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Has Insurtech Jumped the Shark?

On Sept. 20, 1977, Happy Days broadcast its season five premiere. The central characters visited Los Angeles and, having had his bravery questioned, Fonzie took to the water (still wearing his leather jacket, of course) on water skis. And jumped over a shark. Even at the time, the scene was immediately seen for what it was — a credulity-stretching ratings ploy that revealed the network’s desperation to win back an audience for a show that had run out of ideas. Over the years, the concept of “jumping the shark” evolved into an idiom to describe that moment when any idea, brand, design or franchise demonstrably loses its way. Could it be applied to the Insurtech industry today, I wonder?

Certainly, the numbers seem to be pointing in the wrong direction. Insurtech investment was down 35% in 2016 vs. 2015, from $2.6 billion to $1.9 billion, according to CB Insights. The trend accelerated in the first quarter of 2017, with insurtech funding down 64% vs. 2016 to $283 million. The market’s collective pulse can hardly be said to be racing.

For those of us who lived through the dot-com boom (and bust), there is also a depressingly familiar echo between how corporates reacted to the emergence of the internet then and what is happening now. Hardly a day goes by, it seems, without yet another corporate incubator or venture fund being announced or newly minted chief digital officer (whatever they are) being appointed. And while the (often dumb) money continues to pour in to ever more outlandishly named startups, the media is falling over itself to write the incumbents’ obituaries and crown their sneaker-wearing young pretenders. If we haven’t reached peak-hype yet, then we surely can’t be that far off.

Of course, we shouldn’t ignore the insurance industry’s ability to remain resolutely analog in a digital world, insulated from reality thanks to the formidable barriers to disruption that are regulation, brand, customer base and balance sheet. I am reliably told that two trucks a day still leave Lloyd’s for an offsite document storage facility, loaded to the gunwales with paper, while another comes back the other way…

Dig a little deeper, however, and a different picture emerges. The 2015 numbers were arguably distorted by two huge one-off investments (totaling $1.4 billion) in Zenefits and Zhong-An. Ignore those, and the underlying growth story remains compelling, with insurtech investments between 2010 and 2016 growing at a CAGR of more than 50%.

See also: FinTech: Epicenter of Disruption (Part 1)  

Importantly, insurtech, for so long fintech’s poor relation, is closing the investment gap. Analysis by CB Insights shows that the ratio of total fintech to insurtech investments has more than halved from 9.1 to 1 in 2014 to 4.5 to 1 in 2016 as investors wake up to the opportunities on offer.

Also encouraging is where that insurtech investment is being made. While 67% of insurtech investments between 2012 and 2016 have been in the U.S., that proportion shrank to 47% in the first quarter of 2017. A swallow does not a summer make, but other data suggests that this is consistent with a growing diversification of insurtech investment away from the U.S. to other insurance markets, in particular Europe.

Of course, investment is only one window on the insurtech story. And if there is a surprise, it is perhaps that the numbers are not much, much larger, given the size of the industry, the opportunities on offer for new entrants and the stakes at play for the incumbents.

There is some confusion, however, as to exactly what the nature of the insurtech opportunity is, particularly on the P&C side of the industry, which is arguably where the most immediate focus should be.

Some talk of the potential for robotics to drive operational efficiency, particularly in the claims process. This may well be true, but to my mind isn’t really insurtech. This is just the insurance industry waking up to the potential of process automation. Most other parts of the financial services industry got there at least 10 years ago.

Others talk of the impact of driverless cars and how this will slash motor premiums, as vehicles become inherently less prone to crash and the liability burden shifts to software manufacturers. Or how 3D printing will decimate the trade indemnity market as products are printed locally rather than shipped internationally. This may well be true, but isn’t insurtech. This is simply the impact of new technologies on different parts of the global insurance premium pool.

Some talk of the rise of cyber risk and drones and how this will create new categories of risk. Again, this may well be true, but isn’t insurtech. This is just the emergence of new classes of risk that the market will assess, price and refine over time, as it has always done.

To understand what the P&C insurtech opportunity truly represents, you have to strip the insurance industry back to its fundamentals. On this basis, insurance, at its core, could be said to be simply the flow of money and data. Money to pay premiums and pay claims. Data to price risk and analyze claims.

Accept this, and the beating heart of the insurtech opportunity lies in three main areas: distribution, underwriting and claims.

  1. Distribution in terms of i) using technology to identify, attract and convert clients far more effectively than before and ii) in terms of delivering a far better customer experience that more closely matches expectations of convenience, access and transparency formed through people’s interactions with leading online brands and services. Look at the rise of peer-to-peer insurance platforms such as Lemonade or Guevara, for example, and the emergence of products based on actual usage rather than an annual policy, such as sold by Trov and Metro Mile. The change in distribution will be marked by an increasing shift from insurance being viewed as a grudge purchase to being truly optional.
  2. Underwriting in terms of a revolution in the way that data is used to accurately price risk at the individual level, using not just historic information but a continuous stream of data that enables live pricing based on actual risk and usage. Gone are the days when a risk might be underwritten based on five data points and a couple of tickets to Wimbledon. An MGA I met the other day is using more than 1,000 data points in its rating engine, sourced for free through public information, to make tens of thousands of individual underwriting decisions in milliseconds.
  3. Claims in terms of using technology to deliver significant efficiencies in how quickly claims are handled and resolved and through the application of advanced analytics to reduce fraud. And of course if you underwrite better, you will in any case have fewer claims!

The interesting thing is how little the industry still appears to have shifted its ways of working in reaction/anticipation, outside of the well-publicized activities of some of the larger players such as Axa, Munich Re, Allianz and Mass Mutual. There are many potential explanations for this corporate heel-dragging: leadership teams who are the wrong side of the digital divide and who therefore simply don’t get it, a lack of organizational agility, a fear of upsetting existing distribution channels/cannibalization or upsetting staff, the difficulty in running a traditional model alongside a new one, network dependency (i.e. you can only go at the speed of the slowest), a lack of investment capital and the uncertain ROI of any technology investment. After all, why invest in a speculative digital strategy when you can hire a couple of extra brokers and almost guarantee a few hundred thousand of extra commission?

Further, those that are taking action are arguably placing a disproportionate amount of effort into leveraging technology to improve their internal efficiency and reduce costs. The problem is that, while easier and more tangible for them to tackle, internal operations only represent about 10% of the average insurer’s cost base. Compare that with 20% to 40% for distribution and 40% to 60% for claims, and companies appear to be fishing in the wrong pond.

This observation hasn’t been lost on the PE/venture industry, or on the more progressive corporate venture funds. But even here, a disproportionate amount of investment capital appears to have gone toward distribution alone. McKinsey’s Panorama Insurtech Database suggests that 17% of P&C startups are focused on distribution, vs. 10% on pricing and only 7% on claims. At one level this is understandable: Data is boring and incremental, while distribution is higher-profile, easier to target and quicker to monetize. But, by the same token, this means that more and more players are trying to disrupt the same, increasingly crowded part of the value chain, in slightly different ways. They can’t, and won’t, all survive.

A few big winners will no doubt emerge from this feeding frenzy. However, the vast majority of today’s media darlings will fail or find themselves overtaken (or perhaps taken over if they are lucky) by incumbents informed (at their and others’ expense) by the success or otherwise of all these live “pilots” and armed with deeper pockets, a balance sheet, a trusted brand and actual customers. Students of history will again see a clear parallel to the winners and losers of the dot com years. Anyone else remember clickmango.com and its pink inflatable boardroom?

What conclusions to draw from all this?

Well, firstly that the real, lasting disruptive opportunity for the P&C insurance industry is far more likely to be within underwriting and claims. It may be unsexy, but it is where the bulk of the cost is and is the hardest to get at. It is also, therefore, where there is a real opportunity for new entrants to build something of meaningful, differentiated and sustainable value, rather than on the distribution side, where the barriers to entry are far lower and it is far easier for incumbents to simply adapt their offerings and compete away efficiency savings in the form of price reductions.

Secondly, if the above is true, then whoever has the most data wins. This favors incumbents, in particular scale players (on both the broking and the insurer side) or medium-sized players willing to work collaboratively with others to pool resources and know-how and access third-party services. But it also creates opportunities for players (hardware (e.g. telematics), software or consulting) that are supplying, enriching or analyzing data on a partnership basis with players who would not otherwise have the resources to go it alone. Those unable or unwilling to be part of these collaborative networks will fail or have to sell out.

Thirdly, as a consequence of the above, the real risk to incumbents is perhaps less from disruptive new entrants that in many cases will be more interested in partnering with them than eating their lunch, than it is from their traditional competitors stealing a decisive march on them. In today’s kinetic world, being a fast follower may no longer be good enough. Hence the logic of all these corporate incubators and venture funds (as long as they are investing in the right things, of course).

Fourthly, much of what we read about in the media in terms of the incubator/venture activities of the major players should be seen for what it is — noise that more than likely is designed to conceal their real focus: investing in machine learning and advanced analytics that promises to utterly transform their ability to accurately price and distribute risk. This smoke screen is hardly surprising given the potentially seismic implications for their existing broker relationships and staff, not to mention their customers. Indeed, the potential consequences for those no longer able to secure coverage, or only able to do so at rates far beyond what they pay today, are serious and will surely trigger regulation to avoid vast societal imbalances.

Finally, partly as a result of the above as well as related technological innovation, the one thing that is absolutely certain is that the size of the overall insurance revenue pool will shrink significantly. Driverless cars and sensor/IoT technology mean that there will simply be far fewer losses than before. McKinsey’s base case scenario sees a 30% drop in global motor premiums and as much as a 70% fall under some conditions. What’s more, better data doesn’t just lead to better underwriting but also enables better risk prevention and avoidance. Wearable tech, for example, drives healthier living, telematics safer driving. This promises to drive further consolidation across every part of the value chain toward truly value-added players, shift fundamentally the role of the broker (and arguably the insurer too) toward risk consultancy and trigger the rise of a range of complementary services, platforms and product offerings to fuel and profit from this trend.

See also: Insurtech Is Ignoring 2/3 of Opportunity  

For an industry already reeling under the combined impact of increasing regulation, an unrelentingly soft rating cycle, over-capacity, terminally low interest rates and vicious competition, the rise of insurtech could perhaps not come at a worse time. And yet ironically it is precisely this combination of factors that means that the industry has finally come round to the realization that, if it doesn’t change soon, the world will change around it. Or, as Chinese philosopher Lao Tzu said, “If you do not change direction, you may end up where you are heading.”

Global insurance premiums stood at around $3.6 trillion last year, according to Swiss Re. This is a huge, unreformed global market crying out for change. Forget jumping the shark. Now is the time to grab the insurtech bull by the horns. And hold on if you can.

Why Aren’t Brokers Vanishing?

The Loch Ness Monster. Area 51. The grassy knoll. To the list of the world’s great unsolved mysteries can be added a further conundrum — the continued success of the insurance broker.

For years, traditional brokers have labored under the Sword of Damocles that is disintermediation, be it from direct players, comparison sites or even from traditional bank-assurers. And for some parts of the market, those fears have been fully justified. In the U.K., for example, direct insurers have risen from nothing to control 41% of the personal lines market (ABI, 2015). And it has been estimated that comparison sites now account for more than a third of U.K. motor policies.

This has had some inevitable consequences, with many smaller/High Street brokers giving up the ghost and a wave of (often very poorly executed) consolidation sweeping the lower end of the market, as players have turned to scale benefits to counteract dramatic falls in income. And this was before Silicon Valley threatened to unleash a tsunami of further disruption onto the industry’s shores.

And yet the broker survives and, in the commercial lines sector in particular, prospers. As Mark Twain might have said, rumors of their demise have been much exaggerated.

Why is this?

Well, the cynic might argue that the archaic nature of the insurance industry itself has helped shield the market from the sort of Big Bang reform that struck the banking industry 30 years ago. Anyone remember open outcry? Wander around Lime Street today, and you will still see brokers, collars turned up against the wind, off to pitch their wares armed only with a bulging and brightly colored Manila folder wedged hopefully under one arm. Some might say that the industry’s biggest single barrier to entry for new entrants is the fact that it remains so stubbornly paper-based!

However, I would argue that the real reason for the broker’s survival lies in a simpler and more prosaic truth.

See also: Friday Tip For Agents & Brokers: Your Best 30 Seconds  

Trust.

Hardly earth-shattering, I know. But in my experience those outside the industry — and even those inside it, at times — consistently underestimate the extent of the trust that clients place in their broker and the strength of the relationship that springs from this. In few other industries, for example, can often relatively junior individuals leave one shop for another, reasonably confident in their ability to take a couple of million dollars of brokerage across the street with them.

For a product that is often said to be sold rather than bought and that has become, for the vast majority of businesses, relatively standardized, this sense of loyalty to the broker is somewhat counter-intuitive. But that is to ignore the very different psychology and motivations of the corporate buyer, who sees the value of insurance in insulating against shocks, keeping the management team out of court and “de-risking” new initiatives, unlike the consumer, for whom insurance is a grudge purchase where price is the overriding factor.

Because of this corporate dynamic, brokers often occupy a privileged position at the top table, alongside a company’s accountants, bankers and lawyers. Accompany a company on a meaningful claim, and the strength of that position gets enhanced even further. And with the emergence of new risks such as cyber, and with the world today ever more complicated, unpredictable and unstable, then the need for a trusted adviser to help you protect your shareholders, employees and clients from whatever might be thrown at them and navigate the complexities of the market becomes more important than ever. Small wonder, therefore, that commercial lines brokers have proved so resilient.

This, though, exposes the mystery — the classicists among you might even say Hamartia — that lies at the heart of the broking model. The value provided by a good broker is almost entirely in the advice she gives — diagnosing where your risks are, identifying which risks should be transferred and which retained, designing placement strategies, helping put in place active risk prevention and mitigation strategies, getting claims paid, etc. And yet brokers are typically paid via commission for placing the risk, arguably the least value-added and most transactional part of what they do. Particularly in today’s market, where underwriters are falling over themselves to cut rates to secure market share and where, in the words of one former colleague of mine, “my twelve-year-old son could place an offshore energy policy right now.” Her words, not mine!

It is the perfect illustration of someone negotiating over the price of the saddle but giving the horse away for free.

The real problem with commission, of course, is the potential misalignment of interests it creates between brokers and their clients. At the most basic level, in any normal intermediary-based industry, the better deal you get for your client, the more you might expect to be paid. In the insurance industry, however, the more the client pays, the more commission the broker makes. Even stranger, it is paid for by the insurer even though the broker supposedly acts on behalf of the client. The risk of perverse incentives abounds.

That’s not all. Commission is also a pretty blunt way of linking effort to reward. The work involved in renewing a policy with the same insurer, for example, is a fraction of that required to set it up, and yet the same commission rate applies. Similarly, the effort required to place a $20 million policy is not hugely more than that involved in placing a $10 million one, and yet one will pay double the other. Some clients eat up huge amounts of time pursuing a contentious claim and yet will pay the same commission rate as a far more straightforward client with little claims activity. It is hard to see how this doesn’t create a cross-subsidization effect between the simpler, less demanding clients and the more complex, challenging ones, to the detriment of the former.

Further complicating the picture is the fact that the economics of this tried and tested model have become increasingly challenged by the precipitous fall in the rating environment over the past few years, particularly outside the more volume-based classes. Commission is all well and good for brokers when prices are holding firm, but in a market where rates are falling 20% to 30% a year, as they have been in the aviation and energy markets, for example, brokers are suddenly faced with having to do the same, if not more, work for less money and with the prospect of worse to come.

But brokers are nothing if not resourceful. Diversification has allowed some to grow their income by shifting their value proposition to providing a broader risk consultancy offering and cross-selling additional services. Consolidation and automation have taken supply out of the market and released significant efficiency savings. And, perhaps most importantly, ever more elaborate ways have been found to extract value from the market through sophisticated placement strategies, providing analytics and consulting expertise and taking on parts of the insurance value chain in return for a fee. And while brokers have rightly been very careful not to replicate the structures and practices that landed them in hot water with Eliot Spitzer not so long ago, I would speculate that, for the larger brokers at least, income generated from the market is proportionally larger than it was pre-Spitzer.

While the broking community’s inventiveness is to be lauded, the risk is that they start eroding the very foundations of their continued success. The more that clients feel that their broker is more concerned with selling them additional consulting or software services than worrying about their core program, the more revenues that they perceive their brokers to be pulling out of the market beyond their core commission, the more blurred the lines become between where brokers end and where insurers begin, then the more clients may start to question the value their broker is adding and whether the broker is truly acting in their best interests.

See also: On-Demand Insurance: What’s at Stake  

But then, perhaps clients have the market they deserve? Certainly, few apart from the largest and most sophisticated clients have agitated to move their brokers onto fee-based remuneration structures that more clearly link the actual effort involved and value created — as they do for their other professional advisers who largely bill in terms of time and access to relative tiers of expertise. And stories abound of clients not playing fair, rewarding a cut in the premium with a proportionate fee reduction rather than rewarding their broker’s efforts — small wonder that brokers have been happy to let things lie.

Perhaps these things are simply far too entrenched to change? Particularly where all parties feel happy with the relative trade-offs. But I wonder if there isn’t potentially a certain mutual convenience in the broker’s cost being, if not quite invisible to the client, then at least one step removed in that most never have to sign an actual check. It must almost feel like the broker’s service is free….

Besides, you need to be careful what you wish for. There is an interesting read across here to the U.K. wealth management industry, where recent regulatory reforms have banned advisers from earning commissions from whichever provider they recommended to their client, to eliminate the risk of advisers placing/churning business to the highest fee payer and for earning trail commissions for little continuing effort. Instead, if clients want discretionary advice, they now have to pay their adviser an up-front fee that will typically run into the thousands of pounds and then pay further fees every time they transact. In theory, this makes sense, and the money that the providers were paying to the intermediaries by way of commission should have been handed back to client in the form of price reductions, leaving them no worse off once they had paid for advice. In practice, of course, this has created a windfall profit for the providers and left an advice gap at the heart of the British wealth management industry, because many clients have balked at the prospect of cutting a check for a couple of grand even though they were happy to pay this, and probably much more, when the adviser’s costs were discretely embedded into the cost of the product. No wonder clients, brokers and insurers in the insurance industry have largely preferred to stick with the status quo. The law of unintended consequences looms large.

Where does all this point, therefore, when considering the sustainability of the broking industry in the face of the changing market dynamics they are now facing? I would make a couple of suggestions.

Firstly, there is probably a large swath of medium-sized commercial lines business where the economics simply do not justify the continued provision of brokerage advice and services on the same basis that this has been supplied in the past. Radically different operating models will be required, probably leveraging some of the learnings from the banking world, which has also had to evolve its service model. There is probably an opportunity for AI and robo-advice based models, such as are increasingly being seen in the wealth management world. At one level, this will favor those brokers with large retail/affinity/SME customer bases and strong brands that can leverage existing practices and infrastructure up the value chain. But it also potentially suggests a rich seam of opportunity for disruptors armed with weapons-grade analytics and innovative distribution strategies.

Secondly, when it comes to larger, international companies or non-standard, more complex risks, the importance of the trusted broker relationship is not going to change. In fact, as I have argued elsewhere, the world’s greater uncertainty and volatility makes that very simple, human, trust-based relationship more important than ever. Insurers will continue to pay for this distribution — they have no choice. And new entrants, who think that a roomful of MIT graduates and a piece of smart tech can dislodge a 20-year relationship forged in the white heat of a ugly claim, will find out the hard way how wrong they are. In this part of the market, they are far better served focusing on providing solutions to back-end operational efficiencies and supplying discrete tools and services.

However, what is likely to change is what the client’s trust-based relationship with the broker is built on. Being able to navigate your way around a wine list, procuring Center Court tickets at Wimbledon and being an excellent transactional broker may have been enough to win and retain business in the past but just won’t cut it in the future. Clients now need a far more holistic, technical and analytically based approach to helping them understand, manage and mitigate their exposures. The placement will become a hygiene factor for most, if indeed it isn’t already.

The challenge for the brokerage community — and by extension for the sustainability of trusted relationships with clients — is whether brokers are equipped to meet their client’s rapidly shifting requirements from either a capability, a tools or an organizational perspective.

Many brokers simply don’t have enough people with the highly technical, analytical and consultative skills that they need if they are to provide the advice that their clients are increasingly likely to require. This implies the need for a far more strategic and thoughtful approach to long-term resource planning to ensure that people with the right sort of qualifications and attributes are being attracted to the organization and the right sort of skills developed in those who are already there. Some of their people will be able to make the necessary transition to this new world; others, sadly, won’t. And while this may create a short-term opportunity for some players to attract displaced talent and, with them, their loyal clients, over the longer term they are likely to end up saddled with the cost but without the income, unless they, too, can acquire or build these skills.

With this change in capabilities comes a potential change in organizational design, as brokers will need to go from wearing all sorts of hats as they typically do today — sales rep, relationship manager, program designer, placement expert, claims fixer etc. — to acting as a sort of overall risk adviser who then brings in expertise and tools, drawn from specialized teams, as and when they are required. This, in turn, implies quite a significant cultural shift for many brokers, who often guard their client relationships jealously and are wary of exposing them to a colleague who might screw things up.

I realize that for many this sounds like absolute heresy, and no doubt some players will seek to make a virtue of their brokers continuing to operate across a broad front. But to me it feels like an almost inevitable consequence of the world’s increasing complexity and the impossibility of any one person having the depth or range of technical expertise needed if they are to meet their clients’ evolving needs. It can surely be no coincidence that almost every single other professional services industry has evolved in this way?

The real complexity is that this will be an evolutionary change, as the technical and analytical demands of clients in different classes and different parts of the world and even within the same classes and parts of the world will vary. This implies that the successful brokers will be those who can effectively operate two models in parallel, as they mirror their clients’ own evolution.

This would tend to favor the larger brokers, who have both the resources and the scale to develop a more sophisticated relationship-management-based service model alongside their existing one, hire and develop people with the right skills mix and develop the analytics they need based on huge amounts of data.

See also: Is It Time to End the Annual Policy?  

Smaller, more niche brokers and MGAs, too, should be more able to develop their offering because of their narrower focus and ability to target their investments to their advantage. The people who may struggle are those caught somewhere in between, with all the cost of managing this transition (potentially on a global scale) but without the scale to be economic or the investment capital and data to be effective. Further consolidation of those lacking the resources or culture to embrace this new world is inevitable.

One thing is for sure. If history has proved one thing it is that brokers are remarkably good at morphing their offering to reflect their clients’ changing demands and dreaming up new ways to grow their income, whatever obstacles are thrown in their way.

In this, I am somewhat reminded of Louis XIV’s minister of finances, Jean-Baptiste Colbert, who once described the art of taxation as being “in so plucking the goose as to obtain the largest amount of feathers with the least possible amount of hissing.”

On that basis, the broking community might want to consider running for office!

Do We Even Need Insurers Any Longer?

Voltaire once said that “if God did not exist, it would be necessary to invent him.” Could you say the same about insurers today, I wonder?

It is striking that, as organizations have sought to come to terms with the pace and scale of change now confronting them, the story of Kodak’s rapid decline from controlling 90% of U.S. film sales and 85% of camera sales to eventual bankruptcy has emerged as the cautionary tale of what can happen when you fail to keep pace with technological change. The corporate equivalent of the man who failed to sign the Beatles.

However, what many people forget is that Kodak actually invented the world’s first digital camera — in 1975. Far from being some sort of industrial dinosaur, therefore, Kodak was an innovation-driven company operating right at the cutting edge of photographic technology. And while endless books and articles have been written about the reasons for Kodak’s demise, in my view, the principal issue was less the failure to keep pace with change and more a lack of imagination.

See also: Matching Game for InsurTech, Insurers  

Kodak could not imagine a world where a digital camera would be for anyone but the dedicated professional, given its (at the time) prohibitive cost. Kodak could not imagine a world where processing speeds, image resolution, battery life and storage capacity would increase exponentially, at a fraction of the cost. Kodak could not imagine a world where people would not wish to take rolls of film down to the chemist to get them developed, pick them up a few days later and then diligently stick that “Kodak moment” in an album. Kodak could not imagine a world where everyone would carry a mobile phone that contained a camera that allowed images to be instantly shared on vast online networks.

If Kodak hadn’t been helping invent this new world, the failure would have perhaps been more understandable. At the time, such a world must have seemed to have been drawn from the pages of a science fiction novel. And executives’ lack of imagination was compounded by a fatal cocktail of arrogance — Kodak famously saw little point in sponsoring the Los Angeles Olympics in 1984 given its dominant position, allowing Fuji to gain a foothold in the U.S. market and grow its market share from almost nothing to 17% by 1997 — and a complete failure to articulate and execute a plan once the scale of the threat to the core business had become clearer. Fuji, faced with the same market dynamics and yet without the benefits of Kodak’s pioneering R&D, did not fall into the same trap.

To my mind, there is a clear read-across to the financial services industry, right now.

There is no shortage of activity. Market commentators and the media are lining up to sell their vision of both the El Dorado that lies just over the horizon and the sixth circle of Hell (heresy, for those of you who don’t know you Dante!) that awaits those who fail to convert to this new religion based on innovation. Every large player has got some sort of incubator or lab or chief innovation officer, whatever that is. Joint ventures are being formed. Data scrubbed. Analytics teams hired. Digital strategies unveiled. Billions of dollars is pouring into fintech and insurtech startups, most of which will likely not survive the first round of funding.

But does the innovation go far enough? Are the incumbents correctly reading the signs but merely agitating the surface in response, while deep down changing nothing? Are they like Kodak, incapable of imagining what tomorrow’s world could look like, because to do so conjures up an image so terrifying that it implies that they should torch their existing business so as to give birth to a new one from its ashes?

This question is of particular relevance to the insurance market, an industry whose often-archaic business practices and antiquated operating models, not to mention huge frictional costs and under-investment in IT systems, must have the financiers and techies in Silicon Valley licking their chops in anticipation. Show me another industry where a U.S. client, say, will find its risk placed via a local broker, via a U.S. wholesale broker, via a London wholesale broker, via an MGA, into a Lloyd’s syndicate, only to be reinsured via a FAC reinsurance broker to a reinsurer and then potentially via another treaty reinsurance broker to another reinsurer, with each stage of the chain clipping the ticket.

How much of every dollar of premium goes to providing the actual cover versus feeding a serpent in danger of swallowing its own tail?

It doesn’t take much imagination to see the huge potential for eliminating or automating steps in this chain, creating value for the disruptor and hugely improving client outcomes in terms of cost and service levels. But the real winners here will be those who have the scale, firepower and smarts to invest in the analytics and systems to drive not just marginal efficiency improvements in discrete parts of the value chain but to challenge the very basis of the way things are done. Traditional small to medium-sized players, therefore, unless they are operating in very specific niches, may find themselves at a long-term, structural disadvantage to larger and smarter players with more access to data and more ability to invest in the people and systems required to drive insight from it.

More critical than ever, however, will be client relationships and access. Improved analytics and slick systems is all fine, but if you don’t have the customer or the products and marketing skills to get to them, you’re wasting your time. That, at least, has not changed. In fact, if anything, in a more clinical, automated, digital world, client contact and warmth is set to become more important than ever.

This, is turn, raises an interesting question, though. While for years, brokers have operated under the somewhat existential threat of disintermediation, is the boot not now very firmly on the other foot? Unlike the insurers, who only know what they underwrite, the larger brokers, in particular, potentially have access to vast swathes of client and claims data across every single class of business and geography. Armed with this and the client relationships, and with a wall of capital looking to be deployed in the market (the rise of the ILS market bears potent witness) why do they need the insurers at all? Why not just rent the capital, underwrite the best business themselves and use the traditional market for the rest and to reinsure out the peaks? And if the brokers can do that, why not Google or Amazon, which have huge client reach and brand loyalty, unmatched analytical ability and the firepower to build, buy or hire in whatever insurance expertise they might need?

See also: 3 Ways to Improve Agent/Insurer Links  

Of course, the situation is not that simple. The market has not evolved in the way it has by accident. Large, complex and long-tail risks require huge balance sheets and often syndicated underwriting and reinsurance towers, to be written at all. Shareholder returns vary massively between brokers and insurers for a reason. In the rush to embrace the new, we risk ignoring all that works and that is good about the old. And because of this, change, when it comes, is likely to be more gradual and evolutionary.

But change it will, and, as the Kodak story shows, the key risk may well not be that people fail to recognize that the change is coming — I believe most do — but that they fail to imagine quite how radical that change could be and therefore fail to plan accordingly.

Henry Ford famously said that, “If I had asked people what they wanted, they would have said faster horses.”

The danger is that many risk now falling into the same trap.

Is It Time to End the Annual Policy?

Is there anything more emblematic of the largely antediluvian state of the insurance market than the concept of the annual policy?

Admittedly, there is a certain convenience for the customer only having to worry about his or her insurance once a year and for the insurer only having to process the relevant paperwork every 12 months. And for years, of course, insurer returns were almost entirely built off the back of the profits to be gained from investing up-front premiums — as in, not on serving the customer.

But haven’t things moved on?

Certainly, today’s low interest-rate environment (nothing lasts forever, but it is hard to envision what might shift this dynamic in the short- to medium-term) means insurers have to focus far more on correctly pricing risk rather than on yield arbitrage. And our increasingly technically sophisticated and connected world surely raises questions regarding whether market practices essentially inherited from the 17th century are still appropriate.

See also: The Most Effective Insurance Policy  

Consider the humble motor policy.

At the risk of gross over-simplification, the market is currently centered on selling an annual policy with pricing essentially dictated by a number of important risk factors (such as the value of the vehicle, driver age, anticipated annual mileage, where the car is kept at night, previous convictions, etc.) But the price you pay reflects little about the environmental factors that really drive risk when you are behind — or not behind — the wheel. While the industry is far more sophisticated than it was 20 years ago, pricing is typically set according to statistical averages for whatever broad risk grouping you happen to fall into — with all the imperfections this implies — to the inevitable detriment of lower-risk drivers within each of those categories.

Today’s technology — of which telematics is a pretty rudimentary example — enables a different approach.

Rather than an annual policy, why not specify a daily standing charge that reflects the true risk to the insurer of the car sitting in your garage, say, where the risk of accident or personal injury or theft is extremely low? Think of it as a standing charge.

However, as soon as you take your car out of the garage, an additional cost would apply — think of the Uber surcharge — but this additional cost would vary depending on the time of day or the driving conditions. Taking the car out in the rain or when it is icy would be more expensive than when the sun is shining. Driving in the middle of the night when there is less traffic is inherently less risky than battling your way through rush hour. Far fewer accidents occur on the motorway per mile driven than on crowded urban streets. And geo-location software could confirm whether you are, in fact, parking your car at home at night as you have claimed or whether you have left it for a few nights at the airport while you fly off to Rome or Miami for the weekend.

This approach starts to suggest some interesting outcomes. First, it allows insurance companies to price far more accurately for the actual risk they face, based not on relatively blunt risk category averages but for each individual driver down to each specific trip. Second, it ensures that drivers pay the true costs of the risk they represent rather than subsidizing their higher-risk fellow drivers. For most drivers, this is likely to result in a lower price because the average is hugely skewed by the tail risk.

Perhaps most interestingly, the approach also enables the driver to better understand the relationship between how and when she drives and the cost of insurance; thus, it potentially acts as a spur for drivers to moderate or modulate their behaviors accordingly, which is where you start to drive some real alignment of interests and benefits for both drivers and insurers.

The good news is that the necessary technology essentially exists today in the mobile device you are probably reading this post on. The various data feeds — weather, time of day, geo-location, etc. — are already there. Even today, my iPhone varies the time at which I need to leave one meeting to make the next depending on traffic and weather.

Of course, as with any radical change to established operating models, there are some important practical issues to be overcome in terms of the customer interface, billing and mechanisms through which customers would physically agree to a surcharge before, during or after a journey, etc. Insurers would need to work through the change in their cash flow profile and may also feel that the complexity of some of the larger risk classes continues to favor an annual cycle. And the impenetrability of pricing in the mobile phone industry, which marches under the banner of increased customer transparency and choice, stands as a stark warning to how the best intentions can lead to utter confusion.

See also: Insurance Disruption? Evolution Is Better  

There are some broader potential social concerns, too, around third party tracking of your movements. There are also implications for higher-risk drivers who find themselves priced out of the market where, today, their costs are essentially subsidized by the rest (particularly in circumstances where the constraints of people’s day-to-day lives and jobs may not give them a huge amount of choice regarding the conditions under which they choose to drive), although that particular genie is probably halfway out of the bottle, anyway.

The question, as ever, is whether the inevitable change will come from the incumbents that are weighed down by their legacy positions or from some new entrant that has the freedom of movement but lacks the scale, brand and capital to compete in a meaningful way.

One thing is certain: In a world where one of the world’s largest hotel companies doesn’t own any rooms (Airbnb), one of the world’s largest car hire companies doesn’t own any cars (Uber) and one of the world’s largest retailers doesn’t own any merchandise (Ebay), the insurance industry’s continued attachment to the annual policy feels increasingly like a relic from a bygone age of quill and parchment.