my underwriting/selection tools?– Are they allowing me to keep up or fall behind?

• Are we changing fast enough?

• Do we need to make fundamental changes in our emphasis, footprint or business model?– Doing too many things and not any well enough?


Future of the Insurance Industry

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