Casting a Wider Net.

Insurers, who have used the Internet primarily for marketing and distribution, will need to include administration and claims settlement to realize more savings and compete against Internet upstarts.

So far, insurers have regarded the Internet mainly as a new marketing tool and, to a lesser extent, as an additional distribution channel for their products. Compared with online brokerage and online banking, development of the Internet in the insurance industry has been cautious. Most Web sites serve only to provide information about a company and its products. Effective online sales are just beginning.

The reasons for this reluctance to fully embrace the opportunities of the new technology include the complexity of some products, the difficulty of standardizing claims settlement, the low frequency of insurance purchases, still unresolved security issues and regulatory hurdles. Yet, insurers are challenged more often by new entrants, increasing competition and margin pressure, which force them to rethink the distribution of insurance products, the business processes and the vertically integrated business model.

There already are a couple of "pure" Internet companies doing business in the market. They are not expected to gain a substantial market share in the short term, but they will exert influence beyond their market share by setting new best-practice standards. The major impact to the insurance market will originate from established companies proactively embracing the new technology to realize their strategic goals or reacting to the pressures of a changing competitive environment.

Not all insurance products are equally suited to Internet distribution. Their suitability depends mainly on the complexity of the product and the client's need for advice. Products that are particularly suitable for marketing on the Internet are those that can be described and rated using a small number of parameters, thus allowing for online price comparisons. Those lines are automobile, homeowners, term life and individual annuities, accounting for about $250 billion or one-third of total market volume in the United States.

Picking Up Speed

Despite the slow start, Internet insurers likely will gain substantial market shares, especially in personal lines. By 2005, this market segment will represent a 5% to 10% share of new business in the U.S. market and around 5% in Europe. In 1999, only 15% of clients in Europe had an Internet connection, while the figure was as high as 44% in the United States. Only 1.5% of customers used the Internet to purchase financial services in Europe, compared with about 20% in the United States. In 1999, however, only 0.02% of premiums in Europe and roughly 0.2% of premiums in the United States were generated via the Internet.

It is estimated that by 2005 the percentage of clients using the Internet to purchase insurance and financial services could rise to 20% in Europe and just under 30% in the United States. Premiums generated via the Internet would therefore equal $6.7 billion in Europe and $17 billion in the United States, equivalent to online market shares of 5% and 7.5%, respectively.

Products that are not necessarily suitable for online marketing include most life and pension products, health insurance and many commercial lines. But even these products can benefit from the excellent opportunities for quality and service improvements presented by e-business. For example, policy administration and claims settlement can benefit from online support. Modern communication technologies also allow more personalized products, faster response times, greater flexibility in covers and better support for risk management.

Revamping the Value Chain

Although the discussion generally concentrates on developments in personal-lines insurance (business-to-consumer), a similar potential is to be expected in commercial lines insurance and reinsurance. The use of Internet technologies in the insurance industry is not just limited to distribution and marketing support; it also has a fundamental impact on almost all other parts of the value chain.

The integration of all business processes in a unified information flow significantly reduces the cost of gathering and analyzing information. Since the efficient processing of information is a key factor for insurers in the creation of value, the use of new information and communication technologies enables them to revamp and rationalize the value chain.

Newly established insurers are not burdened by legacy business systems and are able to exploit modern information and communication technologies to set "best practice" benchmarks for the entire industry. This will exert significant pressure on established insurers to adapt their business model to the changing requirements for greater efficiency, speed and quality of service.

In the past, the value created by insurers has centered on the aspects of distribution, administration and claims settlement. In these areas there are many routine tasks that could be automated through the efficient use of information and communication technologies. The tasks, therefore, would add less value. In the future, insurers will have to create a greater proportion of their value through a higher standard of service.

Traditionally, many insurance products have been distributed mainly through captive agents or independent brokers. Since enormous investments are needed to build up such a distribution network, established insurers generally were well protected against new competitors. Now the Internet provides new companies with instant access to the insurance market at an affordable cost. In addition, market transparency is improving, since information about products and prices is more readily available through the Internet.

Lower market-entry barriers and higher market transparency are combining to intensify competition and force prices down. This makes it increasingly difficult for an insurer to pass to customers comparatively high costs of traditional distribution through their premium rates.

Brand Recognition

Even if e-business lowers market-entry barriers, start-up companies still will need to establish brand recognition if they want to win significant market share. Another important factor--particularly in the insurance industry--is that the client must have confidence in the insurance company. Online sales still carry an additional element of uncertainty for many clients. This is mainly due to unresolved legal aspects of online policy sales and premium payment, as well as concerns about data protection. Insurers with an established brand name, therefore, have a competitive advantage, as they naturally command a greater degree of confidence.

New companies must build up this goodwill from scratch, and this usually involves high advertising and marketing expenses. Online stockbrokers provide an example of this. The newly founded companies [E.sup.*]trade and Ameritrade, with online market shares of 1 1% and 7%, respectively, spent 54% and 40%, respectively, of their revenues on advertising in 1999. By contrast, the market leader Charles Schwab (online market share of 24%) was already well known as a telephone-based discount broker and spent only 6% of its revenues on advertising.

The current disadvantages experienced by new Internet insurers should gradually become less important over time. First, confidence in the Internet as a distribution channel will improve as its penetration increases. Second, newcomers will be able to build up their weak reputations through solid credit ratings or alliances with well-known Internet brand names. Successful alliances for Internet insurers are feasible with online banks or online brokers, as well as with quality portals such as America Online, Yahoo or Microsoft.

"Lateral entrants" from other sectors can break into the insurance business with the help of the Internet. The most likely candidates are companies that have a well-known brand name and strong customer loyalty. These companies, such as banks, asset managers or Internet providers, could set up new, efficient e-business systems, without the burden of legacy systems or conflicts with other distribution channels. They also could transfer their brand name to the insurance industry and use their financial resources.

The importance of a brand name on the Internet is illustrated by the examples of Charles Schwab, Dell and Amazon. All three companies have managed to acquire substantial market share, despite charging higher prices than their competitors in some cases. Well-established companies who attempted to break into the online market at a later stage, however, such as Compaq in computers and Barnes & Noble in books, have to fight an uphill battle establishing online business.

Efficiency Is the Key

The new e-business capabilities bring significant efficiency improvements in distribution, administration and claims settlement to the property/casualty industry. About 40% of premiums cover the costs of distribution, administration and claims settlement in the property/casualty industry. On average, distribution costs account for roughly 15% of premiums. Administration costs and claims settlement costs each account for about 13% of premiums.

The biggest cost for property/casualty insurers is claims payments, which typically consume almost two-thirds of total premium volumes. Modern information technologies will bring cost savings for claims payments. For example, better data analysis may improve risk selection, and better detection of insurance fraud as well as tighter cost control of vendors--such as car body shops or medical-service providers--can help to further reduce claims costs.

What are the potential savings for the personal-lines insurance industry? E-business is expected to represent potential for cost savings in personal lines of about 10% in claims settlement, 30% in policy administration, 30% in distribution and 5% in claims settlement, assuming that over time all insurers come to exploit the entire range of business opportunities. This results in a total potential savings of $15 billion, or about 12% of premiums (see chart below).

In commercial lines, the greater complexity of the processes involved means that most of the efficiency improvements will be in the areas of administration and claims settlement. Therefore, there is a greater potential for efficiency improvements--15% lower claims-settlement costs and a 35% reduction in administration costs. The savings potential for distribution costs will be considerably less (10%) because of the substantial advisory and service content. Claims-settlement expenses also hold less cost-cutting potential in commercial lines, because of the very intensive exchange of information. The maximum savings should be about 2.5%. The total cost-saving potential, therefore, totals $11 billion, or 9% of premiums.

Impact on Brokers

The impact of e-business on insurance brokers depends a lot on the insurance products in question. If these can be standardized and readily compared with each other and do not require extensive consultation, then the competitive pressure on traditional insurance brokers is considerable. A number of Internet providers already act as aggregators, providing comparisons of quotes from different insurance companies.

Brokers will continue to play a key role, however, where products require extensive advice and benefits and prices are difficult to compare. This will be particularly true for the more complex benefits packages available in life insurance, in the rapidly growing markets of integrated risk management, and in commercial lines. As advisory and risk-management services become increasingly important, demand for independent insurance brokers is likely to rise. This also will be reflected in a different payment structure, with fees no longer charged on the basis of brokered premium volumes.

E-business has the potential to fundamentally revolutionize the insurance landscape. Today, however, it is not possible to accurately forecast how radical these changes will be. It is obvious that the Internet has become a powerful platform for new market entrants into the field of direct insurance. The presents a challenge to established players to come up with their own innovative and efficient business models.

The fight for clients will be won by the companies that increase efficiency and create the most client value. Becoming a technological market leader will be a key strategic success factor over the next few years.

Thomas Holzheu, Thomas Trauth and Ulrike Birkmaier of Swiss Re's Economic Research & Consulting unit in New York and Zurich, Switzerland, recently authored sigma 5/2000,'The impact of e-business on the insurance industry: Pressure to adaptuchance to reinvent."