Power Shift.

Customer Management: Deregulation and the rise of the Internet have passed control of the transaction from the financial-service provider to the customer.

Two powerful converging forces--financial-services deregulation and the Internet--are profoundly affecting how property/casualty insurers distribute their products. These forces will reshape insurers' traditional business models, particularly in the overcrowded personal-lines and small-commercial segments. Pricing transparency will lead to tighter margins, expose undifferentiated insurers and accelerate consolidation.

At no time in history has one delivery system--the Internet--been able to access so many customers across state and country boundaries. The financial-services industry is poised for explosive growth facilitated by online commerce, with nearly one-third of Internet users already using electronic checking and nearly 60% of Internet households using the Web to research stocks, bonds and mutual funds.

Over the next five years, virtually all leading property/casualty insurers will market and sell a portion of their personal and small commercial lines insurance online, either directly or in partnership with value-added agents. While this transformation will be gradual, A.M. Best estimates that by 2004, $10 billion to $20 billion may be sold via the Internet, up from $1 billion in 1998.

Reshaping Models

To succeed in this new environment, insurance companies must reshape business practices to conform with advances in technology and to meet the demands of empowered consumers who want to make their own product choices across former financial-service boundaries. Whether through branch offices, call centers or the Internet, the combination of banks, securities firms and insurance companies will alter today's distribution landscape.

A.M. Best believes that many property/casualty companies are unprepared for the pricing pressures that will result from Internet-enabled competition. The property/casualty industry trails the banking and securities industries in terms of consolidation and strategic positioning for online competition, adding to the pressure.

Virtually all insurers will awaken to the fact that they have no choice but to re-evaluate traditional business models and develop Internet strategies that leverage companies' competitive advantages. Allstate's 1999 announcement that it will transform its predominant distribution channel and expand its Internet capability was clearly a watershed event. Other leading insurers are expected to make similar announcements over the next two years.

Undifferentiated personal-lines and small-commercial insurers, particularly those with high cost structures and minimal control over and loyalty from existing distribution channels, risk being squeezed from the market by the tighter margins enabled by Internet transactions. Conversely, a minority of value-added insurers that have highly specialized products and best-in-class services--including claims and fulfillment systems--will thrive in an era of Internet transparency.

In the middle, fall the bulk of property/casualty insurers that will need to develop appropriate channel-based marketing programs that generate increased Web traffic, reducing their reliance on inefficient and ineffective intermediaries to generate new business. Brand recognition is essential to draw visitors to company-specific sites that will eventually link to and from financial-service and other portals. Low-cost providers, particularly in the commodity segments, will be linked to insurance-aggregator sites such as InsWeb and Quotesmith, facilitating pricing comparisons. Insurers with high-quality products will pursue links with financial-service portals that function as "financial supermarkets." Innovative insurers wild secure links on appropriate nonfinancial channels within general portals--for instance, Yahoo's Auto site--to market insurance tied a customer-event such as purchasing a car.

Branding is Essential

Increasingly, insurers are finding themselves challenged to stand out from the crowd. A risk of competing online is that customers have boundless choices. Traffic control on the Web is critical.

Broader advertising, pricing information and product specialization are powerful tools insurers use to differentiate themselves. Branding is an essential element in influencing customer decisions because it builds a sense of trust. Given concerns about Internet fraud and the absence of an "E-Commerce" regulator, building brands and trust become even more important. Insurers' ability to capitalize on their branding and trust will determine their future success against nontraditional competitors such as America Online and Yahoo.

The Internet is uncoupling product manufacturing from distribution. Soon a consumer may no longer need to buy an insurance policy from an insurance company. The most popular area on America Online is its finance section. To date, consumers still are more likely to buy insurance products from financial institutions than from technology companies; but that will change as sites such as America Online and Yahoo increase customer satisfaction, confidence and trust.

In response, many insurers are creating or reinvigorating brands and logos. High-profile insurance-advertising campaigners include Axa-Equitable; AIG-Sun America and Progressive. Insurers are using high-profile campaigns to drive home their identities, including Geico's low-cost slogan of "Give Us 15 Minutes and We'll Give You 15% Off," Hartford's "stag" and its increased visibility in the print media, and Allstate's aggressive television advertising campaign designed to enhance its image as "The Good Hands People." These pull-through marketing strategies have two aims: to create loyalty among existing customers and to build name recognition among prospective customers who may wish to deal with insurers either directly or through traditional intermediaries.

Price Shopping

Historically, customers have had limited access to price comparisons within the commodity-like personal and small commercial segments. Consequently, consumers relied on their agent, the keeper of this closely-guarded information.

In the early 1990s, Progressive changed that. The group became one of the first personal-lines insurers to pursue alternative distribution beyond the traditional independent agent channel. Progressive adopted the risky strategy of competing with its agent network and established direct links to the consumer through its toll-free telephone network. The company offered auto insurance shoppers its own prices, as well as those of competitors. This recognizes that price transparency and the ability to compare is critical.

More recently, Progressive has made the transition to selling personal auto coverage on the Internet. Progressive's online insurance service center processes policy applications and provides instant approvals. It also provides ongoing services, including bill presentment, online payments, policy changes and individualized claim information. With strong branding, round-the-clock on-site claims service and marketing ties with relevant financial service and general portals on the Web, Progressive has established a fomidable business model that will support growth and profitability for years to come.

Financial-service "aggregators" have emerged on the Internet that provide an objective and open architecture-generally through sites that feature products from multiple providers-for customers to make price comparisons on products such as personal auto, homeowners, term life, deferred annuities and credit card insurance. Internet aggregators that have created on-line insurance consortiums include Autobytel, InsWeb, InsureMarket, Quotesmith and InsurQuote.

InsWeb is an insurance aggregator that offers customers the ability to research, ask questions and obtain price quotes for multiple products. Currently, Insweb provides auto-coverage information from 25 property/casualty insurers, including State Farm, Nationwide, Progressive, American Family, Orion and AIG,. Liberty Mutual, Hartford, Travelers and CNA also offer online quote comparisons through insurance-aggregator sites. Another aggregator, Quotesmith, provides insurance quotes from more than 300 insurance companies and the consumer doesn't need to speak to a commissioned sales agent.

Third-party aggregators will become more prevalent because most insurers will remain uncomfortable selling competing products on their own Web site. The number of participating insurers (personal and small commercial) will increase, which will widen the range of price quotes, exposing insurers that are less efficient.

Building the Storefront

Many financial-service companies have begun altering business models to suit the buying needs of customers. Companies such as Citigroup, Chase, Charles Schwab, and Merrill Lynch are examples of companies whose conventional business models were dramatically overhauled to meet the real-time demands of electronic commerce. Insurance companies are in the early stages of developing their own closed-architecture online sites. For the most part, insurers' online efforts trail those of more aggressive financial services competitors.

A handful of leading insurers have been partnering with securities firms and banks, creating integrated financial-services "supermarkets." Through company-sponsored Web sites and financial service vertical portals, customers can choose from a broad range of products and services.

Merrill Lynch & Co. is an example of a multidimensional, fully integrated financial services online superstore that offers a full range of on-line products and services. Merrill Lynch's supermarket approach, or vertical portal strategy, serves high-net-worth customers who value expert advice and are less price-sensitive. It also attracts younger, less-affluent "asset accumulators" who prefer to direct their own transactions on a no-frills basis. For the high-net-worth customer, the vertical portal business model requires strong customer service and product knowledge.

For the most part, financial giants such as Merrill Lynch still have not adopted an open-architecture Web site that will open their portals to include a broad range of products from multiple vendors, products which might complement or compete with their own brand offerings. The most successful companies will be those that integrate their vertical portals in a framework that supports multiple distribution points, including branch offices, telephone and online.

Insurance products that best fit this model are products such as complex life insurance products, middle-market commercial coverage, and bundled personal auto and home coverage. Banks and insurance companies pursing this vertical portal approach are Wells Fargo with AIG, Fleet with Hartford, and Bank One with Ins Web.

Even prior to financial-services deregulation, many larger banks and securities firms had aligned with insurers to complete the chain of financial-service products offered to customers. With access to a broad range of products and services, customers can actively manage their entire portfolio from one online location. While these alliances typically serve as an alternative distribution channel for insurers, it's only a matter of time before these large institutions begin to manufacture their own insurance products.

Personal Lines: Disintermediation Ahead

Over the next couple of years, consumer loyalty to insurers or local agents will erode as comparative insurance coverage information and price transparency becomes more widely available. Insurers that operate through high-cost independent agencies that lack service advantage and meaningful penetration of their agency plant are most at risk.

Except for Allstate, most captive-agency companies have demonstrated little desire to move beyond the conventional business model and remain extremely sensitive to channel conflict.

Allstate Corp., the nation's second-largest property/casualty insurer, has announced a series of strategic initiatives to aggressively expand its selling and service capabilities beyond its traditional captive agency sales force. This initiative is aimed at integrating Allstate's branded products through direct-response call centers and the Internet. Allstate also announced plans to reorganize its existing captive-agency program into a single, independent-contractor program geared toward making exclusive agents more efficient and innovative. A prime concern is Allstate's ability to manage channel conflict and minimize transition risk.

Allstate's bold new strategy is a signal that even entrenched insurers must adapt to fundamental changes in customer behavior and technology, providing customers with the convenience of conducting business anywhere, anyway and anytime. Allstate's business model positions it to take advantage of future growth opportunities from direct selling and electronic commerce--a necessary step for all property/casualty insurers.

Allstate's model has also been enhanced by several recent combinations, including:

* A partnership with Putnam Investments to market variable insurance products.

* The acquisition of CNA's independent agency personal lines business.

* The acquisition of American Heritage Life Investment Corp., a move designed to market workplace insurance products. The power of the Allstate brand and its local servicing capabilities are powerful factors in attracting new customers.

Aside from joining in selected online aggregators, competing captive-agency companies such as State Farm and American Family remain committed to their traditional distribution models. Eventually, all companies will be forced to embrace the Internet as a viable distribution channel, whether they sell directly to consumers or in partnership with their agency force.

Direct-response remains the lowest-cost distribution channel. Direct-response writers such as AIG, Amica, Geico and USAA are likely to be least affected by price transparency wrought by the Internet.

While direct-response continues to be most effective in marketing to densely populated areas or for reaching lower- to middle-income customers, e-commerce has the potential to reach a broader customer base at a fraction of the cost. Direct-response writers' efforts to sell personal lines products through the Internet will also reach middle to high-income customers who value service and convenience. Direct-response writers' expansion onto the Internet is a natural move, plays to their competitive strengths and does not bode well for higher-cost agency-based insurers.

Small Commercial: Agent Partnering

Commercial-lines deregulation is expected to accelerate the development of new, innovative, customized and highly specialized products. Product innovation and the ability to customize will be key drivers in commercial lines. Since many products will be customized, corporations and business owners will depend even more on their independent agent or broker for risk-management services and determining appropriate insurance coverage.

Online delivery systems are not yet suited to selling specialized products in situations where buying decisions are based on more than price. Commercial-lines products are generally regarded as noncommodity and less price-sensitive.

Instead of positioning their online efforts as building another distinct channel commercial insurers such as Reliance and Atlantic Mutual are partnering with agents on the Web. These insurers allow customers to purchase competitively priced commercial policies online using a private network to refer business to its partner agents. Using a virtual private network--known as an Intranet--all parties benefit from access to shared resources, greater efficiency and the elimination of workflow redundancies and keypunch errors. By reducing paperwork and telephone burdens, the independent agent can be more responsive to customer needs, focusing on risk-management services rather than on administrative duties.

Many independent agents will be challenged to respond to today's more-demanding customers. Agencies will need to embrace new technology and be able to access intranets tied to insurance companies. Equally important, many independent agents must awaken to the importance of branding, which for many has not been a consideration. Independent agents, as a group, must increase consumer awareness by differentiating themselves based on risk-management capabilities and local claims services.

Broker Services Win

Within the mid-to-large commercial segments, sophisticated risk managers will continue to rely on national and regional brokers to provide price-canvassing and risk-management services. Brokers serve as agents of the insurance buyer and are well positioned to respond to risk manager's demands for customized insurance or integrated-risk financing solutions.

The insurance broker will remain the delivery system of choice among large multinational corporations. In those organizations, risk managers rely on the broker's expertise and market savvy to negotiate the best price and to provide value-added services such as loss control, catastrophe management and other risk-management services on a worldwide basis.

More insurance brokers will raise their levels of service through online communications Approximately one-third of brokers use the Internet to interface with their customers, with this percentage expected to double by 2001, according to a recent study by Conning & Co. Through online communications, clients and insurers can access the broker's database network, monitor the elements of a complex risk-management program and retrieve information on a range of business, financial and risk topics worldwide.

Insurance brokers continue to cultivate customer relationships by finding new ways to manage and transfer risk. That includes developing capital-market-based solutions that supplement traditional insurance and reinsurance programs. The two leading insurance brokers--J&H Marsh & McLennan Cos. and Aon Corp.--have rolled out finance-oriented companies that develop noninsurance solutions to protect and enhance their client's balance sheet and earnings stream.

Effective Customer Management

In today's age of technology and real-time information, customers are becoming more empowered and are using the Internet to aid their financial-planning decisions with less help from intermediaries. Insurers must adapt their business models to meet the demands of today's more sophisticated insurance buyer. At the same time, insurers must gain a fuller understanding of consumer preferences as to products, access points, and pricing.

Through technology, customers become more empowered by obtaining information about products and services, and can make choices without the help of an agent. Education-based Web sites such as those developed by All-state and Chase explain insurance coverage and products in great detail and may even provide tips for purchasing insurance products. As people grow more comfortable in their knowledge of insurance products, online sales will rise and insurers will be under more pressure to stand out from the crowd.

As online sales activity by individual and small-business customers increases, disintermediation will accelerate. That will force insurers, agents and brokers to adapt to new standards. Whether consumers are shopping based on price or are seeking advice, convenience or high-end service, business models must be flexible enough to accommodate consumer needs using multiple distribution channels.