Travelers' New Challenge: Luring Consumers

Geico has its dapper gecko and brooding caveman. Progressive Corp. (PGR) has Flo, the chirpy sales clerk. And Travelers Cos. (TRV) has a … red umbrella?

Clearly, Travelers, a major player in commercial insurance and the newest member of the Dow Jones industrial average (its induction to the blue-chip benchmark was announced June 1 along with that of Cisco Systems (CSCO)) faces a marketing challenge as it tries to gear up its direct-channel insurance business to compete with Geico (a unit of Berkshire Hathaway (BRKA)) and Progressive.

It's likely that the property and casualty insurance company will have to endure an extended trial-and-error period—and spend lots of marketing dollars—before it strikes advertising gold, much like Progressive did before settling on Flo last fall, says Vinay Misquith, an analyst who covers the insurance industry at Credit Suisse (CS). (Without an army of agents to market policies, an engaging advertising hook is essential in the direct-channel insurance business.)

That will be a drag on Travelers' earnings for at least the next two years, Misquith estimates, and that could temper some of the enthusiasm around the company's stock, which on June 8 will join the exclusive company of Dow Jones components. In an ironic twist, Travelers will replace its former parent, Citigroup (C), from which it was spun off via IPO in 2002.

"It will be at least two years before [direct-channel insurance] starts contributing meaningfully to [Travelers'] bottom line," says Misquith. "It's hard to know how much of a drag it will be" over those two years or to what extent that's already being reflected in the stock price.

A Safe-Haven Stock?

And as one of the more financially robust insurance companies, with none of the exposure to investment leverage that's forced so many life insurance and financial-services companies to write down asset values over the past 18 months, Travelers in some ways might be viewed as "a bad investment on the thesis that people are looking for companies that will rebound" from the financial-system turmoil, says J. Paul Newsome, an analyst at Sandler O'Neill & Partners in Chicago.

Indeed, Travelers shares are down almost 20% from the beginning of 2008, vs. an 82% plunge in Hartford Financial Services Group (HIG), not to mention the destruction of 97% of AIG's (AIG) market capitalization during the same period. Travelers shares closed nearly 3.1% higher, at 41.91, on June 1.

"It's relatively cheap. If you're looking for a company that has the ability to rebound sharply because of the financial markets, this is not it," says Newsome. "If you're looking for a company that's a safe haven, this is it. A lot depends on how paranoid you are [about] the financial markets and the stock market in general."

While the company isn't straying from its stable business strategy, it will incur much higher expenses as it tries to build its direct-channel marketing of personal auto and homeowners' insurance. Insurance providers can save a lot in overhead costs and agent commissions by selling directly to consumers via phone, mail, or Internet, but they need "serious economies of scale" to be profitable at it, says Newsome, He hopes to learn more about how Travelers plans to do this at the company's Investor Day on June 4.

Commission Savings, Marketing Costs: A Wash?

By switching part of its business to direct marketing, Progressive has avoided paying initial agent commissions of 10% to 15%, or renewal commissions when policies are extended. But it's hard to gauge exactly how much it's saving after its marketing expenditures, says Misquith at Credit Suisse.

Ten years ago, when its direct-channel business was small, Progressive's expense ratio was 20.7% in its agency business and 38.5% in its direct business, due to hefty spending on ads while in startup mode, he says. Last year, its expense ratio was 21.4% for its personal-line agency and just 20.5% for the direct channel.

"As you build scale, [direct marketing] is a much better business to be in, but of course you will be spending much more up front," says Misquith. Besides advertising, Travelers will have to spend money to build a servicing platform, based on a call center operation. Since the company already has a fairly good claims management system, that shouldn't be too hard to set up, he adds.

What may prove more tricky is the thin line the company has to walk in dealing with its independent agents so they don't feel slighted. "Agents don't want to be seen as secondary to the direct-channel [business]," says Misquith.

One advantage that Travelers has over Progressive is that Progressive sells only personal insurance products, and took a chance that its independent agents would drop the company when it added its direct-channel business, he says. Travelers is more insulated from that kind of threat because most of its business consists of its commercial product lines.

Travelers' personal insurance segment generated $154 million in operating income in the first quarter of 2009, vs. $547 million generated by its business insurance segment and $148 million by its financial, professional, and international insurance segment.

Direct Channel Has Room for Growth

Although market share in direct channel has grown fairly quickly, to 12% to 15% of the total personal insurance market, for some reason it hasn't caught on nearly as much as in other countries such as Britain, where it now accounts for most of the market, says Newsome.

But there's no question in Misquith's mind that it's the wave of the future and that Travelers is smart to move in that direction, however steep the initial climb to competitive scale will be.

The key will be building brand recognition, and that's more than just a logo, like a red umbrella. Progressive's new ads with Flo talking to motorcycle and boat enthusiasts are a hit. "People like Flo, therefore they'll buy the auto product for that reason," says Misquith.

Perhaps Travelers could leverage the name recognition of such bumbershoot-wielding characters as Mary Poppins, or even Batman's arch-foe, the Penguin.

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