I was introduced to Alan by a McKinsey partner in 2007, my first year in the insurance business. Alan had just retired as Group President of Progressive Direct, where he grew the earned premium from under $1.3 billion in 2000 to over $4.3 billion in 2006. I was in awe and even more amazed when the first question he asked me was about baseball.
The following is a discussion about Alan’s insurance journey over the last 40 years – an inspiring reflection by an insurance visionary.
I only asked Alan three questions:
- What did you do at Progressive?
- What are your thoughts on auto insurance and the insurance industry?
- How do you see property and casualty insurance evolving over the next decade?
We split the interview into three parts – Alan’s insightful response to each of these three questions.
——————Part II: Alan Bauer – Auto Insurance ————————–
Here is the second part of this three-part interview, discussing Alan’s thoughts on auto insurance and the insurance industry.
David Schapiro: Alan, thank you very much for the reflection on your career at Progressive. Could you please share with us your thoughts on auto/private passenger automobile insurance, different types of insurers and what’s happening now in the market?
Alan Bauer: I’d be happy to. Let me start with some of my thoughts at least on private passenger auto insurance. Having worked at Progressive and then as an independent consultant and as a consultant for McKinsey & Company, I got to see lots of different companies and lots of different ways of thinking about insurance.
One thing I found was that companies often didn’t have a consistent or straightforward objective. I went to many companies where last year they were thinking about growth and this year about making a profit, but then looking to next year, they may want to open a new state and grow, but also be profitable, but without much in the way of plans to do any of these. I would see companies that had beautiful real estate for their operations in very expensive places like downtown Manhattan or San Francisco. I’m thinking, what’s your objective here? Is your objective to have a short commute or to have a low expense ratio for competitiveness? I would try to ask that question in a friendly way but wasn’t always successful.
Progressive had, and I believe it still has, one very simple to comprehend, but not necessarily simple to achieve, objective, which is to grow as fast as possible at a combined ratio of 96 or less. The combined ratio is the sum of the costs of paying claims, costs of settling claims and costs of running the company, divided by the amount of premiums sold. A 96 combined ratio means that you made 4 cents on every dollar you sold besides whatever you would make with investment income.
Progressive has always had the 96 combined ratio goal, which was understood by everyone in the company. Whether you worked in the cafeteria or in the pricing area, you knew that you wanted a 96. You might not always know exactly what a 96 meant, but you knew that your bonus probably depended on it. You always knew that all the changes the company made were made to achieve that combined ratio.
Interestingly, Progressive grew from quite a small company to the third largest auto insurer with a profit objective, not a growth objective. The idea was to grow as fast as you can but make sure you make that profit objective of a 96 combined ratio. That meant you would be very focused on making sure you were competitive while being profitable. The way to do this is to have a low expense structure with pricing that is as accurate as possible.
When you think about US auto insurance, it’s quite unique as a market and as a product. First, it’s a huge business, more than $200 billion per year, but it’s mandatory. If we have a car, we have to buy an auto insurance product. We only buy one, though; you never buy more than one insurance product for your car. It’s expensive, with little or no perceived value. The general public thinks of buying auto insurance only in order to check a box for the state and maybe the bank. You don’t really think about it in terms of a potential claim, because you don’t think you’ll ever have one.
There’s nothing cool about car insurance. Most people have very little understanding of what they’re buying. The agent or the online system will make suggestions, but you really don’t know how to respond. You want a low price, and you want a legitimate company. And you want speed in all your contacts. This is one place that you certainly don’t want to waste your time, and it is an area where I see many companies failing.
Let’s briefly review all the costs of an insurance company. One is the overhead cost: your location, your building, and how much you’re paying all the employees. Next is your loss adjustment expense. In other words, when a claim happens, somebody at your company has to evaluate the claim – whether to pay it or deny it – and that costs money. How do you do that? Do you outsource that? Do you do that yourself? That’s always an interesting trade-off. Outsourcing is probably cheaper on the expense side, but you may pay more for the claim.
Then there is customer acquisition. For this you need brand and awareness, which can happen lots of different ways – TV ads, email feeds or due to a comparative rater suggestion.
The two most successful US auto insurance companies in the last 10 years – in terms of profit, growth and size – are GEICO and Progressive. State Farm, although it remains the largest, has not seen similar growth. In both cases, their branding strategy has been, “We’re big enough that we don’t really need to convince you that we’re legit, so let’s be different than the big old insurance companies. Let’s be the company that you giggle at and like because we’re so different than anybody else.”
More and more you’re seeing other big carriers moving in that direction and having silliness in their commercials. For a category as big as insurance, to have silliness be such an important factor is amazing, until you think about the fact that insurance is not cool. It’s expensive, it’s mandatory, but it’s not cool.
Then once you have acquired a customer, now you must service the customer. She might want a change in her billing schedule or maybe she is buying a new car. There you get into the speed side of things. You need to be able to quickly address those customer service requests. Speed is good not only for the customer’s sake, but for the insurance company as well. Anything sitting around costs you money.
Then you have the balance sheet management. In other words, what are you going to do with your surplus? How are you going to invest it? Are you going to be risky with it? You can only be so risky given the regulatory limitations.
Are you going to invest in companies that have similar goals or goals that are in the same set of activities? Maybe you want to invest in a comparative rater. Maybe you want to invest in a company that settles claims or offers some other business benefit.
Progressive recently acquired a homeowner’s carrier, which greatly helps them keep and attract consumers who own property, but at the same time, they have taken on the greater risk that if a hurricane blows through central Florida, it can materially affect their results.
You have to figure out what reinsurance you want. The bigger you are, assuming you’re not taking anything other than private passenger auto risk, the less you need reinsurance.
Then of course, the main thing that people buy insurance for is to pay for their losses. When you price the losses, or when you price the whole product, you must figure out the frequency and severity of the losses. You must figure out how long the customer is going to stay with you. How long is the set of issues that the customer will present? Sooner or later, they’ll buy a house. What will they do then?
Let’s take a deeper dive into customer acquisition. The three main ways to buy insurance are to find an agent, go directly to the carrier or use an online comparative rating site that may provide you with multiple rates from which you can choose. You may not understand the difference between using an agent and going direct (e.g. GEICO has agents, and you can call Allstate directly), but comparative raters make a different offer.
Comparative raters have not done as well in the US as they have in England. A few years ago, Google asked me to help them develop a comparative rater for the US. At the time, I thought that Google’s so powerful and ubiquitous, they’re going to do great with a comparative rater. Six months later, they pulled the plug on the project. Admiral, the big UK company, has a very successful comparative rater in the UK. They came to the US and started their own comparative rater. It started off with a big bang, but now you don’t hear a lot about them.
Comparative raters face several tough challenges. First, every state is different, so the rates and rules offered by the insurer differ as well. Second, the consumer that the comparative rater supplies to the carrier often has been rejected someplace else, has seen a big rate increase or is new to the market. In aggregate, the risks presented to the carrier by the comparative rater are often not as good as the ones that the carrier could generate themselves.
In acquisition, there’s another set of players that the consumer knows very little about: third-party data providers, not only credit scoring but things like CLUE [Comprehensive Loss Underwriting Exchange, owned by LexisNexis] and other data sources that the carrier uses. CLUE gathers claims data from carriers and provides it to carriers to know the claims history of a potential customer.
Let me tell you a story about my personal consumer experience with CLUE. I was insured by Progressive, long after I left the company. I got a letter from Progressive saying they were investigating the accident I had on a specific date. But on that date, I was in Japan. I made that clear to them, they apologized, admitted that they had made a mistake and said they’d stop the process. I asked Progressive to also contact CLUE and update them so that my CLUE report would be clear. I tried to contact CLUE to make sure that Progressive had eliminated the event from my record, but I gave up after being on hold for 45 minutes. I guess, or rather hoped, that it had been taken care of.
Then my State Farm agent, who provides my homeowner’s and my umbrella coverage, notified me that according to CLUE, there was a bodily injury claim against me. In fact, Progressive had not fixed things with CLUE. I went back to Progressive, got them to fix it using the documentation that State Farm showed me and finally got that off my record. And only then did State Farm renew my umbrella policy.
That kind of thing is exactly why people distrust, don’t understand and dislike insurance companies. I knew enough to ask about CLUE, and I didn’t get anywhere for months. If you haven’t worked for the insurance business for 20 years, you probably don’t know about CLUE and you would never know to try and fix that.
So why do certain companies do well, and others don’t? I think part of that has to do with expense management, and a lot has to do with pricing.
Let’s say six months ago, I wanted to set a price that reflects the cost to the carrier for the next six months. Then let’s assume that in the next six months, I haven’t had a claim. If it were perfect, the price for me would be how much it costs to renew me, how much it costs for the overhead and how much it costs to service me. That’s about it. That might be between $40 and $80. Whereas another guy had a claim for $100,000, and so his premium should have been $100,080. But of course, it doesn’t work that way. No one has perfect pricing.
But the closer you move towards good pricing, the better off you are as an insurer. One of the things Progressive did – which I think was brilliant and I wish I could claim credit for – is offer competitors’ rates on its website and through its call center. People thought that was primarily an interesting way to get traffic to the website or to the phone system. But it was also something else entirely. Progressive, who arguably had a superior pricing algorithm than most other carriers, knew that if you should be charged $1,200 and another carrier is offering you $800, of course you would choose the $800 carrier. Progressive, meanwhile, knows that other carrier just took a $400 loss!
Sending bad risks to other carriers was and is one of the great things about offering comparative rates on your own site, as long as your pricing is superior and your expenses are competitive. Good pricing means using the tools that you can in a fair way and having movement towards the more perfect price with low expenses. Progressive and GEICO, both with low expenses, good pricing and great advertising campaigns, are really the two winners.
If you look at the top three insurance companies from 10 years ago, State Farm would still be number one, but the others have changed as Progressive and GEICO have moved up.
Another area of competition is in consumer retention. There, Progressive isn’t as strong as State Farm or Allstate. It gets an awful lot of new business because it’s got good pricing and good buzz, good advertising, but one reason it lags in retention is that it hasn’t yet developed (as far as I know) a homeowner’s product in all 50 states. Besides that, it still has other opportunities in the area of retaining customers.
Alan Bauer – Bio
Alan Bauer has played a substantial role in changing how automobile insurance is sold and underwritten. His work led to the industry’s first website, its first use of credit scoring in rating automobile insurance and its first internet-only sale. His Progressive tenure included many positions, both line and staff, and assignments in both the agency and direct sides of the company.
While President of Progressive Direct, the company’s direct business earned premium grew from under $1.3 billion in 2000 to over $4.3 billion in 2006, while consistently beating target margins. By the time Bauer left Progressive, the company had become the nation’s third largest auto insurer.
He was awarded some of the first patents for both internet insurance and usage-based insurance. In 2011, he was named as one of the Top Ten Innovators of the Decade by Insurance & Technology magazine.
Since leaving Progressive, Bauer has served on the Board of Trustees at Carleton College (2006–2014; 2017–present) and on the Wikimedia (parent of Wikipedia) audit committee (2007–2008). He has also been active as an investor and consultant, including as the External Senior Adviser on auto insurance to McKinsey & Company.