Non-specialists rarely think about insurance in their day-to-day life. Most people don’t interact much with their insurer, unless they have a claim — the industry actually has one of fewest annual customer touchpoints.
Yet, insurance is one of the largest industries in the world, with global annual revenues north of $4.75 trillion, including more than $1 trillion here in the United States. And since most of the world is still uninsured, opportunities for growth are significant.
Over the past few years, the industry has been undergoing a transformation – one that is necessary and will have significant impact on the way it operates, its customers, and who the sector leaders will be 10 years from now. More on that in a moment, but first let us review some of the basics of insurance.
The underwriting/asset management equation
The traditional insurance business model for many years was to select risks and charge adequate premiums – a process called underwriting – that will provide a reasonable net profit. Careful liability management was such that underwriting profits were common for property/casualty (P&C) insurance in the U.S. before the 1980s; 40 of the 60 years before 1980 were profitable.
But over time, competition and regulatory pressure, as well as too much unmanaged risk-taking focused on short-term volume growth versus value, changed the landscape. The underwriting part of the P&C insurance model has been mostly losing money for the decades that followed the ‘80s: not a single underwriting profit year was recorded from 1979 through 2003 here in the United States. This is not to say that every insurer had underwriting losses year after year, but altogether they did.
So you might wonder how this can be sustainable. The answer lies in assets under management. When an insurer collects a premium, some of it is invested. If investment returns are good enough, they exceed underwriting losses, leading to overall profits. In other words, underwriting losses had been manageable thanks to high investment revenues. But this model has been challenged in the 21st Century.
Two drivers of change
First came a series of catastrophes that impacted underwriting results — think 9/11 terrorist attacks, Hurricane Katrina in 2005, the Japanese tsunami in 2010, Thailand floods in 2011, Superstorm Sandy in 2012, pandemics, technological disasters, geopolitical risks, and increasing number and scale of cyber-attacks, to name just a few. In fact, the average annual cost of natural disasters around the world increased more than 300% from $46 billion over the period 1980-1985, to $188 billion for 2011-2015. And the cost inflicted by cyber-attacks globally is now higher than of natural disasters (although most of it remains uninsured, as of yet).
No wonder that extreme weather events and cyber-risks were two of the top risks in the Forum’s 2016 Global Risks Report. The occurrence of many more “tail” events have triggered a renewed interest in better selecting what risks to insure, under what conditions, and at what price. Moreover, in a fast-changing and highly interdependent environment, risks are becoming more interdependent too, and new risks are emerging, making assessment by traditional actuarial approaches more challenging, if not inappropriate. The past alone cannot predict the future anymore.
The other game changer for many insurers came, more abruptly, with the 2008 financial crisis. It significantly destroyed asset value and led to numerous regulations. Combined with a stagnant low interest rate environment, many asset managers, including insurers, are unable to achieve the investment returns they once enjoyed.
The underwriting/asset management equation, so central to the insurance model, has to be rethought. In other words, insurers need to design and implement strategies that will help them measurably improve underwriting performance again, meet evolving demand and create value.
New strategic thinking towards better risk selection
This new reality has triggered fresh thinking and innovations at a pace that the industry has probably not seen for a long time. Large insurers, typically the incumbents, are challenged by newcomers who want to disrupt the market with new technologies, and are backed by venture capitalists. The word InsureTech, recently coined, refers to technologies and platforms that optimize insurance operations. Last year marked a substantial shift: investment in insurance tech reached $2.65 billion, reflecting the growth happening in the start-up arena for insurance technology.
Large insurers are engaged in an important transformation as well. For instance, American International Group (AIG)’s new chief underwriting officer for its large commercial-insurance unit is not a trained underwriter— he is a data scientist, signifying a sweeping change in the industry. The soon-to-be new CEO of the large French insurer AXA has also publicly stated that improving usage of data and developing predictive analytics will be key to improving risk management practices, strategic decision making and competitiveness.
We are now seeing more companies spending a fair amount of time and money upgrading their risk selection processes, from improving their understanding of their maximum exposure to extreme events around the world (direct, business interruption, contingent business interruption), to extracting information from decades of claims data and combining those with other sources of knowledge. More firms are also moving to directly empower consumers along their insurance journey, rather than relying solely on agents and brokers and on a single annual renewal touchpoint.
More granular, just-in-time and agile risk knowledge is pushing the transformation further
The increasing role of technology is helping insurance companies make smarter assessments of risk and helping their clients be safer, too. The technology is able to aggregate and combine data in a way that is accessible 24/7 and easily understood by busy decision makers. After all, people expect companies like Amazon, Expedia or Google to respond to multiple queries at the speed of light these days. We are all getting use to this “right now” mentality.
One of these start-ups, Maptycs, for instance, has developed new high-performing geographic information systems allowing users to collect and analyze a vast amount of data in a user-friendly, mobile compatible platform. One can now geo-locate and calculate exposure to different types of risks for more than one million physical assets on the planet. Ten years ago, it may have taken a week or more for a team to generate that information. Today, this is done in less than five seconds.
Recent developments are such that any authorized employee can now use a smart phone to receive alerts should certain risks materialize or in a few clicks to perform pre-programed analyses on exposure for all or part of the insured portfolio, and immediately share results.
Digitization progress makes complex analyses and stress-tests of insurance portfolios much easier, reduces operation costs and human biases, help tailor investment in risk management activities, price the risk more granularly and transparently, improve product design, all positively impacting delivery and performance.
This regained emphasis on liability management is true for property/casualty and was shown in recent McKinsey studies (the “Journey” white paper series) to be a key differentiating factor of success in life/health insurance as well.
The ongoing rejuvenation of the P&C industry has started to show results. 2013, 2014 and 2015 were three consecutive years of underwriting profits here in the U.S for the first time since the early 1970s. We will have to see if these results will hold in the face of future catastrophes.
Beyond insurance, risk and resilience are now in the boardroom
The new normal — increased recurrence of severe extreme events of all sorts, growing uncertainty, intensifying regulation, low interest rates impacting asset management, different consumer expectations, better use of modern technology and the quest for resilience— has obviously a much wider impact than just on the insurance industry. As one good barometer, the World Economic Forum annual meeting in Davos earlier this year devoted a large number of sessions to these very issues.
My Wharton colleagues Howard Kunreuther, Michael Useem and I have recently conducted interviews of executives, CEOs and directors of the board of 100 firms in the S&P 500; replicated by colleagues in Germany as well, the research findings confirm that the risk management and resilience landscape is fundamentally changing — how it is performed, by whom, and its increasing importance in C-suites and boards. Once seen as fairly technical and dry, it has now become strategic, and more fun to work on.
Meanwhile, the gap between the top performers who have embraced change and executed on it, and those who have not, is widening.