The European property and casualty business has never looked so attractive. In the past few years, companies have stopped relying on gains in their investment portfolios and started deriving solid profits from rising premiums and skillful underwriting. Yet this overall positive news obscures a significant but little-noticed trend: some segments of the industry are greatly outperforming others. Three leading business models—which we term lean operators, strong brands and distributors, and product experts—have increasingly captured market share from incumbents. These models pose a threat to traditional, multiline insurance companies and are forcing them to rethink their strategies.¹

Nowhere is the trend more apparent than in the United Kingdom, Europe's most dynamic insurance market. Here, the most successful companies adhere to one of the three models and consequently enjoy higher growth and a lower combined ratio² than their multiline competitors. But this is not exclusively a UK phenomenon; companies using these new models have gained dominance in other parts of Europe, including France and Spain.

Lean operators—including Direct Line, a unit of the Royal Bank of Scotland (RBS) and one of the top companies in Europe using this model—mainly sell auto insurance and rely on low costs and competitive underwriting. In the second model, players take advantage of strong brands and distribution by leveraging solid existing relationships with customers. The most successful companies using this model include banks such as France's Crédit Agricole as well as the UK's Tesco, the leading supermarket chain, which outsources its insurance business to RBS. The third group, comprising what we call product experts, includes Hiscox, which sells niche commercial lines such as kidnap and ransom insurance and high-end home insurance.

Confronted by these new strategies, multiline players may resist changing the longstanding business models that have served them well, but they may face dwindling market share if they do. Certainly, embracing change after years of success is difficult. The biggest issue for multiline insurers is what to do with their agents, who have long served as their main distribution arm. In many European countries, agents and brokers play an increasingly limited role in P&C insurance, since direct sales have largely supplanted them in car insurance. In the United Kingdom, for example, agents and brokers handled 80 percent of all transactions in 1993; ten years later, their share had dropped to 40 percent. In Spain, the agents' share of transactions dropped to 41 percent, from 53 percent, from 1998 to 2003. Although Spain's remote direct channel is still small—only 5 percent of the market—it more than doubled during that period.

According to our study of the European insurance industry, large and persistent differences between the most and least successful players are explained primarily by their choice of business model. We examined the three models most closely associated with success as well as their requirements, including the key skills and challenges insurers must identify and master.

Measuring up

The difference between the strongest and weakest performers in the European insurance industry is striking. From 1998 to 2003, there was a gap of up to 15 percent (measured using combined ratios) in the operating results of the leaders and laggards. The difference between the best and the average performers was as high as 10 percent (Exhibit 1). These variations are significant because every ten percentage points added to a combined ratio is equivalent to a 20 to 25 percent increase in return on equity. With a few exceptions, companies with combined ratios lower than 100—the most desired outcome—follow one of the three models we have identified.

From 1998 to 2003, the average compound annual growth rate (CAGR) of the top 30 European insurers was 6.9 percent, which compares unfavorably with those of companies pursuing our three models. Take the following examples. Two lean operators—Direct Line of the United Kingdom and Mutua Madrileña of Spain—achieved a CAGR in their premiums of 11.8 percent and 10.8 percent, respectively. Retailers using the strong-brands-and-distribution model to sell insurance (including Tesco, the most successful) had a CAGR of almost 60 percent during the period; banks using it posted a CAGR of 20 percent. The major UK product experts posted CAGRs from 12 percent to 35 percent.

Three winning models

Adopting any of the three models will undoubtedly pose significant challenges for the larger traditional insurers. Most start-ups and smaller insurers have the advantage of flexibility, which helps them adopt new strategies. In contrast, most multiline companies have a large, general product offering and a single dominant channel, which makes the transition to new strategies more cumbersome for them. Still, the lessons they learn and adopt from the three models may well be the keys to keeping these customers and capturing more market share.

Lean operators

Mainstream automobile insurance has become a commodity because it is compulsory, in some form, in all European countries and typically constitutes the major category of insurance spending for most people. As a result, consumers tend to focus intensively on price, and competition is much greater than it is for other personal P&C products. Insurers must therefore be expert in pricing and cost control. The most successful companies are lean operators (such as Maaf Assurances in France and Mutua Madrileña in Spain), which tend to hold their expense ratios about 10 percent below the market average and outperform the market as a result (Exhibit 2).

Many of these companies sell policies through the Internet and the telephone—channels that reduce the need for agents. Although the face-to-face selling of auto insurance has declined significantly in most countries, important variations remain. In Italy, for instance, more than 90 percent of auto insurance policies were sold in person in 2004—roughly the same percentage that had been sold in person four years earlier. In the United Kingdom, however, only 15 percent of policies were sold in this way in 2004, a significant drop from 26 percent four years earlier. In Spain, 15 percent of car insurance policies were sold by telephone in 2004, a level that is twice as high as those in France and Germany.

Because lean operators compete on price, they must constantly improve the statistical basis for pricing decisions. Skilled pricing experts are crucial for effective risk management too. Some players, including Trygg-Hansa of Scandinavia, set their prices in real time and vigilantly watch for their customers' reactions to differential changes in their offer. But it is still standard practice in some European countries to change prices only once a year—a hangover from the time when rate changes were submitted annually to regulators. The problem is that adjusting prices every year divorces them from current market realities and reduces an insurer's control over the amount and quality of the customers it attracts.

Strong brands and distributors

Companies following the model of strong brands and distributors focus on leveraging their existing customer relationships. Typically, they target bank, grocery, and car customers, as well as small-business customers. Their main products tend to be homeowners' insurance, personal accident and liability coverage, loan protection, and warranties, which are typically bundled with another purchase. Car insurance, primarily sold bundled with a vehicle purchase or car club membership, is a relatively minor part of this market.

Unlike lean operators, insurers using this model do not necessarily compete on cost and may outsource the underwriting of policies. In the case of car insurance, accidents—and thus losses—are more frequent, and the personal liability of injury accidents leads to higher costs and therefore higher premiums, which other forms of P&C insurance generally cannot justify. Homeowners' insurance policies, for example, tend to have lower premiums than auto policies do because the former rarely incur liability payments over many years, as can happen with personal-injury auto accidents. Homeowners' insurance therefore won't support a specialized sales force and must usually be cross-sold with other products—for instance, an extended warranty with a refrigerator or creditor insurance with a home loan.

Tailoring offers to different customers is increasingly a source of competitive advantage in the industry, and this approach comes more easily to companies that have built long-term relationships with consumers. As a result, the fastest-growing companies using this model come from outside the insurance industry. These companies include banks with insurance arms, such as Crédit Mutuel with ACM and Crédit Agricole with Pacifica in France, as well as retailers such as Tesco in the United Kingdom (Exhibit 3).

The most successful companies rely on their strength in distribution to provide opportunities for cross-selling. The two French banks we have cited, for example, research their customer databases to generate new leads and have thus succeeded in cross-selling products to one-third of their existing customers. For retailers (such as Tesco), strong brands are more important than strong distribution networks, though insurers too are beginning to invest in their brands. Some companies compete both as strong brands and strong distributors: Halifax Bank (Scotland) has a powerful brand, a large number of customers, and a branch network it uses to sell insurance effectively. Such companies have a customer base so big that they attract new business at a much lower acquisition cost per policy than do traditional insurers.

Product experts

Product experts focus on capital and risk management and underwriting, including the handling of complex claims. They mostly serve large businesses, though some—for instance, Hiscox—also provide specialized personal lines such as fine-art insurance for high-net-worth individuals. Knowledge and talent management are critical to this model's success, particularly because risk data for niche products are limited. This deficiency makes statistical analysis difficult and means that companies must base their underwriting more on informed judgment. To serve the large commercial segment, where values and risks are considerably higher than elsewhere, insurers require strong balance sheets. They not only need powerful analytical capabilities to understand individual risks and to manage risks across their portfolio but also must be adept at using reinsurance to reduce volatility.

For large commercial risks, the most important decisions are the assessment of risk and the terms on which it is accepted, if at all. In these cases, pricing is based less on statistics than it is in personal lines: it involves a more complex triangulation among base rates, adjustments, and loadings (the premium increases reflecting high risk). Pricing also requires more skill to manage through the insurance cycle (which is more volatile for larger risks) and a greater aptitude for identifying the most profitable products at different times in the cycle.

In addition to applying strong underwriting and risk-management skills, product experts must excel at innovation. It may be conventional wisdom that insurance products can always be copied and therefore aren't a source of sustainable competitive advantage, but in reality some offerings are harder to replicate than others. In commercial lines, the accurate pricing of new products may require data and skills that take longer to duplicate. What's more, phasing out redundant offerings is as important as introducing new ones. Hiscox stopped offering yacht and stand-alone UK property insurance when these lines turned out to be unprofitable, even though at first glance they seemed like staple purchases for their high-net-worth target customers.

Three models, three responses

Although start-ups and smaller insurers can adopt focused strategies more easily, multiliners still have several options that would allow them to compete in this game. Yes, many of them could opt to stay with the status quo; most can turn modest profits that way for years. But such companies should recognize the high risk that hungry new-model competitors will continue to cut into their business. We see three responses for multiliners seeking a bigger piece of the insurance business of the future.

Creating new channels

Building a focused business, such as a direct-channel auto insurance operation, is perhaps the most aggressive move. Few companies would set out to cannibalize a business if not confronted by a strong likelihood that a competitor or start-up would come in and take it away in any case. In the United Kingdom, Aviva—now the country's second-largest direct insurer—has followed this strategy successfully by selling the same products under the same brand through different channels. In 1992 another prominent European direct player, AXA, set up Direct Assurance, which broke even in 2003 and is now France's leading direct insurer. In Italy, Generali's Genertel has become a leading direct insurer. Companies in other countries are moving to open their own direct operations as well; Germany's Allianz Group, for instance, announced the formation of its direct-insurance arm, Allianz 24, in 2005.

Selling the same product under the same brand but for a lower price through a direct channel seems to be an even more radical step in most European countries. In fact it was the fear of channel conflict that prevented UK broker-based insurers from starting their own direct operations in the 1980s, but the rapid growth of freestanding direct insurers eventually forced them to do so. Today they generally compete at different price levels in each channel under the same brands.

Reinventing channels

A second option for multiline insurers is to reinvent their traditional channel by retraining agents, cutting commissions on selected products, and offering online and telephone options for customers who would rather not deal with agents. Multiliners that want not only to provide the direct channels of telephone and the Internet but also to retain the distribution power of a network of agents face the difficult task of helping them find additional products with unit values high enough to support their incomes.

Some European multiline insurers have already employed this option successfully. In Italy, for instance, Lloyd Adriatico made itself more cost competitive in auto insurance by substantially streamlining its internal operations, which lowered its expense-to-premium ratio. Among other things, the reorganization means that fewer than 20 back-office employees are required to process paperwork for 2 million auto insurance policies. This result was achieved, in part, by using IT to relieve the agency of low-value-added work. After five years of reengineering, Lloyd Adriatico has transformed itself into a profitable organization with an expense-to-premium sales ratio that is about 3 percentage points lower than the market average.

Adding new services

A third option for multiliners is to add new lines or services to the core business in order to generate additional revenues and build customer relationships. These lines might be either new kinds of insurance or new offerings (such as roadside support, travel assistance, or home repair services) that complement insurance.

To date, this strategy has been adopted the least by European insurers. One company that did adopt it is Aviva, which in early 2005 acquired the United Kingdom's second-largest motoring organization, the Royal Automobile Club (similar to AAA in the United States) for £1.1 billion. Aviva intends to sell insurance to RAC members and to build its own noninsurance revenues. Allianz Group, through its Mondial Assistance unit (created by a merger in 2000), is the worldwide leader in assistance services. Mondial generated consolidated revenues of 1.1 billion in 2004. Italy's Generali owns the world's second-largest assistance company, which in 2004 generated 640 million in revenues.

Choosing a path

These three strategies are not mutually exclusive; companies can combine them. The choice of strategy will depend on the nature of the player—its strengths, the market conditions it faces, and its appetite for risk. Insurers that sell life and health as well as P&C insurance, for example, have a greater ability to leverage the agent channel than do pure P&C insurers. Mutual insurers that have established a strong relationship with their customers could build solid direct or quasi-direct customer relationships, as USAA (United Services Automobile Association) has done with the US armed forces.

The task starts with an extensive self-examination: what are the multiliner's strengths, market conditions, and willingness to assume risk? A company considering a lean-model approach, for example, must take a critical look at how lean its organization really is. Then it should ask itself if it can streamline its current operating model—for example, by reducing agents' commissions and cutting back-office costs. If it intends to compete in car insurance, it must be willing and able to achieve an expense ratio that is at least 10 percent below the market average.

A multiliner seeking to compete as a strong brand and distributor must assess its distribution power, particularly its sales force. For one thing, it must decide whether to do business as usual or try to reinvent its channels and develop new ones. If a multiliner's agents are merely living off the existing portfolio, it should motivate them to acquire new customers, deepen their customer relationships, cross-sell products, and reduce churn. Meanwhile, the company must be willing to develop a product portfolio that matches its distribution strengths as well as meets the needs of its customers. To do so it will have to support the sales force more effectively by investing in the brand's market strength.

If a multiliner aspires to join the product expert category, it must examine its product skills, especially in underwriting, and determine whether it is making money in commercial lines only in good years or over the full cycle. To compete seriously in commercial lines, the company has to make certain that its risk-management skills are strong and be willing to turn down customers or brokers if the price isn't right. The ability to recruit and retain top people with the requisite superior technical skills will be crucial; this in turn requires creating a culture that values cooperation, the sharing of knowledge, and the development of talent.

On each of these paths, a sense of timing is critical. Insurance is neither consumer electronics nor high tech, and we would argue that persistence is more important than speed. Lloyd Adriatico's successful revamping took five years, which suggests that multiliners serious about change need extended time horizons.

The increasing competitiveness of the European insurance industry will force traditional multiline insurance companies to take a critical look at their core skills and consider how they can transform their businesses to compete with the new challengers. Sticking with the one-size-fits-all, broker-agent-based approach is merely a default option that leaves incumbents vulnerable. Their best chance for high growth will come from developing their own direct-channel insurers, reinventing channels, or adding new services and lines to the core business—or from a combination of all three.