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Insurance companies, like all companies, are constantly looking for new ways to increase market share, boost profitability, and build competitive advantage. However, the insurance industry has lagged behind other industries in one noteworthy area. It has been slow to adopt and leverage the sustainable benefits offered by patents.

In recent years, however, we have seen a reversal of this trend. Insurance companies have begun recognizing the potential of a strong patent portfolio, and the use of patents in insurance is poised to explode.

Today, the most forward-thinking insurance companies realize that patents can both prevent competitors from copying their innovations and can maximize their return on investment for developing and marketing cutting-edge products and technologies. While insurance patents are still small in number, we are seeing sharp increases in the rate of patenting in all areas of the industry, including the property/casualty sector.

It is no wonder that insurance companies are investigating the untapped potential of patents. The financial implications of preventing competitors from copying an insurance product are enormous. To calculate these numbers, insurance executives need only select one insurance product that their company has created and that competitors have subsequently imitated, and then estimate the revenues that their competitors earned from the product.

If the inventing company had possessed a patent for the product, it could have licensed the patent to their competitors and received some percentage, typically around 5 percent, of the revenues. The company could have chosen not to license it to its competitors, maintaining 100 percent market share of a much smaller product market. Either way, the additional revenue resulting from the patent would have been substantial.

The majority of patents in the insurance industry are business method patents, or patents that cover new strategies for doing business.

Before 1998, business methods were not considered to be patentable. The State Street Decision in State Street Bank v. Signature Financial Group Inc., in 1998, opened the floodgates to patenting business methods.

This decision led to a huge increase in patenting in industries where a significant portion of the business is transaction or service-oriented. These industries include online businesses, financial services and insurance firms, and software companies.

Yet, controversy continues to surround the use of business method patents and their legality is being challenged in a number of places.

In February, in response to an appeal filed by Bernard Bilski, an inventor of a method for using hedge fund contracts to reduce the risk of price fluctuation for commodities, the federal appeals court announced that it will reconsider the State Street Decision. Bilski was denied a patent on grounds that his invention is simply an abstract idea.

The Bilski case allows the court to reopen discussions about State Street, as it attempts to stretch the definition of business method patents. If overturned, it could have a dampening effect on the issuance of business method patents, which account for the majority of the patents in the insurance industry.

However, since it is possible for insurance companies to get patents that are not considered business method patents, insurance companies should continue their patenting regardless of the outcome of the Bilski case.

PATENTING AND THE FUTURE

There are two basic scenarios for the future of patenting in the industry.

In the first case, patenting will continue to occur at low levels, possibly based on future changes in the patent rules related to business method patents, but primarily because the insurance industry will fail to enhance its understanding and use of patents.

In the second scenario, patent activity will ramp up quickly ? much like what has been happening in the financial services industry ? and significant opportunities,and also significant risks to insurance carriers.

Executives with responsibility for risk need to understand how the industry may change if patenting does become routine, in order to mitigate the loss of competitive advantage and market share. In addition, since the date a patent is filed is a critical component of how valuable it is, it is important for companies to start filing patent applications immediately, in order to make sure it has filed those patents before a competitor does.

While patenting is relatively new to the insurance industry, we can look to other industries to understand the stages that industry goes through when patents become more common. Those stages are patent litigation, exclusivity through patents, and patent licensing.

In the first stage, companies test the waters by developing a patent or two around new products. Other companies, not understanding the threat of patent protections, choose to conduct business as usual and copy the products. The initial company will then file infringement lawsuits.

Patent litigation is already occurring in the property/casualty industry, for example, with Accenture suing Guidewire in December 2007 for patent infringement on Guidewire's property/casualty and workers' comp claims software.

Based on our analysis and trends from other industries, many of these initial lawsuits will likely not settle, as the participants are not yet sure of the value of patents in the insurance industry. However, once those rulings occur, they will have a major effect on what happens in the industry.

If the rulings are in favor of the defendants, it is likely that insurance patent activity will diminish, at least for a while. If the rulings are in favor of the patent-holders, then they will serve as a wake-up call that patents can have a material impact on business.

Once galvanized by an infringement lawsuit, industry leaders will likely begin patenting with full force. In the first couple of years, this will lead to less competition for new products, as innovative companies defend their work with strong protections.

In turn, competitors will be hesitant to copy these patent-protected products and will instead focus on their own innovations that solve a similar market need. As a result of the increase in patenting in the industry, the innovators will enjoy longer periods of exclusivity, and the innovations stand to become more valuable. The rate of innovation in the industry will increase.

Executives, frustrated at not being able to copy their competitors' successful patent-protected products, will take matters into their own hands and forge ahead with the development of a robust insurance patent licensing industry.

It will soon become commonplace that large insurance companies will patent their large innovations, but then license those patents to their competitors. The savviest companies will begin developing inventions specifically to use as "trading cards" with their competitors to gain access to desirable patents that the competitors hold.

In this final stage of widespread licensing, the industry will, on the surface, look much like it did before patenting became commonplace. Some companies will be more innovative than others, but soon after an innovation is introduced, competitors will quickly follow with similar offerings.

However, in the new landscape--where strong patent portfolios are the norm--the innovative companies will be much more profitable, generating revenues not just through their own sales, but through a percentage of their competitors' revenues via licensing royalties.

Filing patents, licensing patents to competitors, and paying licensing fees for competitors' patents will soon become a basic necessity for large insurance companies. While patent protection, patent enforcement, and licensing fees will become a major expense items for most companies, the innovative companies will see licensing royalties as a major source of revenue.

The development of a strong market for licensing of insurance patents may also change the composition of the insurance industry. Company size and product/service distribution networks have always been key elements of success in the insurance industry.

However, in a world of patent licensing, small companies will be able to develop and patent innovations, and then license those patents to large insurance companies. Based on the receptiveness of the licensing transactions between large insurance companies and small insurance firms, large companies may be faced will a double-edged sword.

While a treasure trove of technologies and products may become available for license or purchase, key product-development employees may leave in favor of starting their own companies, similar to the trend seen in the technology industry in the late 1990s. Insurance companies will need to rethink its reward system for innovators to deter them from leaving.

Given that patenting may become a major force in the insurance industry, it is important through awareness, process development, planning, and patent development, for executives to make sure their company is prepared.

With this kind of preparation, carriers will be in a strong position should patenting become a necessity in the industry, while not having invested significant resources if patenting subsides.

RACHAEL SCHWARTZ is a senior manager and BEN TAYLOR is a senior associate with ipCapital Group Inc., an intellectual-property consulting firm in Williston, Vt.

July 1, 2008

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