Complexity of Risk: Why One Consumer-Focused Concept Could Revitalize the Independent Agent Model

Introduction

Historically, consumers had two main choices when purchasing insurance: They could visit an exclusive agent for a company such as Allstate, State Farm or American Family and select from the offerings of a single carrier, or should they desire a wider range of company options, consumers could visit an independent agent who represented multiple carriers. Under both scenarios, consumers received professional assistance and advice before reaching their decision – a key part of our value proposition.

Around the turn of the millennium, a third distribution channel emerged, as the internet began revolutionizing the way consumers purchased products and services. This online direct response insurance distribution channel, occupied by firms such as Geico and Progressive Direct, is now firmly cemented in place. In place of face-to-face discussions, the online direct channel competes largely on low cost.

Much like many industries that were disrupted by internet retailing, those in the insurance space were forced to deal with some critical questions: How will the new online direct channel affect market share? Which of the three options best serves consumers? Which channel will ultimately prevail?

Fifteen years after the emergence of the online direct channel, there's no shortage of analysis of the relative merits—and ultimate prospects—of each channel.

In 2013, the consulting firm McKinsey & Company roiled the insurance industry with a provocative paper (1) that forecasted looming trouble for the independent agent channel. The paper, "Agents of the Future: The Evolution of Property and Casualty Insurance Distribution," asserted that "there are signs that the economics of the traditional agent model are beginning to unravel." (1)

McKinsey argued that advanced predictive models are making the independent's traditional role minimalized with regard to pricing and risk selection. Consumers, it was suggested, would no longer need or value professional guidance from the independent agent channel to the same degree they once had. Additionally, the report predicted the widespread commoditization of auto insurance would prove financially devastating to the local, independent model, as there will be fewer “opportunities for independent agents to interact with and add value for consumers.” (1)

While these structural shifts in the insurance industry may still manifest themselves in the coming years, the independent channel has yet to suffer a reversal of fortune. A recent report by the Independent Insurance Agents and Brokers of America (IIABA) (2) showed that the independent agent channel grew faster than the overall market in 2013, and increased market share in 23 of the 50 states. Independent owners did particularly well in the homeowner's insurance market, accounting for 57 percent of all growth in 2012 and 2013.

However, despite all the dialogue about which channel will prevail, something material has been left out of the conversation.  Peter Drucker, a great management mind, has famously said: “The aim of marketing is to know and understand the customer so well the product or service fits him and sells itself.” Drucker’s point? Many businesses live and die by aligning their value proposition to the needs of the customer.  The industry conversation about channel has been largely conducted as if there were ONE insurance consumer with a homogeneous set of needs. 

What if the answer, instead, was rooted in a deeper understanding of the consumer?  This paradigm may be due for refinement.

Understanding the Concept of "Complexity of Risk"

Defined simply, complexity of risk is a metric used to establish the risk profile of an insurance buyer. One example: A 25-year-old male (let’s call him Bob), recent college graduate, of modest net worth who rents an apartment and drives a 2011 Honda Accord.  He’s likely only interested in renters or auto insurance, and has very low complexity of risk.  On the other hand, a busy female executive (let’s call her Leslie) with a high value residence, three cars and a vacation home has a far more complex set of holdings.  This person could be characterized as having relatively high complexity of risk and could need a far more robust set of risk solutions.  Insurance consumers could be placed somewhere on this spectrum of risk complexity.

Using complexity of risk as a metric allows for greater specificity when characterizing the consumer marketplace. Currently, much of the industry conversation about the three respective channels occurs as if there is only one type of consumer. By establishing a spectrum of complexity and developing a rough methodology for placing consumers on that spectrum, it could become possible to quickly identify and target the most promising segments of the insurance-buying market for each respective distribution channel.

What could complexity of risk tell us about the future of independent agency distribution?

While McKinsey's overall view of the long-term prospects of the independent agent channel can be debated, it can be safely said that certain inexorable shifts are pushing specific segments of the broader consumer base away from independent agents. Those segments are largely comprised of consumers fitting the low complexity of risk description (their inherent value proposition doesn’t play well with Bob).

Many believe that the battle for low complexity of risk customers has already been lost for the independent agency channel.  Attempts to become more like the online direct channel (via new online portals and other measures) face significant competitive headwind since consumers rarely prefer imitations of already popular products and platforms. Because of this, independent agents are likely better served, in most cases, by allocating resources toward capturing consumers with higher risk complexity.

All of this raises another key question: How to establish a baseline indicator that points to moderate risk complexity – the point at which it makes sense for some independent agents to concentrate their efforts?

Fortunately, there's one obvious point of demarcation: home ownership. Underwriting homeowner's insurance requires much more in the way of information and documentation than auto insurance. It's an entirely different, vastly more complex product universe.

Once you segment the consumer market by complexity of risk, it can become clearer how the value proposition of each distribution channel competes.  Most online direct channel’s value proposition is generally built around a lower cost structure, self-service technology, and massive direct marketing spend to cement brand awareness.  The captive channel generally competes on local service, professional advice and has now begun to compete for consumer share with material marketing spend.  The independent agency channel typically competes on local service, professional advice and extensive product choice.  The independent agent’s higher operational costs structure (lower now than it has been, but still relatively high when compared to the other two channels), and higher cost of customer acquisition (the other two channels have scale that IAs struggle to match when it comes to marketing) are huge competitive disadvantages when competing for low complexity of risk consumers.  Their inherent strengths, choice and advice, also could mean less to these consumers.  However, the needs of consumers with higher complexity of risk are usually aligned with the independent agent’s inherent value proposition.  The Leslies of the world generally have much higher average premiums per household, as they have much more to insure.  Not only is Leslie much more likely to value advice and choice to meet her more complex needs, her higher premiums help offset the independent agent’s higher acquisition costs, and once captured, Leslie’s switching costs (an economic concept that measures how difficult it is for a consumer to switch providers) is relatively high, making it likely she will stay in the channel as long as her needs are met.  This makes Leslie, and many other high complexity of risk consumers like her, excellent target consumers for independent agents in most cases.

Independent agents could redirect the resources currently being invested in competing for low risk complexity consumers and instead focus on mid to high complexity consumers in order to potentially capture market share in the current three distribution channel environment.

Conclusion

The rise of transformational technology is bound to cause consternation in any mature industry. Yet there has been a lot of debate over perceived existential threats to the independent agent model, and emphasis on which channel will ultimately "win." Rather than focusing too much on structural or technological challenges to the local "advice and assistance" model, independent agents could instead focus on consumers, specifically, the consumers who are natural candidates for the independent model.

The inherent value proposition offered by independent agents is still strong. Unlike the online direct and captive channels (which virtually sell only personal), many independent agents sell personal and commercial products. Independent agents typically also offer consumers a broader range of choices.

Today, the online direct channel dominates the low complexity market. This is a battle that has already been fought and won (in most cases). Yet the independent agent value proposition could become more attractive as risk level rises. For that reason, independent agents could focus on growing market share within this segment of the consumer base.

Another critical point to consider: The Millennial Generation already outnumbers Baby Boomers, with 75 million members (3). As this massive cohort ages, their insurance needs will grow more sophisticated, increasing their complexity of risk. And this trend may only become more pronounced. Generation Z, the age cohort coming up behind Millennials, is even larger— 25 percent of all Americans, according to U.S. Census data cited by Forbes.com (4).

By focusing efforts on the market segment best suited to their value proposition (mid to high complexity consumers), independent agents could do more than merely weather industry changes—they could thrive. Widespread adoption of the complexity of risk model could be the first step toward securing a profitable, growth-focused future for independent agents.

References:

(1) "Agents of the Future: The Evolution of Property and Casualty Insurance Distribution," McKinsey & Company," 2013.

(2) "2013 Property Casualty Insurance Market: opportunities and Challenges for Independent Agents and Brokers," Independent Insurance Agents and Brokers of America, 2013-2015.

(3) "This year, Millennials will overtake Baby Boomers," Pew Research, 2015.

(4) "Seven things employers should know about the Gen Z workforce," Forbes, 2015