As insurers rush headlong into the digital scramble, they should keep in mind the proverbial iceberg. Not all the risks involved are strictly tied to the innovation itself. Certain ones are below the water level.
Insurers actively participating in the digital revolution have done so in a variety of ways: 1) innovation labs, 2) insurtech accelerators with external partners, 3) investments in insurtech companies, 4) purchases of insurtech companies. These are reasonable approaches for staying current and competitive. However, there are some caveats that should be heeded.
Insurance is not a simple business. Machines cannot be set to produce thousands of identical items, a sale is not final and competition is never at a low ebb. It is a complex business that relies on actuarial forecasting, capital models, complicated and multi-layered contracts, in many cases, and astute claims handling. Thus, companies must remain focused on the functions and metrics fundamental to the business, if they are to achieve good results.
Over the years, the insurance industry has adapted to paradigm shifts of all types, for example: 1) automation of internal operations, 2) agent/broker electronic interface, 3) paperless environments, 4) increased transparency with regulators and 5) product development responsive to new risks such as cyber or supply chain disruption. Now, creating new ways to interact with stakeholders digitally and developing products that are fit for purpose in a digital world should be within the capability bounds of these same insurers.
The caution is that insurers should not get so focused on their digital initiatives they lose proper sight of the basics of the business: underwriting, claims, actuarial, finance, customer service. Equally, insurers cannot lose sight of other disruptive forces in the environment such as climate change, terrorism and cyber threats.
See also: Insurtech: Unstoppable Momentum
A piece appearing on AIR Wordwide’s website written by Bill Churney asks “Have You Lost Focus On Managing Catastrophe Risk?” He alludes to the fact that catastrophes have been light these past 10 years, which may cause inattention, and that many new insurance staffers were not working when Katrina, Andrew or Hugo hit, thus have no personal experience to tap for handling sizable events. A lack of focus on managing catastrophe risk could be critically detrimental for companies. And although there is nothing concrete to suggest that insurers have lost such focus, the question underscores the possibility of attention deficits. The need for continuous and careful attention to the rudimentary aspects of the business cannot be dismissed, even if they may not seem as exciting or timely as digital inventions.
Within memory, there have been companies that allowed themselves to lose necessary focus. Some got so focused on mergers and acquisitions that core functions were not managed properly while the emphasis was on cross sales and economies of scale. Some got so intent on improving customer relations that business imperatives were ignored in favor of appeasing the customer, and some got so diversified that senior management did not have the bandwidth to manage the whole enterprise.
How can the 2016 results at AIG be explained? Could the more recent focus on divestitures, staff changes and cuts, a drive to return dividends to shareholders and the CEO’s reported concentration on technology have caused it to lose its once unparalleled focus on profitable underwriting, rigorous claims handling and product innovation.
With investments pouring into insurtech, it raises the question: What is left for anything else? Despite fintech investments starting to slow, KPMG reports, "There was a dramatic increase in interest in insurtech in Q3’16, and the trend is expected to continue. The U.S. was the top country in Q3’16 with 10 insurtech deals, valued at $104.7 million in total.”
These numbers do not capture the many millions of dollars that insurers are investing in insurtech activities internally, of-course. As mentioned above, they are spending money to create dedicated innovation labs and accelerator programs and to launch other types of speculative insurtech projects. Many older projects have become operational, including new business unit or company startups, the introduction of bots on company websites, telematics in vehicles, digitized claims handling...and the list goes on.
How does an insurer know when an investment in insurtech is enough or too much, thereby negating other necessary investments required by functions such as underwriting, claims or actuarial?
The caution is not about doing an ROI (return on investment) analysis for a specific project. It is about doing an ROI analysis for the portfolio of projects that are vying for funding vis-a-vis the need to keep the company solvent while maintaining progress with the digital strategy. The larger the insurer, the more used it is to managing multiple priorities and projects. For mid-size to small insurers, this skill may be less developed, and they may face even greater risk of getting out of balance.
Insurance is one of the few industries for which growth can be just as risky as no growth. Industry pundits have long claimed that new business performs about three points worse than policies already on the books. The difference between a company at a combined ratio of 99 compared with 102 can be quite significant. The causes for this phenomenon have to do with such factors as: 1) the potential for adverse selection, 2) the reason customers choose to change carriers and 3) the costs associated with putting new business on the books. These are not the only ones. It is harder for actuaries to predict the loss patterns for groups of customers for whom there is no history in the company’s database.
See also: Infrastructure: Risks and Opportunities
If the reason for investing in insurtech is to increase new business written, insurers should be cautious about how much and what kind of new business they will write because of their insurtech enhancements. To the extent that insurtech enables insurers to hold on to existing business, the outcome is less risky.
For example, it remains to be seen whether drivers who want to buy insurance by the mile are a better or worse risk pool than other drivers, whether those involved in the sharing economy, such as renting rooms in their homes, are more or less prone to loss than homeowners who do not rent rooms. Are small businesses that are willing to buy their coverage on-line likely to file a higher number of claims or a lower number compared with small businesses who use an agent? Do insurance buyers who are attracted to peer-to-peer providers have loss experiences at a different rate than those who are not attracted to such a model?
The march toward more digitization in the insurance industry will and must go forward. At the same time, insurers should be wise enough to realize and address underlying risks inherent in this type of aggressive campaign to modernize.