Market Conduct Challenges.

Customer relationship management can provide an early warning system for inappropriate sales activity.

Insurance companies today face serious market challenges. Declining sales, recruiting issues and new competition have combined to make this one of the most difficult markets in memory.

Yet perhaps none of these issues presents the challenges and questions posed by an increasingly strict regulatory environment.

Regulators--as well as rating agencies--are taking a hard look at market conduct, compliance and suitability issues. Large companies know they must respond to these issues quickly to stem the tide of lawsuits and regulatory inquiry. For smaller companies, it's a matter of survival.

Lawsuits now abound, with at least 64 purported class-action suits against insurers for abuses such as churning, twisting, misrepresentation of products and failure to monitor and discipline agents for improper sales activities. Small and large companies have come under scrutiny and received severe penalties. According to the American Council of Life Insurers, during a period in the 1990s, "one suit involving market-conduct practices and seeking class action against ACLI members had been filed every three days."

Identifying Potential Problems

Deceptive sales practices are at the core of market-conduct problems. Regulators base their assessments of sales practices on customer understanding of the provisions of their policies. Therefore, even if none of an agent's sales literature or statements is incorrect or designed to be misleading, his practices can be deemed deceptive--if the result of the sales practices is a pattern of customer misunderstanding. Agents must be sure their sales tactics clearly express the terms and services of any products a customer purchases.

Accountability Set

The onus is not solely on the agents. Companies are being held responsible for their agents and their customers, and some companies have incurred large penalties because the court felt they were not making any genuine efforts to identify violations. The courts viewed the companies as tacitly endorsing the deceptive practices.

Companies cannot prevent all dishonest behaviors by all employees and agents. While insurers need to implement controls, they still must provide their agents enough room to sell effectively. To walk this increasingly tighter line between compliance, competition and profitability, insurance companies need to radically change their way of thinking about the sales and marketing of their products and services.

Customer Focus

Once the mindset was, "Let's make insurance products for our agents to sell." Now it is, "What are our customers' needs and how can we help to meet them?" Once the process was, "Sell all the life insurance you can to whoever will buy it." Now it is, "What products are right for our customers, and what is the best way to present them?" Once profit was measured by margin on the sale. Now, it is measured by total value of the customer relationship.

Whether an insurer distributes directly, through independent agents, captive agents or brokers, the crux of the problem is identifying and filling the needs of the customer--matching the right product with the right customer at the right time. Insurers that do this will automatically offer products that customers want to buy and be in compliance with market-conduct standards.

The successful company will identify up front which customers fit suitability requirements for which products. Before the underwriting process begins, a company should assess customers based on information in its database. And it should have a monitoring and reporting system in place to constantly check on compliance and customer satisfaction, as well as provide an audit trail for regulatory and rating-agency requirements. The successful company will have an effective strategic differentiation from its competitors based on its unique profile of customers, distribution channels and array of products.

Innovative companies in the property/casualty industry are beginning to use both traditional and nontraditional data sources to screen and preapprove applicants. The banking industry has been doing it for years.

So how does the life insurance industry identify and understand the best customers within its existing customer base? Customer relationship management is one concept that insurers are choosing.

Ideal Conditions

Customer relationship management is most productive when:

* the market is highly competitive;

* the market is mature, with 20% of customers being the most profitable;

* there is the potential for high purchase frequency;

* there is a wide product range and good customer segmentation possibilities; and

* customer loyalty impacts the bottom line significantly.

This definition seems to have been tailored specifically for the life insurance industry.

At the heart of effective customer relationship management is a well maintained customer-information database--a tool for gathering, storing and analyzing critical customer information.

But while most major insurance organizations have significant transactional and legacy systems in place, and many are in the process of establishing enterprise wide data warehouses, few have developed the ability to garner from these systems the specialized information needed to develop and cement customer loyalty--and to be able to target specific segments for policyholder preservation or effective generation of additional revenue.

Most insurers are able to monitor large swings in policy activity, but many have limited ability to review and act on individual events.

The first step in moving from a traditional product focus to a customer focus is data analysis--using segmentation techniques to profile current customers and place them in identifiable groups on the basis of value, persistency and demographics. A similar profile of current agents also should be developed.

Prospecting Cues

Important factors include:

* household persistency--how long the household has held its oldest policy with the company;

* household recency--how much time has passed since the household has been contacted, has purchased a policy or has increased a premium;

* household frequency--the number of policies owned;

* household monetary value--a monetary value assigned to each household, using total premiums, total cash accumulation and surrender values; and

* household revenue flow--an indicator of the relationship between ongoing and new business vs. lapsed or surrendered business.

Once these factors are determined, the database is further segmented along demographic lines using variables such as age, income and lifestyle codes, for example. A decision-tree analysis that places customers into discrete groups based on their shared demographic characteristics often is performed.

This level of analysis enables an insurer to accomplish two important goals. Customer profiles will yield valuable information for targeting or aligning products with customers for more effective cross-sell campaigns based upon customer lifecycle needs. This analysis will generate data that is needed to establish several key metrics used to track changes in customer value over time. These metrics include household profitability and long-term customer value.

With these two metrics in place, an insurer will be able to effectively project how much it can afford to acquire new customers within the various segments and identify which customer relationships must be retained to maintain target levels of profitability.

Sorting for Sales

This combination of segmentation and value metrics will provide answers to several of the fundamental questions necessary to support successful customer relationship marketing efforts, such as:

* Which customers account for the most sales?

* Which customers are the most profitable?

* Which customers are the least profitable?

* Which customers are the most loyal?

* Which products and services are most in demand?

Because this analysis is data driven and quantifiable, it can be used to model the customer base. Models can be developed to predict the answers to several questions about customer behavior, for instance:

* Which customers are in danger of lapsing or surrendering policies?

* Which products is each customer or household most likely to purchase?

* Which agent is a customer most likely to purchase from?

* Will a customer respond to a direct-marketing offer?

Armed with this information, marketing managers can maximize the productivity of a variety of customer contact and sales channels.

With a focus on the customer, the next piece in the alignment strategy that requires examination is the relationship between agents and their clients. A "household revenue-flow analysis" can be performed to provide data on agent sales activities. This analysis will reveal agent sales practices that are jeopardizing valuable client relationships.

Trouble Shooting

Household revenue-flow analysis directly addresses situations in which there is likelihood that policyholder funds are being diverted from existing policies through internal replacement or "financing by inforce" to support the purchase of additional or replacement policies.

This analysis is based on the premise that when a policyholder pays all scheduled premiums, leaves dividends with the company as paid-up additional insurance and never borrows against the policy, the value of the policy is maximized.

Any of the following can be recognized as reducing the value of a customer portfolio:

* a policy loan;

* cash surrender of a policy;

* partial surrender;

* cash payouts of dividends or use of dividends to pay premium; or

* a policy loan that is used to pay premium.

Once these factors are identified, it is then a manageable task to close the gap between expected revenue and actual cash-value growth.

In ways similar to household segmentation, agents are grouped according to sales practices in the following categories:

* agent surrender/lapse rate;

* agent's total sales; and

* agent's premium flow.

With these categories, it is possible to rank agents by their relative profitability. This analysis documents and allows a company to link the activity of the agents with the customers' portfolios and sets the stage for ongoing tracking and compliance monitoring.

The final step in creating customer/company/agent alignment is to put the information from a flow-of-funds analysis to work in an operational environment. With that information, an insurer can spot and track changes in customer household profitability. It's a powerful component of customer relationship management, allowing access to the complete range of sales activities.

Now insurers can identify their best customers, and they can measure the impact a particular agent or agency relationship has on their business. And they can track any changes in the value of the relationship over time, thus establishing an "early warning system" to avoid potential legal pitfalls.

John Wincuinas is vice president of new business development for the insurance industry business practice of Harte-Hanks DiMark, Langhorne, Pa.

Adhering to the Standards

The Insurance Marketplace Standards Association was launched April 1, 1998, by the industry to help increase consumer confidence in the insurance industry.

It was established by the American Council of Life Insurers to counter unethical sales practices that led to class-action lawsuits against many major insurers. Membership was granted to life insurers that demonstrated that their business practices conform to the organization's six principles of ethical market conduct.

Companies must undergo a rigorous se]f and independent assessment of their practices to become a member. IMSA membership must be renewed every three years to assure continued compliance. For information about IMSA, visit the association Web site, www.imsaethics.org/pages/frame.htm