I was recently interviewed by Gillian Muessig and Anne Kennedy at CEO Coach, a webmaster radio program that discusses everything a business owner might need to do business on the web, down to the simple question, “Should a small business buy insurance online?” Gillian co-founded Moz and serves on boards on four continents. Anne was a founding board member of Helium.com and guided numerous Internet start-ups, including Zillow. Together, and with occasional guest experts, they break down the art of small business from the ground up. The episode in which I was asked to participate is titled “Insurance 101 for Startups“. The following are questions and answers that served as the background for that interview.
Insurance for Start-Ups
Q. More and more entrepreneurs are asking if they should buy the insurance for their start-up firms online. Is buying business insurance online a viable option for small businesses?
A. The sale of commercial insurance online in the United States is in its infancy. Online sales amount to only a tiny percentage of the whole.
In contrast, about forty-five percent of all small commercial businesses insurance in the United Kingdom is purchased online.
In the United States the preferred way for commercial insurance to be bought is through independent agents. In fact, a full eighty percent of all commercial insurance in the United States is purchased through independent agents.
Q. Why is that? Do regulatory issues stand in the way of small businesses in the United States purchasing their insurance online?
A. There are no current laws against the purchase of online commercial insurance, which would prevent the same sales percentage as in the U.K. The U.S. online insurance market has been concentrating mainly on private passenger auto insurance because that is where the most property and casualty insurance profits have been realized over the last decade. Recent weather losses have made commercial insurance much less attractive for most carriers.
The catastrophic storms of 2013 were fewer than previous years. This allowed a viable return on investment for insurance companies writing small commercial insurance.
When profits are tight, insurance corporations become horribly risk-aversive and new ideas don’t get much consideration. This would hold companies back from entering online sales for small commercial.
Also private passenger auto insurance offers the largest area of premium to solicit within the property and casualty insurance realm.
There is about $500 Billion in premium written annually in property and casualty insurance. Of that, about $170 billion is private passenger auto insurance. Homeowners’ premium accounts for about $70 Billion. Commercial premium totals around $250 billion, but it is cut up into a lot of segments. Liability and Workers’ Compensation insurance are the largest commercial premium segments at about $40 billion each, and with commercial multi-peril packages coming in at around $35 billion. Commercial auto has about $25 billion in premium. After that come Fire and Allied lines, Medical Professional Liability, Crop Insurance, Surety, Farmowners, Ocean Marine, Products liability, Earthquake, Boiler and Machinery, Aircraft, Crime, and many other coverage areas.
Why Isn’t Homeowner’s Insurance Sold Online?
Q. Looking at those numbers begs the question why hasn’t the insurance industry sold homeowners’ insurance online?
A. They’re starting to, but in a very limited amount. Weather losses have been a problem for homeowners’ insurance in recent years. More importantly, homeowners’ insurance is quite complicated. People express their extreme individuality through their homes so no two are alike. More and more people are working out of their homes, which makes the liability exposure more intricate.
Actually, a large percentage of auto insurance is too complicated to be sold online, but the online companies seemingly ignore those complexities and treat auto insurance as if it is a commodity, which can leave certain exposures uninsured or improperly handled.
The other day I went on a major online auto insurance seller’s website and went through its online advisor questionnaire. I answered every question truthfully and was advised to carry $100,000 per person/$300,000 per occurrence bodily injury and $100,000 property damage limits of liability (100/300/100). The site made no mention of an umbrella.
I have an above average net worth and carry 250/500/100 limits with a two million dollar umbrella. I carry these amounts to protect my current assets and future earnings.
An insurance agent would certainly recommend at least the limits I now carry, if not more.
Is Commercial Insurance Booming Online?
Q. Are there other reasons that the purchase of commercial insurance isn’t a booming online business?
A. There’s a natural conflict between an insurance underwriter’s need for information and an online shopper’s tolerance for the number of questions they will answer.
It costs so much to attract traffic to a website that the online seller has to have high conversion ratios. The keyword “Commercial Insurance” is costing about $18 per click currently. Insurance companies can’t afford to pay that much for the opportunity online only to have potential customers give up on a complicated or lengthy application process.
Unfortunately, insurance underwriters will offset what they view as a lack of total information with increased premium to protect their profit margins.
Also, online insurance underwriters are skeptical of those insureds that haven’t been vetted beyond an online application and will again charge an increased premium to increase their comfort that the person completing the application is being truthful. So buying commercial insurance online usually means you will pay more than if you speak with an individual insurance agent.
Do People Answer Insurance Questions Honestly?
Q. Isn’t an applicant’s honesty a problem even if a traditional agent helps an individual complete a paper application?
A. As I stated, over eighty percent of all commercial insurance in the United States is written through independent agents.
Insurance companies need agents with a strong sense of fiduciary responsibility. Companies foster that fiduciary sense by making sure their agents fear losing their contract with the company more than they fear missing out on placing any single business policy. Their job is to take every precaution to ensure honesty from their customers.
Q. Do you think most small business people will answer questions honestly online?
A. Yes. I believe only about Twenty-five percent will willfully mislead the underwriter as this would reflect the normal bell curve. If their dishonesty rises to the level of material misrepresentation or fraud, the insurance contract can be rescinded in most states.
Further, most start-ups have people running them who have a high level of tenacity. They seem perfect to work their way through an online commercial insurance process. They’re looking to save money wherever they can and insurance can be a major expense. They are risk takers and have the tendency to self-insure.
Shortly after starting their business they soon find that they’re required to have certain kinds of insurance and would seem logical candidates for an online process. Although these small business owners are willing to break a few rules, their landlords and investors require insurance to protect their assets and will demand a certificate of insurance.
Small businesses scour the market for the most cost efficient policies. Start-ups may have more time than money. The small businessperson might be willing to put in long hours to do their own searching. They also might be willing to use online information about insurance coverage to make themselves knowledgeable buyers, rather than using the advice and efficiencies of an agent.
Do People Still Want an Insurance Agent?
Q. I would imagine that independent insurance agencies have lost substantial value in recent years given the advent of online competition and decreased ability to attract revenue.
A. I just sold an insurance agency to a person who’s a lot smarter than I am. I received what I thought was top-dollar based on ratios that have been around for many, many years. It’s my belief that independent agents have a place in insurance for the long run, and that the most profitable system will be a hybrid of internet sales and a local independent agent to do some of the service work.
Recent surveys find that eighty percent of those looking to purchase insurance want an agent involved in the sale.
They want someone local they can trust.
They want someone to help them make a suitable buy.
They want one-on-one communication with someone they know will be there the next time they need help.
They want someone to hold accountable if their reasonable expectations aren’t being met.
Historically only about four percent of small businesses have purchased insurance from a direct writer without the help of an agent of some kind. It’s doubtful the internet will change this behavior pattern.
To recap: “Should a start-up purchase commercial insurance online?” The answer is “yes” . . . I’m not a Luddite. There are advantages for a specific set of individuals to purchase their insurance online. But, the answer is also “no” for many others.
When Shouldn’t a Business Buy Insurance Online?
Q. Can you provide some red flags that might suggest to a start up that they shouldn’t buy online?
A. Many startups seem to think purchasing insurance is an optional expense. They avoid the $300 to $700 cost for basic coverage. An insurance agent will help them see the folly in failing to protect their assets. It would be much easier for a start-up entrepreneur to make the mistake of not purchasing insurance without the immediate advice of an actual advisor.
I believe that those with a distinct professional liability insurance exposure should avoid buying online and seek the advice of a trusted insurance advisor. If you tend to think of your prospective customers as “clients” you might need advice about coverage for professional services that were either not done or done incorrectly.
Those start ups who are manufacturing a product should seek an insurance agent to help them, from the beginning. If you’re a salesman selling brushes door-to-door you should probably buy your insurance online. If you’re the manufacturer of the brush, you should not be buying online. Manufacturers have esoteric risks that need to be discussed and handled through some form of risk management.
If your inventory exceeds $25,000 you should probably talk to an insurance agent. Many insurance policies have specific sub-limits that could create real problems at high values.
If you’re required by a statute or federal law to carry limits of liability in excess of $1,000,000 you should definitely involve an agent because such laws usually mean you have exposures that require professional advice.
If your business is international you should not be buying online due to arcane products liability considerations.
If you have a board of directors you should not be buying online. Your board needs the protection of a good director’s and officers policy. That level of sophisticated policy is far from cookie-cutter.
If you have a number of employees you need to start thinking about finding an agent. The laws regarding proper handling of workers comp claims can cause you to be severely fined if you don’t properly handle the paper. Depending on the nature of your business you might have a frequency of workers’ comp claims. An agent can be an extremely handy resource if you’re large enough to have a flow of claims and don’t have an HR department.
If your business has a daily exposure to minors you need to talk to an agent. Minors are allowed two-year restart on the statute of limitations when they reach majority (usually eighteen years of age). This seemingly innocuous difference can be a business killer and proper insurance is absolutely needed. An exception to this is a very small in-home daycare, which I think is a perfect candidate for online coverage as long as abuse and molestation liability coverage is included.
If you find yourself capturing and storing information about your clients, you should involve an agent. Data privacy laws have very sharp teeth.
If you’re one of those rare start-ups who owns a building, you need to involve an agent. Commercial buildings are each unique and require proper handling.
Is Business Insurance Cheaper Online?
Q. But isn’t insurance significantly cheaper when purchased online?
A. It can be. If your business is fairly easy to define, has a minimal amount of exposure to anything but common trip and fall hazards, and you have no unusual requirements, you might be able to save time and money buying online.
But in reality there is no such thing as a free lunch. The function of an insurance agent has to be fulfilled by someone or something. For simple transactions a website can be beneficial, but as I’ve stated, many insurance transactions are complex.
A few days ago, I had lunch with an executive of one of the largest commercial insurance companies in the United States. He is involved in developing a hybrid approach, which starts with an online application. It is screened by an independent agent and passed to a company in-house service center to help the client through the process, which seems to be the best of all worlds.
Q. So, small commercial owners are likely buyers of insurance online, but that doesn’t answer the question of whether or not buying insurance online is a good idea.
A. Most people looking to buy online are hoping for less costly insurance answers or increased ease of doing business.
As we go through our discussion today, we will try to address both questions. In some instances it can be more efficient to shop online and in some instances the price might be lower.
What Is the Definition of Small Business?
Q. What is your definition of a small business?
A. My definition is quite a bit different than the insurance industry standard, which seems to be defined as any business with less than $5 million in revenue. I currently operate two small businesses. One of them has three employees and $2.4 million in revenue. Yet due to its complexities I wouldn’t call it a small business. Not counting what that business pays for health, life, and disability policies, it pays nearly $20,000 a year for insurance. It also is involved in thousands of complex transactions a year.
To me a small business is one that has few or no employees, no independent contractors working for it, and owns neither a car nor a building for their operations.
Q. Your definition still includes a huge number of businesses. In the United States there are over 21 million business firms that have no employees.
A. Yes. Forty-eight percent of all firms in the U.S. have 0 – 4 employees.
Every month in the United States about 3 out of every 1,000 adults start a new business. These new businesses have a high percentage of failure with sixteen percent failing within a year and thirty-two percent within the first three years.
Most insurance companies want a new business to have at least three years of management experience in a previous business because many failures are due to incompetence and lack of business experience.
Since so many start-ups fail in the first few years, most start-ups will only find insurance coverage in the residual insurance markets, which provide esoteric and hard-to-place insurance. The start-ups might lose interest in purchasing insurance if the company they contact declines their business or will provide only very restrictive coverage. An independent agent, working on their behalf, will find a home for their coverage at a reasonable price. Certain new businesses will require shopping, and since independent agents have access to several companies they can look for the policy and price that fits your business.
The average start up will pay twenty-five percent to thirty percent more than similar operations that have been in business for a number of years.
Will Small Businesses Buy Insurance Online?
Q. Do you see a change on the horizon that suggests more firms will soon be buying online?
A. Most definitely.
There are quite a number of smaller specialty sites such as theeventhelper.com which allows the purchase of premises liability insurance for special events.
American Family Insurance Company created Assurestart to insure small business. They started selling online in December in Texas. They’re partnered with Bolt Insurance Agency.
Insureon.com provides insurance to what they call micro businesses, which they define as up to twenty-five employees.
The most ambitious of these ventures is HISCOX small, business, which has an extensive marketing program with mainstream media and a large Pay Per Click campaign.
Q. Those options seemingly allow a space for small business to buy online, if it’s a good idea, but is it?
A. To answer that fully, I’m going to need to give you quite a bit of private passenger auto insurance information. Private passenger auto insurance is currently being bought online in huge numbers in the United States. This might provide a roadmap for what is coming in the commercial arena. We’ll delve into the good and bad of purchasing private passenger auto insurance online and why. I’ll then apply the lessons we’ll learn to the basic question of whether of not a small business should purchase its insurance online.
GEICO, Esurance and Progressive
Q. I take it you’re going to use the purchase of private passenger auto insurance online as a tool to help a small businessperson understand the process of purchasing insurance for their business online.
A. There are three major distribution channels for the purchase of private passenger auto insurance in the United States. The largest is through captive agents. “Captive agents” generally sell for one company, such as State Farm, Farmers Insurance, or American Family. The companies that use captive agents currently place about forty-five percent of the market’s private passenger auto insurance.
Independent Insurance agents place business for an average of about seven carriers. They shop their several markets to find the best value for their client. Currently they place about thirty-five percent of the private passenger auto market. They place insurance with companies like Hartford or Travelers.
The remaining Twenty percent are the companies who sell direct to the pubic through the internet or over the phone. The most well known of these direct writers are GEICO, Esurance, and Progressive.
Q. Wait . . . you just said direct writers like GEICO, Esurance and Progressive only write about twenty percent of the private passenger auto market. I see ads for them all the time. Based on the number of their ads, why don’t they place at least half of the market?
A. First of all, most companies have multi-channeled distribution. For example, Hartford writes nearly seventy-five percent of its private passenger auto premium through direct sales through its AARP program. However, The Hartford is considered to be an independent agency company. Progressive gets more than half of its private passenger auto insurance premium through independent agents, but Progressive is largely considered to be a direct writer. Even GEICO pays commission to agents on about ten percent of its business.
Possibly the main reason you think Progressive, GEICO, and Esurance are so big is the amount they spend on marketing. GEICO spends nearly seven percent of their written premium on advertising. In contrast, State Farm, who is the largest private passenger auto insurance company in the US, spends 1.7 percent. The industry average is about 2.4 percent but with Progressive spending about 4.5 percent and GEICO nearly seven percent the average is skewed.
Q. Lets say I’m insured by GEICO and I pay them $1,200 a year for my auto insurance. Are you saying they take $84 of that to pay that gecko to tell me I’m getting a good deal?
A. That’s about right. It seems imponderable but of the thirty percent of car owners who will quote their private passenger auto insurance this year are predominantly the most price-conscious and least loyal customers. By buying from the big ad spenders you’re supporting a system that spends more on advertising than it does on claims handling.
Q. Okay so lets get back to GEICO. It would seem like there are only so many pennies in the dollar. If GEICO is paying out that much for advertising then are their premiums higher? All other things being equal.
Years ago, I taught high school economics and often used the phrase “all other things being equal” to explain basic principles, but in real life “all other things” are rarely equal. To understand I’ll give you a little history lesson about some of these companies.
In 1996, GEICO became a wholly owned subsidiary of Warren Buffett’s Berkshire Hathaway. Buffett already owned National Indemnity a large excess and surplus lines company, which specializes in large commercial risks.
While most people define an insurance company as a firm used to transfer risk from one entity to another in exchange for a premium paid, Buffett believes an insurance company is a tool to amass large amounts of capital for efficient investment before taxes paid. He has said that Berkshire Hathaway would not be worth half of what it is today without his insurance operations.
In his 2013 annual letter to Berkshire Hathaway shareholders, Buffett spoke about the $73 billion of FREE money the insurance operation brought in to invest.
Since Berkshire Hathaway took control in 1996, GEICO’s market share has gone from 2.5 percent to 9.7 percent.
Q. I would imagine someone with Warren Buffett’s acumen for investment would see an insurance company as an investment tool. In the current market, an insurance company will generate just under three percent investment income on the money they hold, from the time they charge a premium until they need to pay money out in a claim. Buffett probably does much better than most other companies on his investment income.
A. Warren Buffett is an amazing businessman as was Peter Lewis, who made Progressive what it is today.
In the late 1960s, Peter Lewis took over the leadership of Progressive Insurance. The company had forty employees at that time. The outspoken Peter Lewis made a highly publicized speech at that time predicting the demise of the independent agent. Independent agents widely ignored his quirkiness and helped him grow his company to over 28,000 employees.
Both Peter Lewis and Warren Buffett had watched State Farm grow exponentially in the 1960s by using TV advertising. They both understood that a company that sold direct to the public could completely leverage each advertising dollar. A company that worked through independent agents would not get a direct payback for each dollar spent because the independent agent could decide where business would be placed.
Independent agents are much more likely to find their client the best deal because that’s how they keep them as a customer. Clearly, Lewis and Buffett have little respect for independent agents.
Q. What about Esurance? It’s is such a great name, but is it a great company?
A. In the late 1900s everyone was trying to figure out how to write private passenger auto insurance online. At that time less than one percent of all private passenger auto was written online. People would start the application process and abandon it after answering eight to ten questions. No one seemed to be able to solve the riddle to increase the conversion ratios.
The people who started Esurance, in December 1999, looked at the conversion funnel and made the unique observation that there were two openings. While everyone else was concentrating on the bottom of the funnel and cursing their inability to get people to answer all the necessary questions online, the founders of Esurance quickly became the second largest user of Google Adwords, which greatly increased their traffic.
That seems pretty elementary today. Esurance is still one of the largest users of Google Adwords with a click for “auto insurance” now costing as much as $80. Their marketing strategy was considered revolutionary and in 1999 the cost per click for “auto insurance” was $1.50.
Also at that time data mining became much more prevalent. Esurance was able to take a small amount of data from each customer through questions and leverage it to accumulate extensive information regarding the cars they owned, their loss history, and their credit information.
The underwriters at Esurance were able to have the information they needed to successfully price the risk without having the prospective client spend up to an hour online completing an application.
In 2011 Allstate acquired Esurance for $1 billion and still runs them as a separate business.
Esurance has gone through a number of different business models. As a start up they were much more concerned about premium growth than they were about underwriting profit. A few years into their development they were bought by a major insurance group, who demanded they operate with an eye toward underwriting profit.
Ever since they’ve become part of the Allstate family they’ve once again allowed their expenses to keep the company in the red. I’m assuming Allstate is considering this loss leader as part of R&D.
The loss experience for Allstate and Esurance are practically the same, but the expense ratio for Esurance is almost double Allstate’s. Esurance’s expense ratio and is one of the highest in the industry.
Esurance grew twenty-three percent in the fourth quarter of 2013, but from the outside their model doesn’t seem sustainable.
Q. Can you tie some of this into small commercial buying decisions?
A. Insurance companies who insure private passenger autos follow many of the same business models as those who insure small commercial risks.
More and more of these companies are using predictive modeling to not only predict how responsible an insured you will be, but also how long you will stay with them as a client.
Those companies will charge a teaser rate to gain you as a customer and raise their rates quickly over the years to make the profit they need to meet their return on investment goals.
When a company sells you insurance at a premium level they know will be unprofitable, they have to be fairly confident you won’t go away until they’ve recovered that investment.
Independent agents can be counter to that purpose. Most independent agents have automatic alerts built into their agency management systems. When their client’s premium goes up more than a certain percentage, the system will let the agent know. That agent will make a determination if they should re-market the client’s business to other carriers.
Keep in mind that your agent only continues to make money on your business if you continue to renew your business through her. Her first objective is to make you happy.
Is It Cheaper to Buy Insurance Online?
Q. But isn’t it much less expensive for an insurance company to write business directly rather than using an agent?
A. As I mentioned, Progressive sells through independent agents and also sells online. About fifty-five percent of the premiums they write come to them through independent agents. They publish their expense ratios, which tell us how many pennies of each dollar they spend on acquisition expense. Over the last several years the expense ratios for business produced through independent agents has been nearly identical to the expense ratio for business developed on a direct basis.
Based on their experience, there is no savings to be gained by going directly to the company.
Q. Bottom line: Can a person ever save money by buying online?
A. Absolutely. Companies look at risk much differently. What one company thinks is a risk that requires a $1,400 premium, another might price at $3,000. Online shopping provides more options. The more options to select from the more cost efficient your insurance purchase will become.
Many private passenger auto buyers are starting their purchase journey online. They use that price as a guideline when they approach an independent agent to make their actual buy. I would assume small business owners would take the same approach.
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