Background
One of the key challenges in the insurance business is selling new products (that meets customer’s need) and retention of existing customers which if not met properly may result in increasing customer complaints. Such complaints may induce adverse impact on future new business (brand value), loss of reputation and in a very adverse circumstances regulatory penal action. This paper discusses these risks along with the suggestion to address these risks of not meeting customer’s needs by changing the distribution philosophy from current push-based supply chain system to pull based supply chain by assembling the generic insurance products at a point of sale.
What is the Risk?
Let’s ask some fundamental questions about distribution risks in the life insurance industry? Insurance companies face challenges in selling new products and meetings new business targets; also, there are challenges in maintaining the customer base (retention) resulting from the fact that customers are not satisfied due to products not meeting their needs.
So, in short, the risks of insurance companies may be summarised as not meeting their annual business plan target of new business and depletion of customer base at a faster pace than planned due to products not meeting customer’s needs. This can cause serious dent in the balance sheet of the insurance companies. These things also result in the loss of reputation of insurance entire industry.
Analysis of Risks
Distribution risk as defined above falls under the operational risk category. The operational risk has its definition and method to address risk.
Operational risk as defined by the Basel Committee is:
“The operational risk is defined as a risk of loss resulting from inadequate or failed internal processes, people, and system or from external events. This definition included legal risk but excluded strategic and reputational risk.”
It is important to realise that “cause” is the driver of operational risk and the drivers are “failed internal processes, people, system and external events”. It is the cause that results into “events” which further leads to “consequences” such as financial loss, loss of reputation and adverse impact on customers.
So to control the operational risk, causes need to be addressed; next section analyses causes of distribution risk.
Analysis of Causes of Distribution Risks
The key causes of distribution risks are (not an exhaustive list, more causes can be added)
1. Products not meeting the customers need
2. Products are pushed for relative higher commission
3. Mis-selling by Sales personals
4. Process failure within insurance companies in meeting customers expectation
5. Delayed turnaround time
6. Inadequate administration system leading to company’s failure to serve customers
7. Inadequate hiring and training of sales folks
8. Competition
9. Regulatory and tax changes
10. Others
Each of the above causes falls in one of the four causes listed above, 8 and 9 falls into “external” category; 6 and 7 will fall into “system” category’ 4 and 5 fall into “process” category and top three fall into “people” category.
It is important to address the problem with respect to the category of causes and also addressing any factors that have some cross linkages (correlation) between the four factors.
The consequence of these risks is increase in customer’s complaints, customer’s dissatisfaction, loss of revenue, increase in lapses, regulatory intervention, loss of reputation due to adverse media coverage etc.
Market Profile
Recently, I got the opportunity to chair a two-day summit on products, marketing and distribution in BFSI sector; the objective was to discuss how to fulfil the customer’s need in providing financial solutions that meet their demand; to identify the areas of customer education to enable them making right choice for their financial needs; how to innovate products and services making it useful for customers and what are the emerging trends in technology that can be leveraged to enhance the marketing and distribution.
The key points that came out in two days summit in all the three areas in banking, mutual fund and insurance were meeting the customer’s need, focusing on customer’s education and investing on market research. The extract is given below:
There was almost consensus that the identification of customer’s need is one of the key requirements for the success of financial companies especially where some of the areas such as insurance and mutual fund require more of a push. Market research is one of the important tools to identify the customer’s need; however, many Companies still consider market research as luxury. It means that most of the financial players are manufacturing their products based on the sales force feedback only. There is a need to change in the approach of providers to reach the customer to understand their need, this could be expensive but the sales volume may recover an additional cost incurred on market research.
Understanding of the customer’s mindset and their trust on the brand value are instrumental in the buying behaviour of the customers especially in the banking and insurance sector where traditional customers like to move more towards established brand.
Customers are looking for simplicity over more choices responsible for the success of financial distribution; the providers are to understand the limited understanding of the customers and every customer should not be judged from the yardstick of metro city customers approach. More choices to the customers may confuse rather than providing more choices. May be for more sophisticated customers, more products choices may give compared to lesser sophisticated.
It is important to read the customer’s mind, where they look for assured return irrespective of whether the providers are mutual fund or insurance. This mind set is more influenced by the various advertisements on the assured return along with past history of fixed deposits in the banks in the past.
Manufacturing of products based on target market makes a more focused approach rather than fitting everyone with the same products. A lesser financial aware customer may not be ready to take more risk compared to more financially aware customer who may take more risks and invest in equity related products.
This extract indicates some common issues in financial services industry and that customer focus is the need of the hour.
Management of Risks
There are certain risks that are in the control of insurance companies (management) and certain risks which are beyond the control and both the categories require different treatment. System and process related controls are within the control domain of the management and they may work internally to address the risk. So these two areas are not a discussion point of this article.
Some of the people related risks can be internally controlled and some have external factors to address. For example, sales training, hiring of the sales force, commission distribution and mis-selling are within the control of management. The customer behaviour, buying pattern, and competition are not in the control of management and require a separate strategy to address the risk.
Customer’s Needs and Managing their Demands
Insurance companies are manufacturing the products some with market research and some with internal sales input. These products are suitable under the target market identified. However, if the products are sold outside the identified target market or without proper market research then they are pushed to the customers with some of their needs meeting and some not. As discussed during the BFSI two-day summit, financial services industries consider market research a luxury. This results into sold products not fully meeting the customer’s needs.
The issue is not just about the market research; however, this is a historic method of manufacturing insurance and other financial services products. In the supply chain, this method is referred to as “Build to Stock” popularly known as Push-Based Supply Chain. This concept is used in the manufacturing industries where the production and distribution decision is based on long-term forecast received from the retailer. Such method often leads to inability meeting the changing demands of the customers at a point of sale.
Contrary to “Build to Stock” strategy is a “Build to Order” strategy where order is taken from the customer first and manufacturing is done based on the specification given by the customers. Such strategy is referred as “Pull Based Supply Chain”. In this process, production is just as much consumed and produced, as consumed. There have been many success stories based on pull based supply chain such as Dell Computers, which manufactures post order; United Colours of Benetton, where in their earlier process, dyeing used to be done before assembling of garments, now assembling is done first and dyeing later; and TVS motors with 99 different colours uses modular design in partnership with dealers. In this process, the colour of the motorcycle is done at a distribution point with one out of the 99 colours rather than being manufactured in pre-determined colour.
Can the insurance industry have a similar model where the products are manufactured based on the demand of the customer at a point of sale, so that the needs of the customer are met helping them realize their dream?
Pull-based Supply Chain in Insurance
Pull based supply chain in insurance would mean that manufacturing/assembly of product is done at a point of sale because unlike manufacturing industry, in insurance, the products need to be approved by the regulator. So, the luxury of taking the order before manufacturing is not available in India. This may be possible in countries where regulatory approval is not required. However, it is possible to manufacture generic insurance products approved by the regulator and assemble at the point of delivery. To a small extent, this is happening with “Riders”. Riders are smaller products such accident benefits, critical illness, permanent disability, wavier of premium in the child products, etc., are already available and these smaller products are annexed with the main product at the demand of the customer at a point of sale. So, some element of pull based supply chain is already there. Can we extend this for the main products as well?
Generic Insurance Products
In the life insurance sector, there are only two generic products (ignoring the annuities that act as a payout for pension type products), they are:
- Term insurance and
- Pure Endowment
In a term insurance product, where benefits to the customers are paid only when customer dies and no payments are made if the customer survives for full term of the products. For example, for 20-year term insurance products with sum benefit of Rs 10 lakh, if the customer dies between the time of taking the policy and end of the 20 years, his nominees will get Rs.10 lakh as sum benefit, and if he survives at the end of the term of 20 years, he will not be paid any money.
Similarly, in the pure endowment product of 20 years with sum benefit of Rs 10 lakh, the customer will get the benefit of Rs 10 lakh if he survives at the end of the 20 year where the payment will be made, and if he dies in between the term of 20 years, he will not get any money.
So, all the products in the insurance market are a combination of these two products, if the Term and Pure endowment is combined, they become popularly known in the market as, “Endowment Assurance”. In this product, benefits are paid either the customer dies or survive. If in the Endowment assurance product a periodic pure endowment is added for term say, 5, 10, 15 and 20 years, the combination will become “Money Back” product with periodic payments of money made to the customers upon his survival at the end of 5th, 10th, 15th and 20th (along with the main benefit). Similarly, any combination of the two generic products can be manufactured.
A small comment is in the unit linked products, the payment benefits remain the same, however, the death and survival benefits are made based on the market value rather than fix sum at the time of inception. However, there are products in the market where the final benefits are made as greater than fund value or fixed benefits agreed at the time of inception. So, the generic product concepts work under both the platform of unit linked and traditional, discussed above.
Pull-based Supply Chain Revisited
To meet the demands of the customers in the life insurance field, it is possible to get the approval of generic products from the regulator with one base term product and several pure endowments of various terms and assemble them at a point of sale based on the needs of the customers. Products are generally sold based on the commission basis given to the distributor and those products are pushed where the commission is higher. The assembly of generic products at a point of sale will also address this problem where commission should be based on delivering one combination of product rather than built-in commission.
If this approach is compared with the “TVS motors with 99 different colours”, there is a similarity, the colouring of the bike at the customer’s choice used to be done at the distributor’s end, and here also the stitching of products is at the distributor’s end at the choice of the customers. Such approach can help in managing some of the issues related to addressing customer’s needs in the insurance business.
Challenges in this Approach
Insurance products are manufactured based on the assumptions made at the time of pricing; some of the assumptions made are beyond the control of insurance companies such as claim experience and interest rate. They are driven by demographic and economic factors. One of the key assumptions that goes into the pricing is the expense assumption that is company specific. One of the challenges that may come in pricing the generic products is allocation of unit expense between term and pure endowment, based on the volume as compared to currently done for single products. However, considering the benefits to the customers, the actuarial profession can find ways to address this challenge.
Summary
So, the distribution risk under the operational risk category where people are the driver can be addressed by changing the manufacturing process from current push-based supply chain strategy to pull based supply chain strategy.
