The split of Insurance Products and Services in the Market Place
E-1600 Economics of Business
Professor R. Wayland
December 9, 2014
On several levels, the Internet and related advances in technology have significantly affected financial services broadly, and insurance markets more specifically. When combined with
globalization and regulatory reform, these advances have forced the insurance industry to become more competitive. We will discuss here specifically the split or disruption in the insurance business with a focus on the auto insurance product and ...view middle of the document...
) By removing the entry barriers and the concurrent reduction in insurance costs this advance provides a private market solution to a major insurance regulatory concern - insurance affordability and availability. In addition, companies like GEICO have developed business models that allow technology to replace much of the process that previously required a skilled labor force, i.e. an insurance agent.
The graph shows internet usage worldwide (See graph on number of internet users). North America accounts for approximately a third of this population. Interestingly, when the internet is compared to other “disruptive” technologies (TV, radio, VCR) it has a much higher adoption rate. With this in mind, it’s no surprise that over 70% of auto insurance consumers start their purchases on-line. Consumer trends point to accelerated consumer use of the internet for nearly any type of non-specific (or generic) insurance product.
Furthermore, an auto insurance study in 2013 by McKinsey & Company found that consumers are increasingly leveraging digital channels (internet, mobile and social media) to research and buy insurance products. That trend will only accelerate as today’s millennial consumer increase their purchasing power. Also, the velocity of technology available to support mobile device purchases and an increasingly strong consumer’s preference to conduct transactions via mobile devices is facilitating market purchase choices for products & services with low asset specificity.
The Traditional Insurance Business
The basic business model of the traditional insurance business is to collect more in premium and investment income than is paid out in losses (claims), and to also offer a competitive price which consumers will accept. Profit can be reduced to a simple equation:
Profit = (earned premium + investment income) – (incurred loss + underwriting expenses + operating expenses + advertising costs)
Insurers will often use insurance agents to initially market or underwrite their customers. Agents can be captive, meaning they write only for one company, or independent, meaning that they can issue policies from several companies. The existence and success of companies using insurance agents is likely due to improved and personalized service and relationships.
With regard to the traditional Automobile insurance, the product itself has become standardized primarily due to government regulations and lender requirements. There really isn’t any further “product innovation” that takes place. This has led to extreme process innovation and, combined with the velocity of technological change, has allowed the non-specific auto insurance product to split from the traditional insurer.
Transaction Cost Advantages for Internet based Insurance
“Insurance companies selling and servicing over the Internet will have a cost advantage over traditional insurers in the range of 58% to 71% over the lifetime of a customer. Savings are driven by...