In today's rapidly evolving insurance industry, data is the lifeblood that fuels business growth.

Insurers must harness the power of data and analytics to inform decision-making, drive innovation and maximize competitiveness. Embarking on the journey toward data modernization is therefore essential to staying ahead -- or just keeping up -- and a well-defined data and analytics strategy is a critical first step.

See also: 6 Steps for Cultivating a Data Culture

Building the Foundation: Strategic Alignment

The strength of any data and analytics strategy depends on alignment with the overarching business strategy. Without such alignment, it can be challenging to secure funding and assemble the right resources to drive data modernization. Insurance companies must clearly demonstrate how prioritizing and investing data and analytics capabilities translates into tangible benefits for the organization and serves several key purposes:

• Drives profitability: The insurance industry is inherently data-centric, and optimizing data's potential to achieve business goals can provide a competitive edge. By ensuring a clear path to desired outcomes, insurers can identify areas that require investment, engendering confidence in the decision-making process. Furthermore, emerging trends can be identified early, enabling the company to stay ahead of the curve.
• Maximizes efficiencies: Often, insurance companies focus too much on accessing data and building data infrastructure and not enough on developing insights. Shifting to a results-oriented focus on actionable insights can dramatically improve efficiency by identifying resource-intensive processes, removing bottlenecks and embracing a source-of-truth philosophy to ensure data accuracy.
• Manages costs: The adoption of cloud infrastructure can help reduce run times, improve technology management and consistency and lead to substantial cost savings. Real-time cost monitoring provides transparency and allows for dynamic adjustments to resource allocation, enabling cost-efficient utilization.
• Increases innovation: By leveraging cutting-edge data and analytics techniques, insurers can develop new processes, enhance their capabilities and use novel data assets. Innovation should not be pursued for innovation's sake, but always directed toward the organization's business strategy and long-term goals.

Moving Forward: Next-Generation Data and Analytics

After establishing organizational alignment around strategy and securing corresponding investments into platforms, processes and people, insurers are equipped to modernize their data and analytics programs. This modernization includes three primary elements:

• Shorter analytics platform lifecycles: The modern data environment demands a shift in expectations regarding platform lifecycles. Instead of expecting systems to last for decades, organizations should plan and invest for three to five years to allow for agility and quick adaptation to emerging technologies. This requires developing clear definitions around the purpose and interaction points of these platforms, as well as driving business requirements for enhancements.
• Third-party data integration: The integration of third-party data is becoming increasingly critical. It is essential to create an environment for managing external datasets and connecting them with internal ecosystems. This includes addressing legal considerations and ensuring that data acquisition strategies benefit multiple functions within the organization.
• End-to-end business process integration: Above all, a data and analytics program needs to work, so ensuring interoperability between systems is vital. This involves driving platform uniformity, addressing delays in data flow, enhancing security and clarifying data ownership models across the entire data lifecycle.

See also: Why Becoming Data-Driven Is Crucial

Progressing Prudently: Data Management

Data management underpins the effectiveness of any data and analytics program. While embracing a new era of data-enabled products and processes, insurers must ensure they proceed prudently, giving due attention to data governance, ownership and ethics:

• Data governance: Effective governance is the cornerstone of data management and ensures compliance with internal, regulatory and contractual requirements. Using systems that enable data usage and lifecycle management is crucial for maintaining data quality and integrity and compliance.
• Data ownership: This should be approached strategically, starting with user access management and documentation of roles, responsibilities and data flows. In applying the enterprise governance and ownership model locally, mid-level managers play a vital role in translating enterprise expectations to make them more consumable for local users and in line with regulatory and contractual requirements.
• Model ethics: Ethical considerations should be foundational to any model. As data sources continue to expand and analytics become more advanced, it is paramount for insurers to develop and adhere to enterprise model ethics guidelines that are aligned with their values and goals.

Conclusion

For today's insurer, data modernization is no longer an option but a necessity. It starts with a well-crafted data and analytics strategy -- rooted in business objectives, driven by updated processes and systems and supported by sound data management. By constructing a well-defined strategy around these pillars, organizations can navigate the complex terrain of modernization and position themselves at the forefront of the industry's data revolution.

Climate change is altering the frequency and severity of extreme weather events such as wildfires, floods and windstorms. Over the last few years, it has become increasingly common for insurers to adjust catastrophe model output to reflect these changes, driven in part by new regulatory requirements. 

While most of the focus has been placed on methods for adjusting frequency-severity relationships, little attention has been given to scenario completeness, particularly in the tail of the distribution, where some of the most severe impacts are expected to materialize. As a result, insurers could be underestimating the physical risks to which they are exposed.

See also: How AI Can Help Insurers on Climate

The dominance of short return periods

When it comes to physical climate change impacts on the insurance industry, one of the most cited research papers is Knutson et al. (2020), which presented a synthesis of the expected changes in global tropical cyclone activity for a 2°C warming scenario. Many insurers have used this paper as a basis for adjusting the frequency and severity of tropical cyclones in catastrophe models to quantify the effects climate change could have on insurance claims. 

But if you have ever applied the Knutson et al. frequency-severity adjustments to a catastrophe model, you might have noticed something that at first seems counterintuitive: After the correction, short return period losses tend to increase more percentage-wise than those in the tail of the distribution. Figure 1 shows the impact of a 20% increase in the number of Category 4 and 5 landfalling hurricanes in a U.S. tropical cyclone model. The largest effect is seen near the bottom of the exceedance probability (EP) curve, with a 15% increase at the one-in-two-year return period loss. In comparison, tail losses around the one-in-200-year return period only increase by 5.5%.

The reason for this inconsistency is simple: Short return periods compose most of the loss distribution, so adding in events fattens this portion of the EP curve the most. In a 100,000-year simulation, for example, 90% of the years are at or below the one-in-10 return period. This means that if a new event is included at random, it has a 90% chance of being added to a year at or below the one-in-10.

This effect is counterintuitive because we know that the upper tail of the distribution is likely to contain some of the most severe physical consequences of climate change, particularly under higher emission pathways. Does it, therefore, stand to reason that the percentage increase in tail return periods should be lower compared with shorter return periods? What could we be missing from our scenarios that explains this?

Figure 1: The percentage change in losses for a 20% increase in the number of Category 4 and 5 landfalling hurricanes in a U.S. tropical cyclone model

Unquantified tail risks 

As Nassim Taleb has written in relation to financial markets, traditional models do not handle fat-tailed events well. This limitation means that important things are likely to be missing from the view of risk. The same is true for traditional catastrophe models when it comes to climate change: While frequency-severity distributions can be conditioned for various climate states, they underestimate the true tail risk, especially when we start to think about things like tipping points, feedback loops and systemic risks. 

This is not to diminish the usefulness of catastrophe models. They combine detailed hazard modeling, engineering knowledge and information on exposures in ways that other tools, such as climate models, cannot. However, just as insurers evaluate and quantify non-modeled risks today, for example under Solvency II, they need to deploy the same thinking and methodologies when it comes to climate change adjustments and scenarios. 

For example, traditional risk assessment methods often focus on a single hazard at a time, but research indicates that the likelihood of hazards co-occurring – such as extreme winds and precipitation – will increase in a warmer world. An increase in cross-peril correlation will lead to increased tail risks, but most insurers are not currently considering this possibility in their modeling. 

There is also mounting evidence that some tipping points, such as the collapse of ice sheets or the melting of permafrost, may be triggered at a global mean temperature of 1.5°C. Such events would have far-reaching ramifications, with severe consequences not just for the insurance industry but society as a whole. The world is expected to reach 1.5°C at some point in the 2030s, meaning some of these fat tail outcomes could be closer than many realize.  

In addition to these direct physical risks, there are also several indirect effects that are frequently overlooked, including supply chain disruption, food insecurity, geopolitical conflict and infrastructure failure. All of these have the potential to manifest as systemic effects, which will stress global economies. 

See also: Glimmers of Good News on Climate (Finally)

Climate Amplification Factors

The breadth and complexity of climate change tail risks mean that careful consideration is required when incorporating them into our modeling. In some situations, it will be possible to explicitly simulate the effects within existing frameworks – for example, cross-peril correlations can be included in simulation-based capital models. However, it will be more challenging for other risks, particularly those with socio-economic and systemic components.

Fortunately, there is an analogue in current catastrophe modeling frameworks when it comes to representing socio-economic factors that are difficult to quantify: post-event loss amplification (PLA). PLA is applied to the most severe events, such as Hurricane Katrina in 2005, to account for a range of complex tail sources of loss, including economic demand surge, long-term evacuation and systemic economic problems. 

The same approach could be used to model climate change tail risk using “climate loss amplification” (CLA). The more severe an event, the larger the CLA factor, reflecting the increasing likelihood of socio-economic effects materializing, such as geopolitical conflict and infrastructure failure.

When you next think about building or updating your climate change scenarios, remember to consider not only how to best adjust frequencies and severities but also the completeness of your risk assessment.

What does it take to protect our communities and build a safer world?   

Climate change, natural disasters and other factors elevating property risk worldwide are driving action across society, whether from governmental agencies, technology leaders or property insurers. Groups vary in their approach, but they share a goal: to build resilience on a global scale. To reach this goal together, we need to have honest, open conversations about our new normal – particularly how insurers can work to secure the safety of future generations.  

The Formula: Survivability and Recovery 

There are two fundamental components to resilience. The first is survivability. If severe weather hits a property, what will the damage be and how can it be minimized through specific physical design improvements? The second is recovery. When a property is damaged, how difficult is it to rebuild in a timely manner?  

To answer these questions, insurers are starting to pay attention to government initiatives, IBHS quality standards and innovations in AI to tackle resilience. Close collaboration with both public and private sector groups will be key to build resilience in our cities and neighborhoods.

Survivability and recovery are complex issues that require both government intervention and capital incentives. One obvious approach is to construct buildings with damage-resistant materials, such as hurricane-proof glass and fire-resistant insulation.  

Groups such as the National Association of Home Builders and the Federal Emergency Management Agency (FEMA) have compiled a litany of recommendations based on the latest developments in sustainable and resilient construction. However, these materials tend to be marginally more expensive and largely are not mandated. Additional efforts are needed to encourage the application and adoption of resilient construction techniques, particularly as pan-global re-insurers are seeing the benefit of construction quality indexes. 

One way to accomplish this is to modernize building codes and fast-track accompanying permits where construction is aligned to mitigation designs. A recent FEMA study shows that updated codes have saved the U.S. over $1.5 billion in avoided losses annually since 2000. Naturally, part of this effort will depend on direct government action.  

The Biden administration, for example, recently earmarked over $200 million to update codes and provide incentives for sustainable construction. That being said, the government's influence over building codes is limited and piecemeal at best. It is often easier to establish incentive structures than to enforce strict state-wide mandates. In other words, it is carrots and not sticks that will move the needle on property resilience in the U.S. This is an area where insurers have a unique opportunity to drive influence by insisting on greater resilience. 

See also: Empowering the Underwriter of the Future

Encouraging Resilience 

The model for encouraging resilience has long existed in the insurance industry. Auto owners with a track record for safe driving can obtain discounted rates; primary carriers can improve their reinsurance premiums by mitigating the level of risk exposure in their book. Encouraging safer property construction with mitigation strategies from IBHS and others is no different. All it requires is that insurers resolve to become active promoters of resilience. Take the collaboration between the state of Queensland, the Commonwealth Scientific and Industrial Research Organization (CSIRO) and the insurer Suncorp as they adapt for wildfire in Australia. 

Opportunities to collaborate present themselves throughout the policy lifecycle. When writing new business in hazard-prone regions, insurers can leverage new technologies (such as computer vision and machine learning models) to precisely determine structural vulnerability based on factors like tree overhang, roof condition and age and wildfire defensible space. They can then offer policyholders a choice: Eliminate the risk drivers for a better premium or do nothing and remain exposed. If insurers put in place consistent incentive structures through AI-based learnings, the market will naturally encourage more resilient construction, leading to less costly losses. 

Beyond new business, insurers should take advantage of the recovery and claims process to build resilience. This shift in mindset is already starting to happen. Historically, insurers have responded to loss events by returning a property to its pre-damaged condition. But in an increasingly risky world, this may no longer be the best option.  

Instead, insurers should motivate policyholders to rebuild stronger properties using the latest, damage-resistant materials and design techniques that increase robustness and meet the new building codes for natural peril. It may seem counter-intuitive to say insurers should put more money into replacing damages than was actually lost. However, by expanding the classical concept of indemnity to prevent future damage, insurers will end up saving more on avoided claims in the long run.  

See also: The Biggest Opportunity for Innovation

Actively Promoting Resilience 

Whether it’s through legislation or technological advancements, the intensity of human capital working tirelessly across the globe shows there are pockets of hope. But they, and we, can’t do the work alone, as it requires a herculean effort across many fronts. We need greater collaboration at federal, state and municipal levels with the property insurers themselves. Conversely, property insurers will struggle to survive in the years to come if they don’t start promoting resilience today.  

Equally, as new communities are being built to cater to new lifestyle demands and promote climate adaptivity, insurers need a seat at the table to influence smart city planning. This collaboration is the change management of the future, and it needs to start now to have an impact. There are more reasons to do so than sheer altruism. Everyone, not just insurers, should be taking a pragmatic view. If properties aren't made more resilient, the cost of major loss events will increase exponentially. And if an insurer’s only response is to cancel policies en masse in high-risk peril regions, policyholders will lose their trust in carriers. 

KEY TAKEAWAY:

--Auto insurers are chasing rate increases -- but based on outdated models. SUVs are holding their value much more like trucks than like cars, so traditional models don't reflect the value at risk with the current auto fleet, and consumers are buying lots of them, so their share keeps growing.

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A funny thing happened on my way to Japan (courtesy of an untimely layoff). I spent the Monday before the Tuesday morning flight from Los Angeles to Tokyo doing a “Marty” and tailgating at the fall meeting of the Casualty Actuarial Society (CAS) at the Westin Bonaventure Hotel & Suites. 

A “Marty” in this respect is showing up in the public space around an industry event and connecting with friends and new contacts – a handy way to network while unemployed and off the corporate expense account. (I do get clearance to pop in informally – a nod to the decades of presentations I have made at these types of gatherings.)

Two years prior (almost to the day), I addressed a crowd of executives at the American Property Casualty Insurance Association (APCIA) meeting on customer satisfaction, empathy and of course, risk-based pricing. The economists at the Bureau of Labor Statistics (BLS) had recently adopted a new method to generate insights on the cost of vehicles – new and used. The method was a seeming sea change from economic tradition of trended attributes over time, to a very modern and big data approach that sampled actual sales transactions. While the BLS techs cited a variety of data sources they could use, they affirmed that data from J.D. Power was their current source.

In a whirlwind 24 months, I took a crash course into all things automotive, and here in my 25th month I am sharing how to apply my newly gained knowledge into the 25 years of insurance analytics I've witnessed since moving from healthcare to P&C back in 1998. Far from this being a soliloquy, I have had literally dozens upon dozens of conversations with actuaries, product managers, data scientists, executives, vendors, competitive researchers, consultants, industry analysts and regulators.

Here is where things are…and likely what’s next.

See also: Automakers Build New Insurance Future

The Value of a Vehicle Has Lost Meaning

In the lobby of the Westin, I held court at breakfast tables and at the lobby tables – those floating by the central coffee bar and the ones on the other side by the pseudo-café near the rideshare rally point. Chief actuaries, CAS dignitaries, session speakers and a raft of long-tenured attendees variously stopped by, including a bunch of colleagues from my ISO days (2006-2014), many of whom have found leadership roles both at and beyond ISO.

Restless quarters of broad-based rate taking had started to improve loss ratios. Progressive had just posted a great third quarter and was expected to begin to grow again (on purpose) soon. Investments were contributing to improving loss ratios, as well. But there was a definite “something missing.” Some explanation was needed for why everything done so far was still largely not enough, especially for physical damage.

The ”I told you so” temptation was palpable, but being out of work did temper my flair. Instead, I walked folks through the presentation I made the Friday before -- “Collateral Valuation Risk,” at the Model Risk Managers’ International Association Summit on Best Practices. 

The data explaining the value at risk for vehicles was at odds with current pricing practices developed using decades of experience. At the heart of the issue – the SUV. 

This style of vehicle, the SUV, acts like a truck for holding its value longer than cars, and it also dominated all new vehicle sales in recent years. The change in product mix was blowing up historical trends, and then the pandemic magnified the effect in every possible way – used values, replacement values, trim and option upgrades and “above MSRP” sales across the country. 

Existing "set it and forget it" valuation methods used a traditional two-step pricing classification for physical damage base rates: (step 1) MSRP Base Price New and (step 2) the staid and systemically used Year-Model Factor tables. This process had never seen a body style product mix shift like the rise of the SUV in the prior 50-plus years in use.

What Goes Up Stays Up

While there is no doubt added turmoil when mixing in electric and hybrid power trains and all sorts of ADAS technologies, the simple value of the subject at risk clarifies why base rate bloat is not improving things as hoped. 

The older vehicles in operation are mostly automobiles and are already at their lowest factor in the Year-Model Factor tables – both national tables and state-specific tables level off near the 30% of base price new figure. Increasing premium on those vehicles by a large percentage is offset by its small marginal contribution. On the other end of the spectrum, newer SUVs were retaining value and even selling above asking price. So, eight out of 10 newer vehicles broke ranks with cars, and the value of the subject at risk was much higher than historical Year-Model Factors.

We don’t need slide rules and integral calculus to figure out that when the value of what is being insured goes way up, the price to risk should, too. Comically, the consumer interest in more trucks (SUVs) triggered this outcome – the pandemic, ADAS, supply chain and the EV things are just normal, and abnormal, cyclic happenings.  

Risk Management Opportunities in Auto Insurance

Risk-based pricing practices have evolved to deepen the segmentation of both the risk of a risk and the value of a risk.  Pricing accuracy may improve along perils, coverages and loss costs and be associated to the changing value of the subject at risk. That is, except for standard personal auto insurance, where the traditions for valuation of the subject at risk have left the industry too inflexible to deal with changing times and changing consumer choices.

Most important for current and future pricing issues is that the change over time of consumer appetite for brands, body styles and optional features means that the mix of vehicles in operation and their loss-cost dynamics cannot fit into inflexible traditional processes.

See also: Crash Detection Will Transform Auto Claims – No, Really

Practical Advice Over Coffee and Follow-Up Calls

Many vehicles have wide dollar gaps between base configuration and “as built” configuration – meaning that on day 1 the insurance value is too low. As well, wide disparities of future values are found among brands, body styles and trim levels. What may make more sense is better alignment with “as built” beginning values for new vehicles and using actual cash values for similar “as built” used vehicles. You can still float a percent of “as built” rule for meshing in decades of prior premiums, but you need to get to current insurance-to-value levels for the policies in force today.

Rate-filing reviews across states and carriers conclude that in personal auto insurance the standard approach is to use easy-to-access estimates of base model new vehicle values (MSRP base price new) and then predict that all vehicles always get cheaper than that top value over time (a common Model-Year Factor curve regardless of brand or configuration -- body style, drive train, engine size, luxury upgrades or technology features).  

Sometimes the factor curve will vary by state versus a national curve to account for regional pricing economies, but each is monotonically descending and starts with the lowest MSRP for the vehicle in the make, model, year description. More granular uses of MSRP pricing are evident with the use of structured vehicle identifier number sequences, but the result is the same – none of the added optional features or "as built" features above the base price new are included in the value of the subject at risk.  

Both the value at risk and the risk of the risk are in flux with no clear end in sight. This makes old models and existing predictions sometimes unfit for use, while leaving new data and new models sometimes in the lurch while companies scramble to survive.

A mindful and auditable governance structure for analytics is emerging for next-generation models, yet more work needs to be done to transparently understand existing models and methods institutionalized over the last several decades.

Nick Lamparelli has been working in the insurance industry for nearly 20 years as an agent, broker and underwriter for firms including AIR Worldwide, Aon, Marsh and QBE. Simulation and modeling of natural catastrophes occupy most of his day-to-day thinking. Billions of dollars of properties exposed to catastrophe that were once uninsurable are now insured because of his novel approaches.

Insurance Thought Leadership:

What technology now in the market do you believe will have the biggest transformative impact on insurance and risk management in the next five years?

Nick Lamparelli:

I believe IoT and sensor technology is getting traction, and insurance has finally noticed. Sensors can do much around notifying when events are occurring or about to occur. These technologies will have the capability to reduce both frequency and severity of claims (significantly). These technologies make the insurer highly relevant day to day to the policyholder. Because of this, insurers can get more innovative around coverage design and user experience. Insurers that invest in embedding IoT stand to be seen through a different lens every time a notification on someone's smart phone tells them that "no water was detected" so they can truly feel at ease and get the sense that their insurance premium is actually doing something for them.

Insurance Thought Leadership:

What do you see as the biggest obstacles to insurance innovation, and how would you recommend overcoming them?

Nick Lamparelli:

The biggest obstacle is inertia. And inertia is a byproduct of culture. Many insurance organizations do not have the corporate governance that forces them to enact change (see the mutuals and farm bureaus). For many of these firms, only the cold hard reality of financial existentialism will force someone, anyone to make the changes that need to be implemented.

Insurance Thought Leadership:

What is an area that you believe remains untapped/unfulfilled/overlooked for the promise of innovation in insurance?

Nick Lamparelli:

Knowledge management. We spend way too much time looking for things: searching for files, attachments, emails, etc. Insurers have done a decent job digitizing, but it hasn't helped them because now they have a mountain of data and no ability to mine it. Knowledge management, including using AI technologies to make sense of that data, will be crucial and unveil a ton of insights into a company's own data sets.

Insurance Thought Leadership:

How do you believe AI will transform insurance and risk management?

Nick Lamparelli:

Aside from where it is used now (to detect fraud, mostly), I think AI in knowledge management will be the first big value-producing outcome of generative AI. (See my prior answer.)

Insurance Thought Leadership:

Climate risk is leading to more frequent and severe loss events and contributing to high premiums and insurers withdrawing from some markets. How do you see technology being applied to mitigate risks and improve resilience?

Nick Lamparelli:

First, the jury is still out on more frequent and severe events. I am not sure we know that as of yet. Second, it doesn't matter if the climate is or isn't changing. Mega weather events have always played a critical role in insurance and still do. Technology innovation in the engineering of extreme wind, flood and fire events are crucial to our resilience. We know how to build resilient properties, we need a supply chain and investment that can lower the costs so these technologies can get to more properties. Wind-resistant glass, roof protections, external mist sprinklers and flood gates are all expensive solutions, but they work, and I am confident that technology and innovation in the engineering spaces will drive down the costs of these things. I think insurance can play a critical role in encouraging that push by providing financial incentives so property owners want to invest in them.

Insurance Thought Leadership:

You’ve contributed a lot over the years to Insurance Nerds, which focuses on “Insurance, Careers and Technology.” Do you believe that insurance is becoming more attractive as an industry because of how it is leveraging technology to solve big problems?

Nick Lamparelli:

I do not think it's become more attractive. Young people don't know anything about insurance until they need to (usually when they buy a car or become an adult). By then, they see insurance through the various stereotypes associated with it, instead of the vibrant, fun and engaging career choice it could be. 

When I transferred to the Wall Street Journal's San Francisco bureau in 1996, the bureau chief had a story all lined up for me. He had sold the front page editor on the notion that Moore's law was dying. After decades during which the computing power of a chip doubled every year and a half or so at no increase in cost, the technology for etching devices on chips seemingly couldn't be improved further. 

Every reporter lives to be on the front page, and that was especially true in those days at the WSJ, where the stories in column one and column six (known as "leders') were the stars of each day's paper. But as I reported the story, I couldn't convince myself that Moore's law was dead. Yes, the current strain of etching technology was hitting the limits of physics, but there were other, albeit highly speculative, approaches that might lead to a breakthrough, and an entire industry needed to make one of them work. So I declined to write the story.

And I'm so glad I did. The question at the time was how much smaller devices on computer chips could get than a width of .35 micron -- already impossibly small, it seemed at the time. But breakthroughs in etching technology did happen, and the generation of chips that is now being developed will use 2-nanometer technology, a factor of 175 smaller. 

Imagine if I'd become known as the guy who declared on the front page of the Wall Street Journal in 1996 that progress in chip technology had stopped. Because chips are two-dimensional, that 175-fold improvement in each dimension means today's chips can contain 175 times 175 as many devices on the same-sized semiconductor. That's an improvement by a factor of, oh, 30,625. 

There's been talk for the past few years that etching technology has, in fact, gone as far as physics will let it and that Moore's law is finally and truly dead. But the MIT Technology Review's annual look at the year's breakthroughs suggests chip technology will continue to improve at a furious pace, to the benefit of the insurance industry and our many customers.

I always enjoy the annual review because it stretches me beyond the sort of thing I typically think about. For instance, this year's list of the top 10 technologies covers: the James Webb telescope, which is peering more deeply into the universe than I ever thought would be possible; the ability to analyze ancient DNA to see what it tells us about our origins; and mass market drones, which are changing warfare at least as much as machine guns did in World War I and tanks did in World War II. 

This year, MIT highlights some developments that have the potential to revolutionize healthcare. The article talks about "organs on demand" -- initially by growing organs in pigs for transplant to humans, and over time ending the need for human donors. The piece also describes the use of CRISPR, the gene-editing tool, to reduce cholesterol. This comes on top of the recent approval of a use of CRISPR to cure sickle cell anemia, suggesting that all sorts of diseases could be cured -- not just treated. (Jennifer Doudna, who won a Nobel Prize for the development of CRISPR, describes the potential here.)

But the development that most directly affects insurance is the one that MIT Technology Review describes as "the chip that changes everything."

The key is that progress can continue at great speed even if the basic chip-making technology stalls. We've already seen the potential with AI. ChatGPT and other large language models are possible because specialized chips, initially designed for graphics for computer games, have turned out to be some 100 times as good at AI as general-purpose processors. In other words, with zero improvement in the underlying technology, we've still had a 100X improvement for a specialized, very important purpose.

MIT says that kind of improvement is now available to just about everybody because of a free, industry-standard tool that lets anyone easily design a chip for any purpose. Even if progress does finally slow on the basic technology for chips -- 30,625 times beyond where it was when I was encouraged to declare it dead -- we've just begun at optimizing the technology for the uses that matter to us.

Cheers,

Paul

KEY TAKEAWAYS:

--If you look at Lemonade as a way of examining what insurtech approaches are working and which aren't, you see that everyone, including incumbents, must use data and technology for risk selection, pricing accuracy and automation. Most have already started.

--State Farm's vision abut a platform play and the smart home strategy represents an area that is frequently ignored and could be fertile territory.

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In the 2023 third quarter, Lemonade showed:

• Losses: $62 million loss this quarter (about 10% less than in the previous two quarters), and only $6 million of cash burned from operations (after the $97 million burned in the last two quarters)
• Top line: $213 million written in the quarter (17% more than the previous quarter and 22% more than in the '22 third quarter) and almost 78,000 customers added (highest increase since Q3 '21, without considering the Metromile acquisition)
• Sales and marketing: The top-line growth has been achieved by investing $24 million, which is 11% of the written premiums. In Q3 '22, marketing expenses were $33 million (37% of premiums).
• Loss ratio: 83% (the lowest since Q3 '21)
• Other expenses: 35% of written premiums (the best level since Q3 '21)

We are still talking, though, about a gross combined ratio of 129%.

After an eight-year journey that has burned more than $1 billion, with many seasoned insurance executives hired, these results are the bare minimum that we should be able to expect. But I'm actually more interested in observing their insurtech approach and understanding if there is anything they are doing that can be relevant for the insurer of the future. Moreover, is there anything they're now doing that incumbents have missed?

See also: Insurtech Startups Are Doing It Again!

Why am I more interested in the insurtech approach and tools, instead of the venture per se? Because I'm advising on innovation at insurance incumbents -- 10 of the top 25 global P&C insurers currently are members of the IoT Insurance Observatory -- and each day I'm discussing the future of our sector with them.

Let's look at the key insights from an article I just wrote with a State Farm executive:

• "State Farm envisions a future where virtually everything within the sector is interconnected based on the belief that a platform-based approach to insurance is the best way to capitalize on the availability of data and create a seamless customer experience."
• "State Farm is looking to reinvent the insurance industry once again, by leaning into a model that doesn’t just price, protect and recover. State Farm is proactively seeking ways to integrate experiences and predict and prevent loss."
• "Connected cars, connected homes and connected self are at the heart of this vision for the future. State Farm is committed to progressing in these spaces as it looks toward the next hundred years of industry leadership."
• "State Farm is keen on the smart home and what it means for the carrier’s business. [...] In this scenario, the execution of a thoughtful smart home strategy may not be a nice-to-have goal. Rather, it may be essential to remain competitive."
• "Smart home technology has the potential to forge novel homeownership experiences and strengthen customer relations. This constitutes a relevant motivation for embracing IoT in the realm of home insurance."
• "Central to the State Farm vision for smart homes is the aspiration to transition from recovery to the ability to help predict, intercept and prevent losses, relying upon products like ADT and Ting. [...] State Farm harbors the ambition of preventing 20% of losses related to fire, water and theft (which account for approximately two-thirds of all homeowner insurance losses)."
• "Insurers with the ambition to remain relevant must possess the capability to master connected platforms, specifically those related to IoT."

See also: Lemonade's 'Synthetic Agent' Nonsense

Haven't you started yet your smart home insurance journey? What are you waiting for? 

Now, let's observe Lemonade's journey and its insurtech approaches.

At the outset, Lemonade was all about charity giveback, behavioral economics... and storytelling. None of these has made any dent in their insured risks and has yet to disrupt any segment of the insurance market.

I remember a discussion at a roundtable at the 2018 Annual North America Re/Insurance Conference where I challenged this storytelling, asking if Lemonade really believed that fewer people would submit a claim because there was this charity giveback mechanism.

However, this nonsense has progressively faded in their storytelling and even in the premiums (last year, less than two cents for each dollar of premiums went to charity).

Here is what I said in the first edition of this newsletter: "the insurance professionals - who have fallen in love with their disruptive storytelling over the past six years - should feel a little betrayed."

But let's talk about the current storytelling. There is an interesting interview by @Neil_X10 that covers the key areas they're betting on. (You can enjoy the full two-hour interview here.)

Basically, the issues are risk selection and pricing accuracy. I think everyone in the insurance sector agrees.

Less agreeable is the comment from Lemonade's CEO about being able to "predict risks in ways that incumbents cannot for structural reasons." Well, U.K. personal line carriers (incumbents!) have mastered for years targeted advertising to drive risk selection, and Progressive (incumbent!) has built its journey on superior segmentation and pricing accuracy in the U.S.

The ability to attract and retain good risks doesn't yet seem like an actual Lemonade capability... it's more of an ambition.

I think everyone in the insurance sector agrees even on the need to improve efficiency, applying automation in customer support and claims. It would be difficult to find an incumbent that is not working on applying AI to these processes.

Looking at the current level of expenses (other than marketing and sales), Lemonade doesn't seem efficient (yet), and it has not improved over the past three years even if the size of their business in 2023 increased more than three-fold compared with 2020.

See also: AI and the Future of Independent Agents

Efficiency seems more like an ambition for Lemonade, not a reality.

The current Lemonade's insurtech approach makes much more sense than back in the day, even if they seem far from delivering it.

Using data and technology for risk selection, pricing accuracy and automation is a must for the insurer of the future. But there is consensus around this, and a large part of the incumbents all around the world have already started investing in it. 

State Farm's vision about the platform play and the smart home strategy represents an area that is frequently ignored (or denied after some first rough and unsuccessful attempts), and it is a fundamental area for any personal line insurance carrier in the future.

IoT is a necessary capability, not a nice to have!

KEY TAKEAWAY:

--What's needed is a radical rethink of what is possible. How do we use the home's existing shutoff valve, thereby eliminating the need for the redundant shutoff valve in cut-the-pipe solutions? How do we detect water flow from outside the pipe, thereby eliminating the need for cutting the pipe to insert a flow meter?

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There are a wide variety of home water leak mitigation solutions available today, and yet none of these products is widely deployed, and home water leak losses continue to increase. The reason?  Except in certain special cases, insurers are not seeing a compelling return on investment. 

The return on investment for a water leak mitigation system is primarily determined by two factors: the total cost of the solution (i.e., device cost plus installation and monitoring cost) and its overall effectiveness in reducing claim payouts (i.e., percentage reduction in claim indemnity).  

Total cost for a specific water leak mitigation product is relatively easy to determine. Effectiveness is much less clear. However, water leak mitigation products differ dramatically in effectiveness based on a single functional difference: Does the product automatically shut off the water in the event of a leak, or does it only warn the homeowner of a possible leak? 

Everyone knows at least one home water leak horror story (in many cases, the stories are personal!). A backed-up toilet, a burst washing machine hose, a busted water heater – the list is seemingly endless. However, if you stop and think about these stories, virtually all of them share a trait: The occupants were either asleep or out of the house when the leak occurred. 

For this reason, insurers have found that water leak loss mitigation solutions that automatically shut off the water are far more effective in reducing claims than systems that only warn homeowners of a possible leak. (It can be many hours or even days before homeowners who are away or asleep act on, or even become aware of, a leak warning). Limited published reports from insurers suggest that the effectiveness of products with automatic shutoff capability are 60% to 80% effective in reducing claim payouts, while products that only warn are 15% to 35% effective.

See also: Key Learnings From Winter Storms

The chart below models how total cost and effectiveness affect the rate of return to an insurer for investment in a water leak mitigation product. (The model assumptions are based on reported U.S. industry-wide averages.)

A key observation from this model is that the rate of return for an investment in water leak mitigation product declines exponentially as total cost increases. However, while low total cost is obviously critical, lowest possible cost alone doesn’t yield positive returns; a $100 total cost product with 30% effectiveness generates negative returns.  

The above model is simplistic and omits many details. Nevertheless, it’s easy to see why existing water leak mitigation products don’t make economic sense for the broad home insurance market. Products that warn only are less expensive ($100-$300 total cost), but given their limited effectiveness, they are unlikely to generate a reasonable return (the return for a $200 total cost, 40% effective device is negative).

Products with an automatic shutoff generally require cutting the main water pipe. For this reason, these products, while more effective, are much more expensive ($1,000-$2,500). Even with very optimistic assumptions (80% effectiveness, $600 total cost) the return for a cut-the-pipe automatic shutoff is negative.

One strategy that does work is to deploy cut-the-pipe automatic shutoffs in very-high-value homes that have a much higher average loss per claim. Chubb reports that their average water leak loss per claim is $50,000. With this average loss per claim, the model shows that a cut-the-pipe automatic shutoff with a $1,000 total cost and 70% effectiveness generates a three-year IRR of 19% – reasonable cost and effectiveness assumptions yield an attractive return for high-value homes.

See also: How to Minimize Fraud in Disaster Claims

Clearly, what is needed for mass market deployment of water leak mitigation devices is a breakthrough technology that combines the effectiveness of current cut-the-pipe automatic shutoffs with the low total cost of systems that warn only. The model shows a $250 total cost, 70% effective automatic shutoff installed in an average home (i.e. average loss/claim = $12,500) generates a three-year IRR of 10% -- about the same as a $1,200, 70% effective cut-the-pipe solution in homes with an average loss/claim of $50,000. 

We need to reduce the cost of cut-the-pipe automatic shutoff functionality by at least a factor of five. How do we get there? We will not get there by reducing costs for cut-the-pipe solutions. The devices themselves are not susceptible to cost reduction because all components in contact with water must be strictly controlled so there is no possibility of contaminating home drinking water. Furthermore, the installation cost for cut-the-pipe solutions is increasing, not decreasing, because the hourly cost for plumbers is going up. 

"Think Different" was Steve Job's approach to solving problems like these. What's needed is a radical rethink of what is possible. How do we use the home's existing shutoff valve, thereby eliminating the need for the redundant shutoff valve in cut-the-pipe solutions? How do we detect water flow from outside the pipe, thereby eliminating the need for cutting the pipe to insert a flow meter? One key insight is that the core loss mitigation functionality of cut-the-pipe solutions is to make sure that water doesn’t flow continuously for too long; measuring gallons-per-minute is irrelevant to loss mitigation. 

Smart home and home security companies are constantly developing innovative new home IoT products. Why haven’t these companies recognized the need for innovation to address home water leak mitigation?

These companies develop products to sell to homeowners. Homeowners are motivated to buy today’s home IoT products for safety and convenience. Water leak mitigation products enhance neither safety nor convenience. Smart home and home security companies have learned from bitter experience that there is very little homeowner demand for water leak mitigation products.

Insurers have been waiting for the silver bullet to magically appear. They must recognize that the water damage innovation drought will end only if they take actions and adopt policies that promote investment in the development of innovative new products that generate positive returns for both the product developers and the insurers.

"Everything you've told me is very interesting, Mr Robert. But apart from that, what are your values?"

This was the question asked by the AXA recruitment manager after letting me spout off for 20 minutes. The year was 1991, and I was 27 years old, three of which had been professional.

"What kind of question is that? He hasn't said a word the whole interview, so is he just leading me gently toward the exit, or what"

Go for introspection, then: I talk to him about ambition as an individual driving force, about the need for it to converge with a collective goal and therefore about loyalty to the team. And that's when the recruiter comes to life, gives me a boost and challenges me. After 30 minutes of this game, the interview comes to an end.

"We'll keep you posted," he said.

On my way back to the waiting room, I picked up a leaflet about AXA's values. It talked about ambition, team spirit, loyalty and realism.

I thought, "In the end, I didn't do so badly."

A few weeks later, I received a job offer from AXA and another from the No. 2 company in the French market. I remember my meeting with my potential future boss at the other company: He was negotiating my salary demands by telling me about the great rates at the company restaurant!

See also: The Broad Reality of Diversity

So it was AXA, then only the fourth-largest French insurer but with teams united by a common base:

• The tutelary figure: Claude Bébéar ("CB"), who -- with a civil engineering diploma in his pocket -- joined an obscure provincial mutual insurer in the late '50s and rose through the ranks to take over the reins some 15 years later.
• A founding myth: a seminar in the Ténéré desert in 1985, during which the directors of the mutual company decided to create the AXA Group.
• A crazy goal: in 15 years, to turn just another French insurer into a world leader.
• The grit of the challengers: at the beginning of the '90s, to accomplish in less than two years the merger of five insurance organizations with 16,000 employees, to redeploy them by distribution channel, to adopt a single brand whose name means absolutely nothing but can be pronounced in all the countries where the group will be established.
• A decentralized organization, designed for growth: only a few key functions are centralized -- equity, brand, executive management, financial reporting, IT and data infrastructure. The rest is in the hands of the business.
• The logo, in the form of the pin that we wear: It immediately identifies us when we turn up at industry professionals meetings. The "Axiens" (give or take a letter, are they aliens?) hunt in packs.

Why all this? To illustrate that a company's culture is not a collection of mantras to be displayed as posters. Or, to be more precise, while mantras and posters may have their place, they mean nothing if they are not supported by a common DNA.

It's this DNA that moves the lines, not the posters.

"Culture eats strategy for breakfast," Peter Drucker said. The success of a strategy depends on a strong and congruent culture.

It is largely because there was this bond between employees that AXA achieved its ambition.

G.Johnson, R.Whittington and K.Scholes have modeled the factors that make up a company's culture, in the service of its purpose (the "paradigm"). Their representation echoes AXA's DNA, as I have just outlined it:

This diagram implies that a culture takes time to build. So how can start-ups claim to be building a solid culture from scratch?

See also: Why Innovation Fails (and How You Can Succeed)

I'm reminded of my first few weeks with Paris-based insurtech ALAN. When we hadn't yet started work on designing our first insurance product, the two founders spent a morning in one-on-one talks. Then they came to see me to submit a first version of what they presented as ALAN's values. I laughed.

"Oh, yeah? You expect to make posters out of the value, like AXA does?!"

Of course not: "We want to offer our customers simple, transparent insurance. We think we'll only be able to do that if we're really simple and transparent in the way we work." Aligning corporate values and value proposition.

For ALAN, the idea is not to focus on the slogans of simplicity and transparency for their own sake, but to apply them to day-to-day operations: decision-making on company priorities, HR policy, communication, etc. 

And because ALAN is a start-up, there isn't a question of aligning existing procedures with simplicity and transparency, but of designing a simple and transparent way of working by design. As a result, atypical practices such as the absence of hierarchy, public pay scales, decision-making without meetings, etc. were deployed very early on. 

In the end, these practices harmonize behavior before shaping the start-up's culture, which is probably the opposite of what would happen in an established company.

Operating methods also need to be adapted as the company grows and new issues emerge. The challenge is to flesh out the framework of practices by forging their alignment with values. This is how ALAN is now presenting a set of leadership principles, inspired by other fast-growing companies (such as Amazon). What distinguishes these leadership principles from values is that they are more operational than incantatory.

One of the keys to developing a strong culture therefore lies in the adoption of consistent behavior within teams, much more than in posters displayed in meeting rooms. 

The question then is how to spread these behaviors throughout the company? This is where the practices of ALAN and AXA can come together.

ALAN breaks down  its leadership principles into behavioral traits, which are m easured during the recruitment and individual assessment processes. Clearly, an applicant who does not demonstrate strong alignment (or an employee who deviates from the norm) does not have much of a future at ALAN. 

What remains to be managed is the risk of producing an army of clones from recruiting profiles that are too similar. For me, this is a general issue for start-ups, which goes beyond the introduction of behavioral criteria into HR policy.

AXA deployed an original process in the '90s, consisting of training its managers in Model Netics, which illustrate 150 management situations. This approach provides managers with common responses, even though they do not necessarily have an academic background in management literature. It is also a common language, in the primary sense of the term, marking those who use it with the stamp of those in the know. Example: "So, how are you going to get your team on board with this project? It's simple, I've got my recipe: 50% Attitude-stair-steps and 50% Planning-path." 

In this case, the focus is on practices rather than behavior, so there is a good fit with the diversity of profiles that make up a mature organization. The question of sustainability may arise (once you've trained the management, what do you do?); in fact, AXA has gradually abandoned this tool.

Which goes to show that you can have a strong culture in a young organization: Culture emerges from shared behaviors that form the backbone that allows the organization to grow.

Which goes to show that, for a mature organization, culture is the bedrock of individual commitment in the service of collective ambition. Otherwise, there's always the "mantras and posters" option!

KEY TAKEAWAY:

--ignoring value-added services can lead to customer churn, reduced profits, a bad reputation, loss of market share, missed upselling opportunities and increased susceptibility to market disruptions. 

--Insurers must also do three things: 1) Use AI and predictive analytics to personalize communications, ensuring each interaction resonates with the client's individual needs and emotions. 2) Employ digital platforms for informative and engaging communication about policies and benefits. 3) Analyze client interactions and feedback through technology and use these insights to tailor future targeted direct mail and digital campaigns.

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Now more than ever, insurance companies are finding it challenging to retain clients. With such a competitive market, many companies find that traditional practices are not cutting it. Although remaining competitive is vital, insurance companies need to strike a balance between competitive pricing and delivering exceptional value-added services to ensure long-term customer retention.

The Limitations of Competitive Pricing

Focusing only on having competitive pricing has proven to be insufficient. As more insurance companies offer increasingly similar products, we see more individuals focus on price rather than client loyalty. Clients want more than just low rates for their insurance. They want personalized service that is convenient to use. They desire a positive customer experience.

By providing valuable extras, such as excellent customer service and user-friendly digital tools, insurers will be better positioned to differentiate themselves. Additionally, companies can seize cross-selling opportunities and focus on building strong customer relationships to enhance retention.

Ultimately, customer loyalty in the insurance industry is not just about price; it is about meeting client expectations while building trust and adapting to the evolving market dynamics.

See also: The 'I Told You So'​ Moment

The Long-Term Impact of Ignoring Value-Added Services

Consumers, feeling the economic pinch, are looking for more value. They are moving away from insurers that stick to traditional offerings and toward those that offer more than just basic coverage.

Ignoring value-added services has severe consequences. First, there's customer churn. Better services and additional benefits from competitors easily attract clients. 

By cutting prices to stay competitive, companies are losing profits. This limits the ability to invest in technology and customer support, which are key to attracting new clients.

Then there's the issue of a tarnished reputation. Negative customer experiences stemming from the lack of value-added services deter potential clients. It's a cycle: Poor services lead to a bad reputation, which in turn drives customers away.

Loss of market share follows. Insurers failing to innovate are losing market share to competitors that understand changing customer expectations. Missed opportunities to cross-sell or upsell are also problems. Without additional services, the chance to offer extra products or coverage to existing clients is lost, affecting revenue growth and competitiveness.

Increased vulnerability to market disruptions is another concern. The insurance industry is changing rapidly with technological advancements. Those slow in adopting new technologies like telematics are missing out. Insurance telematics, for instance, promotes good driving behaviors and attracts safer clients, reducing claim incidents.

Ultimately, ignoring value-added services is risky. The long-term impact includes customer churn, reduced profits, a bad reputation, loss of market share, missed upselling opportunities and increased susceptibility to market disruptions. 

Value-added services lead to satisfied customers, and satisfied customers lead to long-term success.

See also: How Cedents Can Win Reinsurance Race

3 Strategies to Successfully Balance Price and Value-Added Services Through Technology

Integrating new technologies is necessary to deliver exceptional value-added services, improve customer retention and stay competitive. The following strategies are the best places to start:

1. Prioritize personalization and emotional engagement.

Use AI and predictive analytics to personalize communications, ensuring each interaction resonates with the client's individual needs and emotions. This includes timing messages strategically during key moments like policy renewals or claims processing. Additionally, incorporating data-driven personalization in direct mail campaigns can increase engagement and conversion rates, making these communications more effective.

2. Offer engaging client communication.

Employ digital platforms for informative and engaging communication about policies and benefits. This approach should focus on making insurance details clear and personalized, enhancing client understanding and satisfaction. Insurance providers can also leverage industry-specific technology solutions to create communications that resonate emotionally with clients. This approach can make clients feel more connected and valued and likely to remain loyal.

3. Review data-driven client insights.

Analyze client interactions and feedback through technology. Use these insights to tailor future targeted direct mail and digital campaigns. That tailoring can lead to increased engagement, conversion rates and overall client satisfaction.

Insurance companies need to go above and beyond implementing competitive pricing strategies to succeed. They must embrace technology and innovatively provide personalized services to meet clients' evolving expectations and secure a lasting competitive edge.