Living benefit riders to life insurance policies: Pricing considerations and strategy
Adding benefit riders to policies provides meaningful coverage for those who need it, and carriers usually can do so at a relatively low cost.
We’ve all seen enough auto insurance ads to know that insurers are battling for your auto insurance premium dollars. In 2019 alone, State Farm and Progressive each spent over $1 billion on advertising—and GEICO almost reached $2 billion.1 But as traditional auto insurers compete against each other for customers, they’re now also faced with new entrants into the auto insurance market race: car manufacturers.
Several car manufacturers are partnering with insurance companies to offer insurance that responds to the emerging needs of the modern car. For example, giving discounts for passive restraint systems (seat belts) is a thing of the past. Recognizing how many feet a driver leaves between them and the car in front of them, or how often automatic braking or other safety features are triggered, is data that modern cars can provide to help insurers better match rate to risk. Electric cars also need insurance for their charging cord, and coverage for when the car is driving itself. Cars have leapt into the future, but insurance is not necessarily keeping pace, recognizing features that are no longer relevant.
One such company that is responding to emerging automotive technology is Tesla. Tesla Insurance currently offers car insurance to any Tesla vehicle owner in California for “up to 20% lower rates, and in some cases, as much as 30%” compared to traditional car insurance. In fact, one of Tesla Insurance’s FAQs asks, “How is Tesla Insurance coverage less expensive than other mainstream insurance?” Their relatively simple answer—out there for all auto manufacturers and car insurers to see—is: Tesla uniquely understands its vehicles, technology, safety, and repair costs, and eliminates fees taken by traditional insurance carriers.2
How can car manufacturers offer discounted premiums compared to large, sophisticated, specialized insurance experts? Unlike the car industry, insurance rate calculations are a complex actuarial estimate of future costs, not an aggregation of known, fixed costs—and the most consistently profitable insurance companies are the ones that excel at the advancement and refined use of technology and data analytics in underwriting, ratemaking, and claims handling.3
However, there are many ways car manufacturers may have an advantage over incumbent insurers. Let’s examine the different elements that insurance premiums cover and how each could be reduced.
Car repairs and medical costs after accidents, along with expenses that come with closing these claims, are the largest costs that premium dollars cover. For each dollar of premium an insurance company collects, about 65% covers the claim itself (the car damages and any medical payments) and another 11% covers claim handling expenses, like in-field claim adjusters, in-office claim managers, and claim-specific legal fees. Insurers call this number the loss ratio–76% in this case–which is the total loss and loss adjustment expenses divided by the collected premiums.
The lion’s share of insurers’ costs is the “indemnity” repair and replacement costs and medical costs. Reducing indemnity costs has a direct correlation to the bottom line. However, in insurance, being able to better estimate those costs also indirectly improves profitability. If pricing is too high and customers are over-charged, they can easily take their premium dollars elsewhere. If pricing is too low and customers are under-charged, the insurers are paying out more than they are collecting. Pricing accuracy and loss ratios improve with better data. If car manufacturers can estimate loss costs more accurately than insurers can, this will translate into more accurate insurance premiums, which is important for insurance profitability.
As Elon Musk highlighted in Tesla’s Q2 earnings call on July 22, Tesla hopes to use its crash data not only to improve their insurance operations but also to learn how to adjust their car designs for less expensive repairs in the future. On the call, Musk said it was, “very helpful for us to have a feedback loop to see what is driving insurance expense.” Seeing collision repair costs of $15,000 is “crazy,” he said, and emphasized that the feedback loop from the insurance data back to the design and manufacturing teams was invaluable. If car manufacturers become car insurers, they may start considering the repair costs of their cars as much as the original build costs. If car design changes in response to medical costs and repair data, future cars can be built in a way that could lower repair costs and increase safety. This will help lower indemnity payments, which should lead to better loss ratios, which should lead to lower customer premiums, which should then lead to more competitive pricing and insurance market for any car maker that can recognize these improvements more quickly than its competitors.
And there is another potential claim advantage in modern cars’ connected data. Insurance companies have launched hundreds of telematics programs using a variety of technologies, such as mobile apps and devices that plug into the vehicle’s computer. While the data has been primarily used in underwriting and in developing new products, it is also useful for first notice of loss and notifying emergency services, determining accident causation and who is at fault in an accident, estimating damages, and reducing fraud. Any time a claim function can be automated, it can greatly reduce claims handling expenses. That said, the data available to a car manufacturer through the sensors embedded in the car when it’s built is likely richer and potentially more accurate than the data available through apps and dongles—and possibly provides greater potential for claims transformation.
Insurers’ focus isn’t only on the loss ratio, however. Many other expenses also affect insurers’ bottom line. In 2019, underwriting expenses to pay for items such as employees’ salaries, rent on office buildings, advertising, and commissions paid to independent agents, were 23% of premium on average.
It’s no longer a surprise to see an insurance outsider such as an insurtech or startup, flush with tech, move into insurance, hoping to drive costs down and profits up. But incumbents are not sitting still–they are also embracing innovation and technological savvy. Most analysts credit insurers’ mobile apps and customer-facing artificial intelligence with lowering expense ratios for the top-performing insurers. Efforts to increase digitalization and automation have streamlined claim management, claim adjustments, and customer support, improving loss and expense ratios and enhancing customer experience.
Could car manufacturers be able to take expense savings further? One way car manufacturers could reduce these expenses is through lower commissions versus the fees traditionally paid to captive or independent insurance agents. Another expense they could dramatically lower is advertising costs due to their existing relationships with their prospective policyholders and the likelihood that the insurance would be sold to the driver at the same time the car is purchased.
There are a number of car manufacturers currently in the insurance field, including Porsche, Ford, and General Motors, which offer their vehicle-specific insurance in conjunction with established insurance companies. Most have partnered with an insurance company. However, Musk recently announced that Tesla is creating its own “major insurance company.”4 Is this a sign that car manufacturers may be shifting from distribution players to full insurance companies? Will other car manufacturers decide to become auto insurers, too?
When asked his opinion, Warren Buffett said, “The success of the auto companies getting insurance business are probably as likely as the success of the insurance companies getting into the auto business.”5 Manufacturers need to consider all aspects and responsibilities of running an insurance company. Harnessing their vehicle crash data and having slick in-office and customer-facing technology won’t be enough. Manufacturers have an advantage with vehicle expertise, but they will need to become (or hire) experts in insurance law, insurance accounting, underwriting, claims handling, and actuarial science to oversee insurance operations, starting with creating policy forms and insurance rates that will need to be filed in each state. Car manufacturers that partner with auto insurers may get the best of both worlds; each business needs the expertise of the other.
To compete against incumbent insurers, car manufacturers will need to innovate faster and leverage their unique data assets. Insurers already have a vast amount of insurance information, but are they fast enough at adjusting their prices to reflect new technologies like advanced driver assistance and safety systems?
The competition for car insurance premium is fierce. Not only are car insurers competing against each other, but now they are also faced with an external-to-the-insurance-industry threat from car manufacturers. As car manufacturers and car insurers gain more vehicle data, the most innovative are in the best position to lower car insurance premiums and gain customers. In this contest, the most specific data, best applied, wins.
1Woleben, Jason. (March 13, 2020). Ad spending at State Farm, Progressive tops $1B in 2019; GEICO nearly hits $2B. S&P Global Market Intelligence. Retrieved on August 26, 2020, from https://www.spglobal.com/marketintelligence/en/news-insights/latest-news-headlines/ad-spending-at-state-farm-progressive-tops-1b-in-2019-geico-nearly-hits-2b-57549297.
2Tesla Insurance. Support. Retrieved on August 26, 2020, from https://www.tesla.com/support/insurance.
4Sonnemaker, Tyler and Rapier, Graham. (July 23, 2020). Elon Musk says Tesla is creating a ‘major insurance company’ after its botched rollout in California last year. Business Insider. Retrieved on September 4, 2020, from https://www.businessinsider.com/elon-musk-tesla-launching-insurance-company-nationwide-hiring-2020-7.
5Imbert, Fred. (May 4, 2019). Buffett knocks Elon Musk’s plan for Tesla to sell insurance: ‘It’s not an easy business.’ CNBC.com. Retrieved on September 4, 2020, from https://www.cnbc.com/2019/05/04/warren-buffett-on-tesla-id-bet-against-any-company-in-the-auto-business.html.