Managing Risk Through Data-Driven Strategy a Game-Changer for Insurers
Michael P. Voelker | December 04, 2015
When I was a kid, my friends and I would spend hours playing Risk, formulating strategy and hoping for a few lucky breaks that would let us gain control of the board.
Insurers are engaged in their own game of risk, but the stakes are much higher. With the pace of change in insurance increasing rapidly, carriers have to be careful that they make plans and investments wisely, knowing that the playing field could look drastically different in the next few years.
“Companies that identify and adapt to strategic risks that could disrupt how they do business will be positioned to not just survive, but thrive,” says Sam Friedman, insurance research leader in Deloitte’s Center for Financial Services. “Conversely, insurers that fail to identify strategic risks on the horizon will find it difficult to compete against those that do, as well as against any new forms of competition that might emerge in the online world.”
Strategic planning has taken on an elevated importance for insurers, and part of that planning includes assessing the multitude of risks that carriers face. Increasingly, industry experts are advocating for the creation of a defined, strategic risk management (SRM) function to identify, track, and respond to threats to the business.
“Without creating a strategic risk management function, insurers run a much greater risk of missing signs that point to developing threats that could impact their business model,” says Joseph Calandro, Jr., managing director at PricewaterhouseCoopers.
Technology is an essential part of the SRM function. And, risk assessment needs to include the evaluation of technology itself in order to guide insurers to make the best-informed decisions about system investments.
Unlike players of the board game Risk, insurers can’t afford to have the success or failure of their strategy tied to lucky breaks or a roll of the dice.
Of course, the practice of risk management is nothing new to insurers. According to Deloitte Touche Tohmatsu Limited’s (DTTL) 2015 Global Risk Management survey, 95 percent of insurance company respondents either have an enterprise risk management (ERM) program in place or are in the process of implementing one.
However, Friedman maintains that ERM programs are not traditionally designed to address strategic risks and emerging threats that could be disruptive to an insurer’s core value proposition or business model.
“Strategic risks are not a situation that will create a one-year hit to the bottom line or cause an insurer to miss a profit target or face a regulatory fine. Strategic risks are existential threats that can destroy an insurer’s business model, and those are the most difficult to identify,” he says.
Friedman points to the collapse of Blockbuster as an example of a company that failed to recognize and manage strategic risk. Blockbuster was once the industry leader in video rental, but saw its market share vanish when its brick-and-mortar strategy couldn’t keep pace with changes in consumer behavior. Today the brand remains only as an on-demand satellite TV channel.
As Michael Raynor, director at the Deloitte Center for Integrated Research, notes, “Blockbuster is no more not because it failed to grapple with the risks associated with its internal context, but because it failed to assess correctly a specific risk in its external context, specifically the risks of and to its strategy."
Blockbuster’s story contrasts with that of Netflix, which recognized changes to the market and adapted its strategy accordingly. “When Netflix recognized that the way consumers wanted to view movies was changing, they reinvented their distribution method,” Friedman says. “They transitioned out of tangible property—the mailing of DVDs—and began to stream content and create their own content. Identifying those types of game-changing risks is something that traditional risk management and risk managers haven’t dealt with in insurance.”
Insurers are already experiencing shakeups in the market. For instance, the traditional agency distribution model of insurance, which has already been impacted by online carriers, is under new assault by non-traditional insurers, including search giant Google and its comparison shopping website.
Telematics is having an impact in the market as carriers that are able to collect and consume massive amounts of data roll out new data-driven programs. In the future, self-driving cars could transform the nature of auto liability, and the new ride-sharing culture could discourage people from buying automobiles.
The risk assessment maturity of most insurers has followed a common path.
“What we think of as traditional risk management in insurance today was essentially put in place after Hurricane Andrew,” says Calandro. “Prior to that most insurers weren’t tracking their natural catastrophe risks. And the risk models that came out of [Andrew] were supplemented considerably after 9/11 with respect to manmade catastrophes.”
By the late 2000s, regulators’ demands to focus on ERM had given a decidedly compliance-based focus to the process. “When S&P decided that as part of their rating they were going to rate ERM, all of a sudden documented governance was added to the mix. After the financial crisis of 2008, some firms that S&P had rated ‘excellent’ had to be bailed out, and the federal government became involved. The lessons of that experience have been learned—no carrier wants to get on the wrong side of the government.”
SRM reflects the next level of evolution. “Strategic risk management is actually not a radical departure from what insurers are already doing or capable of doing. With strategic risk, you move from the level of tangible exposures that you can measure—cat risk, reputational risk—to ones that are more difficult to measure but can still be identified,” says Friedman, stressing that identifying strategic risk requires a heavy focus on business intelligence.
Evaluating business intelligence is the first step in MassMutual’s strategic planning framework. The company’s framework includes a PESTEL (political and regulatory, economic, social and consumer, technological, environmental, and legal) analysis of possible external factors that have a potential impact on the business.
“Our objective is to gain a holistic view of world events, risks, and global business conditions, and link that to market conditions in insurance and what our competitors are doing. We need to be knowledgeable and to judge whether or not our strategy is accomplishing what we thought it would against a changing external landscape,” says Paul Bacon, vice president, chief underwriter, and head of underwriting strategy at Massachusetts Mutual Life Insurance Co. (MassMutual).
In the analysis process, there is no substitute for human insight and experience-based analysis. “There is no ‘Acme SRM’ box I can simply pull off the shelf and use,” Friedman says. “It is an intellectual endeavor, answering questions like ‘If a major search engine starts underwriting, not just distributing, what does that mean for us? What if we have insurance without insurers?’ There are a lot of intellectual gymnastics required to perform effective SRM.”
However, there are tools that come into play—scenario planning, Monte Carlo simulation, and predictive models used in ERM among them. Friedman is also seeing more insurers use risk-sensing tools to collect and digest a growing volume of information.
“Watching social media, keeping an eye on news and trade reports—these activities take a lot of time. It definitely helps to automate parts of that process,” he says.
Friedman is also seeing more insurers create a new organizational function around SRM, although that function tends to fall to existing personnel. “Some companies do have a chief strategy officer to deal with [SRM], but in our experience we don’t see that too often. Most companies lack the personnel or budget or are too focused on short-term strategy and problems to galvanize a true SRM effort led by an individual dedicated to that role.”
Regardless of how a company assigns or approaches the SRM function, the key objective is to achieve what PricewaterhouseCoopers calls an “information advantage.”
“Insurers that can sort through the vast amount of data out there and achieve an information advantage are the ones best able to identify and monitor threats to their business,” Calandro says. Typically, information-savvy insurers excel in four areas: sense-making, holistic decision-making, an efficient information platform, and a governance process to help executives raise awareness, connect the dots, and act on insights. (See figure)
MassMutual uses a combination of people, processes, and technology to achieve an information advantage.
“You’re bombarded with data, sound bites, press releases, and more. That’s the data and information challenge,” Bacon says. “The second challenge is determining what items from the flood of available information are actually relevant to your strategic planning.”
MassMutual created algorithms that collect news feeds, articles, press releases, and other data from LexisNexis and align that information with key strategic objectives. The company uses a centralized database to store pertinent articles and Microsoft SharePoint as the platform for organizing and sharing information. MassMutual then built automated workflows to route information to personnel who are responsible for monitoring it and preparing executive briefs.
“You may ‘own’ a particular topic for anywhere from three to six months, then rotate to another area so that we continue to get fresh insight into different areas of concern and opportunity,” says Bacon. “Since executives don’t have time to sort through all the noise, the ‘fast facts’ reports that are provided to senior leadership are invaluable and help critical topics get elevated quickly. It almost becomes a social-media approach to connecting people around intelligence that is critical to the business.”
From ERM to SRM
In some cases, insurers will find they already have a solid base for SRM, but simply need to apply more rigor to the process.
MassMutual came out of the financial crisis of 2008 stronger than its competitors in large part because of its effective strategic planning. The company also examined the experiences of all its divisions, large and small, in order to see what could be learned going forward.
MassMutual revamped its existing strategic planning framework to create the consistency it needed and tie business divisions together. The new framework, which it calls Pinwheel, began with the CEO’s creation of new strategy and corporate development (SCD) and enterprise risk management (ERM) functions. Those functions report to the CEO and act as liaisons between subsidiaries and the larger corporation.
“Each of the ‘spokes’ of the Pinwheel were activities that occurred at MassMutual; my team just sequenced and organized those activities to help senior leadership and obtain consistency throughout our divisions,” Bacon explains. MassMutual’s SCD and ERM teams rotate staff every few years, which brings new insight into the process and promotes the Pinwheel framework.
Decentralized predictive models were leveraged to form better communications with the goal to put a more formal governance process around strategy to the senior leadership team. Consistency was greatly improved across the enterprise. The company’s strategic model has had business impact, including on the development of new products to seize on strategic opportunity.
“We’ve noticed significant trends of movement of foreign nationals and a multicultural movement in wealth and growth sectors,” Bacon says. “Even though we are U.S.-based, we realize we need to bring solutions to the market for foreign nationals and multicultural constituents. After we identified that, we were able to percolate that information to the leadership team to act on.”
The Pinwheel model has also led to the identification of strategic technology investments, including the creation of new service and self-service solutions for the current generation of consumers.
“Technology is one of our key areas of focus,” Bacon says. “Although most of our solutions are sold through intermediaries, we realize that people’s expectations of the sales process have changed. People, particularly digital-native people, want to be more informed.”
That focus has led to MassMutual’s support for omnichannel capabilities that tie together the customer, intermediary, and online systems.
“Customers are still willing to pay for advice, but they don’t want to walk into an advisor and be completely clueless. They want to learn on their own and close the knowledge gap, which is why we have put more and more research-focused capabilities online,” says Bacon. “They also want to flow between channels freely—to start filling things out online and then switch to a call center seamlessly where the person they talk to is fully aware of the online interaction that has taken place. We’ve continued to increase flexibility enabled by technology.”
Picking up the Pace
The heightened pace of change in today’s economy demands that insurers make plans and investments wisely. Insurers are challenged to create strategies around all areas of their operation and to identify strategic risks that threaten their business model.
“What information advantages will be required to compete, now and in the future, is the essential question insurers must ask,” Calandro says. “It’s an IT strategy thought process that needs to reconcile with an insurer’s financial and underwriting strategies.”
“Insurance companies are very much aware that their business model is under threat,” says Friedman. “The question is if they are willing to develop a more systemic way to manage it so they aren’t running around putting out a fire after it’s already at their door.”
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