Foreword
The insurance industry was already in the midst of vast changes brought upon by regulatory changes, technological innovation, shifting customer demands, climate change, demographic shifts etc. The crisis brought about by the COVID-19 pandemic has only increased the vulnerability of small to medium sized players. Companies that fail to adopt are likely to see falling sales/profitability or, in extreme cases, even failing to survive. Historically insurance companies have taken a traditional approach and have been slow to adopt changes. However, many companies in this sector including carriers, brokers and other supporting providers have realized that the current changes are seismic and the status quo will not work in the changing world. Many have embarked on transformational projects to redesign existing products/channels/services, and also looking to introduce new ones brought about the increased digitization of all stages of the insurance lifecycle. This was already a trend but has been exacerbated during the pandemic. There are also start-ups that are seeking to leverage new technology to change the way insurance is designed and sold. The following are some of the visible and imminent changes taking place and need to be addressed by companies in the sector.
Acknowledgment: The following article leverages information contained in various resources provided by Chartered Insurance Institute and other resources available via Insurance portals, but is original in its presentation and format. The aim is to consolidate key information gained from readings and seminars to highlight the opportunities and risks affecting the insurance sector.
Sri Krishnan, ACII (Chartered Insurer)
Regulation
Following the financial crisis of 2008, there have been landmark changes in regulation, primarily aimed at the banking sector but also the financial services sector as whole including insurance. These affect many areas of the insurance operation including capital adequacy framework, market structure, accounting etc.
A big challenge for insurers is the current low rate of return on investments. This is exacerbated with the new regulatory framework that places restrictions on the type and amount of investments that can be made.
Insurers will have to deal with the implementation of Solvency II amongst other regulatory changes. Pressures on compliance and risk functions will remain high and these need to be addressed in conjunction with business process changes.
International Financial Reporting Standards (IFRS) 17 will dictate the way insurers manage the liabilities on their balance sheets. Further, establishes the principles for the recognition, measurement, presentation and disclosure of insurance contracts within the scope of the standard. This includes insurance & reinsurance contracts an insurer issues and also the reinsurance contracts it holds. The objective of IFRS 17 is to ensure that an entity provides relevant information that faithfully represents those contracts. This information gives a basis for users of financial statements to assess the effect that insurance contracts have on the entity’s financial position, financial performance and cash flows. This is complex regulation and will have a strategic and operational impact on insurers and it is set to come into force for contracts commencing on or after 1st Jan 2023 (as per recent deferral).
Insurance Distribution Directive (IDD) will introduce new standards on insurance firms to improve the quality of information provided to consumers. This aims to improve the transparency across the distribution, but will require additional disclosure from the carriers. The regulator continues to prioritise the registration requirement for insurance intermediaries and particularly the conduct of business rules, such as those on conflicts of interest and (pre-) contractual disclosure requirements.
Solvency II
- Balanced updating of the regulatory framework The regulators’ proposed changes in several areas but with balanced overall impact on insurers. This reflects the fact that Solvency II is overall working well.
- Recognition of the economic situation In particular the persistence of low interest rates and the emergence of negative interest rates. The regulator recommended provisions for the risk of interest rate changes.
- Regulatory toolbox completion Including better protection of policyholders via tools, recovery and resolution measures and insurance guarantee schemes.
Regulation of cybersecurity risks will continue to evolve and there is already a requirement that firms take appropriate security measures to protect against cyber risks and report serious breaches to national authorities within 72 hours. Firms failing to meet the reporting will be subject to penalties of up to 4% of revenues apart from the possibility of lawsuits.
On the favourable side, initiatives on insurance linked securities via special vehicles that can be set up will help insurers. These allow issuance of financial instruments which can be sold to investors and whose value is triggered on the basis of an insured event. The special vehicle will help insulate the financials of the parent company, thus opening opportunities for UK insurer to compete with the expanding new centres such as Bermuda, Dubai etc.
Apart from the known regulatory changes, the fallout from Brexit and its regulatory impact is not known. While it is expected that there will not be any major changes to regulatory framework in the short term, there is uncertainty on the medium or long term. However, the current presumption is that any changes that will be made will only be to lighten the regulatory burden on UK insurers/distributors to make the industry globally competitive, especially in lines in which UK has been losing market share.
Post COVID-19 pandemic risk
COVID-19 has fundamentally changed a lot of facets of life in the medium term and it is predicted that a fair bit of that will continue in the long term. Besides the short term financial impact on insurers from increased claims and reduced premiums in certain lines of business, the long term effect of the pandemic on the insurance industry cannot be underestimated. Some of the ways the insurance industry would be impacted are –
Regulatory scrutiny: There has been an increased focus by the regulators in the way the claims are handled and paid, the handling of customer communication and fairness and the impact of the insurers on the wider economy. Further, the risk controls, business & financial health of the insurers, checks against fraud etc are under increased focus.
Policy Wording: There has been a lot of litigation based on the wording of policy leading to questions on the validity and causality of claims. It started off in the B&I space but will certainly extend to liability, D&O and other policies. For eg – one of the key questions will be the definition of the ‘event’ that triggered the loss.
Shared Risk: As is present in the case of terrorism & catastrophe risks (eg Pool Re), the pandemic has highlighted the need & benefits of sharing risks between private and public sectors in the case of pandemics and may even extend to areas like cyber.
Insurance lifecycle: There will be positive and negative impact throughout the insurance lifecycle from the type of risk an insurer is willing to undertake, the premium charged for the risk, the capital requirements for holding the risk on the books, the investment decisions made in light of changes in returns, the remote handling of claims, changed customer perception and expectations etc. While some of this will be more pronounced in the short term, it is no doubt that a lot of that will have an impact in the long term too.
The pandemic has certainly accelerated the development of digital distribution channels.
Technology has proved its worth in the face of COVID-19, enabling the insurance industry to transition to home working and digital placements swiftly and smoothly. This shift in working patterns has altered attitudes and eased previous reticence in the industry to adopt tech led services, resulting in interest in insurtech rebounding.
Impact of telemedicine: The COVID-19 pandemic is likely to accelerate the demand for telemedicine services given its enormous advantages. However, with the adoption of any new technology health care providers should consider whether using telemedicine as an alternative to in-person care could expose themselves to medical malpractice claims. The increase in telehealth consultations has the potential to result in an increase in claims, particularly against GPs who are often relied upon to diagnose serious conditions from non-specific symptoms.
Cyber security
The threat from cyber attacks is not only growing, but also mutating into new and insidious forms, say risk practitioners. There have been numerous examples of breaches of security and this has only been growing in frequency and impact. A recent example of theft is from Tesco Bank customers’ accounts following a data breach. Further many of the incidents are not reported publicly due to fear of negative publicity or copycat attacks.
Under the European Union’s forthcoming General Data Protection Regulation (GDPR), which came into force in May 2018, financial organisations face fines of up to 4% of their global annual turnover for data privacy breaches. Under GDPR, for example, Tesco Bank’s fine for its data breach could have been as high as £1.9 billion, according to some estimates
Cyber security threats are much more complex to deal with compared to traditional forms of threat. This is because the technology is changing rapidly and insurance companies may not be able technically savvy to appreciate it. The threat can also stem from any part of the globe instead of the localized threats that companies have had to hitherto secure against. The threats are also originated at different levels – from maverick lone hackers, to corporations and in some cases even governments.
The financial sector has been one of the most targeted industries, alongside healthcare. This stems from the size of the organizations, the publicity gained by targeting them and in some cases the political views held against these institutions as they are taken a symbol for modern capitalism and been a target for that reason.
Cyber threat will only grow in scale and implications. Due to the complexity of thwarting these threats, experts believe that these cannot be eliminated and hence a tiered approach should be taken by stakeholders in minimizing, mitigating and absorbing these risks based on the risk appetite of companies. However, the industry will have to work closely with technology providers in identifying and quantifying these ever changing risks and a holistic risk management approach should be taken to ensure that it is highlighted at the right level of all organizations. Group claims and class actions flowing from data breaches will only increase going forward.
Finally, there are implication on non-cyber policies to shoulder liability arising out of cyber related risks. Eg Directors and officers will face increased exposure for cyber related incidents
Sharing Economy
Increasingly, people are open to the idea of sharing their underutilized assets for additional income. Collaborative consumption including ride sharing / office sharing (esp as an effect of the pandemic) / home rentals etc. add opportunities and risks to insurers. The pandemic will shift this paradigm in both ways. The sharing economy has some unique characteristics, requiring rethought to the traditional products brought out by the insurance industry. This presents tremendous opportunities yet comes with enhanced risk, especially as the industry is in the process of gaining maturity. The understanding of the potential risks involved and the pricing of the risk is far more complex when compared to insuring traditional products. Given the short duration of the product, the loyalty of the customer could be limited. This could potentially increase the claim ratio as the customer is less likely to build up discounts based on longevity. Thus the traditional approach to quantifying this risk needs to be reconsidered.
Social Media
Growing use of social media and validation of identity based on that has allowed vetting of potential customers on a private basis. The use of social media has also allowed of pooling customers that are more likely on a similar profile, thus enabling to price risk more easily. This also allows insurers in targeting customers more accurately.
It can help insurers to personalize the communication (e.g. based on location, preferences identified via cookies etc.). The customer is also more likely to interact with the insurer more frequently, given the ease of the medium. This will allow for further cross and up selling to the customer base.
InsurTech
It is used to cover many concepts but on a basic level, it is the combining of insurance and technology functions to provide a better customer experience. The advancement of technology has impacted many spheres of life, however insurance has hitherto not been at the forefront of technological adoption. This is fast changing with the advent of start-ups that use technology to provide innovative service and products. Insurance is based upon analysis vast amounts of information, analysis and processes, all of which can leverage technology. Hence it is certain the big changes are forthcoming in the Insurance sector.
InsureTech encompasses various segments, but 3 key ones that are likely to play a key role are:
1) Internet of Things (IoT) – IoT is a web of connected devices, machines, people and organizations which will have a profound impact on the insurance industry. This will impact the way insurers traditionally conduct business as underwriting can be tailored down to individual customers based on their behaviours, by opening up communication channels between customers and the carrier leading to a collaborative approach to risk management with the aim being to reduce losses rather than meet claims.
2) Artificial Intelligence (AI) – Insurance can leverage AI and other cognitive technologies in many ways including automating increasing number of repetitive tasks, solving problems, analysis of vast quantities of data, decision making etc. Chatbots can interact directly with customers using natural language reducing human interaction and errors. A key application will be the analysis of claims data to aid fraud detection and prevention. Machine learning will be able to leverage existing and incoming knowledge to speed up all aspects of the insurance cycle thereby providing efficiency and better customer experience.
3) Blockchain – It is a decentralized ledger of all transactions in a network. By providing a shared record of transactions that is maintained by a network of computers, it can provide an immutable record of the transactions and a mechanism for all parties to access and agree on a transaction.
However, with Insurance companies not being technically savvy to keep up with the rapid innovation and pure play technical companies not having the full understanding of the insurance domain, it is likely that InsurTech will be an extension of traditional insurance companies and not entities on their own.
Autonomous vehicles e.g. self-driving cars
Self-driving cars could alter the landscape for automobile insurance completely. This will primarily be driven by enhanced safety due to technology. This has already been proven in limited automation (e.g. Autopilot on Tesla cars), with an estimated reduction of accidents by about 40%. Tesla has capitalized on this trend by providing insurance as bundle in the cost of the car in Asia. With enhancements of technology, the automation and safety will increase thereby reducing the need for traditional automobile insurance products. KPMG has estimated that the personal automobile insurance market could shrink by about 40% in two decades, thanks to increased safety.
However, self-driving vehicles can also open wide legal questions on liability when accidents do happen. As with any technical product, there are bound to be errors, however small they may be in number. Who will be liable in such cases – will it be the auto maker, the software provider, the provider of components or other stakeholders? That could lead to complex legal cases, especially if the malfunction causes knock on accidents.
Robots and Automation
Autonomous machines and systems, including robots are increasingly being used by companies to aid or augment human resources. This will lead to increasing exposure for liability due to technical issues or malfunctions. Insurance cover such as public liability, professional indemnity and property damage will still have to exist even if the insurance products have to be redesigned. The use of robotics within the medical industry has proved immensely beneficial, but is also prone to malpractice suits. This is especially the case in highly litigious societies such as the US. This has already raised multi-million dollar lawsuits against Intuitive Surgical, a leading manufacturer of surgical robots. As robots play an increasing role in complex medical and other procedures, so will the need for such insurance cover and a framework of rules for ownership of liability.
Climate change
Regardless of which side of the greenhouse gases debate one is on, it cannot be disputed that the frequency and scale of natural disasters is on the rise. The destruction caused by recent hurricanes in the Caribbean and the US is testimony to the awesome destructive power of mother nature and it is exacerbated by the increasing concentration of wealth and population in urban centres. Apart from the human tragedies and huge pay-outs, another implication from climate change is that it is challenging the traditional source of risk assessment which is based on historical information. As the weather patterns are changing rapidly and unpredictably, it poses a challenge in the quantification of risk by underwriters. Further, with the increase in geographical scale of the impact, insurers need to spread the risk even further to offset the claims against premium incomes.
The need for catering to extreme weather events will lead to an increase in forecasting & analysis (eg catastrophe modelling / analysis etc), mitigation (eg reinsurance), capital requirements (esp in light of increased regulation), education (both internally and to external stakeholders) and longer term planning.
Terrorism
The impact of increased global terrorism has had a profound impact on all stakeholders including customers of insurance. Terrorism has always been a risk factor to varying degrees in every part of the world. However, after the attack on the twin towers in New York in 2001, it has taken on an entirely new dimension. That event brought about approximately USD 30 billion of insured losses which much higher than even those suffered in the aftermath of hurricane Andrew. Hence the 2001 attacks have forced insurance carriers to completely relook at the maximum probable loss from a terrorist event. Like cyber-attacks, terrorism insurance also has unique challenges compared to traditional insurance. Some of them include –
Limited importance of historical data: analysis of past intentions of terrorists does not make their future thoughts more predictable. Ironically past events may be a red herring as the likelihood of terrorists attacking the same spot is less likely due to increased security, lack of the surprise element etc.
Lack of sufficient information: Some of the information affecting probability, risk etc. are classified making it harder for evaluation.
Interdependence: The factors affecting terrorism is not in the control of the insured. In majority of the cases it is external to the insureds capability. ie even if the insured invests in efficient security measures they may suffer losses due to an insufficient level of prevention measures taken externally.
Mergers & Acquisitions
The economic downturn and other factors such as political uncertainty, insurance deal activity in 2021 will be robust due to several factors:
- Premium rates are increasing and a more optimistic outlook for most lines of business will make stronger market players more likely to look for growth opportunities through acquisitions.
- The market conditions for insurers is improving which is attracting more capital into the industry. Additionally, the historically low interest rates will allow buyers to access capital cheaply to fund acquisitions.
- Insurers will benefit from a reduction in the regulatory and commercial uncertainty which resulted from the pandemic, which will allow for more focus on longer term strategy and deal-making.
- The pandemic demonstrated a need to increase the need to adopt innovation into business models and focus on a digital approach to customer experiences. This trend will encourage the acquition of small insuretechs by traditional insurers.
Conclusion
Although the above aims to provide aspects of tangible changes, there is also the intangible changes that must happen in the mind set of insurance companies. This includes a shift in focus from merely trying to sell more insurance products to the customer to taking a more collaborative role in helping the customer in minimizing risks and potential risks that could lead to claims. Ie instead of paying for an ambulance at the bottom of the cliff the companies must focus to identify potential falls and help the customer avert the fall by installing barriers etc. The revenue must be sought in helping minimize the claims and that should take a partnership model thus ensuring a win-win for the provider and the customer. Also, the traditional approach to marketing insurance has relied on the fear factor in the minds of the customer. This approach has resulted in a negative connotation and the industry must adopt a more positive message in highlighting the key role that it plays in society and enabling growth in economy.
