Over the last decade, economic capital has captured the risk management spotlight. Recognizing its merits, insurers have deployed economic capital for many uses. Regulators now rely on it, too — especially internationally — and have put it at the center of their prudential regulatory agenda. Economic capital (defined as value at risk over a year) has two unique and extremely useful characteristics. First, the concept can be applied to any event with an uncertain outcome where a probability distribution of the outcomes can be postulated. Thus, insurers can value, in a consistent and comparable manner, very different risky events — such as mortality claims, credit losses and catastrophic property damages. Second, economic capital calculated for a portfolio of risks can be readily subdivided into the economic capital attributable to each risk in that portfolio. Or, alternatively, economic capital calculated at the individual risk level can be aggregated to economic capital at the portfolio level and beyond, across portfolios to the enterprise level. However, there are four critical enterprise risk management (ERM) tasks for which economic capital is not an effective tool; unfortunately, because of this, we have observed a tendency for risk managers to de-emphasize those tasks and sometimes ignore them altogether. We believe this should change. See also: How to Improve Stress Testing   In response to these shortcomings, insurers should take full advantage of stress testing, a valuable risk management tool that is on par with economic capital in terms of its potential to help solve problems and improve performance. And, because stress testing enables insurers to tackle many of the important tasks that economic capital cannot, it gives insurers the opportunity to double the size of their risk management tool kit and thereby double their ERM output. Liquidity By design, economic capital assumes assets and liabilities can be monetized at their formulaic values — that is, at the values derived from the probability distributions’ assumptions. But, as we saw in the credit crisis of 2008-09, credit markets can seize up under extreme stress. When that happens, many assets — regardless of their formulaic value — cannot be sold at any price. Because of this, economic capital is not an effective tool to understand and manage liquidity risk. To address the risks posed by insufficient liquidity, insurers need to play out meaningful stress events and postulate how they might affect both the ability to monetize assets and the asset’s price if they can be monetized, as well as critically assess the ability to actually access pre-arranged credit in the event these stress events unfold. Then, with an understanding of the likely challenges these stresses may impose, insurers can test the effectiveness of the potential mitigating strategies that they can deploy immediately or when stress events begin to unfold. Selecting and documenting the most effective options can become the insurer’s liquidity risk management game plan. Diversification Diversification is a cornerstone of effective insurance underwriting and risk management. The industry acknowledges the benefit of diversification across similar, independent risks and is able to apply considerable mathematical rigor to measuring this benefit. However, matters become less certain when attempting to quantify diversification across dissimilar risks such as mortality, credit and catastrophe. Extending the benefits of economic capital across risks requires that the capital amounts assigned to different risk types be combined. Recognizing that extreme outcomes for each risk type are not likely to occur simultaneously, the combined capital requirement is typically calculated as the sum across risk types, with a credit given for diversification. Deciding how much credit should be assigned for diversification is a critical question in establishing the enterprise’s total required capital. Unfortunately, historical information about the precise interaction of disparate extreme events is sparse. Empirically, establishing diversification credits is difficult at best and is largely impossible for some combinations. For enterprise risk capital, a best guess may have to suffice. But, just because such a guess is sufficient for the purpose of ascribing required capital, it does not follow that it is sufficient for other purposes — particularly for charting a course of action across all risk types in the event of an extreme risk occurrence. Stress testing is useful for this purpose. Playing out the series of interactions and events that could follow from a catastrophe such as an epidemic will yield much more actionable information than guessing the magnitude of the diversification credit. Constructing a future scenario that thoughtfully considers how an extreme event in one risk type will have an impact on others is key. These impacts occasionally are asymmetric and not easily accommodated in a standard diversification credit matrix. For example, we can be fairly certain that an extreme drop in equity values will not have significant impact on mortality rates. Conversely, it would seem imprudent to assume that an extreme pandemic would not have any impact on equity values. Business risks In a survey of insurance company board members and CROs that PwC conducted in June, the area where board members felt more attention would be most beneficial was “searching for, understanding and finding ways to address new risks” — meaning risks outside of traditional insurance, credit and market. Upon further discussion with the survey respondents, it became clear that they are not as interested in esoteric dialogues on black swans or unknown unknowns as they are in addressing more practical questions about currently evident business risks. In particular, survey respondents want to understand how those risks could materialize in ways that have an impact on their companies and how to mitigate those impacts. Using stress testing to map out the impact of these business risks will help insurers assess how serious the risks are. The stress projection can measure the impact on their future financial condition after a risk event. And if the impact is significant, they can further deploy stress testing to map out potential management actions to reduce the risk’s likelihood of impact or mitigate damage if the impact occurs. Having an effective course of action is far better than hoping black swans won’t materialize. Excessive capital If insurers use only the economic capital tool, then there is a real risk that it will become a hammer, rendering everything in its path a nail. On discovering a new risk, the most likely reaction will be to call for more required capital. However, in the case of, for example, liquidity and business risk, a more effective approach is to use stress testing to create a plan for reducing or eliminating the risk’s impact. Likewise, seeing economic capital as the sole means of addressing insurer insolvency can lead to an overly restrictive regulatory agenda that focuses only on the economic capital formula. This unfortunately appears to be the case in the development of some required capital standards. We think a more productive approach would be to recognize that no economic capital formula will ever be perfect, nor can one formula fit all business and regulatory needs around the world. Instead, a simpler formula augmented with stress testing can form a more effective, globally consistent solvency management framework. Moving to the next level In the paper we published earlier this year about the results of our stress testing survey, we noted that stress testing is well established in the insurance industry. Insurers use it for many purposes, and it has had significant impact. In fact, 36% of survey respondents indicated they have made key decisions markedly differently than prior to or without stress testing. A further 29% indicate stress testing has had a measurable influence (though no single key decision came to mind). The paper also identifies areas where only a little more effort can yield substantial benefit: through a clear definition of stress testing, through more thoughtful stress construction and through building a more robust stress testing platform. See also: Risk Management: Off the Rails?   To get the most advantage from stress testing, we have two further suggestions: 1) Insurers should apply a governance framework commensurate with stress testing’s status, and 2) insurers should advocate its use in new areas. A good governance framework should include policies and procedures, documentation, model validation and independent review, as well as review by internal audit. Board and senior management oversight is also important. While our survey report notes that boards usually receive stress testing results from management, we recommend that management engage the board more in the stress selection process. While stress testing certainly can add additional insight to insurance, credit and market risk analysis, economic capital already provides a good foundation in these areas. We recommend that insurers use stress testing, in particular, to tackle business risks where economic capital is not an effective tool. This includes new threats like cyberterrorism and their reputational impact. Stress testing can also be useful for understanding the risk of missed business opportunities, such as the failure to address how emerging trends in technology and customer behavior may have an impact on future sales and earnings potential. We believe that the scope for the application of stress testing is as significant as for economic capital. And as with economic capital, once an effective tool comes into use, many more useful risk and business management applications will ensue.

As I write this article, I hear the lilting melody of Alicia Keys’ tribute to New York City:

“Hail a gypsy cab, take me down from Harlem to the Brooklyn Bri-i-i-i-idge…”

Can you hear it? There are just certain things that jump to our minds when we think of New York. I think of hot dogs, Central Park, awesome shopping, coffee shops, marquee lights on Broadway and “bouquets of sharpened pencils” (yet another New York reference for you movie buffs). What else comes to mind? Taxis… lots and lots of yellow taxis. In the era of the sharing economy, that also means lots and lots of Uber and Lyft drivers. But did you know that an outdated law is keeping New York consumers from taking advantage of a convenience that millions of drivers in other states already enjoy? In New York, a law requires consumers wanting to sign up for new auto insurance coverage to first have their vehicles inspected by their insurance companies. The law was enacted in the 1970s and was designed to protect against insurance fraud. These days, instead of preventing fraud, the law mostly produces frustration. Individuals must have their vehicles physically inspected by a licensed insurance agent or bring them to an inspection site before they can activate their auto insurance coverage. This inspection requirement is ON TOP of the annual inspection required for all New York vehicles. So, someone who owns multiple vehicles could potentially be required to do multiple inspections throughout the year! See also: On-Demand Workers: the Implications   What else does this mean exactly? Old Technology for New Times Well, for starters, a lot of headaches, hassles and inefficiency for consumers. They frequently report:

• Insurance coverage lapsing due to failure to complete the inspection
• Missing work to complete the inspection
• Long wait times at inspection sites
• Inconvenient hours at inspection sites
• Inspection sites with inconvenient locations
• Students at out-of-state colleges needing to drive their cars all the way back to New York to complete the inspection OR re-register their vehicles in another state
• Insurance companies receiving inaccurate information about inspected vehicles

That’s a lot to deal with for the average car owner, who may be balancing a full-time job, college courses and a family and has precious little time in which to get an inspection done. But what choice do they have? For now, none. Mobile Innovation Changes Everything But advances in mobile technology are radically changing the world we live in, empowering consumers to get work done conveniently and efficiently. Smartphones are at the core of this radical change. In fact, according to recent statistics by GO-Global, not only are smartphones being used by more people than ever, but those people are spending 52% of their time on those smartphones using mobile apps. That’s incredible! Statistics also indicate that 18- to 24-year-olds use more mobile apps than any other age group. See also: How to Embrace Workforce Flexibility   It’s no wonder that the global revenue from mobile apps has risen dramatically over the last few years from $35 billion in 2014 to $58 billion in 2016, and in 2017 is expected to hit $77 billion. Why Are Mobile Apps so Popular? 1. Mobility comes in all shapes and sizes Almost 80% of consumers around the world have smartphones, 50%-plus have tablets, nearly 10% have wearable mobile devices and 7% own all three. That high level of usage has had a significant effect on business practices around the world. 2. Location-Based Services (LBS) Most devices currently have GPS capabilities that empower users to get real-time information, right here, right now. 3. Internet of Things (IoT) Again, this advancement in technology provides users with real-time control and information, regardless of where they are. Forgot to turn your lights off at home? No problem. Just log into your smart home app and do it from the comfort of your office. 4. Virtual and Augmented Reality (VR and AR) This technology is revolutionizing how we interact with each other and with other software systems. Mobile app developers are expecting tremendous growth in this area. In short, these mobile apps allow people to find the goods and services that they need quickly, easily and cost-effectively. In other words, the middlemen and gatekeepers have been all but eliminated. Combining Mobility With Manpower So, let's apply those capabilities to the New York, with its outdated law that requires drivers to obtain a vehicle inspection before they can activate their insurance coverage. With today's technology, the answer just isn't that hard. Drivers in other states already have an alternative: smartphone-based vehicle inspection. WeGoLook has developed mobile technology that puts a large mobile workforce at the fingertips of consumers who are too busy or simply too far away to obtain in-person inspections. Others may have their own solutions; ours looks like this:

1. A client needs an inspection, and orders a vehicle inspection report from WeGoLook via the website or mobile app.
2. A “Looker” is dispatched to perform the inspection. (The number of Lookers has grown from 7,400 in 2012 to more than 30,000 in 2016.)
3. The Looker manages all aspects of the inspection from scheduling to coordinating the different parties to preparing the final report.
4. Throughout this process, the client can monitor real-time progress on the inspection via the mobile app’s online dashboard.
5. The WeGoLook app also has photo and text support so that clients can capture the right angles and desired information needed for the report.
6. A management team reviews the report for quality assurance and accuracy.
7. The client receives the detailed report, quickly and conveniently and can download it directly from the app.

Given the power behind mobile technology and flexible workers, like WeGoLook’s Lookers, there is no reason consumers should be locked into doing their inspections at traditional inspection sites. The use of flexible mobile inspectors can solve the problem of drivers having to physically take their vehicles to an inspection site. Mobile apps like WeGoLook’s also allow for "app consistency" -- that is, if a policyholder, insurance carrier and third-party inspector are all using the same platform, there is a better chance of a successful transaction. For savvier consumers, technology like WeGoLook’s app even opens the door for the consumer to self-inspect the vehicle. Certain states already allow self-inspection via smartphone for home inspections and claim inspections after an auto accident. See also: A New Way of Thinking on Assets   In New York, however, for the pre-insurance inspection requirement, a new law would need to be enacted to empower consumers to self-inspect their vehicles using a smartphone app. This dream scenario would give consumers the option of using a WeGoLook Looker to complete their inspection, of self-inspecting the vehicle using WeGoLook’s app or of completing the inspection via the traditional route. WeGoLook: On-Demand Solutions That Save Time and Energy! The beautiful thing about a mobile app service like WeGoLook is that it will offer consistent and trustworthy results regardless of who requests the report -- the policyholder, a third party or the insurance carrier. So, if you’re a busy and productive citizen of New York state, why not save yourself a heap of time and energy? Smart use of technology benefits everyone involved. So, this spring, I urge Albany lawmakers to enact a new law that would help consumers put today’s smartphone technology to better use. Let’s give New Yorkers smartphone-based options for their pre-insurance vehicle inspections.

Despite awareness that hackers are relentlessly launching cyber attacks, according to a new survey, most companies say they don’t have a clearly defined risk strategy or one that applies to the entire company. The survey, conducted by the Ponemon Institute and sponsored by RiskVision, polled 641 individuals involved in risk management within their organizations. More than half held executive and management positions. “There is a big disparity between awareness and implementation of risk management practices,” says Joe Fantuzzi, CEO of RiskVision, a Sunnyvale, CA, enterprise risk intelligence company formerly known as Agiliance. Eighty-three percent of those surveyed say managing risk is a “significant’ or “very significant” commitment for them, but 76% say their organizations lack a clearly defined risk management strategy or one applicable to the entire enterprise. Only 14% of survey respondents thought their organization’s risk management processes were truly effective. Other survey findings:

• More than half of organizations lack a formal budget for enterprise risk management. Organizations with a formal budget have allocated an average of $2.3 million for investment in risk management automation in the next fiscal year.

• Four of every 10 respondents say “complexity of technologies” that support risk management objectives are a “top barrier.” Roughly the same number says other challenges are an “inability to get started” and difficulty hiring skilled workers.

• Sixty-three percent of respondents fear a poorly executed risk management program will damage their company's reputation. Other top concerns are security breaches and business disruption.

• More than half of respondents say there is little collaboration in managing risk among their finance, operations, compliance, legal and IT departments. They complain of “operating in silos.”

• Sixty-nine percent of respondents say their organizations don’t rate assets based on how critical they are. The same percentage says their enterprises either don’t have — or the respondents are unsure if they do have — metrics for determining risk intelligence effectiveness.

More respondents (19%) work in financial services than any other industry. Respondents in the public sector were next (11%), followed by healthcare (10%) and industrial/manufacturing (10%). See also: Urgent Need on ‘Silent’ Cyber Risks   Reputations at stake The survey’s most surprising finding, Fantuzzi says, is companies’ concern about their reputations. “We often get caught up with headlines about breaches, but what stood out the most was the overwhelming majority of organizations that fear long-term brand damage above all else,” he says. Fantuzzi says data breaches or disruptions to business are still major concerns for organizations. “But if you asked these same organizations just a couple years ago when major brands were making headlines for record-breaking breaches, I would argue that was the top fear of executives and board members across every industry.” There are “dozens of reasons,” Fantuzzi says, about why three-quarters of organizations lack a comprehensive risk management strategy. “Critical roadblocks,” he says, include “the complexity of technologies or not knowing how to identify the appropriate solution for your environment, the lack of resources from a financial or personnel perspective or the basics of not knowing where to start when putting together a strategy.” Automation and awareness improve The study concludes, however, that organizations “are slowly improving the maturity level of their risk management program.” Eighteen months ago, only 21% of organizations represented in the study measured their risk appetites in real time using automated business unit decision-making, board-level risk analytics and metrics trending. Today, 32% say these activities are part of their risk management program. See also: First Line of Defense on Cyber Risk   The study also concludes that an increasing number of companies are automating risk management programs. Eighteen months ago, 53% of organizations represented in the study used “top-down, assessment driven, reactive, manual processes, spreadsheets and siloed information.” Now, 33% have advanced to a bottom-up, process automation, “effective with limited efficiency, centralization and analytics.” Thirty-five percent have advanced to top-down, bottom-up optimization “with real-time enterprise risk intelligence analytics for actionable business decisions.” This article originally appeared on ThirdCertainty. It was written by Gary Stoller.

There is a growing energy around trying to predict the future of the insurance industry. Much of that energy is aimed at the use of technology and seeing what’s possible when we apply new stuff to our current approach to handling risk. I’m more interested in the future of handling risk, as that topic gets to the purpose of our industry. When you look at many of the startup companies attempting to disrupt or reinvent insurance, at the end of the “ultimate” experience, we are still delivering a policy … a hunk of money to replace the financial loss from a seemingly random event. So what might that future look like? Here are a few possible frames for that answer: Finding new, emerging risks Risks are both great and small. Loss of life, health and home are financially catastrophic to most people, and the insurance industry has been keenly focused on these risks for decades or centuries. Smaller risks, like the loss or theft of a phone or credit card, interrupt the continuity of one’s lifestyle but are perhaps not a catastrophe; however, they are a nuisance that insurance can ease. And then there are new, emerging risks that the industry is and should be serving, such as cybersecurity and “overliving” one’s assets. See also: Shaping the Future of Insurance Prediction and prevention of risk There is also a school of thought that suggests the insurance industry should enter the space of prediction and thereby prevention of certain risks. Data is critical to the underwriting of all kinds of insurance and is traditionally used to set rates. This includes weather patterns, health statistics and lifestyle information. Why not turn this data outward and offer products and services that let consumers in on the patterns, perhaps helping them to avoid risk in the first place? This is smart; however, I am not sure the insurance industry is wired to provide services vs. products. What about power? Where does the power from the current insurance model come from? While we have many experts who know a lot about the numbers, stats and so forth, the power really comes from the raw material that makes insurance: people and their money. While the thought of people being the raw material for insurance may conjure up science fiction scenes akin to the classic film “Soylent Green,” it’s actually true. Getting people to pool their money together for common good is a powerful thing. It gives people with few resources the ability to financially hedge against risk even though they are not wealthy enough to replace their own losses. Where else does similar power exist? One example is utilities. We love to hate our energy companies, water providers, phone service companies and internet providers. But, really, they are doing the same thing — pooling people’s money together to create access to something we couldn't do individually. You can say the same thing about toll roads, trains and other services we share with strangers every day. We tend to see these commonly shared amenities as basic human entitlements — civilization, the thing that separates us from the wild. So in that frame, what is the next “basic” human entitlement going to be relative to risk? Here’s an idea: We know technology is proliferating at an accelerated pace, and  there will be new ways to extend and improve our lives in the future that we can’t conceive of yet. What if the cure for cancer or Alzheimer’s disease or the ability to control the weather is owned by a private company? Will average people have any right of access? The recent story about the EpiPen made my blood boil. Mylan, the company that owns the EpiPen, has recently increased its prices more than 400%, shifting the burden to insurers, which then need to push the cost on the consumer -- because Mylan can. See also: The Future of Insurance Is Insurtech   An August 2016 Forbes article said: “The coup de grâce … [is] that … [this] … will divide the ‘have intervention for anaphylaxis’ from the ‘have nots’ and might die as a result.” Can insurance companies use their inherent superpower of pooling to create a product that acts like a futures option to access technologies that have not been invented yet? Perhaps to place bets on the right companies that are working hard to figure them out, and designing an investment product that gives them research funding now, for the right to access it at a fair price in the future? This, I believe, should be the real future of insurance.

One of President Trump’s stated goals is to initiate significant investment in U.S. infrastructure — bridges, roads, airports, seaports, pipelines, fiber optic cables and water projects. As with any major spending measure — and the most common number being tossed around for this one is $1 trillion — there will be political hurdles. However, the U.S. House of Representatives Transportation and Infrastructure Committee just launched its #building21 campaign effort to promote its vision for 21st Century American infrastructure, calling for significant investment. Infrastructure spending of such magnitude will bring many opportunities for construction and infrastructure companies. Organizations need to be strategically positioned to capitalize on the opportunity, well-prepared to engage in the heightened competition facing the industry and flexible enough to absorb an increasing level of risk. Infrastructure Plans In December 2015, Congress passed and President Obama signed the Fixing America’s Surface Transportation Act (the FAST Act), which increased the collection of gasoline taxes to pay for transportation infrastructure projects. The FAST Act authorized $305 billion for highway and motor vehicle safety, public transportation, motor carrier safety, hazardous materials safety, rail and research, technology and statistics programs. Although FAST Act funds are to be allocated to rehabilitate the country’s transportation network, there remains a significant infrastructure deficit in the country. During his campaign, Trump called for $1 trillion in infrastructure investment in transportation, telecommunications, water, power and energy. Before his inauguration, Trump’s transition team circulated a list of 50 priority emergency and national security projects. Since then, Trump has given every indication that he plans to continue pushing to enhance infrastructure. For example, on Jan. 25, he signed an executive action related to one of the more controversial project proposals, a wall along the U.S.-Mexican border that many experts suggest would cost $15 billion to $25 billion. See also: Insurtech Investment to Flourish in 2017   Against the same funding challenges the Obama administration faced, Trump’s plan calls for much of the infrastructure investment to be driven by the private sector through a series of tax credits and private funding as a means to encourage infrastructure investment in a revenue-neutral fashion. Trump’s plan also calls for the relaxation of various regulations to accelerate project delivery times and reduce cost. Challenges and Headwinds Most Democrats and Republicans agree on the need to improve this country’s infrastructure. A key difference, however, is how to pay for the upgrades. On Jan. 24, Senate Minority Leader Charles Schumer introduced a $1 trillion infrastructure plan that relies heavily on direct government funding rather than on tax credits and private investment. Democrats generally argue that, although tax breaks may encourage investment, they will not necessarily bring about those infrastructure projects that are most needed, because the underlying economics may not make such projects profitable. Despite these political differences, it is likely that some form of Trump’s plan will secure support as infrastructure renewal is a common interest. If an infrastructure spending bill is passed by Congress, organizations in the construction and infrastructure industries will be affected in a number of ways, including:

• Increased competition: With an economic slowdown in some areas of the world and with increasing volatility, a large inflow of foreign capital will likely occur as international contractors seek opportunities to invest in and build U.S. infrastructure projects. Consolidation of market share in the sector is also likely.
• Talent and labor shortage: Already facing a shortage of skilled professionals, the construction industry will need to compete with other industries to attract and retain talent.
• Private investment: Regardless of which infrastructure plan takes hold, public-private partnerships will be a pivotal model to deliver infrastructure in the immediate future. Consider that more than 30 states have enabling legislation in place and are poised to act immediately on already-identified projects.
• Increased risk: We are witnessing an ever-increasing trend of infrastructure projects being delivered through complex delivery methods, including design-build; design, build, operate and maintain; and integrated delivery. All such contracts result in increased risk being assumed by contractors. With competition expected to heat up, contractors will be expected to have greater risk-bearing capacity. Another consideration is that infrastructure and construction companies are increasingly tied to the “Internet of Things” through operational technology, electronics, software and network connections; this brings significant cyber exposures. And infrastructure itself is increasingly a target of cyber criminals.
• Risk financing: Insurers and others continue to develop new risk consulting and risk transfer products and services. Not only do insurers absorb performance and hazard risks associated with infrastructure development, they are increasingly becoming infrastructure investors, as well. It remains to be seen how this level of infrastructure exposure will lead to new products and services or new alternative risk structures.

See also: New Wellness Scam: Value on Investment   The American Society of Civil Engineers (ASCE) estimates that the U.S. will face a $1.6 trillion infrastructure deficit in 2020. Although it is too early to know exactly how the new Congress and the Trump administration will proceed, we believe it’s safe to expect that infrastructure and development will be a hot topic this year and for many to come. If you’re not doing so already, now is the time to discuss with your advisers the risk and insurance considerations at the advent of a likely major U.S. infrastructure investment initiative.

If you'll allow me to be parochial for a moment, I'll start this week with the Oroville Dam, which is 75 miles due north of me. You've probably seen or heard some reference to the dam over the past few days because a series of severe storms in California has caused serious structural problems at what is the tallest dam in the U.S. and forced the evacuation of almost 200,000 people. You may hear more about the dam, too, because California is expecting another major series of storms. While dam operators are now letting water out as fast as they can -- faster than the average flow at Niagara Falls -- they felt for a time that they had to slow because erosion has split the main spillway, and they worried that further erosion would be catastrophic. Water has already "overtopped" a section of the dam and cascaded down a heavily forested area designated as the emergency spillway. If the water level continues to rise, so much will pour down the mountainside that the Feather River may wash out downstream dams and levees and a major highway that serves Northern California.

I'm far enough away that I'm in no danger of having a wave wash through my living room window, but I'm still concerned. The U.S. has let infrastructure investment languish for so long that some 50,000 dams are now past their designated lifespans, roughly two-thirds of those in operation in the country. One of those past its expiration date is -- you guessed it -- the Oroville Dam. Environmental groups and local officials warned about potential problems a dozen years ago, but dam managers dismissed the worries. 

As the problem upriver developed, I was delighted to receive a really insightful article about why so many people and organizations don't prepare adequately for possible disasters. I hope you'll read it here. I also hope you'll take it to heart, because I believe we need to start really thinking about the catastrophes that can occur because of, among other things, crumbling infrastructure and climate change.

The article shows all the psychological mechanisms that encourage people to defer preparation -- we've had years and years of drought in California, so why worry about a really wet winter last year and a crazy-severe winter this year? But we in the world of risk management and insurance are supposed to have the data, the experience and the discipline to help others prepare -- so that hundreds of thousands more people, like my poor neighbors to the north, don't wind up in camps in winter while they wait to find if their homes will be washed away. I hope we rise to the occasion.

Cheers,

Paul Carroll, Editor-in-Chief

2015 was a record year for announced insurance deals, as long-anticipated industry consolidation finally started to occur. Several factors have driven consolidation, notably slow economic growth and persistently low interest rates, both of which have limited opportunities for organic growth and forced insurers to reconsider their long-term competitive strategies. Combined with record levels of corporate capital and private equity funding, these pressures have created the perfect opportunity for both buyers and sellers. Historically, regulatory or financial pressures have driven insurance carve-outs. [An insurance carve-out is a transaction in which a seller divests part of its business (e.g., a particular customer group, product line or geographic area) rather than an acquirer buying the entire enterprise. The seller typically benefits from exiting sub-scale or unprofitable lines, while the acquirer is able to increase scale or geographic reach.] These pressures typically have included repayment of emergency funding received during the financial crisis, fulfillment of regulatory conditions for receiving state aid, divestment to free up capital and improve solvency ratios in preparation for Solvency II, or the shoring up of capital via asset sales following losses. In recent years, we have seen the industry move away from complex multi-line business models. Insurers are exiting sub-scale business lines to improve returns and compete in an environment in which technology is disrupting tradition business drivers. There are many insurers considering carve-out transactions or IPOs as sellers, and there are even more looking to build market share by acquiring and consolidating businesses with their existing operations. See also: Insurance M&A Stays Active in 2016   However, insurance carve-outs tend to be more complex in both transaction structure and post-merger integration than an acquisition of an entire insurance enterprise, and require careful planning and execution to successfully separate the acquired business (“SpinCo”) from its former parent (“RemainCo”). What should executives be aware of when they consider these types of transactions?

• Planning and Organization
  • Confidentiality, maintaining optionality and speed of execution are critical to maximizing deal value.
  • The flexibility to execute deals via alternative structures (described below) helps maintain optionality. In addition, a thorough understanding of the M&A landscape is necessary for sellers to run a competitive sales process and for buyers to understand how to properly position themselves for success.
  • To facilitate speed of execution, executives need to simultaneously focus on multiple priorities, including deal execution, separation planning and negotiation of transitional service agreements (TSAs). Leading practices include having a transaction committee that can rapidly make decisions and a project office that guides the planning effort.
• Transaction Structures
  • Acquisitions of an entire insurance enterprise typically involve the purchase of all of a holding company’s issued stock. The holding company, its subsidiary legal entities, assets and liabilities, products and licenses, people, technology and infrastructure transfer to the control of the acquirer at close. A carve-out requires a different approach. It is rare that the business being sold is fully contained within a single subsidiary legal entity. More frequently, the business being disposed of is written across numerous legal entities and is mingled with business that is core to, and remains with, the vendor. Therefore, carve-outs typically use a mix of strategies to separate the insurance business of SpinCo from RemainCo:
  • Renewal rights – The acquirer receives an option or obligation to renew the acquired business in its own legal entities.
  • Reinsurance – Renewal rights may be accompanied by reinsurance transferring the economics of the historical book either to the acquirer, to other entities owned by the vendor or to a third party.
  • Fronting – Certain domiciles, such as Japan and the U.S., require regulatory authorization of products or rates prior to their availability to policyholders, and such product approval frequently takes longer than regulatory approval for a change of control. When an acquirer doesn’t have regulatory approval to immediately write the business in its own legal entities, the transaction structure typically allows an acquirer to:
    • Continue to issue and renew policies using the vendor’s legal entities for a defined period of time, and
    • Assume the economics of the business via reinsurance. The acquirer frequently is responsible for administering the business (which is still the legal and regulatory responsibility of the vendor’s legal entities) via a servicing agreement.
  • Stock transactions – These are used when assets and liabilities can be segregated into legal entities (e.g. using the European Economic Area’s (EEA) insurance business transfer mechanisms), or when a legal entity, such as a specialist underwriting agency, specifically supports the business being sold.
    • Transfer of assets and contracts/TSAs – Just as the insurance business being sold may be diffused across the vendor’s legal entities, the same may also apply to the people, facilities, technology and contracts with sellers that support the business. While a certain portion of these will clearly align either to SpinCo (and will transfer at close) or RemainCo, there will be a significant subset (particularly in IT and corporate services) that support both and are not easily divisible. For such functions where SpinCo is heavily reliant on the resources of its former parent and it is not possible for the acquirer to fully replace such services prior to the transaction closing, a TSA provides the acquirer and SpinCo with continuing access to and support from RemainCo’s resources after close.

Negotiating the TSA TSAs provide access to the resources and infrastructure of the former parent for a defined period. While in certain simpler transactions, TSAs can be for as little as three months and require only that the support provided previously be maintained at the same service levels and at the same cost basis, it is more common that acquirer and vendor during the months prior to close:

• Understand and define the reliance of the business being sold on its parent (and vice versa);
• Set the duration post-close for each service required under the TSA;
• Agree on the charging basis e.g. fixed monthly fee, usage, hourly rates (for tax efficiency, each service is usually priced individually);
• Establish service levels and post-close governance processes.

The acquirer should set realistic timeframes for exiting from individual services. The complexity of insurance policy administration systems, the frequent integration of certain capabilities (such as billing, commissions, and contact centers) across products and the need to separate networks, migrate data centers and implement replacement mainframes frequently require TSAs of 24 to 36 months. TSAs also may cover centrally provided non-IT services, including HR/payroll/benefits administration, facilities management, procurement, compliance or financial and management and regulatory reporting. However, the duration of these TSAs tend to be shorter – usually a few months, or sufficient to support regulatory and financial reporting for the period following close. Ideally, the acquirer should seek as much flexibility as possible with the duration of the TSA. It should have the right to terminate the TSA early, the option to extend it at pre-agreed rates and the inclusion of force majeure clauses (a natural catastrophe can significantly affect exiting from a TSA). Contract assignment and access to shared reinsurance An area of often-underestimated complexity in carve-outs is the need to ensure that the separated business can continue to receive the benefit of third-party contracts with suppliers, distributors and reinsurers. In most jurisdictions, contracts cannot simply be novated (the insurance business transfer mechanisms of the EEA provide certain exceptions), but instead each contract must be evaluated to determine if assignment simply requires notification to the counterparty or its express consent. The challenges that arise in contract transfer are both:

• Logistical – 85% of counterparties contacted typically respond at first instance. However, a recent carve-out had more than 50,000 contracts that needed to be assessed, prioritized and migrated. In this instance, chasing down the remaining 15% was a real challenge.
• Commercial – Certain experienced counterparties, knowing the tight timeframe for most transactions, may try to renegotiate better terms either prior to the contract being assigned to the acquirer, or prior to permitting the vendor to use the contract to provide services under the TSA.

Also important in a carve-out is a clear apportionment of access to historic reinsurance programs shared between the vendor’s continuing business and the business being sold, as well as definition of the resolution process for any post-close disputes. Executing close Transaction close for virtually all insurance carve-outs is triggered by the receipt of one or more regulatory consents enabling the execution of fronting, reinsurance and stock transfer agreements. When migrating staff and assets supporting SpinCo to the acquirer, supporting staff and assets are moved into a legal entity, the ownership of which transfers at close in certain cases. However, when the relevant staff are not employed or supporting assets are not owned by legal entities transferring to the acquirer at close, there will need to be arrangements for the valuation and transfer of both tangible and intangible assets (e.g. trademarks) and the offering of employment and enrollment in benefits to selected staff by the acquirer. This is a significant logistical exercise for an HR function. See also: Group Insurance: On the Path to Maturity   Insurance carve-outs are also particularly challenging for finance functions:

• The combination of renewal, reinsurance and legal entity acquisition in the transaction structure complicates accounting immediately post-close.
• Cross-border acquisitions can include acquirers and sellers with different accounting standards (e.g. IFRS, U.S. GAAP, statutory and JGAAP) that often have very different rules on the treatment of assets and liabilities.
• The practice of closing at a month or quarter end – which in some ways can simplify the transition – may also introduce a tight and immovable timeframe for external financial and regulatory reporting.

Lastly, although there typically will be several months between the deal being agreed upon and the close, this may not be sufficient time – particularly in larger acquisitions across multiple locations – to roll out the acquirer’s networks and desktop technology prior to close. Therefore, full access to the acquirer’s IT capabilities may need to wait until later in the integration. Post carve-out integration While an acquisition of an entire enterprise provides a pre-existing governance structure, an insurance carve-out typically includes fewer members of senior management and requires rapid integration of functional management within the acquirer’s existing structure, the expansion of governance and compliance structures to include the acquired operations and the establishment and communication of delegations of authority and decision-making rights. Due diligence should have provided the acquirer with initial hypotheses as to the organizational capabilities required by the combined organization, interim and end-state operating models, and opportunities for synergies. As with any insurance acquisition, synergies in carve outs are typically realized through:

• Functional consolidation.
• Platform consolidation and process standardization, which enhances productivity and enables staffing efficiencies.
• Facilities and infrastructure reduction, and
• Reduced costs through more efficient third-party vendor selection.

PwC’s research indicates that the most successful acquisitions are those that develop momentum by demonstrating tangible integration benefits in the first 100 days. Accordingly, the acquirer should act fast but should also be prepared to revisit pre-deal assumptions and revise its integration roadmap as the two organizations integrate and new information becomes available. Conclusion Based on what we see in the market, notably a recent succession of P&C and reinsurance megadeals, we predict that insurance industry consolidation will continue apace. Multi-line insurers have divested themselves of numerous franchises and this trend seems likely to continue. Because these types of transactions are complex and depend on many internal and external factors, companies that are considering such moves will need to be aware of and address the many challenges and issues we describe above. This article was written by John Marra, Mark Shepherd, Michael Mariani, and Tucker Matheson.

“The future is here, it’s just not very evenly distributed.” — William Gibson

In his 2003 book, “The Slow Pace of Fast Change,” author Bhaskar Chakravorti highlighted how powerful innovations in technology and business often suffer slow adoption. He illustrated how, in a networked world, individuals, companies and regulators are all interacting, watching each other, guessing and second-guessing which investment choice is right. Often, the conservative choice is hard to dislodge. But when alternatives reach a tipping point, change can be dizzyingly fast. Insurance, a traditionally slow-changing industry, has more than its fair share of headwinds to innovation. It is a fragmented industry, compounded by: state-by-state regulation; an extended value chain of retail and wholesale distributors through carriers; reinsurers and capital markets; and a plethora of orbiting service providers. This fragmentation has inhibited transformational change and led to a prevailing view that, through continuous improvement, industry players can always adapt and catch up to change. This fragmented marketplace has traditionally protected incumbents. However, predators are circling. Insurtech, Silicon Valley-backed software companies, are looking to deliver insurance solutions. They observe the structural inefficiencies in the industry — that agents and brokers work through every day — and see red meat, tantalizing opportunities for new and disruptive paradigms. How are traditional agencies to adapt and stay competitive in the face of this threat? Disrupting the distribution model You can see the signs of coming disruption. Usage-based telematics (Progressive), peer-to-peer insurance models (Friendsurance), e-aggregators (PolicyGenius) and Internet of Things (IoT) companies are offering insurance coverage embedded with their products (autonomous vehicles). In 2015, venture capital companies invested $2.65 billion in insurtech with the intention of, at the very least, shaking things up. See also: 2017: A Journey Toward Self-Disruption   Some see the traditional agency model as living on borrowed time. Debates rage about the unique role and value that agents and brokers provide. When they really want to scare us, potential disruptors talk about “the Uber of insurance,” promising to transform the role of the agent to create a completely different customer experience. This transformation is most advanced in personal lines where digitalization is facilitating straight-through processing and is reducing the need for human intervention in policy processing. By analogy, think of people doing their own taxes online, where data-drive technology and intuitive user interfaces supplant human-driven, client intimacy. But more complex commercial lines are not immune to disruptive transformation. Digitalization, automation, analytics, embedded devices and telematics provide powerful tools to be integrated into new service and business models that can considerably change the value proposition for insureds. How the customer defines “the job to be done” While highly attuned to these possibilities, I align with those who see the role of independent agents remaining relevant well into the future. But there is a caveat: agents must truly and expansively fulfill their core promise to provide “peace of mind” to their insureds. I am often struck by the notion that the “job to be done” by retail agents is to provide “peace of mind.” It is not enough to provide a piece of paper and a commitment to represent the client’s interests in the event of a loss. Increasingly, peace of mind means providing information seamlessly, when and where the client wants it, via a user-friendly interface, backed by data and tools to help prevent losses (rather than simply mitigate or retrieve them). One agency principal recently noted that it was imperative “to make the friction points go away” in the risk management process. But this is only the starting point. Consider your organization. How much of your employees’ time is devoted to increasing your clients’ peace of mind? Or even understanding what peace of mind really means for your clients? By contrast, how much time is spent on “compliance activities,” busy work and redundant processing? While most insurance professionals are highly service-oriented, most insurance activities are not — tipping the scale in the opposite direction. Developing client intimacy and institutionalizing that knowledge into daily practices is critical. This is because agents and brokers have what direct writers, software companies and device manufacturers will struggle to attain: trusted adviser relationships. This is the key asset to protect and enhance. How to make your organization future-ready You might think the first thing to do after reading this article is investing in new online systems, portals and user-experience consultants. This is secondary. The first thing to do is get your operational house in order. Look internally at your service operations and understand how aligned your business processes are to your business strategy. This may seem counterintuitive, but, to improve customer intimacy and deliver peace of mind, focus first on internal operations. Streamlining operations is the foundation of the most successful innovation programs. Simplifying operational complexity increases transparency and strategic focus. Reducing process variability eliminates waste and inefficiency. Most agency leaders don’t realize how much time producers and service teams spend on redundant and non-core activities. This time can be reinvested in deepening an understanding of client preferences, purchase habits and risk profiles that will ultimately have an impact on loyalty and retention and will enhance the new business value proposition. Creating internal capacity is not rocket science. It is achieved through operational best practices such as increasing strategic visibility so employees can better align priorities; segment accounts; standardize ad hoc tasks; source the right work to the right person; and improve the operational IQ of your people. Operational analytics additionally provide insights into which accounts or lines of business are profitable, which are dilutive and what to do where there are gaps. Where once employees were under pressure to meet client needs, compete on price, put out fires and clean up backlogs, new, internal capacity will be discovered and directed to writing more profitable accounts, improving customer intimacy and innovating around digital channels and data-driven risk-prevention business models. See also: Insurance Disruption? Evolution Is Better   While the threats of disruption from insurtech are real, the outcome is not a foregone conclusion. Today's agency will suffer decline, but tomorrow's agency is within our grasp — not by saddling an already-complex operational environment with more sales people and systems but by building an organization on a foundation of operational and process excellence. In doing so, the agents and brokers of tomorrow will assert their relevance and long-term competitiveness by delivering their clients the promise of peace of mind more expansively than ever before. What does peace of mind mean to your organization?

Disruption in the market is threatening to isolate some insurers, keeping them on the outside of new opportunities. But many insurers are embracing the competitive pressures and shifting market boundaries to position themselves for growth. They are navigating their organizations through healthy changes as a part of an overall plan for transformation. We all know that change will often bring some painful challenges. To help insurers anticipate some of those challenges, we have been looking at preparations and steps insurers can take to stay on course. In our first blog in this series, we discussed the groundwork for leading change in your organization — with very practical advice on what leading change really involves. In our second blog, we looked at empowering change among the people involved in it. We discussed how change is personal and how insurers need to consider its impact down to an individual level. In Part 3, we’re going to step into the middle of managing change. What challenges are you likely to encounter once you have started? Are there ways to keep the organization on course, foster engagement and improve the odds of transformational success? We’ll start by looking at the changes within the organization’s business framework. Establish the right kind of foundation Organizational change management is often driven by the insurer’s need to build a new business framework that will operate as a cohesive, integrated and flexible unit. That framework may include new technologies, processes and products, items that are nearly always in flux. So it is important to establish a foundation that you can build on so that you can adapt and change whenever market shifts happen without changing the essential structure of the core. See also: How to Lead Change in an Organization   The foundation will be built to accept change as a fact of life within a dynamic marketplace. It will contain less rigidity and more resilience. It will prepare the organization to effectively handle quick course corrections when strategy shifts or the market changes — or even when teams uncover some detail they may not have envisioned at the outset. Once this foundation is in place, it means that discovery and innovation can happen on the fly, course corrections are no big deal and ideas are much simpler to test. Think of communication as a fabric Because change plans may not be firmly fixed, and because change can be difficult for people to understand, frequent communication is crucial. It needs constant attention to keep people engaged. You can’t communicate too much. However, when most leaders think of communication, they may tend to focus on formal communication, saying things like, “We are putting out a newsletter,” or “Every month we are holding a transformation update meeting.” These are good things, but they treat messages as broadcasts, with very little interactivity. In the real world, the best change communication looks more like a fabric that is woven with equal parts formal and informal communication, as well as both message threads and listening threads. It deliberately overlaps in areas so that a blanket of acclimation and understanding will bring the corporate culture and individuals along at the proper pace, all while acknowledging their value and the importance of including their perspectives. Formal communications — such as newsletters, e-mails and update meetings — ARE important. They are important for clarity. They act as signals regarding time and workload. They keep high-level messages in front of people, bringing the organization under a universal umbrella. Every effort should be made to communicate key messages through on-site meetings with executive leaders participating. Informal communications are also vital. Planned or unplanned one-on-one conversations are potentially more effective than newsletters because they are two-way and you can guarantee that the message was delivered. You can also listen carefully to any concerns or feedback. Tailoring high-level messages to points of individual impact is crucial to maintaining engagement. It is also helpful for managers to keep a journal regarding some of their more detailed conversations for later reference. What is important is that leaders and change agents think of communication, not as a supplemental component to the real work of transformation, but as a mission-critical part of any change effort. Actively manage risk We often hear within project methodologies that we are to expect some level of risk. That doesn’t mean, however, that we are to accept risk while sitting down, waiting and watching for the results of failure. The best way to treat risk is to actively manage it, and the most clear-cut methods for actively managing risk are to grade success and to catch errors quickly. Here, we employ some tried-and-true philosophies that deserve a more detailed understanding. Fast fail forward There is a common misconception in the term fast fail forward that having failures is actually a good thing. In reality, immediate success without failure is ideal. Fast failing forward simply acknowledges that failures are a fact of life, so the best we can do is to identify them quickly, embrace them and then move forward or around them. If there is an issue, it should be dealt with. The faster it is dealt with, the better your chances are for success. To identify problematic issues quickly, managers should time-base project milestones, saying, “In the next three months, we need to accomplish these five things.” After those items are accomplished or even while they are being accomplished, they should be measured. What is going right or wrong? Teams should provide feedback. If goals aren’t time-based, they can just keep rolling and aren’t likely to be measured. If some sort of feedback isn’t required, course corrections can’t be made. Projects with tight analysis, quick feedback and correction are unable to veer widely off course. Even if a transformation project is incredibly successful and if few issues are ever found, time-based milestones and measurements are valuable in the confidence that they can lend the team. Foster open communication The need for feedback returns us to the topic of communication because the wrong kind of feedback will simply damage and delay the process in ways that may be worse than ignoring the issues. Healthy feedback requires openness. First, you, as a change leader, need to resolve to be open in communication. This doesn’t mean losing tact in conversation and unburdening your gripes or finger pointing, but it means acknowledging clear issues without a focus on blame. Issues are a common place for fires to start. Personalities ignite. Invisible walls go up. Politics burden forward progress. Some personalities, for example, will fight against the failures while others will correctly understand that the struggle is against the issues that are at hand. If you guide everyone toward focusing on the issues, your teams will often unify behind the solutions instead of dividing and hiding behind roles and responsibilities. Meetings should be a place for open discussion, encouraging members to be open with each other and open with themselves and helpful in meeting issues head on. See also: The 4 Secrets to Managing Change   An effective leader will model openness by admitting course errors or mistakes and even by acknowledging the assistance given by someone else to make course corrections. Your efforts and words will help build a culture of quick accountability and decisive issue resolution. Instead of apprehensive team members who think, “We really ought to do something about that,” you’ll have a group of observant change leaders who say, “I see an issue. Let’s deal with it right now.” In my next blog series, we’ll take an in-depth look at why insurers need to consider customer experience as their primary motivator for modernization and change. I hope you’ll join me.

For more than a decade, Americans have been trained to assess and buy insurance products as commodities. This is partly thanks to commercials by Geico, the biggest advertising spender in insurance for many years, which has pushed the concept that “Fifteen minutes can save you 15%,” portraying policies as “the same,” where the only differentiator is the price. Some have dubbed insurance's being viewed as a commodity as the industry’s biggest challenge. On top of price-centric buying behavior, most consumers who are required to purchase certain insurance products — such as medical and auto — expect to have a wide selection and may switch insurance carriers at a blink of an eye. With competition increasing, big data and associated technologies provide timely opportunities by reshaping the modern insurance landscape. The insurance business model typically comprises four parts:

• Underwriting — where insurance companies make money.
• Investment — where insurance companies invest money.
• Claims — where insurance companies pay out (the cost factor).
• Marketing — where insurance products and services are promoted and often advertised.

Insurance companies have always used data in each part of the business model — to assess risk, set policy prices and to win/retain consumers. Previously, insurers would formulate policies by comparing customers’ histories, yielding a simplistic and not-very-accurate assessment of risk. Today, our increasing ability to access and analyze data as well as advancements in data science allow insurers to feed broader historical, continuous and real-time data through complex algorithms to construct a much more sophisticated and accurate picture of risk. This enables insurance companies to offer more competitive prices that ensure profit by covering perceived risk and working within customers’ budgets. Such prices, or setting policy premiums, come from underwriting. In this post, we will focus on an underwriting use case in the highly competitive auto insurance space, where accuracy of risk assessment and rate setting ultimately drive the insurers’ profitability. Future posts will address other parts of the insurance business model. More accurate (and competitive) pricing for auto insurance underwriting Auto insurance may be the most competitive part of the insurance marketplace. Customers shop around (often marketed to by price-comparison services) and change insurers at will. To offer competitive premiums that allow profitability, auto insurers have no choice but to assess risk as accurately as possible. See also: Why Data Analytics Are Like Interest   In auto insurance, insurers use both “small” and “big” data. David Cummings explains the two as: “Traditionally, underwriters have developed auto insurance prices based on smaller data — such as the car’s make, model and manufacturer’s suggested retail price (MSRP). But ‘bigger data’ is now available, providing far more information and allowing insurers to price policies with a better understanding of the vehicle’s safety. From manufacturers and third-party vendors, insurers can learn about a car’s horsepower, weight, bumper height, crash test ratings and safety features. That big data helps insurers create sophisticated predictive models and more accurate vehicle-based rate segmentation.” As data increasingly becomes the lifeblood for insurance companies, the combination of big data and analytics is driving a significant shift in insurance underwriting. For example, faster processing technologies such as Hadoop have allowed insurers like Allstate to dig through customer information — quotes, policies, claims, etc. — to note patterns and generate competitive premiums to win new customers. The data and analytics movement has also made room for newcomers like Metromile to enter the market. Although the company started out with no proprietary data of its own, Metromile has quickly gained customers and collected data with a new model: auto insurance by the mile. This entrance of Metromile into the auto insurance space has both disrupted the industry and put pressure on incumbent insurance providers to make advances with their own models. In auto insurance underwriting, a number of ways to use new data to achieve more accurate pricing have gained attention:

• Using usage-based insurance (UBI)
• Leveraging external data
• Leveraging real-time data

Usage-based insurance UBI can be used to more closely align premium rates with driving behaviors. The UBI idea is not new — there have been attempts to align premiums with empirical risk based on how the insured actually drives for a couple of decades. In 2011, Allstate filed a patent on a UBI cost determination system and method. Progressive, State Farm and The Hartford are just a few examples of other companies that are embracing UBI methods in underwriting. Technological evolutions like the Internet of Things (IOT) and all its attendant sensors provide new ways to capture and analyze more data. The UBI market has flourished and is expected to reach $123 billion by 2022. The U.S., the largest auto insurance market in the world, will lead the way in UBI marketing and innovation in 2017. With UBI’s market potential, there has also been a rise in business models such as pay-per-mile insurance for low-mileage drivers using UBI methods in underwriting. Embracing UBI methods in underwriting is no small feat, because of the huge amounts of data that must be collected and integrated. Progressive collected more than 10 billion miles of driving data with its UBI program, Snapshot, as of March 2014. For the most part, the data focuses on mileage, duration of driving and counts of braking/speeding events. These are all “exposure-related” driving variables, which are considered secondary contributors to risk. They can be bolstered with external data such as traffic patterns, road type and conditions, which are considered primary contributors to risk, to create a more accurate picture of an individual driver’s risk. Leveraging external data The idea of using external data is also not new. As early as the 1930s, insurance companies combined internal and external data to determine the rate for policy applicants. However, more recently, the speed of technological advancements has allowed insurers to dramatically redefine and improve their processes. For example, customer applications for insurance today are significantly shorter than before, thanks to external data. With basics like name and address, insurers can access accurate data files that will append other necessary information — such as occupation, income and demographics. This means expedited underwriting processes and improved customer experiences. Some speculate that all insurers will purchase external data by 2019 to streamline their underwriting (among other things). Another consideration is that the definition of external data has been evolving. Leveraging external data in an auto insurance risk assessment today may mean going beyond weather and geographic data to include data on shopping behaviors, historical quotes and purchases, telematics, social media behaviors and more. McKinsey says, “The proliferation of third-party data sources is reducing insurers’ dependence on internal data.” Auto insurers can incorporate credit scores into their underwriting analysis as empirical evidence that those who pay bills on time also tend to be safer drivers. Better access to third-party data also allows insurers to pose new questions and gain a better understanding of different risks. With the availability of external data like social data, insurers can go beyond underwriting and pricing to really managing risks. External data doesn’t just go beyond telematics and geographic data; it may also have real-time implications. Leveraging real-time data Real-time data is a subset of the rich external data set, but it has some unique properties that make it worth considering it as a separate category. The usage of real-time data (such as apps that engage customers with warnings of impending weather events) can cut the cost of claims. Insurers can also factor data such as weather into the overall assessment at the time of underwriting to more accurately price the risk. In the earlier example of using external data to shorten the underwriting process, accessing external information in real-time and checking with multiple sources makes the information in auto insurance application forms more accurate, which, in turn, leads to more accurate rates. Underwriters can also work with integrated sales and marketing platforms and can reference data such as social media updates, real-time news feeds and research to provide a more accurate assessment for those who seek to be insured. Real-time digital “data exhaust” — for example, from multimedia and social media, smartphones and other devices — has offered behavioral insights for insurers. For example, Allstate is considering monitoring and evaluating drivers’ heart rate, electrocardiograph signals and blood pressure through sensors embedded in the steering wheel. See also: Industry’s Biggest Data Blind Spot   Insurers can influence the insured’s driving behaviors through real-time monitoring, significantly altering the relationship with each other. A number of insurance companies, such as Progressive — in addition to the pay-per-mile insurer Metromile — are monitoring their customers’ driving real-time and are using that data for underwriting purposes. Allstate filed a patent on a game-like system where drivers are put in groups. Those in the same group could monitor driving scores in real-time and encourage better driving to improve the group’s driving score. Groups can earn rewards by capturing better scores. Conclusion There’s no doubt that the risky business of insurance is sophisticated. The above examples of leveraging UBI, external data and real-time data merely scratch the surface on data-driven opportunities in auto insurance. For example, what about fraud? Efficiency and automation? Closing the loop between risk and claims? Because only 36% of insurers are even projected to use UBI by 2020, those that embrace data-driven techniques will quickly find themselves ahead of the game. While it’s outside the scope of this post, we should note that leveraging data and methods shouldn’t be done without careful consideration for consumers. As consumers enjoy easier insurance application processes, as well as having more products to choose from and compare prices on, increasingly they will want to understand how these data and analytics techniques affect them personally — including their data privacy and rights. As we pause and reflect on how data and analytics have driven changes in auto insurance underwriting, we welcome questions and discussions in the comments section below. In the future, we’ll examine other ways the insurance market is becoming more data-driven, including the changes that data and analytics are driving in auto insurance claims and the rising focus of marketing. This article first appeared on the site of Silicon Valley Data Science.