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Transparent Reinsurance for Health

Transparent reinsurance programs could emerge as significant opportunities for healthcare providers, issuers, reinsurers, technology innovators and regulators to address health insurance.

The message is clear. Having to factor in higher costs associated with new entrants to the healthcare system gives insurance firms license to charge higher rates. If these new people were put into a reinsurance pot for three to five years with costs spread over all insurers, no one insurer would be unnecessarily burdened. After this period, costs for these entrants could be reexamined and a decision could be made on how to proceed with them, depending upon the deviation from the remaining population.

Several factors are coming into play. 

United Health Group indicates it will be leaving all but a few of the 34 states where it is offering health insurance under Obamacare.

A fresh Blue Cross Blue Shield study finds recent Obamacare entrants have higher rates of specific illnesses and used more medical services than early entrants. “Medical costs of care for the new individual market members were, on average, 19% higher than employer-based group members in 2014 and 22% higher in 2015. For example, the average monthly medical spending per member was $559 for individual enrollees versus $457 for group members in 2015,” the study found.

What emerges in conversations with economists, regulators and healthcare actuaries is a sense that properly designed, fair and transparent reinsurance could—and would—advance industry and public policy goals to continue insurance for all at affordable prices. This approach would represent tangible improvements over inefficient, incumbent systems. Information would be used by insurers and reinsurers, providers and regulators and, crucially, insureds to establish best performances for healthcare outcomes and expenses. Virtually everyone knows that state or regional reinsurance would have to be mandated, as voluntary systems could be gamed.

“The implementation of new policies, the availability of research funding, payment reform and consumer- and patient-led efforts to improve healthcare together have created an environment suitable for the successful implementation of patient-reported outcome measures in clinical practice,” fresh research in Health Affairs also indicates.

Risk analysis technologies could help issuers, reinsurers, healthcare institutions and citizens rein in the healthcare system’s enormous costs. Earlier this year, the Congressional Budget Office and Joint Committee on Taxation projected that, “in 2016, the federal subsidies, taxes and penalties associated with health insurance coverage will result in a net subsidy from the federal government of $660 billion, or 3.6% of gross domestic product (GDP). That amount is projected to rise at an average annual rate of 5.4%, reaching $1.1 trillion (or 4.1% of GDP) in 2026. For the entire 2017–2026 period, the projected net subsidy is $8.9 trillion.”

CBO/JCT published this stunning projection amid consensus that $750 billion to $1 trillion of wasted spending occurs in healthcare in the U.S. “Approximately one in three health care dollars is waste,” Consumer Reports says.

Key metrics should focus on estimates of risk using demographics and diagnoses; risk model descriptions; calculation of plan average actuarial risk; user-specified risk revealing and detailing information; drill-down capabilities clarifying research; monitoring and control; and calculation and comparison measures to address reinsurance validation.

Several major refinements yielding and relying upon granular, risk-revealing data and metrics would support more efficient reinsurance. All would, and could, update reinsurance information and address customer experience, trust and privacy concerns.

As the industry has noted, ledger technologies could play fundamental roles as blockchains. Indeed, blockchain technologies are just now being introduced in the U.K. to confirm counter party obligations for homeowners’ insurance.

“Advanced analytics are the key,” remarked John Wisniewski, associate vice president of actuary services at UPMC Health Plan. “Predictive capability that looks at the likelihood a patient admission may be coming is the information that we can give to doctors to deal with the matter. … Whoever develops algorithms for people who will be at risk—so providers can develop plans to mitigate risk—will create value for issuers, providers and members alike.”

Available technologies support the connecting of risk assessments with incentives for risk information.

Michael Erlanger, the founder and managing principal of Marketcore, said, “We cannot know what we cannot see. We cannot see what we cannot measure. These available technologies provide clarity for more efficient health insurance and reinsurance.”

Context: Three Rs: Reinsurance, Risk Corridors and Risk Adjustment

When Congress enacted the ACA, the legislation created reinsurance and risk corridors through 2016 and established risk adjustment transfer as a permanent element of health insurance. These three Rs—reinsurance, risk corridors and risk adjustment—were designed to moderate insurance industry risks, making the transition to ACA coverage and responsibilities. The Centers for Medicare and Medicaid Services (CMS) within the Department of Health and Human Services (HHS) administers the programs. All address adverse selection—that is, instances when insurers experience higher probabilities of losses due to risks not factored in at the times policies are issued. All also address risk selection, or industry preferences to insure healthier individuals and to avoid less healthy ones.

With the expiration of ACA reinsurance and risk corridors, along with mandatory reporting requirements this December, healthcare providers, issuers, reinsurers, technology innovators and regulators can now evaluate their futures, separate from CMS reporting.

Virtually all sources commend reinsurance and risk adjustment transfer as consistently as they deride risk corridors. Reinsurance has paid out well, while risk corridors have not. Risk adjustment transfer remains squarely with CMS. 

ACA numbers

While House Republican initiatives try and fail to repeal the ACA, and some news programs and pundits say it is unsustainable, approximately 20 million subscribers are enrolled in Obamacare: with 12.7 million as marketplace insureds, with others through Medicaid and as young adults on parent plans. President Obama, in March, remarked: “Last summer we learned that, for the first time ever, America’s uninsured rate has fallen below 10%. This is the lowest rate of uninsured that we’ve seen since we started keeping these records.” Subscription ratios are off the charts. Premium increases have been modest, approximately 6% for 2016, experts find. “I see no risk to the fundamental stability of the exchanges,” MIT economist Jonathan Gruber observed, noting “a big enough market for many insurers to remain in the fold.”

Transitional Reinsurance 2014-16: Vehicle for Innovation 

One of the great benefits of the ACA is eliminating pre-existing conditions and premium or coverage variables based on individual underwriting across the board. Citizens are no longer excluded from receiving adequate healthcare, whether directly or indirectly through high premiums. Prices for various plan designs go up as coverage benefits increase and as co-pays and deductibles decrease, but the relative prices of the various plans are calculated to be actuarially equivalent.

To help issuers make the transition from an era when they prided themselves on reducing or eliminating less healthy lives from the insureds they covered, to an era where all insureds are offered similar ratings, the ACA introduced reinsurance and risk corridors to cover the first three years (2014 through 2016), in addition to risk adjustment transfer, which will remain in force.

The concept is relatively simple: Require all issuers to charge a flat per-dollar, per-month, per-“qualified” insured and create a pot of money with these “reinsurance premiums” that reimburses issuers for excess claims on unhealthy lives. Issuers would be reimbursed based on established terms outlined in the ACA.

Reinsurance reimburses issuers for individual claims in excess of the attachment point, up to a limit where existing reinsurance coverage would kick in. Individuals involved with these large claims may or may not be identified in advance as high-risk. The reimbursed claim may be an acute (non-chronic) condition or an accident. The individual may otherwise be low-risk.

The important aspect is that all health insurance issuers and self-insured plans contribute. By spreading the cost over a large number of individuals, the cost per individual of this reinsurance program is small to negligible. Non-grandfathered individual market plans are eligible for payments. A state can operate a reinsurance program, or CMS does on its behalf through this year.

As a backstop, the federal government put some money in the pot through 2016—just in case the pot proved inadequate to provide full reimbursement to the issuers. In a worst-case scenario, the sum of the reinsurance premiums and the federal contribution could still be inadequate, in which case the coinsurance refund rate would be set at less than 100%.

As it turned out, 2014 reinsurance premiums proved to be more than adequate, so the refund rate was 100%, and the excess funds in the pot after reimbursement were set aside and added to the pot for 2015, just in case that proves inadequate.

Reinsurance functions on this timetable through this year:

Screen Shot 2016-04-11 at 1.41.01 PM

CMS transferred approximately $7.9 billion among 437 issuers—or 100% of filed claims for 2014, as claims were lower than expected— and it has yet to release 2015 payments. The results for 2015 are coming this summer.

From the outset, states could, and would, elect to continue reinsurance, the CMS contemplated. In 2012, the CMS indicated that “states are not prohibited from continuing a reinsurance program but may not use reinsurance contribution funds collected under the reinsurance program in calendar years 2014 through 2016 to fund the program in years after 2018.”

Subsequent clarification in 2013 did not disturb state discretion. Current regulation specifies that “a state must ensure that the applicable reinsurance entity completes all reinsurance-related activities for benefit years 2014 through 2016 and any activities required to be undertaken in subsequent periods.”

One course of action going forward from 2017 and varying from state-to-state could be mandatory reinsurance enacted through state laws. Healthcare providers, issuers, reinsurers, regulators and legislators could define the health reinsurance best suited to each state’s citizens.

Reinsurers could design and manage administration of these programs possibly at a percentage of premium cost that is less than what is charged by the federal government today. While these reinsurance programs would be mandated, they could include a component of private reinsurance. For example, reinsurers could guarantee the adequacy of per-month reinsurance premiums with provisos that if these actuarially calculated rates turned out to be inadequate in any given year or month, there will be an adjustment to account for the loss in the following year. Conversely, if those rates turn out to be too high, 90% or more is set aside in an account for use in the following year. This way, reinsurers could participate by providing a private sourced solution to adverse claims.

Risk Corridors

Risk corridors apply to issuers with Qualified Health Plans (exchange certified plans) and facilitate transfer payments. The CMS noted: “Issuers whose premiums exceed claims and other costs by more than a certain amount pay into the program, and insurers whose claims exceed premiums by a certain amount receive payments for their shortfall.” Technically, “risk corridors mean any payment adjustment system based on the ratio of allowable costs of a plan to the plan’s target amount,” as the CMS designated.

Issuer claims of $2.87 billion exceeded contributions, so the CMS transferred $362 million among issuers; that is, a 12.6% proration or a $2.5 billion shortfall in 2014.

Risk corridors are politically contentious. Sen. Marco Rubio (R-Florida) likened risk corridors to bailouts. The HHS acknowledged it will “explore other sources of funding for risk corridors payments, subject to the availability of appropriations… includ[ing] working with Congress on the necessary funding for outstanding risk corridors payments.” And, a knowledgeable analyst, Dr. David Blumenthal, noted that risk corridors are not bailouts.

Going forward, evaluations of risk corridors will demand due diligence. Several health exchanges failed from any number of factors—from too little capital for growth experienced, inadequate pricing, mismanagement or risk corridor payments.

Whether innovation can yield effective risk corridors or whether risk corridors will simply fade out as transitional 2014-2016 regulation will depend on institutional and industry participants. Risk corridors did not score unalloyed approbation among sources.

Risk Adjustment: Permanent Element of ACA

Risk adjustment remains in force and impels issuers with healthier enrollees to offset some costs of issuers with sicker ones in specific states and markets and of markets as a means toward promoting affordable health care choices by discouraging cherry picking healthier enrollees.

The HHS transferred approximately $4.6 billion for risk adjustment among issuers for 2014.

At first blush, one might postulate that risk adjustment does the job and that reinsurance and risk corridors could just as reasonably fade out. There is some logic to that argument.

On the other hand, state or regional level reinsurance could make up for risk adjustment shortfalls. In some instances, risk adjustment seems to be less friendly to issuers that take on higher-risk individuals, rather than rewarding high tech issuers and providers with back office capabilities coding claims in such a way as to tactically game risk adjustment.

Evaluating and cultivating these opportunities are timely amid the uncertainties of the presidential and congressional elections that may yield executive and legislative lawmakers intent on undoing ACA provisions, starting with risk corridors. Such legislation could produce losses for issuers and reinsurers.

Nelson A. Rockefeller Precedent

In 1954, then-Undersecretary of Health Education and Welfare Nelson A. Rockefeller proposed reinsurance as an incentive for insurers to offer more health insurance. S 3114, A Bill to Improve the Public Health by Encouraging More Extensive Use of the Voluntary Prepayment Method in the Provision of Personal Health Services, emerged in the first Eisenhower administration to enact a federally funded health reinsurance pool. Rockefeller intended the reinsurance as a means toward an end, what would eventually be dubbed a “third way” among proponents of national health insurance. President Truman and organized labor championed the approach into the mid-’50s. So did the Chamber of Commerce and congressional Republican adversaries of the New Deal and Fair Deal, who were chaffing to undo Social Security as quickly as they could. The American Medical Association also supported this third way because it opposed federal healthcare reinsurance as an opening wedge for socialized medicine. Despite limiting risk and offering new products, insurers demurred because of comfort zones with state regulators and trepidation about a federal role.

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Nelson A. Rockefeller, then-undersecretary of the Department of Health, Education and Welfare, presenting a federally funded health reinsurance plan, 1954.
Source: Department of Health Education and Welfare—now Health and Human Services

Rockefeller’s health reinsurance plan would “achieve a better understanding of the nation’s medical care problem, of the techniques for meeting it through voluntary means, and of the actuarial risks involved,” HEW Secretary Oveta Culp Hobby testified to a Senate subcommittee in 1954.

Rockefeller’s health reinsurance plan did not make it through the House. Organized labor decried it as too little, the AMA said it was too intrusive. Upon hearing news of the House vote, a frustrated Dwight Eisenhower blistered to reporters, “The people that voted against this bill just don’t understand what are the facts of American life,” according to Cary Reich in The Life of Nelson A. Rockefeller 1908-1958. “Ingenuity was no match for inertia,” Rockefeller biographer Richard Norton Smith remarked of industry and labor interests in those hard-wired, central-switched, mainframe times.

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“’It’s déjà vu all over again’ like Yogi Berra,” said one insurance commissioner immersed in the ACA on hearing Ike’s quote.

Source: Yogi Berra Museum & Learning Center

The idea of national health insurance went nowhere despite initiatives by Sen. Edward M. Kennedy (D-Massachusetts) in the late ’70s and President Bill and First Lady Hillary Clinton roughly 20 years ago, until Congress legislated Obamacare.

Innovative, Transparent Technologies Can Deliver Results

Nowadays, more than 60 years after Rockefeller’s attempt, innovative information technologies can get beyond these legislative and regulatory hurdles. Much of the data and networking is at hand. Enrollee actuarial risks, coverage actuarial values, utilization, local area costs of business and cost-sharing impacts on utilization are knowable in current systems. Broadband deployment and information technology innovations drive customer acquisition and information management costs ever lower each succeeding day. Long-term efficiencies for reinsurers, insurers, carriers, regulators, technology innovators and state regulators await evaluation and development.

Reinsurance Going Forward From 2017

So, if state reinsurance programs can provide benefits, what should they look like, and how should they be delivered?

For technology innovators—such as GoogleMicrosoftOverstockZebra or CoverHound—these opportunities with reinsurance would apply their expertise in search, processing and matching technologies to crucial billion-dollar markets and functions. The innovators hope to achieve successes more readily than has occurred through retail beachheads in motor vehicle and travel insurance and credit cards and mortgages. One observer noted that some of those retail initiatives faltered due to customer experience shortfalls and trust and privacy concerns. Another points out that insurers view Amazon, Apple and Netflix as setting new standards for customer experiences and expectations that insurers will increasingly have to match or supersede. A news report indicated that Nationwide already pairs customer management data with predictive analytics to enhance retention.

Reinsurers including Berkshire Hathaway, Munich Reinsurance Company, Swiss Reinsurance Company Limited and Maiden Holdings could rationalize risks and boost earnings while providing a wealth of risk management information, perhaps on a proprietary basis.

For issuers, state-of-the-art transparent solutions improve the current system by enabling issuers to offer more products and services and becalm more ferocious industry adversaries while lowering risks and extending markets. Smaller, nimbler issuers may provide more innovative solutions and gain market share by providing the dual objectives of better health outcomes with lower costs.

For regulators, innovative, timely information sustains the indispensability of state regulators ensuring financial soundness and legal compliance—while allowing innovators to upgrade marketplace and regulatory systems, key regulatory goals that Iowa’s insurance commissioner, Nick Gerhart, pointed out recently. Commissioner Gerhart envisions regulators as orchestra conductors, acknowledging that most insurance regulatory entities are woefully understaffed to design or operate such reinsurance programs themselves, but they will, and they can lead if the participants can provide turnkey capabilities.

Think of health insurance and reinsurance as generational opportunities for significant innovation rather like the Internet and email. When the Department of Defense permitted the Internet and email to evolve to civilian markets from military capabilities in the 1980s, the DOD initially approached the U.S. Postal Service. Senior Post Office management said it welcomed the opportunity to support email: All users need do is email correspondence to recipients’ local post offices by nine p.m. for printing, enveloping, sorting and letter-carrier delivery the following day.

Similarly, considerable opportunities chart innovative pathways for state and regional health reinsurance for 2017 and beyond.

One path, emulating the post office in the ’80s, keeps on coding and bemoans a zero sum; it would allow the existing programs to fade away and will respond to whatever the president and Congress might do.

Another path lumps issuer health reinsurance as an incumbent reinsurer service without addressing the sustainability of state health exchanges or, indeed, any private health insurers in the absences of risk spreading with readily available information technologies.

The approach suggested here—mandated state health reinsurance—innovates to build sustainable futures. Enabling technologies empower all stakeholders to advance private and public interests through industry solutions advancing affordable healthcare.

Insurance M&A: Just Beginning

Insurance M&A activity in the U.S. rose to unprecedented levels in 2015, surpassing what had been a banner year in 2014. There were 476 announced deals in the insurance sector, 79 of which had disclosed deal values with a total announced value of $53.3 billion. This was a significant increase from the 352 announced deals in 2014, of which 73 had disclosed deal values with a total announced value of $13.5 billion. Furthermore, unlike prior years, where U.S. insurance deal activity was isolated to specific subsectors, 2015 saw a significant increase in deal activity in all industry subsectors.

The largest deal of the year occurred in the property & casualty space when Chubb Corporation agreed on July 1 to merge with Ace. The size of the combined company, which assumed the Chubb brand, rivals that of other large global P&C companies like Allianz and Zurich. This merger by itself exceeded the total insurance industry disclosed deal values for each of the previous five years and represented 53% of the total 2015 disclosed deal value for the industry. However, even without the Chubb/Ace megamerger, total 2015 deal value was still nearly double that of 2014.

See Also: Insurance Implication in Asia Slowdown

While the insurance industry saw a significant increase in megadeals in 2015, there also was a significant increase in deals of all sizes across subsectors.

Tokio Marine & Fire Insurance’s acquisition of HCC Insurance Holdings, announced in June 2015, was the second largest announced deal, with a value of $7.5 billion. The purchase price represented a 36% premium to market value before the deal announcement.

The largest deal in the life space (and third largest deal in 2015) was Meiji Yasuda Life Insurance’s acquisition of Stancorp Financial Group for $5 billion. The purchase price represented 50% premium to market value prior to the deal announcement and continued what now appears to be a trend with Asian-domiciled financial institutions (particularly from Japan and China) acquiring mid-sized life and health insurance companies by paying significant premiums to public shareholders.

The fourth and fifth largest announced deals in 2015 were very similar to the Stancorp acquisition. They also were acquisitions of publicly held life insurers by foreign-domiciled financial institutions seeking an entry into the U.S. In each of these instances, the acquirers paid significant premiums.

In 2014, we anticipated this trend of inbound investment – particularly from Japan and China – and expect it to continue in 2016 as foreign-domiciled financial institutions seek to enter or expand their presence in the U.S.

Independent of these megadeals, the overwhelming number of announced deals in the insurance sector relate to acquisitions in the brokerage space. These deals are significant from a volume perspective, but many are smaller transactions that do not tend to have announced deal values.

In addition, there were a number of transactions involving insurance companies with significant premium exposure in the U.S., but which are domiciled offshore and therefore excluded from U.S. deal statistics. Some examples from 2015 include the acquisition of reinsurer PartnerRe by Exor for $6.6 billion, the $4.1 billion acquisition of Catlin Group by XL Group and Fosun’s acquisition of the remaining 80% interest of Ironshore for $2.1 billion.

See Also: New Approach to Risk and Infrastructure?

Drivers of deal activity

  • Inbound foreign investment – Asian financial institutions looking to gain exposure to the U.S. insurance market made the largest announced deal of 2014 and four of the five largest announced acquisitions in the insurance sector in 2015. Their targets were publicly traded insurance companies, which they purchased at significant premiums to their market prices. Foreign buyers have been attracted to the size of the U.S. market and have been met by willing sellers. Aging populations, a major issue in Japan, Korea and China, as well as an ambition to become global players, will continue to drive Asian buyer interest in the U.S. However, the ultimate amount of foreign megadeals in the U.S. may be limited by the number of available targets that are of desired scale and available for acquisition.
  • Sellers’ market – Coming out of the financial crisis, there were many insurance companies seeking to sell non-core assets and capital-intensive products. This created opportunities for buyers, as these businesses were being liquidated well below book values. Starting in 2014, the insurance sector became a sellers’ market (as we mention above, largely because of inbound investment). Many of the large announced deals in 2015 involved companies that were not for sale but were the direct result of buyers’ unsolicited approaches. This aggressiveness and the significant market premiums that buyers have paid on recent transactions should be cause for U.S. insurance company boards to reassess their strategies and consider selling assets.
  • Private equity/family office – Private equity demand for insurance brokerage companies continued in 2015, even as transaction multiples and valuations of insurance brokers increased significantly. However, we have also seen increased interest among private equity investors in acquiring risk-bearing life and P&C insurance companies. This demand has grown beyond the traditional PE-backed insurance companies that have focused primarily on fixed annuities and traditional life insurance products. Examples include: 1) Golden Gate Capital-backed Nassau Reinsurance Group Holdings’ announced acquisition of both Phoenix Companies and Universal American Corp.’s traditional insurance business; 2) HC2’s acquisition of the long-term care business of American Financial Group Inc.: and 3) Kuvare’s announced acquisition of Guaranty Income Life Insurance. We anticipate private equity activity will continue in both insurance brokerage and carrier markets in 2016.
  • Consolidation – While there has been some consolidation in the insurance industry over the past few years, it has been limited primarily to P&C reinsurance. With interest rates near historic lows and minimal increases in premium rates over the last few years, we expect the economic drivers of consolidation to increase in the industry as a whole as companies seek to eliminate costs to grow their bottom lines.
  • Regulatory developments – MetLife recently announced plans to spin off its U.S. retail business in an effort to escape its systemically important financial institution (SIFI) designation and thereby make the company’s regulatory oversight consistent with most other U.S. insurers’. MetLife’s announcement was followed by fellow SIFI AIG’s announcement that it intended to divest itself of its mortgage insurance unit, United Guaranty. The two other non-bank financial institutions that have been designated as SIFIs, GE Capital and Prudential Financial, have differing plans. While GE Capital has been in the process of divesting most of its financial services businesses, Prudential Financial has yet to announce any plans to sell assets. In other developments, the new captive financing rules the NAIC enacted in 2015 and the implementation of Solvency II in Europe may put pressure on other market participants to seek alternative financing solutions or sell U.S. businesses in 2016 and beyond.
  • Technological innovations – The insurance industry historically has lagged behind other industries in technological innovation (for example, many insurance companies use multiple, antiquated, product-specific policy administration systems). Unlike in banking and asset management, which have been significantly disrupted by technology-driven, non-bank financing platforms and robo-advisers, the insurance industry has not yet experienced significant disruption to its traditional business model from technology-driven alternatives. However, we believe that technological innovations will significantly alter the way insurance companies do business – likely in the near future. Many market participants are focusing on being ahead of the curve and are seeking to acquire technology that will allow them to meet new customer needs while optimizing core insurance functions and related cost structures.

Implications

  • We expect inbound foreign investment – especially from Japan and China – to continue fueling U.S. deals activity for the foreseeable future. If there is an impediment to activity, it likely will not be a lack of ready buyers but instead a lack of suitable targets.
  • Private equity will remain an important player in the deals market, not least because it has expanded its targets beyond brokers to the industry as a whole.
  • The need to eliminate costs to grow the bottom line will remain a primary economic driver of consolidation.
  • Regulatory developments are driving divestments at most, though not all, non-bank SIFIs. This remains a space to watch, as a common insurance industry goal is to avoid federal supervision.
  • Actual and impending technological disruption of traditional business models is likely to lead to increased deal activiy as companies look to augment their existing capabilities and take advantage of – rather than fall victim to – disruption.
innovation

Does Your Culture Embrace Innovation?

Why does it matter whether your organization embraces innovation by design? We are at the beginning of an era where the confluence of increasingly powerful computing capability, ease of starting a tech-intensive firm and massive data in a deeply networked world will drive more innovation more broadly than ever before. The rate of change and, indeed, the speed with which new incumbents enter markets and existing players fail will only increase. This means innovation must become part of a company’s fabric and its culture to ensure success.

Looking over the past 20 years to gain a better view of the next 20 years, there are three things that stand out, are surprising and are instructive.

  1. Science, geo-politics, sports, weather, information technology and cyber are all areas full of events that, a year or two before the “event,” prominent insiders would have said were not in the realm of possibility—they were not just unlikely but impossible, if not loony.
  2. While impressive, the huge growth and acceleration we have seen in information technology, social media, mobile, big data, several areas of science and cyber all exhibit patterns of the beginning of something—not a pattern of stability, maturation or, even, peaking. The amount of data, the amount of IP-enabled nodes and the throughput cost of computing could all scale 100 – 500 times in the next decade, making today just the beginning of a hockey-stick-like curve.
  3. The simple truth, threat and opportunity is that the rate of change is increasing across all areas of life while the scale of change is expanding.

What does all that mean? One thing is certain: Being agile is not enough. Those who effectively embrace innovation at an organizational (if not cultural) level will fare better than those who do not. Indeed, if this is the beginning of accelerating rates of change with massive outlier impacts, then driving innovation pragmatically across an organization is imperative.

See Also: Innovation Trends in 2016

If, from the top, the mission for everyone in an organization includes being innovative, this can become part of the fabric, the culture of the organization. Businesses that effectively embrace innovation at a cultural level will fare better than those that do not.

Still, there is a massive amount of fog surrounding the word “culture.” I often hear it is the insurmountable obstacle to innovation at scale and pace.

One Fortune 500 Example: Motorola

In the early 2000s, I was an officer with tech and business responsibilities at Motorola. The culture was largely internally focused, obsessed with continuous (often marginal) improvements, in love with engineering and intellectual property (IP) filings and not necessarily the monetization of IP. It was a family-oriented culture with, literally, generations of the family working at the firm. But the firm was failing.

The board brought in a new CEO from Silicon Valley, and we changed the company culture radically in 18 months. We did six simple things, instigated and championed by the new CEO:

  1. Clearly communicated a broad new mission about being externally focused, fast-paced, innovative and customer-centric
  2. Set out the behaviors that we expected and that the company would reward, as well as behaviors we would punish
  3. Continually “sold” (over-communicated) the rationale of why we were changing
  4. Made sure rewards and punishments were publicly meted out to support the new direction
  5. Matched structure to mission and talent to task; (when the game changes from soccer to rugby, not all team members have a role despite prior excellent performance)
  6. Eliminated active objectors and passive resistors who simulated support but were not rowing the boat (a third of the top 120 executives changed in about 12 months, mostly for this reason)

Motorola changed its culture and performance radically in 18 months. We released the breakthrough RAZR phone, which became the best-selling phone of all time. IT, for example, became a platform for tech breakthroughs and even had a venture arm for emerging tech.

Unfortunately, shortly after that, Apple made a thing called the iPhone, we made some very bad leadership talent decisions and we backed hardware over software in our largest business unit.

No amount of motivation or positive innovation culture will save you from a bad strategy that is married to poor talent decisions in key posts, compounded by groundbreaking, world-class competition.

Cultural obstacles

A well-communicated mission, backed up by clarity on what garners rewards and punishments, is key. The rewards and punishments must be broadly, consistently and continuously meted out for the behaviors that merit them. This will drive the behaviors in the organization. Lots of organizations get the reward part generally right, but they fail miserably on the punishment side, then wonder why they have cultural obstacles.

Done properly, rewards and punishments drive the behaviors inside your organization. The sum of those behaviors is your culture. 

Tips for building an innovation culture

Innovation must be about both big and small innovation, not just breakthroughs. Almost all organizations have an untapped wealth of innovation they can access by just eliminating the longstanding negativity that confront the rank and file daily. The front-line person in accounts payable and customer service or the distribution center in Managua may have process ideas that are innovative and high-impact for the whole organization.

See Also: Tech Innovation Is No Longer Optional

The simple question, “What really dumb stuff do we do around here?” in the right penalty-free environment usually unleashes a torrent. But without a culture of innovation, small, incremental, continuous improvements lie dormant.

Idea platforms and innovation/suggestion processes are all well and fine, but they should live inside an innovation culture where everyone thinks it’s part of their individual mission, with the underpinning or institutional agility and continuous improvement that goes with it. Again, you are not asking each person to reinvent Google, Facebook or the low-cost Fusion; you are rewarding them for innovative improvements.

To keep up with the changing external environment, an organization must be adaptable, agile, great at managing change and effective at the necessary but mundane underlying program management. An organization must also be deeply externally aware and manage emerging potential challenges, opportunities and threat profiles as far in advance as possible. No culture can remain innovative if it is internally focused and not connected purposefully to the outside world.

One simple approach to help instantiate innovation is to use “HLI” and that modern cultural artifact PowerPoint to drive innovation into the bedrock of the culture. I did this at several firms where PowerPoint was closer to an addiction than a facet of the culture. Quite simply, I insisted every program update, every group or function presentation, start with HLI.

  • H = Highlights: Show highlights of what the team did well. The real objective is to say “thanks” and acknowledge a mini win. Over time, teams start to think in terms of what they can put under ‘H’ on the front page. Accomplishment and recognition of accomplishment are necessary for a motivated environment.
  • L = Lowlights: Here you want to see some stretch, some failure. But, most of all, you want to see some learning and experimenting. By reviewing this without beating anyone up—maybe even praising the effort—you eliminate the fear. The message quickly goes through the organization that no one got killed for stretching or trying harder and occasionally dropping the ball. This also helps kill one of the most anti-innovation elements in business, the “under promise, over deliver” malaise.
  • I = Innovation: This is simply asking what you tried that was new, what you grabbed from phase two and did in phase one, what serial process you made parallel, what new method or tool you used, what you borrowed from prior efforts, etc.

If anyone shows up with a presentation that doesn’t lead with HLI, you politely cancel the meeting and get them to come back later. Over time, this creates activity inside teams so they can fill in the three sections. Teams start to have early conversations about how they are going to innovate, stretch and learn.

Innovation at scale requires change management 

There are many stories about the initial excitement of going big on innovation that are then followed by failure and disillusionment because the leadership attention waned as the novelty of the program passed and the hard work of change management, scaling and maintaining ensued.

I cannot talk about creating a culture of innovation without also teaching which change management models work best. It sounds obvious to say driving a culture of innovation is change-intensive, yet I almost never see a decent understanding of change management models and which one is most effective.

There are four basic management models:

  1. Edict
  2. Persuasion
  3. Participation (the communities of interest help define the change)
  4. Intervention (the sponsor justifies the need for change, monitors the process and communicates progress)

The change management model that has the highest frequency of success is intervention. It is at least twice as effective as the next-best model. It requires active leadership to continually “sell” the vision or plan, even while executing it. Understanding how that works and making sure everyone understands and follows the changed playbook are topics for a later article.

Suffice it to say, if you were to map the change processes at most firms, they often resemble spaghetti–an inefficient, unintended, sub-optimized maze. The majority of large tech-intensive programs are late, over budget, deliver less than promised or all of the above. Most companies have never mapped their processes and assume all is well.

Bottom line

Creating a culture of innovation inside a supporting ecosystem with a modicum of useful tools and the right leadership can lead to great success. Innovation is a pragmatic, broad-based journey, not a fad-centric exercise. Done well, innovation is the key to being effectively agile, and it is a concrete force multiplier. It very well may be the only sustainable competitive advantage over the next decade.

Do you have a culture that can innovate broadly, or do you have a silo-ed innovation team or champion or campaign?

Traditional Insurance Is Dying

Finance. Taxis. Television. Medicine. What do these have in common?

They’re all on the long–and growing–list of industries being turned upside down by disruptive technology. 

The examples are legion. Once-sure-bet investments like taxicab medallions are at risk of going underwater. Bitcoin is giving consumers the power to bypass banks. Traditional television is at risk from online streaming.

Insurance Is No Different

In fact, innovative players have been disrupting the insurance market since before “disruption” was the buzzword it is today. 

Look at Esurance, which in 1999 rode the dot-com wave to success as the first insurance company to operate exclusively online. No forms, no policy mailers–it didn’t even mail paper bills.

By going paperless, Esurance told customers that it was the kind of company that cared about their preferences–and established itself as a unique player in an industry that places a premium on tradition. Insurance isn’t known for being innovative. 

Most insurance leaders operate under the assumption that if it ain’t broke, you shouldn’t fix it. And in a heavily regulated industry, that’s not totally unreasonable. 

But you only have to look at the scrappy start-ups that are taking down long-established players to understand what awaits the companies that aren’t willing to innovate.

Thinking Outside the Box

Take Time Warner–profit fell 7.2% last quarter as industry analysts foretold “the death of TV.” Meanwhile, Netflix’s profits are soaring beyond expectations–even as the risks it takes don’t always pan out. 

Remember the “Marco Polo” series that cost a reported $90 million? Neither does anyone else. But for every “Marco Polo” there’s an “Orange Is the New Black.” Highly successful programs on a subscription model show that Netflix’s willingness to take risks is carrying it past industry juggernauts.

The market is changing–and if you want to stay competitive, you need to use every weapon in your arsenal. Millennials aren’t buying insurance at the rate their parents did

To a consumer population weaned on technology like Uber and Venmo, the insurance industry seems positively antiquated. Facebook can advertise to you the brand of shoes you like–so your insurance company should be able to offer a product that you actually want.

The Information Importance

According to Accenture, “Regulated industries are especially vulnerable” to incumbents. When there are barriers to entry based on licensing requirements or fees, competition is lower. Decreased competition, in turn, leads to less incentive to innovate. This can leave regulated industries, such as insurance, healthcare and finance, in a highly vulnerable position when another company figures out a way to improve their offerings.

Other attributes that can make an industry vulnerable, per Accenture’s findings, can include:

  • Narrow focus: If a brand focuses entirely on cost savings, convenience or innovation, it isn’t effectively covering its bases. A disruptor that manages to offer two or three of these factors instead of just one has a near-immediate advantage.
  • Small scope or targets: Failing to expand offerings to all demographics can mean that industries or service providers aren’t able to replicate the broad reach of disruptors.
  • Failing to innovate: Disruptors don’t always get their product right on the very first try. Companies must innovate continuously and figure out ways to build continuous improvement into their business model.

Tech start-ups use information as an asset. How can you tell if information is a valuable weapon in the battle you’re fighting? 

“Big data” isn’t just a buzzword; industry analysts are calling it the wave of the future. At Citi, they’re talking about “the feed”: a real-time data stream that leverages the Internet of Things to reshape risk management. 

Auto insurers are turning to connected cars to let them reward safe drivers. Some life insurers are even offering discounts to customers who wear activity trackers.

It Can Happen to You

For most insurance companies, incorporating an unknown element into the way they operate is daunting. 

But talk to any cab driver, grocery store clerk or travel agent, and they’ll tell you that the only way to survive in a technology-driven world is to innovate.

Look at the insurance technology market to see what improvements you can incorporate into your organization, and think expansively about how you can use information: for agency management, to attract new customers and retain old ones, to expand your profit margins or to streamline operating costs. 

Your survival depends on it.

excess

The State of Workers’ Comp in 2016

Over the last two years, employers and groups that self-insure their workers’ compensation exposures have enjoyed reasonably favorable terms on their excess insurance policies. Both premiums and self-insured retentions (SIRs) have remained relatively stable since 2014. This trend is likely to continue through 2016, but the long-term outlook for this line of coverage is less promising. Changing loss trends, stagnant interest rates, deteriorating reinsurance results and challenging regulatory issues are likely to have a negative impact on excess workers’ compensation insurance in the near future.

Predictions for 2016

Little direct information is available on the excess workers’ compensation marketplace even though written premiums well exceed $1 billion nationwide. Accurately forecasting changes in the marketplace is largely a function of the prevalent conditions of the workers’ compensation, reinsurance and financial marketplaces. But, based on available information, premium rates, retentions and policy limits should remain relatively flat on excess workers’ compensation policies for the balance of the 2016 calendar year. This projected stability is because of four main factors: positive results in the workers’ compensation industry over the last two years, availability of favorable terms in the reinsurance marketplace, an increase in the interest rate by the Federal Reserve at the end of 2015 and continued investment in value-added cost-containment services by excess carriers.

For calendar year 2014, the National Council on Compensation Insurance (NCCI) reported a 98% combined ratio for the workers’ compensation industry nationwide. In 2015, the combined ratio is projected to have improved slightly to 96%. This equates to a 2% underwriting profit for 2014 and a projected 4% underwriting profit for 2015. This is the first time since 2006 that the industry has posted positive results. The results were further bolstered by a downward trend in lost-time claims across the country and improved investment returns.

Reinsurance costs and availability play a significant role in the overall cost of excess workers’ compensation coverage. On an individual policy, reinsurance can make up 25% or more of the total cost. Excess workers’ compensation carriers, like most insurance carriers, purchase reinsurance coverages to spread risk and minimize volatility generated by catastrophic claims and adverse loss development. Reinsurers have benefited from underwriting gains and improved investment returns over the last three years. These results have helped to stabilize their costs and terms, which have directly benefited the excess workers’ compensation carriers and, ultimately, the policyholders that purchase excess coverage.

According to NCCI, the workers’ compensation industry has only posted underwriting profits in four of the last 25 years. This includes the two most recent calendar years. To generate an ultimate net profit and for the industry to remain viable on a long-term basis, workers’ compensation carriers rely heavily on investment income to offset the losses in most policy years. For the first time since 2006, the Federal Reserve increased target fund rates at the end of 2015. Although the increase was marginal, it has a measurable impact on the long-term investment portfolios held by workers’ compensation and excess workers’ compensation carriers. Workers’ compensation has a very long lag between the time a claim occurs and the date it is ultimately closed. This lag time is known as a “tail.” The tail on an excess workers’ compensation policy year can be 15, 20 and even as much as 30 years. An additional 0.25% investment return on funds held in reserve over a 20-plus-year period can translate into significant additional revenue for a carrier.

Excess workers’ compensation carriers have moved away from the traditional model of providing only commodity-based insurance coverage over the last 10 years. Most have instead developed various value-added cost-containment services that are provided within the cost of the excess policies they issue. Initially, these services were used to differentiate individual carriers from their competitors but have since evolved to have a meaningful impact on the cost of claims for both the policyholder and the carrier. These services include safety and loss control consultation to prevent claims from occurring, predictive analytics to help identify problematic claims for early intervention and benchmarking tools that help employers target specific areas for improvement. These value-added services not only reduce the frequency and severity of the claims experience for the policyholder, but excess carriers, as well.

Long Term Challenges

The results over the last two years have been relatively favorable for the workers’ compensation industry, but there are a number of long-term challenges and issues. These factors will likely lead to increasing premiums or increases in the self-insured retentions (SIRs) available under excess workers’ compensation policies.

Loss Trends: Workers’ compensation claims frequency, especially lost-time frequency, has steadily declined on a national level over the last 10 years, but the average cost of lost-time claims is increasing. These two diverging trends could ultimately result in a general increase in lost-time (indemnity) costs. Further, advances in medical technology, treatments and medications (especially opioids) are pushing the medical cost component of workers’ compensation claims higher, and, on average, medical costs make up 60% to 70% of most workers’ compensation claims.

Interest Rates: While the Federal Reserve did increase interest rates by 0.25 percentage point in late December, many financial analysts say that further increases are unlikely in the foreseeable future. Ten- year T-bill rates have been steadily declining over the last 25 years, and the current 10-year Treasury rate remains at a historically low level. A lack of meaningful returns on long-term investments will necessitate future premium increases, likely coupled with increases in policy retentions to offset increasing losses in future years.

Reinsurance: According to a recent study published by Ernst & Young, the property/casualty reinsurance marketplace has enjoyed three consecutive years of positive underwriting results, but each successive year since 2013 has produced a smaller underwriting profit than the last. In 2013, reinsurers generated a 3% underwriting profit followed by a 2% profit in 2014 and finally an underwriting profit of less than 1% in 2015. Like most insurance carriers, reinsurers utilize investment income to offset underwriting losses. As the long-term outlook for investments languishes, reinsurance carriers are likely to move their premiums and retentions upward to generate additional revenue, thus increasing the cost of underlying policies, including excess insurance.

Regulatory Matters: Workers’ compensation rules and regulations are fairly well-established in most states, but a number of recent developments at the federal and state levels may hurt workers’ compensation programs nationwide. The federal government continues to seek cost-shifting options under the Affordable Care Act (ACA) to state workers’ compensation programs. Later this year, state Medicaid programs will be permitted to recover entire liability settlements from state workers’ compensation plans – as opposed to just the amount related to the medical portion of the settlement. At the state level, there are an increasing number of challenges to the “exclusive remedy” provision of most workers’ compensation systems. Florida’s Supreme Court is currently deliberating such a challenge. Should the court rule in favor of the plaintiffs, Florida employers could be exposed to increased litigation from injured workers. A ruling against exclusive remedy could possibly set precedent for plaintiff attorneys to bring similar litigation in other states. Lastly, allowing injured workers to seek remedies outside of the workers’ compensation system would strip carriers and employers of many cost-containment options.