Product and Pricing Innovation in a competitive Market

1. Product and Pricing Innovation in a competitive Market The 3rd international Insurance Conference, Insurance Practitioners Association 25-26 May 2011 Reproduction in whole or part of this material isstrictly prohibited. They should not be reliedon as a substitute for specific advice.Therefore, no responsibility for loss occasionedto any person as a result of acting or refrainingfrom acting on the contents of or informationcontained in these notes can be accepted byTowers Watson.

2. Agenda • Pricing strategies • Product Innovation: the insurance telematic example • Conclusions

3. Tariff personalisation leads to higher profitability: an example for the US market. . . Competitive Landscape — Personal Auto A B C D E G Performance H F I Rating Sophistication Where is your company now? Where would you like to be in the future? Source: Towers Watson, A.M. Best.

4. . . .enabling companies to understand which costumers create and destroy value. . . ILLUSTRATIVE Roughly 15%of customers contribute 100% of value The worst 5% of customers destroy 40% of value 200% 180 40% of customers contribute 180% of value 160 140 Cumulative Value Expressed as Percent of Total Portfolio Value 120 100 80 60 40 20 0% 0% 20 40 60 80 100% Percentage of Customers (Ranked from Highest to Lowest Value) What if you could predict which policyholders will have losses, better than your competitors?

5. . . .a strategy that has paid off, Progressive advantage was gained using rating sophistication

6. Market prices (2) Elasticity of demand (3) Market share Competition Economic Cost (1) Profitability What does rating sophistication means? • Costing is the traditional approach in personal lines insurance • But costing is only the first step in the pricing process • Competitive positioning • Market dynamics • Constraints given by regulators and distribution channels • Customer Behaviour and lifetime events • Exploiting dynamics to enhance profitability and grow market share through making effective use of information in an integrated approach

7. COSTING Better costing will lead to better costumers Impact of Mis-PricingActual Pricing vs. Indicated Rates Company A (“sophisticated pricing”) Percent of Business Company B(“traditional pricing”) Overpriced: Profitable, but hard to attract/retain Underpriced: Easy to attract/retain, but unprofitable + + + + + -25% -20% -15% -10% -5% 0% 5% 10% 15% 20% 25% Percent Departure from Indicated Rate

8. MARKET PRICE . . .but costing is an inner focused exercise; you need to understand market dynamics and . . . ILLUSTRATIVE Rate Competitiveness by Age of Driver Relative to Market Vehicle Distribution

9. 0 Expected Profit Price 0 Profit maximizing price Demand d Competitor Prices Price PRICE OPTIMIZATION . . .integrate Costing, Market and Elasticity into a Price Optimization Approach…. Profit/Cost Models Profit per customer Price Optimization Models Price Claims plus other costs X Elasticity Models

10. An example of an innovative rating variable: Credit Scoring Correlation between Credit Score e Loss Ratio in three of the main US companies • 9 out of 10 US major companies use this variable to discriminate the risk Fonte: Conning Survey, Towers Watson

11. Agenda Pricing strategies Product Innovation: the insurance telematic example Conclusions

12. Steps to complete solution

13. Telematics can discriminate risk 5 times better, a competitive advantage largely yet to be gained Better technical profiling of clients Better address significant market segments Enabling Technologies Decreasing cost of technology

14. As well as a unique opportunity to change the commodity perception of Motor Insurance into service • Insurers’ offering substantially undifferentiated • No major change in the market, from customer perspective, over last years (except for new distribution models such as Direct Companies and Aggregators) • Customer’s choice totally based on: • Price • Relationship with the agent/broker

15. . . .considering that customers live mobility in an extremely diverse way (when, where, how). . . • Frequency of use • Reasons for use • Mileage • Driving behaviour (day of week, time of day, speeding, hard braking and cornering,…) • Type of road • . . .

16. . . .that technology is able to capture. . . • By “measuring” when-where-how-how much clients drive, technology can enable insurers to gain competitive advantage through: • More effective risk selection and pricing capabilities • Definition of a tailored offer by customer segments • Delivery of value-added services to clients • PAYD product will also have an effect on distribution, elasticity of demand • The key to success will be managing and analysing information, process and keeping up with the rapid change into technology

17. It is a win / win situation giving benefits to all players • Insurers • Enhance pricing accuracy • Attract favourable risks • Fight fraudulent claims • Costumers • Reduce premiums • Demonstrate safe • Value-added services • And society • Reduce accident response time • Establish fault to improve equity in settling claims • Reduce driving, pollution, traffic congestion and energy consumption

18. Usage-Based Auto Insurance (UBI) CanadaAVIVA Europe Royal & Sun Coverbox Insure the Box AXA Polis Direct MAPFRE AVIVA WGV Uniqua Allianz Lloyd Adriatic Aryeh Reale Mutua Sara Unipol Generali Aryeh USA Allstate Am. Family CSAA Esurance GMAC Liberty Mutual MileMeter Nationwide Plymouth Rock Progressive The Hartford Travelers State Farm SoCal AAA Unigard JapanAIOI South AfricaHollardMiWay Nedbank AustraliaReal Insurance

19. Evolution of Insurance Telematics market (1/5) Evolution path Market share of players adopting the solution In Italy Insurance Telematics evolution Pricing based on “driving behavior and style” Value-added services for clients “Pure discount” product “Pay as you drive” ~70% ~25% 0% ~20%

20. Telematics may partially, or fully, replace some other rating variables • Telematics directly measures driving behavior • Historically, insurers have used less direct factors to measure driving behavior, e.g.: • Age • Gender • Marital status • Credit • Statistically, the strongest rating plans include telematics data and traditional rating factors

21. Profitability structure for a Pay As You Drive product ILLUSTRATIVE Profit Loss (antiselection) “Pure” technical tariff Top Tariff “applied” Tariff “applied” Floor “Pure” technical tariff X % of portfolio (1-X) % of portfolio Mileage

22. Example of “Pay As You Drive” premium components ILLUSTRATIVE year 1 year 2 UW Term Renewal Term α * Km actual α * Km actual Including box rental fee Discount gathered according to driving patterns (β) Discount gathered according to driving patterns (β) Floor Initial payment according to declared mileage Complement based on actual mileage Total premium year 1 Floor Renewal discount gathered in year 1 Initial payment according to declared mileage (or effective in year 1) Complement based on actual mileage Total premium year 2

23. Exposure (based on mileage) Pure premium Multivariate analysis: urban mileage percentage EXAMPLE -50% / - 60% Low Medium High Urban mileage percentage

24. Exposure (based on mileage) Pure premium Multivariate analysis: average trip mileage EXAMPLE +15 / + 20% <=3 >3 <=4 >4 <=5 >5 <=6 >6 <=7 >7 <=8 >8 <=9 >9 <=10 >10 <=11.5 >11.5 <=13 >13 <=14.5 >14.5 <=17 >17 <=20 >20 Average trip mileage

25. Conclusions • Personalisation and differentiation are key success factors for profitability in the insurance market • Telelematics represent an effective and efficient (as technology costs are decreasing ) way to personalise and differentiate • No major insurer can afford to stay out of Insurance Telematics in the short-mid term • Implementation and managing the change are key to success • FIRST MOVERS ADVANTAGE WILL BE SUBSTANTIAL

26. Alessandro has considerable expertise in the following areas: • Personal lines, reinsurance, London market and Lloyd’s syndicates reserving. • Customer segmentation. • Competitive pricing strategy. • Reinsurance pricing. • Mergers and acquisitions. • DFA analysis • Market entry studies. Role at Towers Watson Alessandro is Sales and Practice Leader PC for Italy. Education and Credentials Mr Santoni holds a degree in statistics and actuarial science from “La Sapienza” University in Rome. Alessandro is co-author of a study on asbestos risk in Europe presented at Astin in 2000 and co-author of a study on personal line pricing presented at Astin in 2007, for this article he won the James Anderson Award. He has also published other articles in specialized journals in particular on Motor TPL , Pricing and reinsurance markets. Mr Santoni is a fellow of the Italian Order of Actuaries and a fellow of the English Institute of Actuaries. Alessandro SantoniSales and Practice Leader PC Italyalessandro.santoni@towerswatson.com Background Alessandro Santoni has spent over 15 years with Towers Watson, in 1997 he moved to London to work with the international team of Towers Watson, in July of 2000 he returned to Italy to continue his work in Rome and became principal in 2007. His main areas of expertise include the review of claims reserves for insurance and reinsurance companies and setting of rates for personal lines. He has worked with several companies in Italy, Europe and the Middle East Alessandro is signing actuary for Lloyds Syndicates and Appointed Actuary for Italian companies. He is also EMEA initiative leader for Reserving. Relevant Experience/Specialisation