Tag Archives: economic

2016 Latin America Insurance Outlook

Despite sluggish economic growth and troubling inflation in key markets, the 2016 insurance market outlook for Latin America remains relatively bright. The rollout of new insurance products and distribution approaches at a time of low market penetration should drive strong growth for insurers. Insurance premium growth is expected to rise by around 6% to 7% in 2016 and possibly beyond should the economic environment improve as expected. At the same time, the emergence of end-to-end digital capabilities is transforming the Latin American insurance market. This digital market disruption will force insurers to make rapid revisions to existing business models to stay competitive and build market share.

Customer expectations rising

Commercial customers will continue to require more sophisticated insurance solutions in 2016, including coverage for business interruption, cyber security, civil unrest and errors and omissions. Latin American consumers, many of whom are young, cosmopolitan and tech-savvy, will continue to push for new insurance channels and services that fit their lifestyle. To respond, insurers will need to simplify and adapt products for Millennials and sharpen their focus on mobile and social media interactions. Evolving customer needs throughout the region are compelling insurance companies to rethink their strategies, processes and services. The rise of financial technology, or fintech, companies is causing insurers, particularly in the consumer insurance sector, to reconsider their business models and increase their investment in new digital technologies. Despite a desire to avoid conflicts with legacy models, insurers realize that flexibility, efficiency and innovation are critical for success in a more demanding marketplace

Competition heating up

The liberalization of industry regulation across Latin America has opened insurance markets to wider competition. The abundance of insurance capital has intensified competition from various directions: from global insurers seeking a foothold in the region to local insurers looking to expand cross country to entrenched insurers defending their turf. These competitive trends are keeping insurance rates flat through much of the region and, in some cases, pushing them lower. The most substantial rate decreases have been in non-catastrophe property.

Pockets of premium increases can be found in areas of instability, such as Venezuela. However, insurance capacity is very limited for Venezuelan political risk, with most risks dependent on the international reinsurance market.

As markets develop in Latin America, commercial demand is increasing for new forms of insurance coverage, such as environmental liability. The opening of the oil industry to the private sector in Mexico, for example, is exposing new oil exploration and production entrants to potential losses from environmental damages. But market capacity is still restrained in key markets, such as Brazil, where only a few insurers offer such liability coverage.

Read our Market Outlook for LATAM Insurance in 2016 to understand more about the dynamics facing the South America Market here.

The Defining Issue for Financial Markets

For anyone who has spent time on the open sea, especially in a small craft, you know the sea can be quite the moody mistress. Some days, the gale winds are howling. Some days the sea is as smooth as glass. The financial markets are quite similar.

In late August, the U.S. equity market experienced its first 10% price correction in four years. That ended the third longest period in the history of the market without a 10% correction, so in one sense it was long overdue. But, because the U.S. stock market has been as smooth as glass for years now, it feels as if typhoon winds are blowing.

Cycles define the markets’ very existence. Unfortunately, cycles also define human decision making within the context of financial markets.

Let’s focus on one theme we believe will be enduring and come to characterize financial market outcomes over the next six to 12 months. That theme is currency.

In past missives, we have discussed the importance of global currency movements to real world economic and financial market outcomes. The issue of currency lies at the heart of the recent uptick in financial market “swell” activity. Specifically, the recent correction in U.S. equities began as China supposedly “devalued” its currency, the renminbi, relative to the U.S. dollar.

Before we can look at why relative global currency movements are so important, we need to take a step back. It’s simply a fact that individual country economies display different character. They do not grow, or contract, at the same rates. Some have advantages of low-cost labor. Some have the advantage of cheap access to raw materials. Etc. No two are exactly alike.

Historically, when individual countries felt the need to stimulate (not enough growth) or cool down (too much inflation) their economies, they could raise or lower country-specific interest rates. In essence, they could change the cost of money. Interest rates have been the traditional pressure relief valves between various global economies. Hence, decades-long investor obsession with words and actions of central banks such as the U.S. Fed.

Yet we have maintained for some time now that we exist in an economic and financial market cycle unlike any we have seen before. Why? Because there has never been a period in the lifetime of any investor alive today where interest rates in major, developed economies have been set near academic zero for more than half a decade at least. (In Japan, this has been true for multiple decades.) The near-zero rates means that the historical relief valve has broken. It has been replaced by the only relief valve left to individual countries — relative currency movements.

This brings us back to the apparent cause of the present financial market squall — the supposed Chinese currency devaluation that began several weeks ago. Let’s look at the facts and what is to come.

For some time now, China has wanted its renminbi to be recognized as a currency of global importance — a reserve currency much like the dollar, euro and yen. For that to happen in the eyes of the International Monetary Fund (IMF), China would need to de-link its currency from the U.S. dollar and allow it to float freely (level to be determined by the market, not by a government or central bank). The IMF was to make a decision on renminbi inclusion in the recognized basket of important global currencies in September. In mid-August, the IMF announced this decision would be put off for one more year as China had more “work to do with its currency.” Implied message? China would need to allow its currency to float freely. One week later, China took the step that media reports continue to sensationalize, characterizing China’s action as intentionally devaluing its currency.

In linking the renminbi to the dollar for many years now, China has “controlled” its value via outright manipulation, in a very tight band against the dollar. The devaluation Wall Street has recently focused on is nothing more than China allowing the band in which the renminbi trades against the dollar to widen. With any asset whose value has been fixed, or manipulated, for so long, once the fix is broken, price volatility is a virtual guarantee. This is exactly what has occurred.

China loosened the band by about 4% over the last month, which we believe is the very beginning of China allowing its currency to float freely. This will occur in steps. This is the beginning, not the end, of this process. There is more to come, and we believe this will be a very important investment theme over the next six to 12 months.

What most of the media has failed to mention is that, before the loosening, the renminbi was up 10% against most global currencies this year. Now, it’s still up more than 5%, while over the last 12 months the euro has fallen 30% against the U.S. dollar. Not 4%, 30%, and remarkably enough the lights still go on in Europe. Over the last 2 1/2 years, the yen has fallen 35% against the U.S. dollar. Although it may seem hard to believe, the sun still comes up every morning in Japan. What we are looking at in China is economic and financial market evolution. Evolution that will bring change and, we assure you, not the end of the world.

Financial market squalls very often occur when the markets are attempting to “price in” meaningful change, which is where we find ourselves right now.

What heightens current period investor angst is the weight and magnitude of the Chinese economy, second largest on planet Earth behind the U.S. With a devalued currency, China can theoretically buy less of foreign goods. All else being equal, a cheaper currency means less global buying power. This is important in that, at least over the last few decades, China has been the largest purchaser and user of global commodities and industrial materials. Many a commodity price has collapsed over the last year. Although few may realize this, Europe’s largest trading partner is not the U.S., it’s China. European investors are none too happy about recent relative currency movements.

Relative global currency movements are not without consequence, but they do not spell death and destruction.

A final component in the current market volatility is uncertainty about whether the U.S. Fed will raise interest rates for the first time in more than half a decade. Seriously, would a .25% short-term interest rate vaporize the U.S. economy? Of course not, but if the Fed is the only central bank on Earth possibly raising rates again that creates a unique currency situation. Academically, when a country raises its interest rates in isolation, it makes its currency stronger and more attractive globally. A stronger dollar and weaker Chinese renminbi academically means China can buy less U.S.-made goods. Just ask Caterpillar and John Deere how that has been working out for them lately. Similarly, with a recent drop in Apple’s stock price, are investors jumping to the conclusion that Apple’s sales in China will fall off of the proverbial cliff? No more new iPhone sales in China? Really?

The issue of relative global currency movements is real and meaningful. The change has been occurring for some time now, especially with respect to the euro and the yen. Now it’s the Chinese currency that is the provocateur of global investor angst. Make no mistake about it, China is at the beginning of its loosening of the currency band, not the end. This means relative currency movements will continue to be very important to investment outcomes.

We expect a stronger dollar. That’s virtually intuitive. But a stronger dollar is a double-edged sword — not a major positive for the near-term global economic competitiveness of the U.S., but a huge positive for attracting global capital (drawn to strong currencies). We have seen exactly this in real estate and, to a point, in “blue chip” U.S. equities priced in dollars, for years now.

In addition to a higher dollar, we fully expect a lower Chinese renminbi against the dollar. If we had to guess, at least another 10% drop in the renminbi over next 12 months. Again, the price volatility we are seeing right now is the markets attempting to price in this currency development, much as it priced in the falling euro and yen during years gone by. Therefore, sector and asset class selectivity becomes paramount, as does continuing macro risk control.

Much like a sailor away far too long at sea, the shoreline beckons. We simply need to remember that there is a “price” for being free, and for now that “price” is increased volatility. Without question, relative global currency movements will continue to exert meaningful influence over investment outcomes.

These are the global financial market seas in which we find ourselves.

Insurance at a Tipping Point (Part 2)

This is the second in a series of three articles. The first is here.

With the entire insurance industry at a tipping point, where many of the winners and losers will be determined in the next five to 10 years, it’s important to think through all the key strategic factors that will determine those outcomes. Those factors are what we call STEEP: social, technological, environmental, economic and political.

In this article, we’ll take a look at all five.

Social: The Power of Connections

The shifts in customer expectations present challenges for life insurers, many of which are caught in a product trap in which excessive complexity reduces transparency and increases the need for advisers. This creates higher distribution costs.

A possible solution lies in models that shift the emphasis from life benefits to promoting health, well-being and quality of life. In a foretaste of developments ahead, a large Asian life insurer has shifted its primary mission from insurance to helping people lead healthier lives. This is transforming the way the company engages with its customers. Crucially, it’s also giving a renewed sense of purpose and value to the group’s employees and distributors.

Further developments that could benefit both insurers and customers include knowledge sharing among policyholders. One insurer enables customers to share their health data online to help bring people with similar conditions together and help the company build services for their needs. Similarly, a DNA analysis company provides insights on individual conditions and creates online communities to pool the personal data of consenting contributors to support genetic studies.

A comparable shift in business models can be seen in the development of pay-as-you-drive coverage within the P&C sector. In South Africa, where this model is well advanced, insurers are realizing higher policyholder retention and lower claims costs.

This kind of monitoring is now expanding to home and commercial equipment. These developments are paving the 
way for a move beyond warranty or property insurance to an all-’round
 care, repair and protection service. These offerings move the client engagement from an annual transaction to something that’s embedded in their everyday lives. Agents could play
 an important role in helping to design aggregate protection and servicing.

In banking, we’ve seen rapid growth in peer-to-peer lending; the equivalent in insurance are the affinity groups that are looking to exercise their buying power, pool resources and even self-insure. While most of the schemes cover property, the growth in carpooling could see them play an increasing role within auto insurance.

Technological: Shaping the Organization Around Information Advantage

More than 70% of insurance participants in our 2014 Data and Analytics Survey say that big data or analytics have changed the way they make decisions. But many insurers still lack the vision and organizational integration to make the most of these capabilities. Nearly 40% of the participants in the survey see “limited direct benefit to my kind of role” from this analysis, and more than 30% believe that senior management lacks the necessary skills to make full use of the information.

The latest generation of models is 
able to analyze personal, social and behavioral data to gauge immediate demands, risk preferences, the impact of life changes and longer-term aspirations. If we look at pension planning, these capabilities can be part of an interactive offering for customers that would enable them to better understand and balance the financial trade-offs between how much they want to live off now and their desired standard of living when they retire. In turn, the capabilities could eliminate product boundaries as digital insights, along with possible agent input, provide the basis for customized solutions that draw together mortgages, life coverage, investment management, pensions, equity release, tax and inheritance planning. Once the plan is up and running, there could be automatic adjustments to changes in income, etc.

Reactive to preventative

The increasing use of sensors and connected devices as part of the Internet of Things offers ever more real-time and predictive data, which has the potential to move underwriting from “what has happened” to “what could happen” and hence more effective preemption of risks and losses. This in turn could open up opportunities for insurers to gravitate from reactive claims payer to preventative risk adviser.

As in many other industries, the next frontier for insurers is to move from predictive to prescriptive analytics (see Figure 2). Prescriptive analysis would help insurers to anticipate not only what will happen, but also when and why, so they are in a better position to prevent or mitigate adverse events. Insurers could also use prescriptive analytics to improve the sales conversion ratio in automated insurance underwriting by continually adjusting price and coverage based on predicted take-up and actual deviations from it. Extensions of these techniques can be used to model the interaction between different risks to better understand why adverse events can occur, and hence how to develop more effective safeguards.

figure-2

Environmental: Reshaping Catastrophe Risks and Insured Values

Catastrophe losses have soared since the 1970s. While 2014 had the largest number of events over the course of the past 30 years, losses and fatalities were actually below average. Globally, the use of technology, availability of data and ability to locate and respond to disaster in near real-time is helping to manage losses and save lives, though there are predictions that potential economic losses will be 160% higher in 2030 than they were in 1980.

Shifts in global production and supply are leading to a sharp rise in value at risk (VaR) in under-insured territories; the $12 billion of losses from the Thai floods of 2011 exemplify this. A 2013 report by the UN International Strategy for Disaster Reduction (UNISDR) and PwC concluded that multinationals’ dependencies on unstable international supply chains now pose a systemic risk to “business as usual.”

Environmental measures to mitigate risk

Moves to mitigate catastrophe risks
 and control losses are increasing. Organizations, governments and UN bodies are working more closely to share information on the impact of disaster risk. Examples include R!SE, a joint UN-PwC initiative, which looks at how to embed disaster risk management into corporate strategy and investment decisions.

Governments also are starting to develop plans and policies for addressing climatic instability, though for the most part policy actions remain unpredictable, inconsistent and reactive.

Developments in risk modeling

A new generation of catastrophe models is ushering in a transformational expansion in both geographical 
breadth and underwriting applications. Until recently, cat models primarily concentrated on developed market peak zones (such as Florida windstorm). As the unexpectedly high insurance losses from the 2010 Chilean earthquake and the 2011 Thai floods highlight, this narrow focus has failed to take account of the surge in production and asset values in fast-growth SAAAME markets (South America, Africa, Asia and the Middle East). The new models cover many of these previously non-modeled zones.

The other big difference for insurers is their newfound ability to plug different analytics into a single platform. This offers the advantages of being able to understand where there may be pockets of untapped capacity or, conversely, hazardous concentrations. The result is much more closely targeted risk selection and pricing.

The challenge is how to build these models into the running of the business. Cat modeling has traditionally been the preserve of a small, specialized team. The new capabilities are supposed to be easier to use and hence open to a much wider array of business, IT and analytical teams. It’s important to determine the kind of talent needed
 to make best use of these systems, as well as how they will change the way underwriting decisions are made.

Emerging developments include new monitoring and detection systems, which draw
 on multiple fixed and drone sensors.

Challenges for evaluating and pricing risk

Beyond catastrophe risks are disruptions to asset/insured values resulting from constraints on water, land and other previously under-evaluated risk factors. There are already examples of industrial plants that have had to close because of limited access to water.

Economic: Adapting to a Multipolar World

Struggling to sustain margins

The challenging economic climate has 
held back discretionary spending on life, annuities and pensions, with the impact being compounded by low interest rates and the resulting difficulties in sustaining competitive returns for policyholders. The keys to sustaining margins are likely to be simple, low-cost, digitally distributed products for the mass market and use of the latest risk analytics to help offer guarantees at competitive prices.

The challenges facing P&C insurers center on low investment returns and a softening market. Opportunities to seek out new customers and boost revenues include strategic alliances. Examples could include affinity groups, manufacturers or major retailers. A further possibility is that one of the telecoms or Internet giants will want a tie-up with an insurer to help it move into the market.

More than 30% of insurance CEOs
 now see alliances as an opportunity to strengthen innovation. Examples include the partnership between a leading global reinsurer and software group, which aims to provide more advanced cyber risk protection for corporations.

Surprisingly, only 10% of insurance CEOs are looking to partner with start- ups, even though such alliances could provide valuable access to the new ideas and technologies they need.

SAAAME growth

Growth in SAAAME insurance markets will continue to vary. Slowing growth 
in some major markets, notably Brazil, could hold back expansion. In others, notably India, we are actually seeing a decline in life, annuity and pension take-up as a result of the curbs on commissions for unit-linked insurance plans (ULIP). Further development in capital markets will be necessary to encourage savers to switch their deposits to insurance products.

As the reliance on agency channels adds to costs, there are valuable opportunities to offer cost- effective digital distribution. Successful models of inclusion include an Indian national health insurance program, which is aimed at poorer households and operates through a public/private partnership. More than 30 million households have taken up the smart cards that provide them with access to hospital treatment.

The already strong growth (10% a year) in micro-insurance is also set to increase, drawing on models developed within micro-credit. The challenge for insurers is the need to make products that are sufficiently affordable and comprehensible to consumers who have little or no familiarity with the concept of insurance.

Rather than waiting for a market-wide alignment of data and pricing, some insurers have moved people onto the ground to build up the necessary data sets, often working in partnership with governments, regional and local development authorities and banks and local business groups.

Urbanization

The urban/rural divide may actually be more relevant to growth opportunities ahead than the emerging/developed market divide. In 1800, barely one in 50 people lived in cities. By 2009, urban dwellers had become a majority of the global population for the first time. Now, every week, 1.5 million people are added to the urban population, the bulk of them in SAAAME markets.

Cities are the main engines of the global economy, with 50% of global GDP generated in the world’s 300 largest metropolitan areas. The result is more wealth to protect. Infrastructure development alone will generate an estimated $68 billion in premium income between now and 2030. Urban citizens will be more likely to be exposed to insurance products and have access to them. Urbanization is also likely to increase purchases of life, annuities and pensions’ products, as people migrating into cities have to make individual provision for the future rather than relying on extended family support.

Yet as the size and number of mega-metropolises grow, so does the concentration of risk. Key areas of exposure go beyond property and catastrophe coverage to include the impact of air pollution and poor water quality and sanitation on health.

Tackling under-insurance

A Lloyd’s report comparing the level 
of insurance penetration and natural catastrophe losses in countries around the world found that 17 fast-growth markets had an annualized insurance deficit of $168 billion, creating threats to sustained economic growth and the ability to recover from disasters.

Political: Harmonization, Standardization and Globalization of the Insurance Market

Government in the tent

At a time when all financial services businesses face considerable scrutiny, strengthening the social mandate through closer alignment with government goals could give insurers greater freedom. Insurers also could be in a stronger position to attract quality talent at a time when many of the brightest candidates are looking for more meaning from their chosen careers.

Government and insurers can join forces in the development of effective retirement and healthcare solutions (although there are risks). Further opportunities include a risk partnership approach to managing exposures that neither insurers nor governments have either the depth of data or financial resources to cover on their own, notably cyber, terrorism and catastrophe risks.

Impact of regulation

Insurers have never had to deal with an all-encompassing set of global prudential regulations comparable to the Basel Accords governing banks. But this is what the Financial Stability Board (FSB) and its sponsors in the G20 now want to see as the baseline requirements for not just the global insurers designated as systemically risky, but also a tier of internationally active insurance groups.

The G20’s focus on insurance regulation highlights the heightened politicization of financial services. Governments want to make sure that taxpayers no longer have to bail out failing financial institutions. The result 
is an overhaul of capital requirements 
in many parts of the world and a new basic capital requirement for G-SIIs. The other game-changing development is the emergence of a new breed of cross-state/cross-border regulator, which has been set up to strengthen co-ordination of supervision, crisis management and other key topics. These include the European Insurance and Occupational Pensions Authority (EIOPA) and the Federal Insurance Office (FIO) in the U.S.

Dealing with these developments requires a mechanism capable of looking beyond basic operational compliance at how new regulation will affect the strategy and structure of the organization and using this assessment to develop a clear and coherent company-wide response.

Technology will allow risk to be analyzed in real time, and predictive models would enable supervisors to identify and home in on areas in need
 of intervention. Regulators would also be able to tap into the surge in data and analysis within supervised organizations, creating the foundations for machine-to-machine regulation.

A more unstable world

From the crisis in Ukraine to the rise of ISIS, instability is a fact of life. Pressure on land and water, as well as oil and minerals, is intensifying competition for strategic resources and potentially bringing states into conflict. The ways these disputes are playing out is also impinging on corporations to an ever-greater extent, be this trade sanctions or state-directed cyber-attacks.

Businesses, governments and individuals also need to understand the potential causes of conflict and their ramifications and develop appropriate contingency planning and response. At the very least, insurers should seek to model these threats and bring them into their overall risk evaluations. For some, this will be an important element of their growing role as risk advisers and mitigators. Investment firms are beginning to hire ex-intelligence and military figures as advisers or calling in dedicated political consultancies as part of their strategic planning. More insurers are likely to follow suit.

The final article in this series will look at scenarios that could play out for insurers and will lay out a way to formulate an effective strategy. If you want a copy of the report from which these articles are excerpted, click here.

Insurance at a Tipping Point (Part 1)

Since the start of the decade, we’ve encouraged insurers and industry stakeholders to think about “Insurance 2020” as they formulate their strategies and try to turn change into opportunity. Insurance 2020’s central message is that whatever organizations are doing in the short term, they need to be looking at how to keep pace with the sweeping social, technological, environmental, economic and political (STEEP) developments ahead.

Now we’re at the mid-point between 2010 and 2020, and we thought it would be useful to review the developments we’ve seen to date and look ahead to the major trends coming up over the next five years and beyond.

Where are we now?

Insurance is an industry at the tipping point as it grapples with the impact of new technology, new distribution models, changing customer behavior and more exacting local, regional and global regulations. For some businesses, these developments are a potential source of disruption. Those taking part in our latest global CEO survey see more disruption ahead than CEOs in any other commercial sector (see Figure 1), underlining the need for strategic re-evaluation and possible re-orientation. Yet for others, change offers competitive advantage. A telling indication of the mixed mood within the industry is that although nearly 60% of insurance CEOs see more opportunities than three years ago, almost the same proportion (61%) see more threats.

The long-term opportunities for insurers in a world where people are living longer and have more wealth to protect are evident. But the opportunities are also bringing fresh competition, both from within the insurance industry and from a raft of new entrants coming in from outside. The entrants include companies from other financial services sectors, technology giants, healthcare companies, venture capital firms and nimble start-ups.

graph-1

How are insurers feeling the impact of these developments?

Customer revolution

The insurance marketplace is becoming increasingly fragmented, with an aging population at one end of the spectrum and a less loyal and often hard to engage millennial generation at the other. The family structures and ethnic make-up within many markets are also becoming more varied and complex, which has implications for product design, marketing and sales. This splintering customer base and the need to develop relevant and engaging products and solutions present both a challenge and an opportunity for insurers. On the life, annuities and pensions side, insurers could design targeted plans for single parents or shift from living benefits to well-being or quality of life support for younger people. On the property and casualty (P&C) side, insurers could create partnerships with manufacturers and service companies. Insurers could also offer coverage for different lifestyles, offering flexible, pay-as-you-use insurance or providing top-up coverage for people in peer-to-peer insurance plans.

As the nature of the marketplace changes, so do customer expectations. Customers want insurers to offer them the same kind of easy access, show the same understanding of needs and provide the sorts of targeted products that they’ve become accustomed to from online retailers and other highly customer-centric sectors. Digital developments offer part of the answer by enabling insurers to deliver anytime, anywhere convenience, streamline operations and reach untapped segments. Insurers are also using digital developments to enhance customer profiling, develop sales leads, tailor financial solutions to individual needs and, for P&C businesses in particular, improve claims assessment and settlement. Further priorities include the development of a seamless multi-channel experience, which allows customers to engage when and how they want without having to relay the same information with each interaction. Because the margins between customer retention and loss are finer than ever, the challenge for insurers is how to develop the genuinely customer-centric culture, organizational capabilities and decision-making processes needed to keep pace with ever-more-exacting customer expectations.

Digitization

Most insurers have invested in digital distribution, with some now moving beyond direct digital sales to models that embed products and services in people’s lives (e.g., pay-as-you drive insurance).

A parallel development is the proliferation of new sources of information and analytical techniques, which are beginning to reshape customer targeting, risk underwriting and financial advice. Ever greater access to data doesn’t just increase the speed of servicing and lower costs but also opens the way for ever greater precision, customization and adaptation. As sensors and other digital intelligence become a more pervasive element of the “Internet of Things,” savvy insurers can – and in some instances have – become trusted partners in areas ranging from health and well-being to home and commercial equipment care. Digital technology could extend the reach of life, annuities and pension coverage into largely untapped areas such as younger and lower-income segments.

Information advantage

Availability of both traditional and big data is exploding, with the resulting insights providing a valuable aid to customer-centricity and associated revenue growth. Yet many insurers are still finding it difficult to turn data into actionable insights. The keys to resolving this are as much about culture and organization as the application of technology. Making the most of the information and insight is also likely to require a move away from lengthy business planning to a faster and more flexible, data-led, iterative approach. Insurers would need to launch, test, obtain feedback and respond in a model similar to that used by many of today’s telecom and technology companies.

A combination of big data analytics, sensor technology and the communicating networks that make up the Internet of Things would allow insurers to anticipate risks and customer demands with far greater precision than ever before. The benefits would include not only keener pricing and sharper customer targeting but a decisive shift in insurers’ value model from reactive claims payer to preventative risk advisers.

The emerging game changer is the advance in analytics, from descriptive (what happened) and diagnostic (why it happened) analysis to predictive (what is likely to happen) and prescriptive (determining and ensuring the right outcome). This shift not only would enable insurers to anticipate what will happen and when, but also to respond actively. This offers great possibilities in areas ranging from more resilient supply chains and the elimination of design faults to stronger conversion rates for life insurers and more effective protection against fire and flood within property coverage.

Two-speed growth

These developments are coming to the fore against the backdrop of enduringly slow economic growth, continued low interest rates and soft P&C premiums within many developed markets. Interest rates will eventually begin to rise, which will cause some level of short-term disruption across the insurance sector, but over time higher interest rates will lead to higher levels of investment income.

On the P&C side, reserve releases have helped to bolster returns in a softening market. But redundant reserves are being depleted, making it harder to sustain reported returns.

The faster growing markets of South America, Asia, Africa and the Middle East (SAAAME) offer considerable long-term potential, though insurance penetration in 2013 was still only 2.7% of GDP in emerging markets and the share of global premiums only 17%. Penetration in their advanced counterparts was 8.3%. Rapid urbanization is set to be a key driver of growth within SAAAME markets, increasing the value of assets in need of protection. Urbanization also makes it harder for those from rural areas to call on the support of their extended families and hence increases take-up of life, annuities and pensions coverage. The corollary is the growing concentration of risk within these mega-metropolises.

Disruption and innovation

Many forward-looking insurers are developing new business models in areas ranging from tie-ups between reinsurance and investment management companies to a new generation of health, wealth and retirement solutions. The pace of change can only accelerate in the coming years as innovations become mainstream in areas ranging from wearables, the Internet of Things and automated driver assistance systems (ADAS) to partnerships with technology providers and crowd-sourced models of risk evaluation and transfer.

At the same time, a combination of digitization and new business models is disrupting the insurance marketplace by opening up new routes to market and new ways of engaging with customers. An increasing amount of standardized insurance will move over to mobile and Internet channels. But agents will still have a crucial role in helping businesses and retail customers to make sense of an ever-more-complex set of risks and to understand the trade-offs in managing them. On the life, annuities and pension side, this might include balancing the financial trade-offs between how much they want to live off now and their desired standard of living when they retire. On the P&C side, it would include designing effective aggregate protection for an increasingly broad and valuable array of assets and possessions.

Companies can bring innovations to market much faster and more easily than in the past. These companies include new entrants that are using advanced profiling techniques to target customers and cost-efficient digital distribution to undercut incumbent competitors. It’s too soon to say how successful these new entrants and start-ups will be, but they will undoubtedly provide further impetus to the changes in customer expectations and how insurers compete.

In the next two articles in this series, we look at how all these coalescing developments are likely to play out as we head toward 2020 and beyond and outline the strategic and operational implications for insurers. While we’ve set a nominal date of 2020, fast-moving businesses are already assessing and addressing these developments now as they look to keep pace with customer expectations and sharpen their competitive advantage.

What comes through strongly is the need for reinvention rather just adjustment if insurers want to sustain revenue and competitive relevance. As a result, many insurers will look very different by 2020 and certainly by 2025. As new entrants and new business models begin to change the industry landscape, it’s also important to not only scan for developments within insurance but also maintain a clear view of the challenges and opportunities coming from outside the industry.

For the full report from which this article is excerpted, click here.

The Rise of the Robo-Advisers?

The robots are here. Not the humanoid versions that you see in Hollywood movies, but the invisible ones that are the brains behind what look like normal online front-ends. They can educate you, advise you, execute trades for you, manage your portfolio and even earn some extra dollars for you by doing tax-loss harvesting every day. These robo-advisers also are not just for do-it-yourself or self-directed consumers; they’re also for financial advisers, who can offload some of their more mundane tasks on the robo-advisers. This can enable advisers to focus more on interacting with clients, understanding their needs and acting as a trusted partner in their investment decisions.

It’s no wonder that venture capital money is flowing into robo-advising (also called digital wealth management, a less emotionally weighted term). Venture capitalists have invested nearly $500 million in robo-advice start-ups, including almost $290 million in 2014 alone. Many of these companies are currently valued at 25 times revenue, with leading companies commanding valuations of $500 million or more. This has motivated traditional asset managers to create their own digital wealth management solutions or establish strategic partnerships with start-ups. Digital wealth management client assets, from both start-ups and traditional players, are projected to grow from $16 billion in 2014 to roughly $60 billion by end of 2015, and $255 billion within the next five years. However, this is still a small sum considering U.S. retail asset management assets total $15 trillion and U.S. retirement assets total $24 trillion.

What has caused this recent “gold rush” in robo-advice? Is it just another fad that will pass quickly, or will it seriously change the financial advice and wealth management landscape? To arrive at an answer, let’s look at some of the key demographic, economic and technological drivers that have been at play over the past decade.

Demographic Trends

The need for digital wealth management and the urgent need to combine low-cost digital advice with face-to-face human advice have arisen in three primary market segments, which many robo-advisers are targeting:

 

  • Millennials and Gen Xers: More than 78 million Americans are Millennials (those born between 1982 and 2000), and 61 million are Gen Xers (those born between 1965 and 1981); accordingly, this segment’s influence is significant. These groups demand transparency, simplicity and speed in their interactions with financial advisers and financial services providers. As a result, they are likely to use online, mobile and social channels for interactive education and advice. That said, a significant number of them are new to financial planning and financial products, which means they need at least some human interaction.

 

 

  • Baby Boomers: Baby boomers, numbering 80 million, are still the largest consumer segment and have retail investments and retirement assets of $39 trillion. Considering that this segment is either at or near retirement age, the urgency to plan for their retirement as well as draw down a guaranteed income during it is critical. The complexity of planning and executing this plan typically goes beyond what today’s automated technologies can provide.

 

 

  • Mass-Affluent & Mass-Market: Financial planning and advice has largely been aimed at high-net-worth (top 5%) individuals. Targeting mass-affluent (the next 15%) and mass-market (the next 50%) customers at an affordable price point has proven difficult. Combining automated online advice with the pooled human advice that some of the digital wealth management players offer can provide some middle ground.

 

Technological Advances

Technical advances have accompanied demographic developments. The availability of new sources and large volumes of data (i.e., big data) has meant that new techniques are now available (see “What comes after predictive analytics?”) to understand consumer behaviors, look for behavioral patterns and better match investment portfolios to customer needs.

 

  • Data Availability: The availability of data, including personally identifiable customer transactional level data and aggregated and personally non-identifiable data, has been increasing over the past five years. In addition, a number of federal, state and local government bodies have been making more socio-demographic, financial, health and other data more easily available through open government initiatives. A host of other established credit and market data companies, as well as new entrants offering proprietary personally non-identifiable data on a subscription basis, complement these data sources. If all this structured data is not sufficient, one can mine a wealth of social data on what customers are sharing on social media and learn about their needs, concerns and life events.

 

 

  • Machine Learning & Predictive Modeling: Techniques for extracting insights from large volumes of data also have been improving significantly. Machine learning techniques can be used to build predictive models to determine financial needs, product preferences and customer interaction modes by analyzing large volumes of socio-demographic, behavioral and transactional data. Big data and cloud technologies facilitate effective use of this combination of large volumes of structured and unstructured data. In particular, big data technologies enable distributed analysis of large volumes of data that generates insights in batch-mode or in real-time. Availability of memory and computing power in the cloud allows start-up companies to scale on demand instead of spending precious venture capital dollars setting up an IT infrastructure.

 

 

  • Agent-Based Modeling: Financial advice; investing for the short-, medium- and long-term; portfolio optimization; and risk management under different economic and market conditions are complex and interdependent activities that require years of experience and extensive knowledge of numerous products. Moreover, agents have to cope with the fact that individuals often make investment decisions for emotional and social reasons, not just rational ones.

 

Behavioral finance takes into account the many factors that influence how individuals really make decisions, and human advisers are naturally skeptical that robo-advisers will be able to match their skills interpreting and reacting to human behavior. While this will continue to be true for the foreseeable future, the gap is narrowing between an average adviser and a robo-adviser that models human behavior and can run scenarios based on a variety of economic, market or individual shocks. Agent-based models are being built and piloted today that can model individual consumer behavior, analyze the cradle-to-grave income/expenses and assets/liabilities of individuals and households, model economic and return conditions over the past century and simulate individual health shocks (e.g., need for assisted living care). These models are assisting both self-directed investors who interact with robo-advisers and also human advisers.

Evolution of Robo-advisers

We see the evolution of robo-advisers taking place in three overlapping phases. In each phase, the sophistication of advice and its adoption increases.

 

  • First Generation or Standalone Robo-Advisers: The first generation of robo-advisers targets self-directed end consumers. They are standalone tools that allow investors to a) aggregate their financial data from multiple financial service providers (e.g., banks, savings, retirement, brokerage), b) provide a unified view of their portfolio, c) obtain financial advice, d) determine portfolio optimization based on life stages and e) execute trades when appropriate. These robo-advisers are relatively simple from an analytical perspective and make use of classic segmentation and portfolio optimization techniques.

 

 

  • Second Generation or Integrated Robo-Advisers: The second generation of robo-advisers is targeting both end consumers and advisers. The robo-advisers are also able to integrate with institutional systems as “white labeled” (i.e., unbranded) adviser tools that offer three-way interaction among investors, advisers and asset managers. These online platforms are variations of the “wrap” platforms that are quite common in Australia and the UK, and offer a cost-effective way for advisers and asset managers to target mass-market and even mass-affluent consumers. In 2014, some of the leading robo-advisers started “white labeling” their solutions for independent advisers and linking with large institutional managers. Some larger traditional asset managers also have started offering automated advice by either creating their own solutions or by partnering with start-ups.

 

 

  • Third Generation or Cognitive Robo-Advisers: Advances in artificial intelligence (AI) based techniques (e.g., agent-based modeling and cognitive computing) will see second generation robo-advisers adding more sophisticated capability. They will move from offering personal financial management and investment management advice to offering holistic, cradle-to-grave financial planning advice. Combining external data and social data to create “someone like you” personas; inferring investment behaviors and risk preferences using machine learning; modeling individual decisions using agent-based modeling; and running future scenarios based on economic, market or individual shocks has the promise of adding significant value to existing adviser-client conversations.

 

One could argue that, with the increasing sophistication of robo-advisers, human advisers will eventually disappear. However, we don’t believe this is likely to happen anytime in the next couple of decades. There will continue to be consumers (notably high-worth individuals with complex financial needs) who seek human advice and rely on others to affect their decisions, even if doing so is more expensive than using an automated system. Because of greater overall reliance on automated advice, human advisers will be able to focus much more of their attention on human interaction and building trust with these types of clients. 

Implications to Financial Service Providers

How should existing producers and intermediaries react to robo-advisers? Should they embrace these newer technologies or resist them?

 

  • Asset Managers & Product Manufacturers: Large asset managers and product manufacturers who are keen on expanding shelf-space for their products should view robo-advisers as an additional channel to acquire specific type of customers – typically the self-directed and online-savvy segments, as well as the emerging high-net-worth segment. They also should view robo-advisers as a platform to offer their products to mass-market customers in a cost-effective manner.

 

 

  • Broker Dealers and Investment Advisory Firms: Large firms with independent broker-dealers or financial advisers need to seriously consider enabling their distribution with some of the advanced tools that robo-advisers offer. If they do not, then these channels are likely to see a steady movement of assets – especially of certain segments (e.g., the emerging affluent and online-savvy) – from them to robo-advisers.

 

 

  • Registered Independent Advisers and Independent Planners: This is the group that faces the greatest existential threat from robo-advisers. While it may be easy for them to resist and denounce robo-advisers in the short term, it is in their long-term interest to embrace new technologies and use them to their advantage. By outsourcing the mechanics of financial and investment management to robo-advisers, they can start devoting more time to interacting with the clients who want human interaction and thereby build deeper relationships with existing clients.

 

 

  • Insurance Providers and Insurance Agents: Insurance products and the agents who sell them also will feel the effects of robo-advisers. The complexity of many products and related fees/commissions will become more transparent as the migration to robo-adviser platforms gathers pace. This will put greater pressure on insurers and agents to simplify and package their solutions and reduce their fees or commissions. If this group does not adopt more automated advice solutions, then it likely will lose its appeal to attractive customer segments (e.g., emerging affluent and online-savvy segments) for whom their products could be beneficial.

 

Product manufacturers, distributors, and independent advisers who ignore the advent of robo-advisers do so at their own risk. While there may be some present-day hype and irrational exuberance about robo-advisers, the long-term trend toward greater automation and integration of automation with face-to-face advice is undeniable. This situation is not too dissimilar to automated tax-advice and e-filing. When the first automated tax packages came out in the ’90s, some industry observers predicted the end of tax consultants. While a significant number of taxpayers did shift to self-prepared tax filing, there is still a substantial number of consumers who rely on tax professionals to file their taxes. Nearly 118 million of the 137 million tax returns in 2014 were e-filings (i.e., electronically filed tax returns), but tax consultants filed many of them. A similar scenario for e-advice is likely: a substantial portion of assets will be e-advised and e-administered in the next five to 10n years, as both advisers and self-directed investors shift to using robo-advisers.