Should Insurers Use an Amazon or Netflix Business Model?

I’ve seen many insurance trade press articles or social media posts asking why insurers aren’t using either an Amazon or Netflix business model. The articles or posts mention that Amazon and Netflix are massively successful, are driven by a strong customer focus, have operations throughout the globe, and, equally importantly, conduct commerce using web-based mobile apps.

The obvious question, and subject matter of my post is: should insurers use an Amazon or Netflix business model?

However, there are functional areas within the insurance value web that can be strengthened using aspects of or principles driving the Amazon and/or Netflix business models.

Before getting to those aspects and principles and why I answered the question triggering this blog post title in the negative, let’s consider at a very high level: business models, the Amazon business model, the Netflix business model, and the insurance industry business model.

Business Models

The following is from a post I wrote titled: Business Models, Moats, & Start-ups: An Insurance Analyst Perspective, (https://rabkinsopinions.com/2020/02/12/business-models-moats-start-ups-an-insurance-perspective/).

There are many descriptions of business models available from a multitude of sources. I’ve created an illustration from an interview that Harvard Business Publishing had in late 2008 with Professor Clayton Christensen discussing “reinventing your business model.”

To paraphrase Professor Christensen’s description of a business model,

First, a firm creates a value proposition. The value proposition is defined in a manner to help someone accomplish a ‘job’ (i.e. fulfill a need) affordably, conveniently, and effectively. Next, the firm establishes a profit formula to deliver the value proposition in a profitable manner. Then, the firm identifies the resources it needs (i.e. buildings, equipment, people, products, and technology) to support the value proposition (and deliver it profitably). Finally, processes coalesce that are required to support the firm’s value proposition and resources simply and affordable.

Expanded Business Model

For me, this is a reasonable, logical description of a business model before factoring in the forces within a specific industry that will alter the components to align with the realities of the specific industry.

However, I want to expand on Professor Christensen’s business model components. My expansion (see visual below) encompasses three other major components: activities, technology applications, and technologies.

Each of these three additional components are similar to Russian Nesting Dolls in that processes are comprised of several activities, each activity can be – and usually is – supported by several technology applications, and in turn, each technology application can be – and usually is – supported by several technologies.

I think of my three additions to Professor Christensen’s description of a business model as an ‘expanded business model.’

Firms regardless of industry, whether startups or incumbents, need to consider how the set of additional components enable the company to profitably deliver the value proposition (i.e. help a customer fulfill a need) affordably and simply to the company’s target markets. However, I can’t leave this unstated again because it is of critical importance: “and with regard to the realities of the industry in question.”

For this post, I will not use all of the aspects of the Expanded Business Model to discuss the Amazon, Netflix, and Insurance Industry business models. However, to maintain your sanity and mine, I will discuss the same three elements of the Expanded Business Model (Value Proposition, Profit Formula, and Technology Applications) throughout this post.

(I believe that a more extensive discussion encompassing all the components of the Expanded Business Model would make sense to write at some future point in time. I’m not sure when I would get to do that.)

Amazon: Industry, Markets, and Business Model

In the 2017 letter to Shareholders, Jeff Bezos wrote [emphasis in bold is mine]: “One thing I love about customers is that they are divinely discontent. Their expectations are never static: they go up. We didn’t ascend from our hunter-gathered days by being satisfied. People have a voracious appetite for a better way. And yesterday’s ‘wow’ quickly becomes today’s ‘ordinary'”

I submit that his company strives to continually provide contentment for his clients in both the consumer and corporate markets that Amazon targets. Whether he succeeds with every initiative or not, Jeff Bezos – based on recorded interviews with him, his letters to shareholders, and the stream of new capabilities offered to clients – is driven to continually satisfy people’s voracious appetite by finding a better way for Amazon’s clients to conduct commerce with Amazon.

Amazon Industry and Markets

Industry Description – NAICS

The US Government uses both the Standard Industrial Code (SIC) and the North American Industry Classification System (NAICS) code systems to categorize companies. I prefer using the NAICS code systems, specifically the 2017 NAICS Code systems, and will do so for this post.

The US Government has categorized Amazon as belonging to:

• NAICS code 518210: Data Processing, Hosting, and Related Services
• NAICS code 454110: Electronic Shopping and Mail-Order Houses.

Note that on a NAICS 2-digit level, code 51 encompasses “Information” industries and code 45 encompasses “Retail Trade” industries.

During my desk research for this post, at first glance it seems that Amazon employs its products, solutions, and services from both industries to its target markets. However, it is more applicable to state that Amazon learns from and leverages its capabilities in each of its NAICS-coded set of industries to satisfy its clients “voracious appetites” in both of its target markets.

Target Markets

Amazon targets both the consumer and corporate markets. (See visual.) The company began its operations in the consumer markets (selling hard-copy books) in 1994 and in 2004 the firm decided to offer AWS’ Simple Queue Service (and in-depth knowledge of maintaining, enhancing, and managing that infrastructure) to clients in corporate markets. A Wikipedia entry about AWS states that: “Amazon Web Services was officially re-launched on March 14, 2006, combining the three initial service offerings of Amazon S3 cloud storage, SQS, and EC2.”

Again from Wikipedia: “In 2020, AWS comprised more than 212 services spanning a wide range including computing, storage, networking, database, analytics, application services, deployment, management, mobile, developer tools, and tools for the Internet of Things.”

Beyond mentioned the range of AWS services, I believe discussing these services in any detail is beyond the scope of this post.

Four principles guide consumer and corporate markets

Jeff Bezos stated in the firm’s 2020 Annual 10-K (for the fiscal year ending December 31, 2019) that “they seek to be Earth’s most customer-centric company.” He further wrote in that 10-K that the firm is guided by four principles:

• customer obsession rather than competitor focus
• passion for invention
• commitment to operational excellence
• long-term thinking.

I submit that Jeff Bezos applies the same four principles to both the consumer and corporate markets. From the 2012 re:invent Day 2 conference, Mr. Bezos had a ‘fireside chat’ with Amazon’s CTO Werner Vogels about a variety of issues. When Werner asked him about Amazon’s customer obsession, Jeff said that the firm’s customer obsession (with retail customers) was the same with corporate AWS customers. To paraphrase Jeff, he said that it was necessary to continually:

• improve the reliability of AWS
• lower prices for AWS clients
• innovate faster APIs for AWS clients.

It is not one of Amazon’s four principles but constantly lowering costs for customers is part-and-parcel of the firm’s customer obsession. It is apparent that one major theme that weaves throughout interviews with Jeff and articles about Amazon is the firm’s drive to answer the question: “How can we generate more revenue from our own infrastructure to lower costs for our (consumer and corporate) customers?” We’ll return to Amazon’s quest to lower costs for customers below when we discuss the Amazon Flywheel.

Summing up Amazon’s consumer market

I think of Amazon as a firm that offers a ‘fusion’ of physical and digital artifacts, specifically:

1. purchased physical and digital artifacts, supported by
2. a supply chain (encompassing digital and physical artifacts supported by servers, distribution centers and delivery vehicles), which are in turn supported by
3. Amazon’s technology solutions (including AI applications used to quicken and improve customers’ navigation, search, and selection of known and predicted CPG and Media & Entertainment products that they might want to consider for future purchase.

I assume that a description of Amazon’s corporate markets, beyond stating that AWS offers scale-as-a-service, could be crafted in a manner that is similar (and more than likely, much tighter) to my ‘summary’ thinking about Amazon’s consumer markets.

Now, let’s discuss the three selected components of the Expanded Business Model (Value Proposition, Profit Formula, and Technology Applications).

Value Proposition

Keep in mind that a company’s value proposition is all about fulfilling a customer need.

I believe that Amazon has two value propositions: one for their consumer markets and one for their corporate markets. It pains me not to have thought of one value proposition for both types of markets. However, both of the value propositions are based on the same foundation of customer obsessiveness.

Value proposition for consumer markets: Provide consumers a panoply of digital and physical distribution channels to purchase products from a growing selection of retail and information goods and services at low prices that will be delivered quickly.

Value proposition for corporate markets: Provide corporations a secure, scalable cloud services platform offering storage, compute, analytics, and other capabilities-as-a-service at low prices.

Profit Formula

Amazon generates revenue from a wide and expanding selection of sources, including:

• retail (CPG)
• media and entertainment (including Amazon Prime, a subscription service for consumers)
• corporate markets (AWS)
• digital advertising services.

Some of the relatively newer sources of revenue include Amazon’s entry into prescription drugs and groceries (Whole Foods).

Amazon continually strives ways to make it easy for its retail market consumers to conduct commerce with the firm, not only using mobile apps and the firm’s web site, but also through its voice-responsive Alexa devices and more lately, shopping at the Amazon Go stores.

Similar to the Amazon Marketplace (discussed below in the Amazon Flywheel section) of applying its lessons to create products for other firms, Amazon is offering their Amazon Go store functionality to other retailers. See TechCrunch article dated March 9, 2020 by Sarah Perez titled “Amazon is now selling its cashierless store technology to other retailers.”

Concerning profit, Amazon’s net income in fiscal year 2019 was $11.588 billion which was up from the firm’s net income in fiscal year 2018 of $10.073 billion. Operating income for fiscal year 2019 was $14.541 billion, up from the $12.421 billion of operating income in fiscal year 2018.

Amazon Flywheels: Consumer and Corporate Markets

I’ve noted before that Amazon strives to provide a high-quality customer experience by providing consumers with an increasing choice from a vast, growing selection of products and services. The firm reaffirms and accomplishes this mission through its stellar implementation of the flywheel. I believe that the flywheel, discussed by Jim Collins in his 2001 book “Good to Great”, drives the firm’s strategy to strengthen the retail and corporate client experience while simultaneously lowering the firm’s expenses.

There are several explanations of how Amazon uses the flywheel to the utmost benefit of its customers (and Amazon itself) on the web. I believe one of the best discussions of the Amazon Flywheel is given by Simon Torrance (dated April 9, 2018 on YouTube and titled: New Growth Playbook – Amazon’s Growth Flywheel).

I am using his visual below (with his permission) with some minor alterations.

I added the “Bridging / Fusion of physical and digital artifacts” as a subtitle because 1): I believe that Amazon’s fusion of physical and digital artifacts (including the products and goods they sell and their supply chain to obtain and move the products and goods to consumers) is one of the essential attributes of the firm and 2) I’m preparing my (and your) ‘mind-share’ for the next major sections where I will discuss Netflix and the Insurance Industry.

I also added an arrow pointing to both ‘customer experience’ and ‘Amazon branded connected IoT physical devices.’

I purposely made two elements stand out in the visual: ‘Amazon Marketplace’ and ‘Amazon branded connected IoT devices:

• The ‘Amazon Marketplace’ amplifies Amazon’s mission to strengthen customer experience by providing both a wider choice and selection of goods and services and simultaneously helping Amazon lower the firm’s cost structure which can be passed on the customers.
• The ‘Amazon branded connected IoT physical devices’ (e.g. Alexa, Amazon Fire TV Stick) serve as a bridge connecting Amazon’s consumer and corporate markets enabling corporations to consume more of AWS’ services, create IoT capabilities (in this particular instance) for Amazon’s consumers which in turn strengthens customer experience, and continues to lower the cost structure of AWS which can be passed on to corporate AWS clients.

Describing the Amazon Flywheel: Amazon’s raison d’être is providing an excellent customer experience. To accomplish that, Amazon continually expands the selection of goods and services for customers to choose (which is why it is number 1 in the visual: it drives the flywheel); doing that increases traffic to Amazon.com; and that traffic both drives expanding selection of goods and services which lowers Amazon’s cost structure which leads to lower prices. And around the flywheel goes.

But wait a second: Amazon decided to allow third parties to use Amazon’s infrastructure to offer their own goods and services. Doing this accelerates the speed of the flywheel: increased selection leading to even stronger customer experience and …

Amazon’s implementation of the flywheel also illustrates the firm’s realization that it could leverage knowledge of its own infrastructure by offering that infrastructure (i.e. AWS) to corporations for their use to serve their own clients. Moreover, the visual captures how Amazon bridged the consumer and corporate markets to help their corporate clients, their consumer customers, their Amazon Marketplace participants, IoT developers (in this instance), and, of course, Amazon itself. By introducing its own branded connected IoT physical devices (Alexa, Fire TV Stick), Amazon introduced and accelerated purchases (and the Corporate Flywheel) that corporations could create and deliver to Amazon’s customers which strengthens, yet again, Amazon’s experience for consumers.

(I apologize if I made this more complicated than it is. I’ll again point you to Simon’s YouTube explanation if you want a clearer discussion.)

Technology Applications

Amazon constantly strives: to make it easier for consumers to conduct commerce with the firm, to drive down the firm’s cost, and to expand the number of retail (CPG) and Media & Entertainment goods and services that customers might want to purchase. Add all of that to one of the firm’s four principles – its passion for invention – and it is no surprise that Amazon is essentially a CX-driven laboratory that continues to create applications from current and emerging technologies to support the firm’s objectives.

Amazon’s technology applications include, but are certainly not limited to:

• Recommendation engines to suggest products that consumers might want to consider purchasing. The recommendation engines are a quick solution to customer’s need to navigate Amazon’s vast selection and make a choice of a purchase.
• Warehouse robots working with humans to quicken the responsibilities of pickers, packagers, and stowers.
• Alexa, the cloud-based voice-controlled virtual assistant that provides information and, of course, an easy way to purchase goods and services. (Discussing Alexa cries out for a deeper dive into Natural Language Processing [NLP] and virtual assistants but I will blithely ignore those cries in this post.)
• Amazon mobile apps available on iOS, Android, and Windows devices.
• eReader (e.g. Kindle – offered as a physical device and as an app available on mobile devices) that enables customers to read purchased books (and magazines) and the ability to purchase more books.
• Amazon Prime Video – a streaming app for movies (licensed and original Amazon content) and television shows available on mobile devices. (Seems to make sense that the Kindle should eventually support movies similar to the video support capability of the Amazon Fire Tablet.)

One final point, and I realize some people might not think this point belongs in a section about technology applications: Amazon continually leverages what the firm learns using its own capabilities and then using that knowledge refines its operations involving either consumer markets or corporate markets. For their corporate markets, I call this self-recognition of capabilities a creation of a ‘meta’ representation of an offering that other companies might require either in part or in whole. (it’s the razor-and razor blade strategy on steroids because Amazon profits from the use of the ‘meta creation’ rather than from the sale of the ‘meta creation.’ It is certainly worth its own future post about Amazon).

AWS and Fulfillment by Amazon (FBA) are the two best examples of Amazon’s using a ‘meta creation’ to expand its capabilities and profit footprint. A third example is Amazon’s Ground Station-as-a-Service. This is an offering to satellite / earth observation / NewSpace operators firms who don’t want to build their own ground stations, want to expand the number and location of ground stations they already have built, or want to expand the number and location of ground stations they are getting from their current set of partners.

Netflix: Industry, Markets, and Business Model

Industry Description – NAICS

The US Government has categorized Netflix as belonging to NAICS code 515210: Cable and Other Subscription Programming and NAICS code 532230: Video Tape and Disc Rental. More specifically,

• NAICS 515210 includes: establishments primarily engaged in operating studios and facilities for the broadcasting of programs on a subscription or fee basis.
• NAICS 532230 includes: establishments primarily engaged in renting prerecorded video tapes and discs for home electronic equipment.

When Netflix began operations in 1997 by offering DVD rental by mail, the appropriate NAICS code would have been 532230. And that one fact (of the two different NAICS codes) that can be too easily overlooked, Netflix’ shift from renting DVDs by mail to becoming a subscription-based media firm, obscures the reality of constant reinvention that is the firm’s hallmark to support its vision of offering a high-quality customer entertainment experience.

Target Markets

Netflix targets the global consumer market with its offerings of on-demand subscription-based streaming content.

Since launching in 1997 by providing customers with an easy method of renting and returning DVDs by mail, Netflix has become (according to the firm’s 2020 10-K for Fiscal Year 2019) “the world’s leading subscription streaming entertainment service with over 167 million paid streaming memberships in over 190 countries enjoying TV series, documentaries and feature films across a wide variety of genres and languages.” Netflix also has a set of approximately two million customers who still rent-and-return DVDs by mail.

In a 2002 interview with Wired and in several interviews since that date, Reed Hastings (who with Marc Randolph co-founded Netflix) has stated, in one form or another, that “… our dream is to have a global entertainment distribution company that provides a unique channel for film producers and studios.”

Netflix creates content in different countries around the world and distributes that content worldwide. Below, the chart shows the average paying memberships growing in the four major regions Netflix operates: US and Canada, EMEA, LATAM, and APAC. (Note: APC excludes China and North Korea.)

Creating compelling content

One quote that stood out for me from one of the interviews with Reed was his affirmation that “Our North Star is how do we do the absolute best content we can to please our customers.” Netflix is all about offering compelling stories to become a destination site for their customers’ viewing.

Compelling story-telling is an integral component of who we are as humans (see visual). Back in the very early dates, our ancestors drew pictures on walls letting others know where food was located. At almost the end of the 19th century, Thomas Edison built the first movie studio called The Black Maria. Silent movies ruled the era, including Charlie Chaplin’s “Modern Times.” Much more recently, Netflix created their first Netflix Original web television series that won seven Primetime Emmy awards, two Golden Globe awards, two Screen Actors Guild award, and one Satellite award. Through six seasons, House of Cards won 27 awards.

Selected Key Dates in Netflix’ History

Obviously, the dates of incorporation and IPO are very important for Netflix (see visual). However, if I had to pick some other major dates on the Netflix timeline, my choices would be the dates:

• Netflix began streaming (because this initiative redefined the consumer entertainment marketplace to an on-demand (or binging) marketplace)
• of all the acquisitions and partnerships of which I show only two in the visual. The acquisitions and partnerships provide Netflix with intellectual property (IP) that the firm can use to create series and movies.

Value Proposition

To attract customers from other activities that take place in what Reed called consumer’s ‘Moments of Truth’, Netflix created a value proposition to provide on-demand, personalized, streaming entertainment available for viewing on any internet-connected screen for an affordable, no-commitment monthly fee. (Source: Netflix Investors web site page: “Overview” section.) Did you catch the ‘no-commitment monthly fee?’ Customers can cancel at any time (and come back when they want).

One of Reed Hasting’s guiding principles that drives his company to strengthen and reinvent Netflix is his belief that “time is the real competition.” Not Disney+, not Amazon Prime Video, not Apple TV Plus, not Hulu, and not other visual entertainment content but time itself. Time that customers could enjoy by reading a book, taking a walk, going to Starbucks, or doing anything in their free time other than watching entertainment on Netflix.

Netflix bolsters the value proposition by allowing members to watch as much as they want, anytime, anywhere, on any internet-connected screen. Members can play, pause and resume watching, all without commercials. (Source: Netflix 2020 10-K for Fiscal Year 2019.)

Moreover, Netflix puts the member (or customer) center-stage by creating metrics based primarily on each customer rather than on the content. From the Product Habits blog (sorry, I couldn’t find the date for this post) with my underlining the key points: “Cable TV channels typically calculate their audiences based on viewership or how many viewers a TV show has. Netflix comes at this from the opposite direction by focusing on how many movies (or shows) a viewer has watched. Rather than optimizing individual shows to maximize the number of viewers, Netflix instead leverages its vast media catalog to optimize for movies watched per individual user.“

Strength of vision

I use the phrase “strength of vision” describing what Reed Hasting wants to do and doesn’t intend to do. I like Jim Cramer’s (host of Mad Money) phrase “clarity of vision” to reflect the same characteristics.

Why ‘strength or clarity of vision?” Because Netflix intends to stay true to their value proposition by stating (and often restating in articles and interviews) that they have no intention of introducing advertisements into their content, adding sports content, or going into gaming.

Story-telling – whether series, films, or unscripted content – comprises the entertainment that Netflix currently and plans to offer in the future.

Constant reinvention of Netflix

But that laser-focus on story-telling – and not on other content – does not mean that Netflix has not and will not reinvent itself. Far from it. Reinvention has been the foundation of Netflix’ success since it began operations in 1997.

The firm has moved from DVD rentals by mail to streaming licensed content (and by introducing streaming – or binging – the firm redefined what it meant to ‘watch’ content on the web) to creating and streaming original content. Supposedly, Reed Hasting’s forthcoming book “No Rules Rules: Netflix and the Culture of Reinvention” will discuss in more detail the path that Netflix has taken from its beginnings of a DVD rental firm to a global media streaming giant.

Refining the amount of content available on Netflix

The phrase “Are we there yet?” is as much a well-known as the phrase “What’s on [television] tonight?” It is the latter phrase that is of import for this post. Of course, since Netflix and other Multichannel Video Programming Distributors (MVPD) redefined the ‘what’ (and the ‘where’ and ‘when’) of content to view, people want to know the availability of streaming content.

Obviously this raises the question of what content is available on Netflix?

There is quite a bit of Netflix content. Although the amount of current Netflix content is less content than years ago. From an article on Vox dated January 27, 2020 titled “How Netflix is winning more with less content” written by Rani Molla (@ranimolla) highlighted below in both ‘orange’ and ‘blue.’ (Bold emphasis is mine. I highlighted in blue a key part, at least for me, of Rani Molla’s Vox article.)

Implications of Netflix creating original content

Netflix is not only “Talking the Talk” but more importantly “Walking the Talk” about their investments in original content. An article dated January 16, 2020 titled “Netflix Projected to Spend More Than $17 Billion on Content in 2020” by Todd Spangler discusses a BMO Capital Markets forecast on this matter. Specifically, Mr. Spangler’s article captures the following from the BMO Capital Markets forecast: “The streamer will invest around $17.3 billion this year in content on a cash basis … up from around $15.3 billion in 2019. Netflix is not expected to ease up anytime soon: Its content spending will top $26 billion by 2028, per BMO’s report.”

The spend on original content will have implications on Netflix’ financials. (See next section discussing Profit Formula). Moreover, creating and distributing original content has many other implications, including:

• decreased licensing cost of other studio’s content
• increased costs (for original content)
• increased need, and cost, for people skilled in creating high-quality desirable content
• tactical hope that original content keeps existing customers and attracts new customers
• significantly more control of how long the (original) content can remain on the Netflix media system for viewing by customers.

Profit Formula

Netflix states in their 2020 10-K that: “We derive revenues from monthly membership feed for services relating to streaming content to our members. We offer a variety of streaming membership plans, the price of which varies by country and the features of the plan. As of December 31, 2019, pricing on our plans ranged from the US dollar equivalent of $3 to $22 per month.We expect that from time to time the prices of our membership plans in each country may change and we may test other plan and price variables.”

Selected Financials 2015 – 2019

I am not a financial analyst. But with that important caveat, I want to point out some of Netflix’ financials during the 2015 – 2019 time period: operating income, net income, free cash flow, and in a second visual the firm’s long term debt.

Netflix’ Operating Income and Net Income have been steadily increasing from 2015 through 2019. However Netflix’ Free Cash Flow has steadily declined from -$921 million in 2015 to -$3,274 million in 2019.

Similarly to Netflix’ steady decline in Free Cash Flow over the 2015 – 2019 time period, Netflix has also seen a steady increase in the firm’s Long Term Debt from $2,371 million in 2015 to $14,759 million in 2019.

I think these financials point to the sustainability of the firm: using long-term debt to create a repository of more original content. My question is straightforward: how many years can Netflix operate in this manner? Keep in mind that I realize that I may very well be wrong on this matter – please let me know.

Technology Applications

Netflix strives to keep its members entertained by offering personalized content each member would enjoy watching. Netflix may no longer have 11,000 titles for viewing it had some years ago but 5,800 + titles remains a large content repository for members to choose from. Moreover, the repository is not static: Netflix continues to license content and will, as we read above in the quote from the Vox article), continue to create Netflix Originals.

The volume of current and future planned content creates a challenge for Netflix: determining how to steer the appropriate content to each member. Or put another way, the continual challenge for Netflix is how to identify and tell each member about the specific content they would enjoy that is residing in a particular place (at any point in time) in the Long Tail. (I realize that the heuristic of the Long Tail is also extremely useful for the Amazon e-commerce platform but I chose to discuss it here.)

Obviously, no member cares about the Long Tail but rather only viewing the content s/he prefers. However, I suggest that Netflix researchers should care where the content is along the Tail, at least from the perspective of other related content (genre, characteristics of members wanting to view the content, cost of the content, and/or other variables).

I don’t plan to delve into the concept of the Long Tail in this post except to mention that:

• Chris Long introduced it in his book “The Long Tail: Why the Future of Business is Selling Less of More” published on July 11, 2006 by Hyperion
• One method of using / describing it is that the Head of the Tail represents the “Blockbusters” (the small number of products such as movies or television series that are enjoyed by a large number of people) and the Tail encompasses all of the ‘other products’ which only a few individual people enjoy viewing.

The ‘magic’ of the web enables Netflix to find a large number of members under the Tail from different parts of the world who, while not necessarily being interested in the ever-popular Blockbuster, provide a sufficient number of viewers for content that might have been considered not worthy of being on retailers’ physical shelves. On the web, the Tail delivers scale: scale of revenue and hopefully scale of profit. If I worked at Netflix (whether in Marketing or Research), I’d want to know where along the Long Tail each piece of content resided.

Now we’re back to how Netflix resolves the challenge of getting the ‘appropriate’ content to each individual member. The answer rests with Netflix’ applications of machine learning to improve each member’s experience. And yes I am reneging on my statement of discussing technology applications rather than technologies.

Netflix uses machine learning (which is a technology and not a technology application) to optimize the Netflix service end-to-end, including to (this is directly from the Netflix Research web site):

• create and improve the firm’s recommendation engine
• optimize the production of original movies and TV shows
• optimize video and audio encoding
• optimize the in-house Content Delivery Network
• power the firm’s advertising spend
• power the firm’s channel mix
• power the firm’s advertising creative.

If Netflix offers a virtual assistant for its members to use to ask for a series, movies, or documentaries to view, that would be an application of technology.

Insurance: Industry, Markets, and Business Model

Industry Description – NAICS

The insurance industry is not a homogenous industry. It has many sub-industries, including but not limited to the following sub-industries (using information from the US Census Bureau about the 2017 NAICS codes) of which more than one is required to get-and-keep (consumer or corporate) customers:

• NAICS code 524113 – Direct Life Insurance Carriers: includes establishments primarily engaged in initially underwriting (i.e., assuming the risk and assigning premiums) annuities and life insurance policies, disability income policies, and accidental death and dismemberment insurance policies.
• NAICS code 524126 – Direct Property and Casualty Insurance Carriers: includes establishments primarily engaged in initially underwriting insurance policies that protect policyholders against losses that may occur as a result of property damage or liability. Illustrative examples include Automobile insurance carriers, direct; Malpractice insurance carriers, direct; Fidelity insurance carriers, direct; Mortgage guaranty insurance carriers, direct; Homeowners’ insurance carriers, direct; Surety insurance carriers, direct; Liability insurance carriers, direct.
• NAICS code 524130 – Reinsurance carriers: includes establishments primarily engaged in assuming all or part of the risk associated with existing insurance policies originally underwriter by other insurance carriers.
• NAICS code 524210 – Agencies and Brokerages: includes establishes primarily engaged in acting as agents (i.e. brokers) in selling annuities and insurance policies. [My note: This includes annuity and insurance policies underwritten by establishments with the four-digit NAICS code ‘5241.’]
• NAICS code 524291 – Claims Adjusting: includes establishes primarily engaged in investigating, appraising, and settling insurance claims.
• NAICS code 524292 – Third Party Administration of Insurance and Pension Funds: includes establishments primarily engaged in proving third party administration services of insurance and pension funds, such as claims processing and other administrative services to insurance claims, employee benefit plans, and self-insurance funds.
• NAICS code 524298 – All Other Insurance Related Activities: includes establishments primarily engaged in providing insurance services on a contract or fee basis (except insurance agencies and brokerages, claims adjusting, and third party administration). Insurance advisory services, insurance actuarial services, and insurance ratemaking services are included in this industry.
• NAICS code 525110 – Pension Funds: includes legal entities (i.e. funds, plans, and/or programs) organized to provide retirement income benefits exclusively for the sponsor’s employees or members.
• NAICS code 525190 – Other Insurance Funds: includes legal entities (i.e. funds (except pension, and health – and welfare-related employee benefit funds)) organized to provide insurance exclusively for the sponsor, firm, or its employees or members. Self-insurance funds (except employee benefit funds) and workers’ compensation insurance funds are included in this industry.

Keep in mind that not every sub-industry participates in the process of ‘getting-and-keeping’ each insurance customer. The role of each sub-industry participant in the process heavily depends on which insurance lines of business the potential client wants (needs?) to purchase, the financial and staff resources of the insurance carriers underwriting the risks, and, and the sub-industry participants involved with customer and claim services.

Two iron-clad rules of insurance commerce

There are two facts that absolutely rule insurance commerce absolutely:

1. Insurance can only be underwritten in any one or more jurisdictions by a entity regulated and licensed to conduct insurance commerce in the jurisdiction(s) the insurance is being underwritten.
2. Insurance can only be sold by a regulated salesperson (i.e. insurance agent, insurance broker, managing general agent as examples) who is trained, certified and licensed to sell specific insurance line(s) of business in specific jurisdictions.

The importance of insurance regulation

The concept and nature of insurance regulation is critically important to the underwriting, sale, and service of insurance. Why the stringent emphasis on the mandate to underwrite, sell, and service insurance? Because insurance mitigates or manages the risks to:

• people’s lives, property, income / assets, health, actions, and behaviors
• company’s (or non-profit’s) financial well-being, behaviors, actions, property, products and services.

All of that said, the topic of insurance regulation is beyond the scope of my post. Perhaps in future posts I will discuss the US Federal and State regulatory matters of insurance (with some inclusion of international regulatory insurance industry issues).

I’ll mention my personal opinion about US insurance regulation: long live the State-based regulation of the US insurance industry !!

Target Markets

The insurance industry targets consumers, corporations, non-profit organizations, and, in actuality, any entity that could be negatively impacted financially by any type of risk whether the risk is caused by natural events or human actions or behaviors.

The reality is that the insurance industry offers its products and services to every person and every company in every industry subject to the risk appetite of each insurance carrier in the industry. The insurance firm’s risk appetite is subject to a variety of attributes of the insurance firm and the potential client including the various exposures the potential client faces that require insurance.

Exposures – of individual people, groups of people, and/or companies – to a variety of risks (and in turn exposure to financial losses) that various insurance lines of business provide risk mitigation / management include, but are certainly not limited to:

• living too long
• dying too soon
• planning for college education of children
• retirement planning
• having a swimming pool in a homeowner’s property
• getting into an automobile accident
• manufacturing products
• managing a restaurant
• holding sporting events
• holding company picnics/outings
• using entertainment venues
• managing nursing/assisted living homes
• launching satellites.

In summary, insurance offers products and services to exposures of life, living, health, working, entertaining, and conducting commerce (in any industry).

Skeleton Framework of the Insurance Industry

The insurance industry offers products (i.e. insurance policies) for the exposures articulated above and more within a specific industry structure: Life & Annuity Insurance (L&A), Property & Casualty Insurance (P&C), Health Insurance (which I do not cover in this post, future posts, or any reports that I research and write), and Reinsurance (which I rarely if ever cover). [I realize this is a simplistic structure that omits other lines of insurance.]

Explaining the differences and similarities; customer, market, and competitive dynamics; and other aspects within the insurance industry or across specific insurance lines of business is beyond the purpose of this post. I’ve included the visual below only to give a taste of the industry structure. (I agree a short post to discuss which insurance lines of business provide risk mitigation / management for specific exposures facing specific retail and corporate markets cries out to be written. But not in this post.)

One aspect of the insurance industry structure I do want to note is the difference in descriptors: note that L&A describe the retail market as “individual life and annuity” whereas their counterparts in P&C describe the retail market as “personal property and casualty.” Similarly for the corporate markets: “group” versus ” commercial are used for essentially the same type of markets.

Value Proposition

The value proposition of the insurance industry, regardless of major insurance line of business, is to mitigate or manage the risks, with conditions, of its clients. I discuss “conditions” below in the Profit Formula section because those “condition” are tightly correlated with the profit, or lack of profit, that an insurance company generates.

Before getting to the Profit Formula, let’s consider two value chains encompassing the flow of risk of the consumer purchase of insurance and of the corporate purchase of commercial P&C insurance. In the second visual the term ART means Alternative Risk Transfer and RRG means Risk Retention Groups. In this corporate commercial P&C market, capital markets either do or could play a role financially enabling ‘reinsurance’ requirements.

My intention is to visually point out not just a flow of the acceptance of risk by some of the key participants in the insurance transaction but also to reinforce the complexity of the insurance transaction. I agree that consumers (i.e. individuals purchasing personal lines property and casualty insurance) don’t need to know the machinations behind their transactions but that ignorance doesn’t negate the facts of the transaction complexities.

However, corporate clients (certainly clients working in ‘Medium’ and ‘Large/Jumbo’ corporations rather than in small ‘Mom-and-Pop companies’) of commercial property and casualty insurance should understand most of the complexities behind their insurance transactions.

Illustrative Risk Flow for the Consumer Purchase of Insurance

Illustrative Risk Flow for the Corporate Purchase of Commercial P&C Insurance

Jumping out of the insurance industry value proposition for a second, technology vendors providing (or wanting to provide) software solutions to either or both of the consumer or the corporate insurance markets should have a strong understanding of the insurance transaction and all of its complexities.

Profit Formula

Insurers generate their income from two main sources: premiums and investment income. To generate ‘profitable’ premiums, insurers must strive for quality underwriting (i.e. to truly know the current and future exposures the prospective client faces through the intended length of the insurance policy).

To generate targeted investment income, insurers must strive for excellence in investing within the boundaries required by insurance regulators and by understanding the current and future economy, political situation, and insurance regulatory philosophies regarding all aspects of getting-and-keeping customers, whether retail or corporate.

Investment income

I’m going to cover the “investment income” component of the insurance industry with a broad brush. Insurers have to comply with insurance regulations concerning the areas that insurers can invest their money. The acceptable investment areas are conservative in nature.

Statistics from the the National Association of Insurance Commissioners web site (naic.org), capture the investments of the life and annuity insurance industry and the property and casualty insurance industry.

For the U.S. Life and Accident & Health Insurance Industry the investment portfolio includes: bonds, preferred stock, common stock, mortgages, real estate, BA assets, and cash. BA assets refers to the long-term invested assets as would be required to be reflected on Schedule BA of the NAIC Annual Statement Blank or the successor to such Schedule. For 2Q19, bonds represented 78% of the Life and A&H insurance industry’s asset concentration.

For the U.S. Property & Casualty and Title Insurance Industries, the investment portfolio of the industries’ Cash & Invested Assets includes: bonds; affiliated common stocks; unaffiliated common stocks; BA assets; cash, cash equivalents, and short term investments, mortgage loans, real estate, and preferred stocks. For 1H19, bonds represented 53% of the investments, and preferred stocks were 0.3%. Common stocks were almost evenly split between affiliated (14%) and unaffiliated (17%).

Premiums

Premiums are the second major component of insurance company profitability. However, as I mentioned above, insurers must strive for quality underwriting (which is what is needed to generate ‘profitable’ premiums). I realize that my belief that ‘quality underwriting’ is not equivalent to acquiring as many customers as possible as quickly as possible is just that: my belief (but that belief is based on almost 20 years working in the insurance industry and the last 30 years being a management consultant to the insurance industry or being a technology-focused insurance industry analyst).

Going further, I believe that accepting every person who wants to become a policyholder is a recipe for financial distress or potentially financial ruin for insurance companies. In other words, scale is not an insurance company’s friend, at least for most insurance lines of business.

Let’s discuss the concept of scale – from the perspective of generating premium – in the insurance industry.

Scale

Scale – from the perspective of generating increasing amounts of premium from increasing numbers of customers – worries me. The mobile app that underwrites and binds an insurance policy within seconds (or nano-seconds) is the equivalent of a modern-day Frankenstein monster that runs amok through an insurance company’s financials delivering rivers of blood red ink.

Why?

The fact is that when a L&A or P&C insurance company underwrites and sells an insurance policy, it is simultaneously purchasing a future claim.

Or to ask two questions that every insurance (underwriting, actuarial, claims, marketing, sales and distribution) executive should consider with the sale of every insurance policy: what is the loss cost associated with the insured (i.e. policyholder) and when will that loss cost emerge for the insurer to adjudicate (and at what costs to adjudicate the claim including any required investigations into possible fraud)?

I am stating, however, that the more insurers focus on scale, the more likely that they will incur underwriting losses (meaning that the insurers will not have generated ‘profitable’ premium).

L&A Insurers

The negative impact of scale is minimal for life insurance policies and annuities because L&A insurance companies have the Law of Large Numbers to use in addition to each L&A insurers’ own mortality and morbidity statistics and trends. L&A insurers, using these capabilities can create models that have a high level of confidence predicting how many people (and more specifically their clients) will live during the year and also predict when death claims will occur. Still, even in this market, L&A insurers need to to take care of the situations that are not candidates for simplified/accelerated underwriting (i.e. for those prospective insureds who don’t need a medical because of age, face amount of policy, or other factors).

The negative impact of scale is more apparent for life insurers selling Short-Term Disability (STD), Long-Term Disability (LTD), and Long Term Care (LTC) insurance policies are not in the same situation: these life insurers need to develop strong models to create predictions regarding occurrence – and cost – of claims. Mortality and morbidity statistics and trends obviously are in play in these markets. But so are a panoply of costs associated with delivering healthcare and physical rehabilitation. Scale is definitely not a desired attribute of STD, LTD, or LTC sales.

P&C Insurers

The P&C insurance market, whether personal or commercial P&C insurance, is where the Frankenstein Monster of scale can truly run amok. I believe this holds true in the:

• personal lines P&C insurance market
• small commercial P&C insurance market
• mid-size commercial P&C insurance market of corporate clients that do not have risk managers or only have CFOs that are not experienced in purchasing commercial P&C insurance.

In the above three P&C insurance markets, insurers must manage the attraction of scale by continually honing their insurance firm’s risk appetites. This means that P&C insurers must focus their underwriting skills on prospective clients by creating policy ‘conditions’ (encompassing terms, conditions, and restrictions) that stipulate what exposures are covered (and not covered) and selling the policies at actuarially-sound rates (that comply with insurance regulations, of course).

Technology Applications

The insurance industry is essentially an industry comprised of a portfolio of processes to get-and-keep customers. There never was a time in the history of the insurance industry when the industry didn’t use technology applications to support each insurance firm’s processes.

There are a myriad of ways to discuss the technology applications used by insurance firms. One path is to discuss the technology applications used to support not only the processes that insurance firms use to operate but also the technology applications that support the activities within each process. Another path encompasses selecting important business objectives of each insurance functional area / department and discussing the technology applications used to support those business objectives.

For the purposes of this post, I will use a ‘systems’ perspective and discuss a few of the applications of technology in each of the ‘systems’ (note that the first three are interdependent customer / market-facing systems while the fourth system that is ‘horizontal’ in that its spectrum of initiatives support – or should support – every insurance process):

• Systems of Record: The technology applications include those supporting the business objectives of quoting / rating, underwriting status / final decision, policy administration, billing, and claims management.
• Systems of Customer Engagement: The technology applications include those supporting the business objectives of customer service, customer communication (using both analog and digital pathways), marketing campaigns, cross-sell / up-sell initiatives, and customer satisfaction programs.
• Systems of Broker Management: the technology applications include those supporting broker calendaring/client appointments, broker training, broker pipeline management, broker / client communication, broker / insurer management (including campaign management), insurer downloading / certification requests, and broker productivity / profitability management.
• Systems of Decision-Making: the technology applications include those that support determining the effectiveness of marketing campaigns, measure agent/broker productivity or profitability, predict customer life-time value, predict probable maximum loss (by customer, by market segment, by …), and model the potential premium flows from entering new markets or creating new products for existing markets.

Insurers should not use either Amazon’s or Netflix’s business model …

Finally, I’m at the point in this post where I can repeat my answer of ‘no, insurers should not use either Amazon’s or Netflix’s business model’ and offer my reasoning. Without the discussion above, albeit a very lengthy discussion, I didn’t feel right about offering my reasoning to my response.

Based on the above sections on business models, Amazon, Netflix, and the insurance industry, my reasoning for my answer to my post’s title in the negative is based on my opinion that:

• Amazon’s and Netflix’s Business Models are built to quicken the sale of commodities.
  • Insurance is not a commodity. This holds true for every line of insurance.
  • Insurance, in several instances, is a legally required product (personal P&C insurance) or an expected product (commercial P&C insurance) or is just good sense to purchase (individual L&A; Group Life) to manage/mitigate the continually changing risk landscape to support people’s or company’s financial expectations or well-being.
• Amazon’s and Netflix’s Business Models are built to enable and amplify scale.
  • Scale is an enemy of insurance companies. In almost every insurable situation, insurers must apply stringent and high-quality underwriting skills to ensure profitable premium.
  • While algorithms and models can be, and should be, used to assist insurance product development, sales, customer service, and claim adjudication processes, those algorithms and models must take into account that “one size does not fit all” and need to be tuned to meet the profit requirements of each insurer and to meet the changing regulatory requirements in each jurisdiction the insurer and each of its distribution channels conduct insurance commerce.
• Amazon’s and Netflix’s Business Models are built to accommodate speed, particularly the speed of customers using mobile devices.
  • Speed, like scale, can be an enemy of the insurance industry. Although not discussed in this post, settling (either personal or commercial lines) P&C insurance claims quickly (within seconds or nano-seconds) can be a wonderful recipe for fraud.
  • Speed of bringing new insurance customers onboard can also be a serious problem. Insurers must strive for quality underwriting (to generate profitable premium). Can that be done with algorithms? Yes. But the algorithm (besides needing to be approved by insurance regulators in every jurisdiction the insurer wants to operate) should be personalized to each prospective customer and continually changed for new products, enhancements to existing products, and to meet changing regulatory requirements.
• Amazon’s and Netflix’s business model support of new products and services is primarily hampered by having the funds to create the new products and services. Netflix, specifically, is funding their Netflix Originals with long-term debt.
  • New insurance products and services have several hurdles to get to market, other than having the requisite funding, including at a minimum: ideation process involving participants from multiple departments, actuaries creating the actuarially-sound rates (and reserves and surpluses), getting legal approval, training agents / brokers, training customer service representatives, creating claim adjudication practices, creating the requisite IT support, determining the amounts of ceded or assumed reinsurance if applicable, and getting insurance regulatory approval.
  • I am definitely not a financial analyst but I’m not sure how well the philosophy of loading up on long-term debt to bring new products to market would appeal to insurance company executives.
  • Moreover, there is the reality that insurance is ‘not a book or a movie or a household appliance.’ It is a necessity (legally required in some instances) to mitigate or manage the risks to people’s lives, property, future financial requirements, actions, and behaviors. (Put another way, no-one is holding a gun to any person’s head and mandating that they use Amazon or Netflix.)
• Both Amazon’s and Netflix’s Business Models include Recommendation Engines enabled by machine learning.
  • In the insurance industry, the insurance agent / broker serves as a “recommendation engine.” Slower than an algorithm obviously, but a repository (hopefully) of the products and services that the various insurers s/he does business with that would be appropriate for the client. However, it would be helpful if insurers could create and provide machine-learning recommendation engines for their agents / brokers to use before or during an agent or broker’s sales meeting with prospective clients.
  • One issue for insurers going forward is to decide where (which could be either an algorithm or an agent/broker) they want to put the legally-required insurance regulated skills and knowledge to conduct insurance commerce. Of course, insurers and the distribution channels know they have to have continual training and certification for each insurance line of business they want to sell in each jurisdiction. If the human is entirely replaced with an algorithm, that algorithm has to be continually retuned to meet insurance regulatory requirements.

Thoughts? Comments?