Tag Archives: alternative capital

The ‘New Normal’ for Reinsurers

Third-party reinsurance, or alternative capital, has become a “new normal” for reinsurers as they seek to remain competitive, meaning that so-called convergence capital from the insurance-linked securities (ILS) market will remain key.

Despite falling for the first time in 10 years, the use of ILS or convergence capital by insurance and reinsurance firms has become increasingly strategic and embedded within their business models.

This has led rating agency S&P Global Ratings to call ILS capital “key,” explaining that the use of third-party capital, particularly by reinsurance firms, should be considered a “new norm” as it is incorporated into their operations to help them remain competitive.

In a new report, S&P explains that after the dip seen in ILS capital following the losses of recent years, the inflows to ILS funds and other collateralized reinsurance vehicles have continued, although at a slower rate.

S&P notes the flight to quality, the well-documented ability of the more established, largest and best-performing ILS fund managers to continue attracting capital, explaining that, “we believe capital will continue to flow into the market, particularly to insurance-linked security (ILS) funds with strong underwriting, established track records of successful capital deployment and transparent reporting.”

Overall, the rating agency says that it expects that “convergence capital will continue to play an important role in the competitive dynamics of the global reinsurance market and bolster capacity.”

While traditional reinsurance firms will increasingly “factor third-party capital into their strategies to help them respond to the ongoing challenging competitive environment.”

See also: Model for Collaboration and Convergence  

S&P highlights that investors have shown some reluctance to enter the ILS market, or to reload their allocations to reinsurance linked investments following the major catastrophe loss years.

This is “not surprising,” S&P says, following the two worst performance years for ILS and catastrophe bond investments since the market’s inception.

In addition, 2019 returns have been depressed by the continued impact of prior year losses and loss creep, as catastrophe loss events such as typhoon Jebi and hurricanes Irma/Michael continue to develop.

But even taking into account the catastrophe losses and loss creep suffered by ILS investors, “new capital has entered the market–albeit at a slower rate,” S&P explains.

But the focus of investors has sharpened, S&P continues, saying that “the recent losses have put investors’ focus on seeking out the best available returns.”

S&P believes that enhancements to models and adjustments to contract language, such as peril exclusions, will encourage further growth of the ILS market, once the recent losses are settled.

“Many third-party capital investors have made good returns over the long term, and the argument for investing in insurance risk to achieve portfolio diversification remains valid,” the rating agency explains.

It added, “For cedants, this means that there is capacity for the right risks at the right price.”

The collateralized reinsurance segment of the market has demonstrated that “convergence is truly underway,” S&P notes.

“All players continue to innovate and explore different routes and solutions to gain access to capital or insurance risk in the most cost-effective manner,” S&P continues, trends that are developing very quickly as new startups are set to demonstrate in months to come we would add.

Rated reinsurance vehicles is one route to market that is more direct and efficient, as are initiatives that seek to bring ILS capital closer to pools of directly originated risk.

Insurer- and reinsurer-owned third-party capital vehicles are perhaps where the greatest convergence is seen, as here the capital markets are directly integrated into the traditional business model as augmentation to the re/insurers own balance-sheet capacity.

“These platforms help insurance and reinsurance companies attain greater scale and relevance as well as target lines of business where the returns might not support their own cost-of-capital adequately, which would allow them to provide more complete solutions to their clients,” S&P explained.

In the past, traditional reinsurers viewed third-party capital as a “nice to have,” S&P says.

But now, “It has become the new norm, with established players incorporating third-party capital into their operations to stay competitive.”

S&P further explains that in analyzing reinsurers for rating purposes it looks closely at the businesses risk profile, with its competitive position compared with peers a key factor in this.

Typically, a company with a stronger competitive position is expected to exhibit consistently higher and more stable profitability metrics than peers, S&P explains, leading it to say, “Using third-party capital to profitably grow the top and bottom line should, in general, reflect positively on this assessment.”

That reflects the rising importance of having access to third-party capital and owning the deployment of it for reinsurers.

But, we would again note that it has yet to be proven out how this strategy will play out for all reinsurers, as they look to juggle own balance-sheet shareholder capital with that raised into reinsurance vehicles and ILS funds they own.

Is the fee income and profit share that can be earned by underwriting using third-party capital really a sufficient replacement for the profit earned by underwriting using a reinsurers’ own balance-sheet?

Or will the use of increasing amounts of third-party capital force the need for increasing efficiency and lower expenses on reinsurers?

In addition, the questions of conflicts of interest remain and have not been answered to the satisfaction of many investors, who find allocation decisions by reinsurer-owned ILS vehicles and funds often difficult to understand, largely because the explanations for decisions are often not particularly well-articulated.

While some players seem to be managing this juggling act adequately for now, it is going to take time for the industry as a whole to establish just how successful this will be across the sector.

Questions also still exist about what will happen if rates continue to rise, so reinsurers decide their appetite for catastrophe risk on their own balance-sheet has increased?

See also: Shift in Capital for Reinsurers?  

Will they continue to feed their third-party investors at that point in the cycle, and how will allocation decisions (to the different forms of capital) change at the same time?

The crux of this is that reinsurance is still evolving and the market adapting to the availability of capital market financing, the use of financial market technologies such as securitization, and the emergence of the ILS investment market.

In addition, the use of data and technology is going to change the playbook again for re/insurers and ILS fund managers alike in years to come, with the evolution and disruption we’ve seen so far likely to be eclipsed by what comes next.

Yes, convergence continues, looks set to be sustained, will likely accelerate and has certainly become a “new normal.”

At the same time, it remains early days in this evolving world of reinsurance and risk transfer, with the winners and losers yet to be fully identified.

Which all means there is plenty of room for change and for new strategies to emerge, as the traditional insurance and reinsurance market continues to converge with the growing sources of third-party capital.

You can find the article originally published here

3 C’s for Commercial Brokers in 2018

As we first noted in our 2014 publication, Broking 2020: Leading from the front in a new era of risk, trends reflecting larger macroeconomic forces have been fueling a contentious debate between brokers and underwriters on compensation, leading to a war of words in 2017 that saw leading players on both sides invest to reinforce their market positions. The same trends are also driving increased customization of products, increasing reliance on direct-to-consumer models and greater economies of scale for an increasingly large number of market participants. Collectively, we categorize these trends into the “three Cs” of consolidation, customization and collaboration.

Consolidation: We continue to see overall consolidation of the brokerage market; Conning tracked more than 450 transactions through October 2017. This activity compares favorably with 537 transactions in 2016 and an annual average of 414 transactions from 2011 to 2015. Looking forward, the factors that are driving consolidation and greater levels of operational efficiency include a low-interest-rate environment, the presence of alternative capital providers and continuing demand for expanded broker capabilities.

Customization: Over all, the desire for more localized market knowledge and custom products is a strong and recurring trend, with historically strong insurance hubs such as Lloyd’s recognizing the increasing need to meet local demands. For brokers, the need is clear: provide local knowledge coupled with global scale to rapidly place risks across geographies.

Collaboration: Technologies such as blockchain have the potential to transform insurance processes, providing efficiency savings and greater levels of information to both brokers and their customers. Depending on blockchain’s ultimate implementation, it is possible that brokers could operate within a fully electronic process or be innovated out of it (i.e., be replaced by electronic platforms and algorithms for many categories of risks). Ultimately, the broker’s place in the insurance lifecycle likely will remain despite increasing automation, but for those risks from which an intermediary can be removed, disintermediation will occur. For example, we have seen innovative carriers such as Hiscox offer a direct-to-consumer model for small commercial risks.

Trends that had an impact on the personal lines market in prior years are beginning to affect commercial lines, with risk managers looking for more customized products and technology-driven innovations for even the most specific product classes.

Consolidation: The commercial brokerage market has experienced continued consolidation, with the top 10 brokers generating 2.5 times more revenue than the next 90 brokers in the market (Conning Insurance Segment Report: Property – Casualty Distribution, p. 2). We believe that three trends are driving this M&A wave:

1. Alternative capital – Alternative capital providers (e.g., hedge funds, private equity) have continued to play a role in accelerating consolidation, lured by consistent revenue streams (many brokers have renewal rates in the 80% to 90% range), as well as systemic diversification outside of the debt and equity markets. With continuing low investment yields, the presence of alternative capital is expected to keep influencing the market. The “hunt for yield” has raised broker multiples and created a feedback loop of higher valuations and deal volumes.

2. Stagnant revenue – Despite some short-term hardening as a response to catastrophic events in the second half of 2017, we believe generally favorable loss experience and historically high policyholder surplus will continue to pressure pricing for the foreseeable future. As a result, premium pricing could remain soft across most commercial classes, thereby restricting both premium and commission growth.

This ceiling on commission growth will challenge brokers of all sizes to improve their internal cost structures, particularly for back-office processing, which can represent well over half of their operating costs. They are increasingly able to cut costs through technology initiatives that automate standard or low-value processes, as well as introducing better analytics and sales tools to increase conversion and retention ratios.

3. Demand for local market presence – As risk managers struggle with increasingly complex risk exposures, they are looking for brokers to provide enhanced services across their enterprises. While this would seem to benefit the largest brokers, we believe there is a growing appetite for a seemingly contradictory skill set: a global footprint with enhanced local knowledge – which puts pressure on brokers to expand their footprint in new or existing locations.

See also: Why Commercial Insurers Can Rock  

For brokers whose operating model is “hub and spoke” with branch offices remitting central placement to a global office, we believe smaller specialist firms that can provide immediate service on the spot will continue to compete strongly against brokers that are unable to provide comparable, enhanced local support. In fact, this expectation goes beyond the brokerage side of the value chain to insurers and even placement markets such as Lloyd’s, which are increasingly challenged to provide more efficient and localized service.

PwC’s 2014 “Risk Buyer Survey” noted that risk managers ranked price-driven change as the third most likely reason to switch brokerages, below service capabilities and geographic reach. This strongly implies that brokers must continue to expand their service offerings while simultaneously offering local market knowledge and global scale.

Three trends will continue to fuel the broker consolidation wave: alternative investors bringing new capital to the market, stagnating broker revenue driving efficiencies of scale and demand for greater local market presence.

Customization: Current operating models need reassessment as the insurance buyer demands change. Beyond price, buyers are looking for a variety of choices and flexibility when working with their insurance brokers. The demand for choice has begun to split the commercial market, with buyers falling into two behavioral groups:

  • Insurance as a service: These buyers look for comprehensive risk management solutions and view insurance as a set of services (risk transfer, risk management and risk mitigation) that can lower their overall exposures to loss.
  • Insurance as a product: These buyers view insurance as a product and transaction and therefore look for the best combination of price and ease of doing business.

“Insurance as a service” buyers look for bespoke risk management services beyond placement. Their carriers need to provide risk advisory, value-added services such as site audits and close interaction with the company’s internal finance and accounting departments to align their insurance portfolios to their risk exposure. A relevant example is Hartford Steam Boiler providing site inspection and engineering consulting as a complementary service that moves beyond risk transfer into a recurring advisory role.

On the opposite end of the spectrum, “insurance as a product” buyers look for a variety of insurance choices and the ability to compare and build more modular insurance products as needed. These buyers look to on-line solutions for their purchases and want to easily understand products for which robo-advisers and comparison sites are becoming competitors to traditional brokerages.

We believe there are a number of new market entrants that can challenge incumbents in the “insurance as a product” space:

  • Direct-to-consumer carrier: Insurers such as Hiscox offer a consumer-facing website that allows SME markets to quote select liability exposures directly.
  • E-brokerage: Internet brokers such as Coverhound allow purchasers to submit quote information on-line.
  • Peer to peer: Startups like Lemonade and Bought by Many may displace the entire insurance model with peer-to-peer risk pooling.

Consumers are increasingly looking for more customized buying experiences and products from all industries. Commercial risk buyers are no different, and, as buyer expectations change, brokers will need to align their business models to their targeted buyer profiles.

Collaboration — In the U.S. alone, Conning has estimated that 3,000 insurance companies and more than 30,000 agents and brokers serve the insurance market. Looking forward, blockchain could enable common data sharing across this fragmented market. Two possible scenarios could play out, broker-centric v. direct-to-consumer.

In either model, blockchain has the potential to transform the (re)insurance value chain, including:

  • Risk Management – Blockchain could be combined with other Internet of Things products (such as RIFD) to track the transport of high-value goods.
  • Policy Validation – Blockchain implementation could support policy validation in real time, minimizing coverage validation and improving subrogation/recovery capabilities. Steps to create insurer-to-insurer (I2I) communications have already begun, with the carrier-led “B3i” initiative between Aegon, Munich Re, Zurich, SwissRe and Allianz to link the numerous insurer-specific use cases for blockchain.
  • Reinsurance – Complex, multi-layer reinsurance contracts could be managed on a common blockchain, allowing participants to automatically track and manage ceded/assumed premiums and losses.

In addition, as we noted in Broking 2020, one way brokers can create value in this environment is to become risk-facilitation leaders. This role would connect various industry leaders, (re)insurance leaders and governmental officials on select
risks (e.g., cyber) to discuss holistic risk management solutions. Brokers seem ideally placed to facilitate such discussions, which would provide them an opportunity to move beyond risk transfer and become a collaborative partner in their clients’ operational success.

PwC’s 2014 Risk Buyer Survey supports this idea: 67% of risk managers considered their brokerage firm a “trusted adviser,” versus 46% who simply viewed themselves as a “placer of coverage.” (Note: respondents were able to select multiple choices, resulting in values greater than 100%.)

See also: Commercial Lines: Best Is Yet to Come  

New technologies such as blockchain could provide the insurance industry a unique opportunity to collaborate. How these technologies will affect the industry remain to be seen, but forward-thinking (re)insurers are already establishing collaborative initiatives to establish proofs of concept.


  • Faced with the “three C’s” of consolidation, customization and collaboration, we believe brokers have an opportunity to implement changes before these trends cause even more disruptive change(s). Changing buyer demands will require brokerages to reassess their operating models to confirm they provide the correct balance of enhanced local market knowledge and scale efficiencies.
  • Industry consolidation will further concentrate market power. Smaller brokerages need to determine the appropriate business strategy for a market where the top 10 brokerages produce 2.5 times as much revenue as the next 90 firms.
  • Brokers could position themselves to compete in price-sensitive “insurance as a product” markets or establish risk management/advisory offerings to serve “insurance as a service” buyers.
  • Emerging technologies such as blockchain have the potential to disrupt insurance placement and policy management processes. Brokers should establish a plan to leverage these emerging technologies to manage or avoid disruption from new market entrants.

This article was written by Richard Mayock, Jamie Yoder, Francois Ramette, Marie Carr, Matthew Wolff and Joseph Calandro Jr.

You can find the PwC report here.

The Unicorn Hiding in Plain Sight

Attend any insurance-focused conference, and you will undoubtedly hear about the high volume of angel and venture capital currently chasing the next unicorn in insurance – the industry equivalent of Facebook or Amazon. In the search for value, investors are first asking questions about how long it will take for innovation to transform the industry’s business model or who will be the major disrupters. Is it the new approach to distribution that will render the current ecosystem extinct? Is it a different approach to underwriting courtesy of new advancements in data and analytics? These are legitimate questions – but what if we are looking in all the wrong places? What if the next Uber of insurance has already arrived?

An important component of the value chain in consumer-facing markets is access to the customer. Creating a user-friendly application drives user engagement, and therefore retention. The critical difference in the insurance industry, however, is the lack of engagement. Insurers are challenged with a product that does not lend itself to a frequent interaction with clients. There are typically only two points of contact: sale and claim payment. Though both present opportunities to build customer relationships, this number is orders of magnitude lower than for consumer technology applications. This means insurers need a better solution to work around the value chain to gain control of the customer, one that involves driving down costs. Herein lies an unexpected solution – alternative capital.

Alternative capital refers to pools of capital available for the transfer of risk from an insurer to the capital markets, typically in the form of insurance-linked securities (ILS) or special purpose vehicles (SPVs). The impact of alternative (or third party) capital is well understood in the reinsurance world today as global risks have been packaged, turned into portfolios and offered to the very largest providers of capital in the world as an alternative, risk-bearing asset class. The size of the market has grown considerably in recent years, with alternative capacity reaching $86 billion, or 14% of global reinsurance capital, as of the first quarter end of 2017, according to Aon.

Alternative capital represents 14% of global reinsurance capital

The question, though, that investors should be asking is: Who has access to the cheapest capital? The answer to this question, the authors believe, will yield important insights as capital efficiency enables players in this space to get closer to the clients and, more specifically, the source of risk. After providing appropriate scale for disruption in the industry, along with an important framework to understand industry cost of capital, we consider evidence from the banking sector and anecdotal data from current trends in the market to argue that the Uber of insurance is already here.

See also: Preparing for Future Disruption…  

Disruption at Scale

In an era of rampant overcapacity, it is sometimes easy to forget the historical significance of access to risk-based capital. The explosion of new technology applications to challenge the gatekeepers in the industry, funded by a dramatic rise in venture capital for Insurtech startups, has taken a lot of interest among industry participants. Insurance and reinsurance applicants are still, though, fundamentally sending submissions and applications to be accepted as insureds and cedants. There is an offer of risk transfer for premium. Unless platforms that control the customer also start retaining the risk with an equal to or lower cost of capital, the incumbents are still likely to control the system. Until this happens, those who build the best capital platform can offer the best products to attract customers, with the lowest-cost capital translating to lower prices for consumers – a reality supported by the scale of alternative capital disruption.

Alternative capital currently on risk in 2016 dwarfs VC funding in Insurtech

While the scale of insurtech investment itself is enough to make serious people sit up and take notice, it is the speed, velocity, sources and efficiency of capital that will drive the future direction of the industry. To assess the long-term impact to the industry of these dueling solutions to disruption, an understanding of the drivers of industry cost of capital is required.

Insurance Company Cost of Capital

While ILS as a practice is nearly 20 years old, we are still in the first inning of how this once-niche part of the global reinsurance and risk transfer market will expand its influence. The current problem the industry is facing is that it does not do a good job of differentiating capital sources with specific levels of risk. Investors looking for a 5% or 7% or 11% return all fund risk whether at the 1-in-50 return period or 1-in-250 return period. This capital inefficiency not only lowers margins but also increases the cost of capital and perpetuates a system that hinders new product development at the expense of the end consumer. The use of third party capital gives underwriters the ability to cede remote, capital-intensive risk off their books and onto a lower-cost balance sheet. This matching of different types of risk with different pools of capital produces a leaner, more customer-focused, lower-priced risk transfer market, ultimately benefitting the end consumer from cheaper reinsurance products.

The industry also cares about returns. Meeting analyst expectations has become increasingly difficult as pricing and investment yields have declined. Because insurance companies operate in a market that is becoming more commoditized, insurers and reinsurers need to either find another way to increase returns or figure out a way to lower their cost of capital. Alternative capital providers have a fundamental advantage in this respect, as “…pension fund investors are able to accept lower returns for taking Florida hurricane risk than rated reinsurers, for whom the business has a high cost of capital.” Similarly, the opportunity cost of capital for a typical venture capital fund (17% before management fees and carried interest) outstrips the hurdle rate for pension fund investors who turn to catastrophe risk as a diversifying source of return.

Similarities to the Banking Sector

The importance of cost of capital in determining winners and losers in capital-intensive industries can be clearly seen in the banking sector. When banks accessed lower-cost capital through capital market participants, their balance sheets were essentially disintermediated as they no longer had to finance the bank’s capital charges. By going straight from the issuer to capital and removing the need to finance these expensive capital costs, the aggregate cost of the system (value chain) was reduced. This benefitted consumers and drove retention in the same way we normally associate technology disintermediating distribution in other industries to drive down costs.

Just as loan securitization transformed the banking industry, so, too, can risk securitization change the economics and value proposition of insurance for the end consumer. Capital disintermediation offers new operating models that connect the structurers of risk with the pricers of risk, until disrupters prove they can do this better. Because insurance underwriters and mortgage loan originators retain differing levels of risk ceded to the capital markets, gaining access to the most efficient forms of financing is an increasingly important battleground for players in the insurance space. When investors no longer tolerate capital inefficiency and increasing returns proves challenging, value chain disruption is a real threat because the lack of client proximity and customer engagement provides no competitive moat. A comparison between the recent growth in U.S. P&C industry direct written premiums and growth in U.S. P&C industry surpluses shows just why capital efficiency is so important.

Renewed focus on capital efficiency as industry surpluses overtake industry premiums

Industry surpluses have increased at a rate more than double that of industry premiums ($418 billion increase vs. $200 billion increase) since 2002. The surplus growth relative to premiums highlights the steep drop in capital leverage from 1.4 in 2002 to 0.8 in 2016. As insurers sit on larger stockpiles of capital, they are relying less on underwriting leverage to juice up returns to meet their cost of capital. Hence, pricing power and cost controls have taken on increased importance.

The Current Fall-out

The growth of alternative capital has fostered innovation, both directly and indirectly, among industry participants across the value chain. Under the weight of efficient capital, industry players can take a step beyond leveraging insurtech to create value within the system – they can collapse it. In fact, we are seeing this happen right now. ILS funds such as Nephila are bypassing the entire value chain by targeting primary risk directly. Nephila’s Velocity Risk Underwriters insurance platform enables the ILS manager to source risk directly from the ultimate buyer of insurance. From consumer to agent to the Nephila plumbing system, homeowners’ risk in Florida can be funded directly by a pension fund in another part of the world.

See also: Innovation: ‘Where Do We Start?’  

Innovation is a healthy response, and this evolution of the reinsurance business model, while producing losers, will produce a leaner, more customer-focused, lower-priced risk transfer market in the end, ultimately benefitting everyone. The opportunity set for alternative capital to benefit the industry is not just limited to retrocession and access to efficient capital. Leveraging third party capital to provide better products and services to clients allows insurance companies to not only expand their current product offerings but also extend the value proposition beyond price alone, with different capital sources offering different structural product designs, terms, durations and levels of collaterization.

Consider solar. The insurtech solution to creating a product that will provide protection for this emerging risk might include distribution and analytics. In contrast, partnering with third party capital providers can allow an insurance company to create a product with unique features such as parametric triggers that could solve a problem the traditional reinsurance industry, with its complicated and long casualty forms, has long struggled with. In doing so, third party capital can help grow the market for insurance in a way that insurtech has not yet achieved.


Two of the most common counterarguments for alternative capital’s Uber-like impact on the industry are that it remains largely untested capital in the face of a significant event and that we’ve hit a ceiling on the limit of third party capital in the traditional reinsurance market.

On the first point, as of this writing, it is still too early to assess how existing and new potential third party capital investors will respond to hurricanes Harvey and Irma in coming renewals. However, the combination of the ILS market’s established track record, experience paying claims and fund managers staffed by people who have long experience as reinsurers provides support that investor interest post-event will remain strong.

As for the second, in a static world, that claim may be true. But we believe there is plenty of room to grow in this market from both a supply and demand perspective. On the supply side, ILS accounts for only 0.6% of the global alternative investments market, with ample room to increase assets under management, according to the latest survey on alternative assets from Willis Towers Watson. On the demand side, around 70% of global natural catastrophe losses remain uninsured, and these risks are only growing. Insurers will require protection against aggregation and accumulation risk, and increasingly see the natural home for the tail risk in the capital markets and ILS.

We have witnessed alternative capital’s ability to attract risk to capital and lower aggregate cost of the entire value chain. Many in the industry are monitoring how insurtech will sustainably attract risk and attract customers over the long term. In the meantime, the companies that have used their time wisely in the soft market by increasing capital efficiency to source, return and attract new forms of capital the quickest will be well-positioned in the space and can happily partner with great distribution partners of their choice. Even so, the players with the lowest cost of capital can accept risk more quickly and easily and can develop products more cheaply and with unique technological features for consumers.

Insurtech will still play a pivotal role in shaping the future of the industry. Most of the participants in the insurtech space are in the early stages of capital formation. As investment scales and business models mature, insurtech should help leverage the proliferation of new sources of information and data pools to advance the securitization of different types of risk. Access to enhanced analytics helps make the underwriting and funding of more intangible risks, such as reputation and contingent business interruption, more sustainable, thereby increasing the participation of third party capital in lines of business outside property catastrophe.

In the mid-1990s, far less than 1% of global reinsurance capacity was alternative capital; by 2016, its influence had grown to nearly 15%. Here is our question for the next industry conference: What will alternative capital look like in 2030?

A Simple Model to Assess Insurtechs

“The paradox of teaching entrepreneurship is that such a formula necessarily cannot exist; because every innovation is new and unique, no authority can prescribe in concrete terms how to be innovative.”

― Peter Thiel, Zero to One

Whether we’re talking about telematics, artificial intelligence (AI), digital distribution or peer-to-peer, investing in insurance-related technology (commonly termed “insuretech” or “insurtech”) is no longer considered boring. In fact, insurtech is one of the hottest investable segments in the market. As a 20-plus-year veteran in insurance, I find it surreal that insurance has become this hip. Twenty years ago, I gulped as I sent an email to the CFO of my company, where I proposed that there was a unique opportunity in renters insurance. That particular email was ignored. Today, that idea is worth millions of dollars.

What changed?

Insurance seems to be the latest in a string of industries caught in the crosshairs on venture capital. With the success of Uber and AirBnB, VCs are now looking for the next stale industry to disrupt, and the insurance industry carries the reputation of being about as stale as they come. The VCs view the needless paperwork, cumbersome purchasing processes, dramatic claims settlement and overall old-school look and feel of the industry and think they can siphon those trillions of dollars of premium over to Silicon Valley. It seems like a reasonable thesis.

The problem is, it’s not going to happen that way. Insurance will NOT be disrupted. While insurance looks old and antiquated on the exterior, it is actually quite modern and vibrant on the interior. The insurance industry is actually the Uncle Drew of businesses; it’s just getting warmed up!

The Model

Much of the reason I think VCs are unaware of their doomed quest for insurance disruption is that they are looking at the market from a premium standpoint and envisioning being able to capture large chunks of it. $5 trillion is a lot of money. Without an appropriate model, an outsider coming into insurance can naively think they can capture even a fraction of this. But premium is strongly tied to losses. Those premium dollars are accounted for in future claims.

I once had a VC ask me what the fastest way to $100 million in revenue was. The answer is easy, “slash the premium.” I had to quickly follow up with, “and be prepared to be go insolvent, as there is no digging yourself out of that hole.” He didn’t quite get it, until I walked him through what happens to a dollar of premium as it enters the system. And it was this that became the basis of the model I use to assess new product formation and insurtech startups.

There are four basic components to my model. Regardless of new entrants, new products or new sources of capital, these four components remain everpresent in any insurance business model. Even if a disruptive force was able to penetrate the industry veil, that force would still need to reflect its value proposition within my four components.

Component 1 – EXPOSURE

This is the component that deals with insurance claims: past, present and future. Companies or products looking to capture value here must be able to reduce, prevent, quantify or economically transfer current or new risks or losses. Subcomponents in this category include expenses arising from fraud and the adjustment of claims, both of which can add substantially to overall losses.

See also: Insurance Coverage Porn  

Startups such as Nest are building products that increase home security by decreasing the likelihood of burglary (or increasing the likelihood of capturing the criminals on video) and thus reduce claims associated with burglary or theft. Part of assessing the value proposition of Nest is to first understand the magnitude of the claims associated with burglary and theft and then quantify what relief this product could provide (along with how that relief should be shared among stakeholders).

Another company that is doing some interesting things in this model component is Livegenic (disclaimer: I have become friends with the team). Livegenic allows insurers to adjust claims and capture video and imagery using the mobile phone of the insured. This reduces the expenses associated with having to send an adjuster out to each and every claim. Loss adjustment expenses can be in excess of 10% of all claims, so technology that reduces that by a few basis points can be quite valuable to an insurer’s bottom line and ultimately its prices and competitiveness.

Component 2 – DISTRIBUTION

This component focuses on the expenses associated with getting insurance product into the hands of a customer. Insurtech companies in this space are typically focused on driving down commissions. This can be done by eliminating brokers and going directly to customers. Savings can also be achieved by creating efficient marketplace portals that allow customers to easily buy coverage.

Embroker is one of many companies trying to do just that in the small commercial space by creating a fully digital business insurance experience. Companies such as Denim Labs are providing social and mobile marketing services to companies in insurance. And then there is Lemonade, which is developing AI technology that it hopes will reduce the friction of digitally purchasing (its) insurance and making the buying process “delightful.”  Peer-to-peer (P2P) insurance is a fairly new insurtech distribution model that attempts to use the strength of close ties via social methods for friends and close associates to come together to make their own insurance pools.

Distribution expenses in insurance are some of the highest in any industry. As with the risk component, reducing expenses in this component by even a few basis points is incredibly valuable.

Component 3 – CAPITAL

This component focuses on the expenses associated with providing capital or the reinsurance backstop to a risk or portfolio. For many insurers, reinsurance is the largest expense component in the P&L. Capital is such an important component to the business model that the ramifications of it almost always leak into the other components. This was one of my criticisms of  Lemonade recently. Lemonade will have a lot of difficulty executing some of the aspects of its business model simply because it cedes 100% of its business to reinsurers. So, when it comes to pricing or its general underwriting guidelines, its reinsurance expenses will overwhelm other initiatives. Lemonade can’t be the low-cost provider AND a peer-to-peer distributor because its reinsurance expenses will force it to choose one or the other. This is a nuance that many VCs will miss in their evaluation of insurtechs!

For those seeking disruption in insurance, we have historical precedent of what that might look like based on the last 20 years of alternative capital flooding into the insurance space. I will devote space to this in future articles, but, in brief, this alternative capital has made reinsurance so inexpensive that smaller reinsurers are facing an existential crisis.

Companies such as Nephila Capital and Fermat Capital are the Ubers of insurance. Their ability to connect investors closer to the insurance customer along with their ability to package and securitize tranches of risk have shrunk capital expenses tremendously. Profit margins for reinsurers are collapsing, and new business models are shrinking the insurance stack. It is even possible today to bypass BOTH veritable insurers and reinsurers and put the capital markets in closer contact with customers. (If you are a fan of Michael Lewis and insurance, you will enjoy this article, which ties nicely into this section of the article).

In the insurtech space, VCs are actually behind the game. Alternative capital has already disrupted the space, and many of the investments that VCs are making are in the other components I have highlighted. Because of the size of this component, VCs may have already missed most of the huge returns.

Component 4 – OPERATIONS

The final component is often the one overlooked. Operations includes all of the other expenses not associated with the actual risk, backing the risk or transferring the risk from customer to capital. This component includes regulatory compliance, overhead, IT operations, real estate, product development and staff, just to name a few.

It is often overlooked because it is the least connected to actually insuring a risk, but it is vitally important to the health and viability of an insurer. Mistakes here can have major ramifications. Errors in compliance can lead to regulatory problems; errors in IT infrastructure can lead to legacy issues that become very expensive to resolve. I don’t know a single mainstream insurer that does not have a legacy infrastructure that is impinging on its ability to execute its business plan. Companies such as Majesco are building cloud-based insurance platforms seeking to solve that problem.

See also: Why AI Will Transform Insurance  

It is this component of the business model that allows an insurer to be nimble, to get products to market faster, to outpace its competitors. It’s not a component that necessarily drives financial statements in the short term, but in the long run it can be the friction that grinds everything down to a halt or not.


I have presented a simple model that I use when I assess not just new insurtech companies but also new insurance products coming into the market. By breaking the insurance chain into these immutable components, I can estimate what impact the solution proposed will provide. In general, the bigger the impact and the more components a solution touches the more valuable it will be.

In future articles, I will use this model to assess the insurtech landscape. I will also use this model to assess how VCs are investing their capital and whether they are scrutinizing the opportunities as well as they should, or just falling prey to the fear of missing out.

Originally published at www.insnerds.com,

How to Seize the Opportunities in 2016

This keynote address was delivered to the EY/Insurance Insider’s Global Re/Insurance Outlook conference at the Hamilton Princess Hotel in Bermuda.

It’s a pleasure to be here this morning. I appreciate being invited to offer some thoughts on the state of our industry and where we seem to be headed.

If you’ll indulge me for a few minutes, I’m going to look back at 2015 before I look forward to 2016. It feels like the right thing to do, given the year we’ve had.

I don’t know about all of you, but for me 2015 has come and gone in the blink of an eye.

And what a year it’s been.

You could invoke Dickens and say: It was the best of times. It was the worst of times.

This was the year that a youthful head of state swept into office in Canada on a promise of “sunny ways” – and it was the year that terror ripped through a nightclub in Paris, and a Christmas party in San Bernardino, CA, shattering our personal sense of security.

It was the year that the pope declared a Holy Year of Mercy, and it was the year that more than a million refugees streamed out of the Middle East and into Europe, in a desperate attempt to escape a jihadist war.

It was the year that almost 200 nations signed a landmark agreement to address climate change, and it was the year that another once-in-100-year flood lashed northern England for the second time in less than 10 years.

It was the year that the concept of “the singularity” – when human computing is overtaken by machines – became a distinct possibility.

It was also a year when driverless cars, packages delivered by drone and 3D printing became tangible realities.

Here in Bermuda, 2015 was the year that signaled the demise of a brand name close to my heart – that would be ACE – as M&A fever reshaped the island’s market landscape. It was also the year that the Bermuda Monetary Authority pulled off a coup – seven years in the making – by getting the European Commission to grant us Solvency II equivalence.

2015 was the year when Millennials – the generation born between the late ’80s and the turn of this century – became the largest demographic ever. Think about it. More than half the world is now under the age of 30.

And it was the year when we truly began to exit a world driven by an analog mindset and woke up to the fact that we’re living in a digital age. Labels like digital immigrants and digital natives were used to describe two of the four generations now making up our labor force.

I was invited to speak at a number of different venues this year, and, at each, I tried to describe this sense of being between two worlds.

I’d like to share some of the highlights with you, as I think these issues are going to be key to transforming our industry.

The first speech I gave this year was called “Risk in 140 Characters.”

I was speaking to a group of Millennials in London, and I used Twitter as an example of stripping out inefficiencies to get to the core of a business model. I challenged them to figure out how we can leverage technology to make our industry more efficient.

I also challenged them to spread the word about the industry to their peers. Millennials don’t think much of insurance as a career. With 400,000 positions opening up in five years in the U.S., this lack of interest is creating a talent crisis.

The next speech was “Can We Disrupt Ourselves?”

I spoke to the International Insurance Society in New York a few weeks after I spoke to the Millennials in London, and described some of the game-changing forces our industry is facing – driven by disruptive technology.

I challenged this group – who represent executive management – to figure out how to attract a new generation to our industry, AND to figure out how to work with them. The solution to our disruption will come from the digital natives among us.

Then there was “Where Are the Women? One Year Later.”

In 2014, I gave a speech called “Where Are the Women?” I asked why there aren’t more women in the C-suites and boardrooms of the insurance industry.

This year, I looked at whether much has changed in a year – the answer is no – and what might be done.

The short answer is that people like me – the white males who dominate our industry – need to make gender parity and diversity a priority, and mean it.

A speech I gave to St. John’s University’s School of Risk Management was called “The Canary in the Coal Mine.”

St. John’s organized a day-long conference on issues facing the industry. I talked about M&A, alternative capital and the changing roles of brokers, cedants and reinsurers.

I also addressed the talent crisis, making the point that Millennials are the canaries in the coal mine.

If we don’t pay attention to what they’re telling us about our workplaces and work policies – and this includes our attitude toward diversity and inclusion – they’re going to continue to snub our industry. And we can’t afford to let that happen. Not only are they our future workforce, they’re our current and future customers.

An address to 400 top producers of a brokerage firm was called “Do You Know How to Think Like a Unicorn?”

In Silicon Valley, companies backed by a $1 billion or more in capital are called unicorns, and those backed by more than $10 billion are called “decacorns.” There are more companies with this level of capitalization now than at any other time.

And remember, most of these are tech start-ups, many of which are behind the disruption that’s transforming our world.

I told the brokers that, in the digital world, they need to know their clients’ business, and their clients’ risks, better than the CEO does.

There’s currency in knowing how to interpret data, and brokers have a great opportunity to develop specialized skills that they can monetize.

That’s where the real value-add is.

According to a recent study by IBM, C-suite executives around the world are kept awake at night worrying about being ambushed by so-called digital invaders.

More than 5,000 executives participated in the IBM study. More than half of them told researchers that, above all else, they fear being “Uberized” – blindsided by a competitor outside their industry wielding disruptive technology.

While loss activity, interest rates and pressure on terms and conditions will always affect underwriting and financial performance, it’s now a given that technology and talent will determine who will succeed and who will fail.

So, I asked the brokers: do you know how to think like a unicorn?

I was told later that this firm is now describing itself as a technology company whose product is insurance – so I guess they took my suggestions to heart.

So this year, I focused on five main themes:

  • We still have rampant inefficiency in the way much of our business is conducted.
  • We’re threatened by technological disruption.
  • We have unprecedented risks for which there are no actuarial data.
  • The roles we play are being reinvented in real time.
  • And we have a looming talent crisis.

Not a pretty picture, and not for the faint of heart.

But what scope for innovation!

I really do believe this is one of the most exciting times to be working in this industry in the 40 years since I joined it.

We enter 2016 with the hope that terms and conditions will improve, and the expectation that industry consolidation will continue.

[The recent increase] in interest rates could mean that our capital may take a hit, but we’re likely to earn greater investment income over time, leading to increased revenue.

But these are the traditional hallmarks of a market cycle. This is the easy stuff.

There’s nothing easy or traditional about what’s facing our industry right now. Those of us who cling to the old way of doing business aren’t going to make it.

It’s the manner in which we navigate from the analog to the digital – how we move between two worlds – that will set our future course. This is going to take bold, courageous moves, some leaps of faith and a willingness to fail as often as we succeed.

I think it’s telling that [in November] about 200 industry representatives and entrepreneurs gathered in Silicon Valley to figure out how to change the traditional insurance model.

They felt we need to flip the value proposition from protection to prevention, using data analytics to define the characteristics of a risk and identify how to avoid it.

A report on this conference described it this way:

“One of the biggest challenges for successful executive teams is to reframe a company’s purpose away from its past greatness, and toward a different future.”

We’ve been an industry where past is prologue. But for many of the risks we’re facing, there is no past.

It really shouldn’t matter. We’re awash in data, but data pure and simple isn’t the point.

We need to harness data to predict the future – in other words, adopt the prevention mindset.

The issue isn’t simply gathering massive quantities of data. We need to take the data we have and know how to ask the right questions, and refine the right algorithms, to get the analysis we need to provide our products quickly and efficiently to a world doing business on smart phones.

To create the best risk solutions, we need to redefine the relationships we have with each other and build new organizational ecosystems. This is no time for staying in our traditional comfort zone.

And as an industry whose purpose is to secure the future, we have a collective obligation to address the massive protection gap between the developed and emerging economies.

In 2014, there were an estimated $1.7 trillion in losses. $1.3 trillion of that number was uninsured.

With collaborative undertakings like Blue Marble, the microinsurance consortium that was launched this year, we can begin to close this gap. This not only helps prevent disaster for the underserved, it helps build a sustainable planet.

I know we can figure out how to re-create our workplaces, finding ways to meld the experience and traditional perspective of Baby Boomers like me with the open, diverse, purpose-driven focus of Millennials.

This might be one of our greatest challenges, because it aims straight at the heart of our industry’s old-school DNA.

By the way, I like that Millennials are purpose-driven – because what industry can more rightfully lay claim to purpose than insurance?

As I said in one of my earlier speeches, insurance should be catnip to a Millennial.

Several of us are banking on that being true by supporting an awareness program to let the younger generation know that this is a great career choice.

I’ve been joined by Marsh’s Dan Glaser and Lloyd’s Inga Beale in signing a letter urging our fellow CEOs to put their companies’ weight behind this initiative.

The first phase of this plan is an Insurance Careers Month that will be launched in February 2016. This is primarily a U.S.-based project because that’s where the urgent need is, but other markets will be participating, too. We were aiming to enlist the support of at least 200 carriers, brokers, agents and industry partners – and at last count we had almost 260 signed up. The response has been great.

So, in closing:

It HAS been quite a year.

The way we live and work is changing faster than I think any of us thought possible. We have some amazing challenges and opportunities ahead of us – here in Bermuda, and in the countries where many of us do business.

I’m excited about where we’re going and how we’ll get there, and I hope you are, too.

I believe it’s the best of times.

In the meantime, I hope you all have a great morning of provocative thought and discussion, and I wish you a safe, happy and healthy holiday season.