Lessons from the Revolution in the Direct Distribution of General Insurance in Europe.

by Elizabeth Stevens. Director, International Financial Consultants Ltd 1997

"Lessons from the Revolution in the Direct Distribution of General Insurance in Europe" sounds a very dramatic title for a speech about insurance. What I am really talking about is the impact of one insurance company, Direct Line and its ramifications throughout Europe.


Although some insurance companies have been selling insurance without intermediaries over-the-counter, by mail or telephone for many years, this direct revolution in the sale of insurance was started in the United Kingdom in 1985 by the Royal Bank of Scotland subsidiary, Direct Line. By 1995, ten years later, founder Peter Wood's brainchild became the UK's largest motor insurer with a market share of over 10 per cent. Direct Line and its emulators selling over the telephone now hold a 30 per cent share of the UK motor market which is set to increase to 60 per cent or more by the end of the decade. Insurers from Canada, to Hong Kong, to South Africa and here in Australia have sought to copy the successful techniques of Direct Line which combine lower premiums for the customer with better standards of service at lower cost. Gone is the image of the insurer producing incomprehensibly wordy policy documents, inflated premiums and an obstinate attitude towards the payment of claims. Personal lines are now consumer products, advertised with lively television advertisements with the emphasis on convenience and good value. Now revolution has turned to evolution as more players enter this highly competitive market which is becoming more sophisticated and mature. Elsewhere in Europe, the direct revolution has generally not been as dramatic as in the UK. The exception is in the Netherlands which in common with the UK, was a predominantly broker market. Direct distribution is as important in the distribution of non-life products as it is in the UK. In France, the Mutuels sans Intermediares stole the march on direct writers by reducing commissions to levels at which direct writers could not enter the market with a significant price advantage. French insurers have taken more interest in developing direct activities in foreign markets than in their own. In Germany, deregulation following the introduction of European Union single market legislation has eliminated the fixing of premium levels. This has led to an influx of insurers entering the direct market both from inside and outside Germany. One of the latest new entrants is Allstate of the United States. Spain has proved to be a promising market for direct. Royal Insurance started a small operation in Barcelona in 1989 and in 1995, Direct Line started its first international operation there. It followed the same strategy as in the UK using high budget TV advertising to sell the concept of direct. It won over 60,00 policyholders in its first sixteen months of operation. In Italy, where the market has also been recently deregulated, direct writers have been unsuccessful in breaking the stranglehold of the local agents. My observation is that this development in Europe shows that an deregulated market and a broker-dominated one are important prerequisites for the development of direct insurance. My agenda for this morning is to discuss three subjects relating to this direct revolution:

Identifying key factors for success;

Implications for the intermediary market;

Lessons and issues for Australia.

Let us start by looking at the key factors of this success : Key Success Factors

In my view, the key success factors of direct writing are:

* Low costs

* High retention

* High volume

* Selective underwriting

* Effective use of technology

Low costs

The direct writers have flat management structures with none of the historical bureaucracy of the traditional insurers. This enables some of them to operate with expense ratios below the market average. For motor, Direct Line's expense ratio in 1995 was 11.8 per cent, less than half of the industry average of 28.7 per cent. Another smaller direct writer, Preferred Direct also showed an impressively low expense ratio of 9.7 per cent per cent. However, not all direct writers have low expense ratios, Churchill Insurance, the Winterthur subsidiary, showed that direct is not always better with an expense ratio of 28.2 per cent only slightly below the industry average. I should explain that we have limited statistical evidence to compare the direct writers because only these three report their results to the Department of Trade and Industry, the others are mainly alternatively distribution channels for composites such as the recently merged Royal & Sun Alliance. Direct writers have cut costs by eliminating the cost of commissions. But this is partly offset by huge advertising budgets. In 1996, Direct Line spent 13 million on advertising of which 90 per cent was spent on television, 10 per cent on press advertising and nothing on radio spots. This high budget spend has enabled Direct Line to achieve prompted recognition for its bleeping red telephone of 95 per cent. Even if consumers find it annoying, this is the first clear example of an insurance brand in consumer marketing terms. Market research shows that spontaneous awareness of Direct Line is more than double its nearest competitor. Despite Direct Line's multi-million pound advertising budget, its acquisition costs per policy are far lower than the commission levels paid in the traditional market. About 30 per cent of a direct writer's costs are his staff. Telephone operators account for 80 per cent of total staff. Therefore, direct writers universally use advanced telephone technology to ensure that operators are used efficiently. Control of the timing of advertising is also used to shift demand to minimise peaks in incoming calls. The accuracy with which direct writers are able to match staff levels to demand is clear in the correlation between policyholders and staff numbers.

High retention

Motor insurance customers shop around telephoning perhaps three companies which may now be either direct writers or telebrokers. Direct insurers have a relationship with their customers that insurers using intermediaries do not. They have efficient systems and the ability to respond quickly to the customer. The UK's direct writers were quoting retention rates in excess of 85 per cent before the intensified competition in 1995-6 brought retention rates down about 10-15 points. Direct Line's retention rate has dropped from its high point of 83 per cent in 1993 to 72 per cent in 1994, recovering slightly to 74 per cent in 1995. Significantly, it was impossible to calculate the retention figure from the 1996 accounts. In the broker market, retention rates are lower at 50-60 per cent. This difference in retention rates creates a huge differential in the acquisition costs of new business. If a broker and a direct writer both sell a policy valued at 250, the direct writer may spend 10 per cent of that on advertising and telesales staff costs. The broker's sales will cost a 12.5 per cent commission. For the direct writer, the customer is assumed to be won for five years so the 10 per cent cost of 25 is paid just once. For the broker, it is paid every year, making the five year total cost of retaining the customer 156 or six times that of the direct writer. The broker's level of retention is assumed to be 50 per cent and the direct writer's 75 per cent. Starting with a 1000 policies in each case, the broker achieved 1938 policy years while the direct writer achieved 3051 in five years. By multiplying the acquisition cost in each year by the number of policy years produces cash flow for the direct writer of over 760,000 or more than one and a half times that of the broker. If the retention rate were to increase to 85 per cent again, this multiplier becomes nearly double. New entrants into the financial services arena have sought to capitalise on their consumer franchises in retailing and other consumer services to transfer brand loyalty to their new banking and insurance products. Richard Branson's Virgin introduced first investment products and then life insurance in May 1996. The company is now planning to move into banking. Despite the lack of obvious of corporate logic of transferring the brand from airlines, to vodka and condoms and lastly to financial services, the brand is closely associated with the image of Branson himself, simple products, value for money with a young target audience. When asked why he was moving into such a dreary, discredited business, Branson replied, "Yup, that's why". Of Britain's major retailers, Marks & Spencer led the way, first with its store card then with life products and pensions. Now supermarket Sainsbury's is moving into banking. A recent survey by MORI showed that 32 per cent of people would be willing to take out a current account with a large supermarket, 21 per cent another financial product. For Marks & Spencer these percentages were 25 per cent and 20 per cent, for Virgin 20 per cent and 19 per cent. For financial service providers, the real threat of cross-selling competition is coming from outside the industry. Commenting on the evolving character of the UK's direct insurance industry, Guardian Direct Chief Executive, Ray Pierce, commented, "It used to be all about placing ads and answering calls. Now it is about cross selling and managing claims." With the exception of Prospero Direct, all of the UK's direct writers entered the market with motor insurance. They then moved into more complex products, typically household and have now moved into proving a range of financial services including life, pensions and banking. The latest direct products are pet insurance, travel cover and small commercial lines. The move into products such as life and pensions meant that direct writers had to meet the requirements of the UK's stringent Financial Services Act. Insurers could either sell products over the telephone on an execution basis or give "best advice". Giving advice meant a lengthy telephone call and insurers have had mixed success. Direct Line withdrew from offering advice in the summer of 1996, but Virgin, Abbey National and Scottish Widows do offer advice over the telephone. Direct writers continue to compete on price at cut-throat premium levels. They now are attempting to distinguish themselves on service. At first this was difficult define and resulted in insurers measuring how long it took to answer the telephone rather than any more significant variable. Now, the focus is on claims processing. Both Direct Line and Churchill have set up their own accident repair centres offering guaranteed repairs to policyholders and considerably lower costs to the insurers. Direct Line has introduced service standards for its network of 140 independent repairers which include:

Provision of 24 hour recovery service for damaged vehicles;

Collection and delivery service to and from the customer's home;

Requirement to contact the customer within 30 minutes of being notified;

Requirement to recover the stranded vehicle within an hour.

All direct writers allow customers to make their claims by telephone and have made dramatic improvements in the length of time it takes to settle claims.

High volume

The high fixed costs of technology and the initial advertising campaign mean that a substantial customer base is essential. A sample of direct writers indicates that between 60 and 70 per cent of a direct writer's costs are fixed. Spreading these costs over a large number of policyholders is vital, Direct Line achieved profitability at 200,000 policyholders out of a total UK motor market of 18 million drivers. There are examples of profitable direct writers at this size and some that are unprofitable with a much larger customer base. Volume is not the only success factor but a new entrant must select a market niche, geographic spread and advertising strategy which enable it to build a critical mass of customers quickly. In the UK market where nearly every major insurer has a direct distribution channel, there are now more than 20 direct writers jockeying for market share. Some insurers are pricing premiums at loss making levels to grab a larger share. In a period of intense price competition, some companies will withdraw from their direct channel and others will either fail or merge. Churchill is expanding its book by underwriting the relaunch of the Halifax's motor insurance. We can expect to see this as a trend as direct writers are forced to acquire market share by means other than advertising to the consumer. For example, Touchline acquires customers with a product branded for Lloyd's Bank clients. Smaller motor insurers have withdrawn from the market. Many Lloyd's syndicates writing motor have merged. The former building society, Abbey National has abandoned its plan to enter this highly competitive market. There is no longer enough room in the market for new competitors to gain sufficient critical mass to achieve profitability. Industry leaders have mixed views of the importance of high volume. In the view of Charles Crawford, Technical Services Director of Churchill, the race for volume has now ended and profit is now the objective in the direct industry. Chris McKee, Executive Director of Direct Line, argues that size is vital to establish a brand image which Direct Line has done so successfully with over 90 per cent recognition of its bleeping red telephone. Branding to build a name reduces acquisition costs and these cost are spread over a larger number of policyholders. Peter Hallett, Managing Director of Preferred Direct thinks that it is difficult to be viable at below 250-300,000 policies in force but it depends on the relationship between your planned and achieved targets in terms of investment. In other words, if the company invests in computer and telephone equipment to become a 500,000 policyholder company and only achieves 300,000, it will be unprofitable. But if it invests to be a 300,000 policyholder company and achieves that target, it will be profitable. Henry Engelhardt, Managing Director of Admiral, argues that the relationship between expenses and loss ratio is more important than size. "You can be small and profitable", he says.

Selective underwriting

The direct writers have developed sophisticated underwriting systems which quote a price for the individual customer's risk profile right down to his post code which narrows it down to about 14 houses in the UK. This tailors the premium to the risk for the customer's neighbourhood. Some are adopting the credit scoring systems of banks to take advantage of the relationship between credit worthiness and claims risk. Direct writers can access external databases of information on car details, county court settlements and credit worthiness in seconds during the course of the quotation call. The price can be tailored to the individual risk based on his driving record, profession, marital status and a myriad of other factors. Churchill can offer one third off its premiums to married drivers knowing that their claims record is so much better that their profits will not be reduced. New technologies such as neural computing and geodemographics enable underwriters to pinpoint risks with great accuracy. Neural computing can use the insurer's internal data to predict which customers are most likely to renew. This enables the insurer to target the type of customer who is most likely to be loyal and also least likely to claim. Geodemographics can be used both for underwriting to map risks related to geography and to pinpoint targets for direct mailing, saving money by increasing effectiveness.

Effective technology

The use of advanced technology enables direct writers to change their rates over night, when at one time, traditional insurers dependent on software houses could take six weeks to change their rates. Vast relational databases enable them to identify profitable niches in the market which are invisible to other insurers. They have started with new systems and are not burdened by expensive commitments to outdated technology. Policy documents are printed and sent over night giving the consumer fast delivery of the only tangible evidence of his purchase. Direct writers use technology to manage the flow of vast numbers of telephone calls. Neural computing has been used by one insurer to predict the levels of calls for days in the future. But now we see that direct writing is no longer all about managing the flow of telephone calls. The Internet is just beginning to be a medium for the sale of insurance rather than just an on-line brochure service. In California the insurance mall InsWeb allows the surfer to get three competitive quotes for cover from one on-line application. The use of software agents should enable the surfer of the near future to key in his insurance requirements and have this electronic intermediary find the cover he needs.

Implications for Intermediary Market

Five or ten years ago, everyone dismissed the direct phenomenon thinking that it would go away. Now, brokers have reacted by adopting the same selling techniques. With full cycle Electronic Data Interchange (EDI), the broker can now emulate the systems of the direct writer. The differences are imperceptible to the consumer on the telephone. The quote can be just as quick and efficient as the direct writer. Market research shows that over 40 per cent of consumers now buy motor insurance directly over the telephone from the insurer. Of the 30 per cent that buy through a broker, roughly half contact him over the telephone. This is a revolutionary change. Its highly significant that AA Insurance Services, Europe's largest personal lines intermediary has been setting up its own direct insurance company. The direct writers initially targeted the low risk, middle class, 30-45 year old market. But this niche is also the AA membership. Former Managing Director Mark Wood, said that going direct will mean that the costs of acquisition will be virtually nil selling to its own members. The telephone calls will be very quick, at about 3.5 minutes, because the operators will have access to their own customer database to pick up details of the member's address and car details. Because its association with the breakdown service, it expects to offer service seven days a week with extended hours. This will give the AA an availability advantage over its competitors. Direct writers are generally reporting that consumers are now phoning over a much wider range of hours that when they first started-later in the evenings and on Saturdays. Very few man their telephones on Sundays. As the broker has responded to the direct competition, he has adopted electronic data interchange (EDI), the telephone selling techniques and claims handling efficiency of the direct writers so that the difference in distribution channels is not perceptible to the consumer. The direct distribution channel is part of the insurer's strategic armoury whether it is in a stand-alone subsidiary or as an alternative to intermediary distribution. It can be used to weaken the power of an agent force, drive competing brokers to close high street branches, to increase market share and to enter new markets.

Lessons and Issues for Australia

When I was writing my management report for Lafferty, Direct Dial to Success, I compared the potential for success in 28 countries including Australia in terms of five parameters which are important precursors of telephone sales of insurance. These are:

* Market size

* Insurance sophistication

* Direct marketing tools

* Telephone propensity

* Market access


I then ranked each of these parameters from 1 for the lowest score and the least suitability for direct insurance to 5 for the highest score and the most suitable for direct insurance. The result is a graph showing the scores for all five vectors. The examples from the UK and Australia show clearly the contrast between the highly developed UK market and the yet to be realised potential of the Australian one. Let us examine each of these factors in turn:

Market size

For the direct writer the size of the potential market is key. It must be large enough to achieve the volumes required to repay his investment in advertising and information technology. The tiny markets of Scandinavia, New Zealand, and Singapore are less likely to be the targets of the global direct players. However, Ireland with a population of only 3.6 million has become an important competitive market for UK direct writers as they test their ability to go overseas in a market where language is not an issue.

Insurance sophistication

Markets where people spend a very small part of the family budget on insurance are less likely to buy insurance from an unseen supplier. In fact, they are less likely to buy insurance at all. Insurance sophistication is ranked by examining the state of development of the economy in terms of GDP per capita, the level of insurance spending (both life and non-life) per capita, and the importance of insurance in the economy in terms of the ratio between total premiums and GDP.

Direct marketing tools

Successful direct selling of insurance is dependent on the availability of the essential tools, these include:

* Availability of mailing lists

* Postage costs and efficiency of mail

* Telemarketing services and skills

* Direct mail production facilities

* Availability of external data


The scoring system is based on the assessment of a direct marketing expert. Also included in this vector is the importance of telephone banking in the market. In most cases, in my view, telephone banking will precede telephone sales of insurance. Telephone propensity Consumers will not buy insurance over the telephone if they do not have easy access to telephones. This vector ranks countries in terms of the cost of a local three minute telephone call, the number of telephones per household and the number of trunk calls per capita. This and the number of mobile telephones per capita are measures of how much people use the telephone as well as the availability of devices.

Market access

The market access is ranked on three elements-regulation of premiums, market concentration, and the characteristics of existing distribution channels. One of the competitive advantages of the direct writers is their ability to set prices to for very small segments of the market and to change those rates quickly in response to market forces. In the UK, the direct writers can change their rates over night while in the past, it has taken longer for the broker competition to alter rates. In markets where rates are approved by the regulatory authority, such as Australia, this is likely to makes the pricing structure of direct writers less flexible and less responsive to market forces. Countries were also evaluated on the market share of the top five general insurers on the grounds that if there is a high level of concentration in the market then it will be difficult for a new direct player to enter. From the experience of the UK and Netherlands where the telephone sales have a significant share of distribution, direct is more likely to take off in broker-dominated markets. Perhaps this is because the concept of shopping around for the best cover has already been introduced. Direct sales just transfers this role to the consumer.


Direct distribution of insurance may develop more slowly here because of the structural factors which will inhibit strong price competition. However, this will not stop the Australian consumer from demanding the convenience of buying over the telephone and before long over the Internet.


Contact details : 7 Driftway, Mead End Road, Sway, LYMINGTON, Hampshire SO41 6EH United Kingdom Telephone +44 (0)1590 682843 Facsimile +44(0)1590 683415; Mobile +44 (0)385 536063 Email estevens@intfincn.demon.co.uk

Copyright by Elizabeth Stevens 1997. All Rights Reserved.


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