At the dawn of the Internet consciousness (and in the heat of the IPO explosion), the insurance industry seemed ripe for the picking. The market itself is enormous by any measure and it is riddled with ubiquitous process inefficiencies that would make any red-blooded consultant drool.The market is extremely fragmented and populated by the purportedly sleepiest behemoths on the face of the financial services industry. Thus, it would seem that a nimble Web-based company that could fundamentally improve the consumer experience stands to reap massive economic rewards.

Malls proves problematic

The first wave of online companies were the shopping/aggregator sites. These companies added value by aggregating information for consumers about a wide array of vendors. Consumers could then be referred to the underwriter of their choice to continue down the path toward full coverage, with the aggregator earning a fee.

This referral model revealed some characteristics of the nascent online insurance market. The models provides value to both consumers and to carriers. Insurance companies can have a presence on the Web much sooner than they could have on their own, and hopefully develop a new source of consumer leads without offending the hand that feeds them-the agents.

However, all that glitters is not gold. In practice, the "hand off" of the consumer to the carrier proved more difficult than imagined. As any good customer-service provider knows, controlling the consumer experience is vital to success. Regardless of who deserves the blame for the botched handoff (the carrier or the referring party), the consumer loses. And in the Age of Instant Gratification, that does not fly.

Early players in online insurance also faced a tough challenge in that they were striving to build a brand for a product that requires a tremendous amount of consumer trust. Although there is some brand leverage by advertising the well-known carriers in the online mall, building an online insurance brand has proven to be difficult and expensive.

Past, present and future

The teething pains of the early online insurance industry have driven three major themes.

Referral models get an overhaul. Existing online-based referral model companies are realizing the importance of being able to bind a policy online and are, thus, adapting their models to become online agents. We believe these companies will continue to feel heat from both public and private investors until they can demonstrate that they have successfully made the change by delivering attractive operating and financial results.

Incumbents counterattack. Having learned many initial lessons from participating in early online marketplaces, incumbent carriers have moved aggressively. They have revamped marketing efforts to emphasize their "human" component, but have also accelerated online efforts. However, the traditional carriers are not being forced to navigate the Web by themselves. Technology enablers such as Inc. and InsLogic Corp. have popped up to ease the pain of this transition.

Next generation start-ups are more robust. At this point, we consider it highly unlikely that the venture capital community will fund pure referral-based models in the insurance market, having seen the challenges contained therein.

The next wave of start-ups has more ambitious plans. Specifically, new companies like eCoverage are aiming to deliver an online bindable product directly out of the gate.

Those that successfully leverage technology to drive fundamental improvements throughout the process stand to build retail businesses that enjoy wholesale cost structures and, therefore, superior economic returns. Certainly, the brand-building exercise will likely still prove challenging, but we believe a fundamentally improved consumer experience should aid this process.

Matthew L. Vetto is a financial services analyst with Salomon Smith Barney, New York.

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