Industrial Organization and the Consequences of Digitalization for the Insurance Industry

Introduction

The rise of big data, information technologies and artificial intelligence have led to a software revolution that significantly influences firms and industries. Artificial intelligence software may take over many functions resulting in automated pricing, risk assessment, inventory management etc.. Therefore, software devices collect, store and analyze massive amounts of data about customer behaviors, preferences, productivity enhancements, market trends and more. This data provides the company with valuable insights and allows them to capture critical advantages. However, to effectively exploit these advantages a firm has to adapt to the new settings which comes along with structural changes and other consequences. This essay tries to identify the consequences drawing on the example of the insurance industry. Here the information technologies may help to assess risks, remove uncertainties and assist the company in their decision making. Thus, the essay focuses on the aspects of decision making and internal organization. Further, the consequences for the insurance industry will be discussed. The essay is structured in four parts. At first, historical technological limitations and their impacts in the insurance market will be discussed. After that the advances in software, big data and artificial intelligence will be considered and opportunities for insurance companies will be shown. Moreover, the essay will discuss the impacts of these issues on the future of the firm. Finally, industry impacts will be considered. The research is based on secondary data from books, journals, newspapers and websites.

The Historical Origins of the Firm

The software revolution and technological developments come along with various advantages. However, before these advantages will be identified, the essay will discuss how technical limitations shaped the activities and the organization of insurance companies.

At first, without the collection and analysis of data through software and big data systems there was asymmetric information in the insurance market which influenced the decision making of the firm (Baye, 2008, p.453). An insurance firm had no chance to reveal hidden characteristics of potential subscribers, effectively prevent harmful behaviors of the policyholder after a contract was concluded or make reliable predictions (Tumay, 2009, p.107-112, Shani, no date). Thus, the decision making process of insurance firms were ineffective which could even result in market failures (Baye, 2008, pp.452-453). Thus, for example Cummins and Tennyson (1992) found massive increases in the car insurance prices in the 1980s. Insurance companies tried to deal with that issue. They used deductibles and co-payments to incentivize subscribers to avoid any damage (Tumay, 2009, p.111). However, with the rise of big data and information technologies companies started to mitigate or eliminate asymmetric information issues, as they could gain valuable insights and information concerning the policyholder's characteristics and behaviors (Tabarrok, Cowen, 2015).

Moreover, the lack of information and the absence of the technological development resulted in higher costs. A firm could not easily gather critical information, such as personal communication or characteristics, which clearly increased the search costs for insurance companies. Additionally, these information were not available in real-time resulting in a slower and less effective decision making (Einav, Levin, 2014, p.715). Further, according to Grant (1996, pp.117-118) a firm that serves many individuals like an insurance company has to deal with coordination and cooperation issues. As a solution firms used tall hierarchies to effectively coordinate the separated knowledge of the workers and increase the firm's productivity (Grant, 1996, pp.117-118). Garicano and Wu (2012, p.1382) argue that communication is a further mechanism to coordinate knowledge. The lack of digital communication channels resulted in higher costs of transmitting information to managers which ended up with an increase in centralization (Bakhshi , Bravo-Biosca, Mateos-Garcia, 2014, p.8). As you can see, without technological developments the communication, coordination, information gathering and analyzing were more difficult resulting in higher costs for insurance companies or lower performance in terms of unfair contracts.

Additionally, without the technological developments of today an insurance firm could not identify complex patterns or segmented variations (Einav, Levin, 2014, p.1243089-1). Especially for an insurance company it is important to be aware of regional variations. However, without the suitable technological devices a firm had no chance to recognize such patterns resulting in a higher chance of losses. Further, inefficiencies of manual work could also lead to losses (Neudesic, 2015).

As a result, the technological limitations resulted in several disadvantages for the insurance company, for example a lack of personalization, a lack of specific targeting, increased costs and inefficiencies in the decision making process (Gaitho, 2015).

Emerging Technologies and Opportunities

Without technological advances information about economic activities was scarce, but this has now changed (Einav, Levin, 2014, p.2). More and more firms rely on software, artificial intelligence and big data (Einav, Levin, 2013, p.3). Software advances allow firms to make use of big data and artificial intelligence and thus capture valuable advantages. Big data means massive data sets and has typically three characteristics (Oracle, 2014, p.3). The high volume of data that can be stored, the increased velocity of collecting and analyzing data as well as the high variety of data types that can be analyzed result in valuable insights and improved decision making (Laney, Lapkin, LeHong, 2013). Artificial intelligence systems profit from that increase in data availability. Machine learning algorithms enable systems to track complex patterns and make informed decisions (Manyika et al., 2011, p.29). Thus, several opportunities are emerging, such as a better informed decision making, valuable insights, automated processes, increases in productivity, avoidance of unnecessary risks, reliable predictions and many more (Laney, Lapkin, LeHong, 2013; Kiron et al., 2011, p.7).

There are several concrete examples in the insurance market. For example 'Climate Corporation' analyzes loads of data from weather measurements to make reliable weather forecast (Wikipedia, 2015-a). Additionally, the corporation offers automated and personalized insurance contracts against harmful weather to US-farmers (Wikipedia, 2015-a). Thus, the company uses technological advances and big date to make reliable predictions, to offer personalized contracts and to automatically pay out in the case of a claim. The firm 'Octo Telematics' collects data about the driving behavior of individuals through the 'Octo Clearbox' that is installed in many vehicles worldwide (Octo Telematics, no date). Thus, the company gains valuable insights and analyzes the collected data to offer personalized and fair policy contracts (Octo Telematics, no date). The 'Sprint Protect app' protects individual's data on their mobile phone and allows individuals to track their phone and lock or delete content in the case of a loss (Sprint, no date). 'Qualcomm' offers wireless telecommunication products and services to provide individuals with connectivity while coping with the massive amount of data (Qualcomm, no date). These examples show that technological advances come along with various opportunities that can shape the future of the firm.

The Future of the Firm

Firms may try to exploit the opportunities mentioned above resulting in competitive advantages (Manyika et al., 2011, p.6). However, in order to effectively use the technological developments the firms have to adapt to the new settings (Dapp, 2014, p.4).

At first, firms need to restructure their internal organization. The use of software and big data results in the collection of massive amounts of data that need to be processed, structured and analyzed in order to give the firm any advantage in terms of critical knowledge (Bakhshi, Bravo-Biosca, Mateos-Garcia, 2014, p.6). Thus, firms can be seen as information processors (Bakhshi, Bravo-Biosca, Mateos-Garcia, 2014, p.6). For example 'Octo Telematics' collects vast amounts of data about the driving behavior of their subscribers, but this information needs to be analyzed to give the firm the chance to exploit their knowledge. With this valuable insights the firm is able to offer personalized insurance contracts, overcome information asymmetry issues and base their decisions and management on critical data (Octo Telematics, no date). In light of this, firms have to adapt their internal processes, communication and organization to avoid communication or cooperation problems (Grant, 1996, p.117). Bakhshi, Bravo-Biosca and Mateos-Garcia (2014, p.6) argue that the investment in intangible assets will rise and advances in internal communication technologies will impact the costs of transmitting information resulting in changes in the firm's organization and decision making. Services like the 'Enterprise-Resource-Planning' (ERP) or the computer-aided manufacturing (CAM) will simplify the access to critical information leading to decentralized and flat structures as well as to a simplified management (Bakhshi, Bravo-Biosca, Mateos-Garcia, 2014, p.6). For example 'Qualcomm' collects massive amounts of data while reducing their costs of transmitting information within the firm resulting in a more efficient decision making (Qualcomm, no date). Further, the automating of processes will be an important part of a firm's new structure (Laney, Lapkin, LeHong , 2013). The real-time availability and analysis of data will result in automated decisions, cheaper distribution channels and predictions about future needs (Kiron et al., 2011, p.7; Laney, Lapkin, LeHong, 2013). Thus, the weather predictions from 'Climate Corporation' are based on real-time data to offer automated insurance contracts. Further, artificial intelligence and big data are used to assist a firm's decision making (Ogonowski, Latawiec, no date, p.197). Moreover, firms need to be aware of the reduced consumer search costs and the increasing impact of price advantages on market-shares (Bakos, 1997, p.23).

Further, with the collection and analysis of critical data firms can enhance their productivity, improve efficiency, avoid unnecessary risks and effectively monitor subscribers (Kiron et al. 2011, p.7; Manyika et al., 2011, p.7). For example, the 'Octo Clearbox', a devices that is installed in many vehicles, collects data about the driving behavior and skills of 'Octo Telematics' subscribers (Octo Telematics, no date). Thus, the firm can analyze critical data to gain valuable insights. As a result, the firm eliminates information asymmetries between subscriber and insurance company leading to an increase in customization and enhanced performance. The use of data to remove information asymmetries or monitor the post-transaction behavior of policyholders will be an important point in the insurance market.

Moreover, the technological advances provide the insurance firms with the opportunity for experimentation to discover new customer needs and segmenting individuals to tailor their services (Manyika et al., 2011, p.5). With the improved communication channels and the ability to collect and analyze vast amounts of data a firm can easily track regional variations and segment customers (Einav, Levin, 2014). Insurance companies can thus identify risk groups and account for regional variations. For example, 'Octo Telematics' can identify bad-skilled drivers leading to more expensive contracts for them. In the health insurance market segmentation can account for regional variations. An individual living in a big city may has to pay more than one living in the countryside. Further, experimentation can lead to the discovery of new needs, which can be served from the firm through individual contracts (Dapp, 2014, p. 4; Manyika et al., 2011, p.5). This could be done through interviews or online questionnaires.

As you can see, the technological advances are likely to influence the future of insurance firms. However, to capture the advantages the firms have to adapt to the new settings and be aware of negative influences on customers, such as privacy or security concerns (Manyika et al., 2011, p.11). Effectively used the technological advances can be the key to outperform competitors and succeed in the market (Manyika et al., 2011, p.6). The resulting impacts on the industry will be discussed in the following.

Industry Impacts

The technological advances mentioned above will have a significant impact on the insurance industry. At first, Kiron et al. (2011, p.3) argue that firms that effectively adapt and use the technological advances can exploit critical advantages and outperform their peers. Firms that fail to adapt or resist the technological developments are likely to be forced out of the market (Dapp, 2014, p.4).

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