Riddled in mystery: the development of insurance products is sometimes shrouded in mystery. Other products and services develop incrementally, without a whiff of a "Skunkworks" mentality. Perhaps most surprising, though, is the role regulators play in spurring firms to develop new products. Some of the most successful products took off in the wake of federal and state laws

Risk & Insurance, Sept 1, 2004 by Thomas J. Slattery

To many, Winston Churchill's words, "It is a riddle, wrapped in a mystery, inside an enigma," might as easily apply to the subject of product development and innovation in the insurance business, a process equally shrouded in mystery.

Where do insurance products come from? Do they bubble up from below? Do they come from customers? Are they generated by experience in the field? Or do they trickle down from management? Do they spill from the hand of God? Do they arrive through the side door, forced into the marketplace by regulation and legislation? Do they result front the rigorous R&D, testing and monitoring we see among the purveyors of other consumer products? Or is this a largely ear-to-the-ground, nose-to-the-wind, fly-by-the-seat-of-your-pants process, with product development plans all but written on the backs of envelopes?

Conversations with four insurance company executives indicate that the answer to all of the above (except for references to the "hand of God") seems to be "yes." We got a lot of expected answers, but some surprising and a couple of conflicting ones as well.

Even more puzzling is the question of innovation. In the history of ideas, the ideal of covering a loss is clearly in the front rank. Insurance introduced the notion of security into human commercial and personal affairs. It was a truly innovative and transforming development in that life afterward was different, having taken a turn for the better. But what's happened since?

The executives we spoke with, ironically, gave the industry low marks for innovation. But they shared some interesting perspectives on the subject.

WHAT'S THE DIFFERENCE?

Joe Gilles, president mad chief operating officer of Wausau Insurance Co., admits there's a difference between how the insurance business goes about developing its products compared with others.

"We do product development as they do, but the biggest difference is that our products are legal contracts, which have to be [viewed] in the context of how will they be interpreted in the court system," says Gilles. Consumer goods companies, those developing cereal or soap for example, "have fewer hurdles to overcome."

But Tom Brown, vice president for product management at Hartford Financial Services, isn't of the same opinion. "There may not be a lot of differences," he says, even if insurance is more regulated and restricted. "The basic model is pretty similar," Brown says.

Where does tile cycle begin for an insurance company?

It begins with feedback "at the street level," primarily front intermediaries, but from customers as well. The questions, "What are our competitors doing? What are our customers thinking? What arc tile brokers running into that they never used to run into?" often serve as the starting gate out of which new products come.

Next comes an underwriting/claims/actuarial analysis, and yet more questions--"Is it a real exposure or a fad? Is it a forecastable risk? Is it a controllable risk? Is it a risk that requires insurance, or one where the largest loss would be large enough that companies should consider it a business risk, not an insurable risk?"

THE VIEW FROM ACE

Brad Crow, vice president of Ace Professional Risk (Digital Techology), says sometimes something "gets caught in the craw of senior management and they begin to ask questions." He knows "some carriers have formal product development teams that get together and kick things around." His own approach, however, is "to stay close to customers, see what's on their minds, and get direct feedback from folks who might buy the coverage."

Gow holds client meetings with Fortune 500 technology firms. "I sit down with the risk manager and ask, "What keeps you up at night? What do you feel your exposures are? With open-ended questions like these, some interesting things pop out."

The next question is whether you've got the expertise internally to think through the problem. "As we were putting cyberrisk programs together, we found we really didn't. We had IT staff that had part of the picture. We had liability experts as part of the picture. But we didn't really have the tech background we needed. So I brought in IBM. We needed to make sure that our proposed scope of coverage, which was then a work in progress, identified all the perils we'd be exposed to. Then we consulted with our tech experts and decided which were insurable and which were not."

In some cases, Gow sat experts around a table and worked through questions generated by the company's product developers and actuaries--identifying frequency and severity by peril and by industry, and from there building a framework from which to structure a basic rating model.

Peter Eastwood, senior vice president of AIG E&S carrier, Lexington Insurance Co., says his goal is "to put ourselves in a position where we know what our clients and our distribution partners want."

"We spend a lot of time with the brokerage community and a lot of time with our clients," he says. "We ask very directly about their concerns, the issues they face and where they think the insurance market is not being responsive." He spends time too with think tanks and futurists sniffing out emerging regulatory, legislative and demographic trends that will affect his clients down the line.