Tag Archives: regtech

What Should Future of Regulation Be?

It is of course much easier to look back and second-guess regulatory actions. It is far more difficult to propose a way forward and to do so in light of the emerging hot-button issues, including data and the digitization of the industry, insurtech (and regtech), emerging and growing risks, cyber, the Internet of Things (IoT), natural catastrophes, longevity and growing protectionism. The way forward requires consideration of the primary goals of insurance regulation and raises critical questions regarding how regulators prioritize their work and how they interact with one another, with the global industry and with consumers.

We offer below some thoughts and suggestions on these important questions and on how regulation might best move forward over the next 10 years.

Establish a reasonable construct for regulatory relationships.

Relationships matter, and it is imperative for there to be careful consideration of how regulators organize their interactions and reliance on each other. We have some examples in the form of the Solvency II equivalence assessment process, the NAIC’s Qualified Jurisdiction assessment process (under the U.S. credit for reinsurance laws), the NAIC’s accreditation process for the states of the U.S., the U.S.-E.U. Covered Agreement, ComFrame, the IAIS and NAIC’s memorandum of ynderstanding and the IMF financial sector assessment program (FSAP). Each of these provide varying degrees of assessment and regulatory cooperation/reliance.

These processes and protocols, however, have largely emerged on an ad hoc, unilateral basis and in some cases have had a whiff of imperial judgment about them that may not be justified – and certainly is off-putting to counterparties. We would urge regulators to give careful consideration to the goals, guiding principles and the process for achieving greater levels of cooperation and reliance among global regulators.

We hope these efforts would include an appreciation that different approaches/systems can achieve similar results that no jurisdiction has a monopoly on good solvency regulation. There must also be respect for and recognition of local laws and a recognition that regulatory cooperation and accommodation will benefit regulators, the industry and consumers. Most importantly, regulators need to work together to develop confidence and trust in one another.

The IAIS first coined the phrase “supervisory recognition” in 2009. In March of that year, the IAIS released an “issues paper on group-wide solvency assessment and supervision.” That paper stated that:

“To the extent there is not convergence of supervisory standards and practices, supervisors can pursue processes of ‘supervisory recognition’ in an effort to enhance the effectiveness and efficiency of supervision. Supervisory recognition refers to supervisors choosing to recognize and rely on the work of other supervisors, based on an assessment of the counterpart jurisdiction’s regulatory regime.”

See also: Global Trend Map No. 14: Regulation  

The paper noted the tremendous benefits that can flow from choosing such a path:

“An effective system of supervisory recognition could reduce duplication of effort by the supervisors involved, thereby reducing compliance costs for the insurance industry and enhancing market efficiency. It would also facilitate information sharing and cooperation among those supervisors.”

This is powerful. We urge global insurance regulators to take a step back and consider how they can enhance regulatory effectiveness and efficiency by taking reasonable and prudential steps to recognize effective regulatory regimens − even where these systems are based on different (perhaps significantly different) rules and principles, but which have a demonstrated track record of effectiveness.

As noted above, we have seen some efforts at supervisory recognition. These include Solvency II’s equivalence assessment process, the NAIC’s accreditation process for other U.S. states, the NAIC “Qualified Jurisdictions” provisions for identifying jurisdictions that U.S. regulators will rely on for purposes of lowering collateral requirements on foreign reinsurers, the E.U.-U.S. Covered Agreement and the IAIS’s Memorandum on Mutual Understanding. Some of these processes are more prescriptive than others and have the danger of demanding that regulatory standards be virtually identical to be recognized. This should be avoided.

One size for all is not the way to go.

The alternative approach to recognition of different, but equally effective systems is the pursuit of a harmonized, single set of regulatory standards for global insurers. This approach is much in vogue among some regulators, who assert the “need for a common language” or for “a level playing field” or to avoid “regulatory arbitrage.” Some regulators also argue that common standards will lead to regulatory nirvana, where one set of rules will apply to all global insurers, which will then be able to trade seamlessly throughout all markets.

There are, however, a variety of solvency and capital systems that have proven their effectiveness. These systems are not identical, and indeed they have some profoundly different regulatory structures, accounting rules and other standards such as the systems deployed in the E.U. (even pre-Solvency II), the U.S., Canada, Japan, Bermuda, Australia, Switzerland and others. Attempting to assert a signal system or standard ignores commercial, regulatory, legal, cultural and political realities.

Moreover, we question some of the rationale for pursuing uniform standards, including the need for a common language. We suggest that what is really needed is for regulators to continue to work together, to discuss their respective regulatory regimes and to develop a deep, sophisticated knowledge of how their regimes work. From this, trust will develop, and from that a more effective and efficient system of regulation is possible. The engagement and trust building can happen within supervisory colleges. We have seen it emerge in the context of the E.U.-U.S. regulatory dialogue. We saw it in the context of the E.U.-U.S. Covered Agreement. No one, however, has made a compelling case for why one regulatory language is necessary to establish a close, effective working relationship among regulators.

Similarly, the call for a level playing field sounds good, but it is an amorphous, ambiguous term that is rarely, if ever, defined. Does the “playing field” include just regulatory capital requirements? If so, how about tax, employment rules, social charges? How about 50 subnational regulators versus one national regulator? Guarantee funds? Seeking a level playing field can also be code for, “My system of regulation is heavier, more expensive than yours, so I need to put a regulatory thumb on the scales to make sure you have equally burdensome regulations.” This argument was made for decades in the debate surrounding the U.S. reinsurance collateral rules. We hear it now regarding the burdens of Solvency II. It must be asked, however, whether it is the responsibility of prudential regulators to be leveling playing fields, or should their focus be solely on prudent regulatory standards for their markets.

Finally, the dark specter of regulatory arbitrage is often asserted as a reason to pursue a single regulatory standard, such as the development of the ICS by the IAIS. But one must ask if there is really a danger of regulatory arbitrage today among global, internationally active insures? Yes, a vigilant eye needs to kept for a weak link in the regulatory system, something the IMF FSAP system has sought to do, supervisory colleges can do and the IAIS is well-equipped to do. But using regulatory arbitrage as an argument to drive the establishment of the same standards for all insurers does not seem compelling.

Proportionality is required.

Often, regulators roll out new regulatory initiatives with the phrase that the new rules will be “proportionate” to the targeted insurers. Too often, it seems there is just lip service to this principle. Rarely is it defined – but it is tossed out in an attempt to say, “Do not worry, the new rules will not be excessive.” Greater debate and greater commitment to this principle is needed. Clearly a key component of it must be a careful cost/benefit analysis of any proposed new standard, with a clear articulation of the perceived danger to be addressed – including the likelihoods and severity of impact and then a credible calculation of the attendant costs – economic and otherwise to industry and to regulators. In October 2017, the U.K. Treasury Select Committee published a report criticizing the PRA for its excessively strict interpretation of Solvency II and its negative effect on the competitiveness of U.K. insurers. The report concluded that the PRA had enhanced policyholder protection at the expense of increasing the cost of capital for U.K. insurers, which hurt their ability to provide long-term investments and annuities. Although the PRA emphasized its mandate of prudential regulation and policy holder protection, the Treasury Committee reiterated its concern with how the PRA interpreted the principle of proportionality.

Simplicity rather than complexity.

Over the past 10 years, there has been a staggering increase in proposed and enacted regulatory requirements, many of which are catalogued above. There is a danger, however, that increasingly complex regulatory tools can create their own regulatory blind spots and that overly complex regulations can create a regulatory “fog of war.”

Andrew Haldane, executive director at the Bank of England, in August 2012 delivered a paper at a Federal Reserve Bank of Kansas City’s economic policy symposium, titled “The Dog and the Frisbee.” He graphically laid out when less is really more by talking about two ways of catching a Frisbee: One can “weigh a complex array of physical and atmospheric factors, among them wind speed and Frisbee rotation” − or one can simply catch the Frisbee, the way a dog does. Complex rules, Haldane said, may cause people to manage to the rules for fear of falling in conflict with them. The complexity of the rules may induce people to act defensively and focus on the small print at the expense of the bigger picture.

Focusing on the complexity of the banking world, Haldane compared the 20 pages of the Glass-Steagall Act to the 848 pages of Dodd-Frank together with its 30,000 pages of rulemaking, and compared the 18 pages of Basel 1 to the more than 1,000 pages of Basel III. The fundamental question is whether that additional detail and complexity really adds greater safety to the financial system or has just the opposite effect and significantly increases the cost. Haldane’s analysis provides compelling evidence that increasing the complexity of financial regulation is a recipe for continuing crisis. Accordingly, Haldane calls for a different direction for supervisors with “…fewer (perhaps far fewer), and more (ideally much more) experienced supervisors, operating to a smaller, less detailed rule book.”

Although Haldane’s analysis and discussion focuses on the banking system, his assessment and recommendations should be considered carefully by global insurance regulators. The sheer volume and complexity of rules, models and reports that flood into regulatory bodies raise the real question of who reviews this information, who really understands it and, worst of all, does a mountain of detailed information create a false confidence that regulators have good visibility into the risks – particular the emerging risks – that insurers are facing? A real danger exists of not seeing the forest for the trees.

See also: To Predict the Future, Try Creating It  

Regulation should promote competitiveness rather than protectionism.

At a time when competition has been growing not only from within the established companies but also more importantly from outside the traditional companies, protectionism will only inhibit growth and stifle better understanding of risk in a rapidly changing business environment. The goal must be to make the industry more competitive and to encourage transfer of innovation and create better ways to address risk, distribution of products and climate changes. Protectionism will only limit the potential of growth of the industry and is both short-sighted and self-defeating.

Recognition of the importance of positive disruption through insurtech, fintech and innovation.

The consensus is that the insurance industry is ripe for disruption because it has been slow (but is now working hard) to modernize in view of an array of innovative and technological advancements. Equally, regulators are trying to catch up with the rapid changes and are trying to understand the impacts through sandbox experiments and running separate regulatory models. The pace is fast and presents challenges for the regulators. Solvency and policyholder protection remain paramount, but cybersecurity, data protection, artificial intelligence and the digital revolution make advancements every day. Where this will lead is not clear. But changes are happening and regulators must work to understand the impact and need to calibrate regulatory rules to keep up with the industry and encourage innovation.

Regulation must be transparent.

Too often, regulation is drafted in times of crisis or behind closed doors by regulators believing they know better how to protect policy holders and how to prevent abuse of the system. As we have said, getting it right matters. A strong and healthy industry is the best way to protect consumers and policy holders. Industry engagement is essential and acknowledging and actually incorporating industry’s views is critical. This is particularly true given the dramatic changes in the insurance sector and the need to adopt regulation to new economics, business practices and consumer needs and expectations

This is an excerpt from a report, the full text of which is available here.

How to Get Ahead of the Watchdogs

The compliance and ethics functions within insurance organizations face continued regulatory pressure. But, nowadays, they must also deal with new threat vectors that are shaping a higher-stakes global compliance environment. More and more, investigative journalists are analyzing big data to spot fraud as well as compliance violations. Third-party agencies are increasingly using technology to identify incidents and monitor corporate behavior. Enforcement agency whistleblower programs are motivating employees to speak out about perceived violations. And, rapidly escalating grassroots campaigns, such as the #metoo movement, are making strong corporate culture and rapid-response capabilities even more critical. When these watchdogs form the genesis of a complaint, social media channels and the round-the-clock news cycle can rapidly increase awareness of the incident – in some cases even before the company itself is aware.

Compliance functions need the agility to adjust to business changes and to the inevitable surprises inherent in a dynamic business climate. But, without a strong technological underpinning to help them operate efficiently in real time, it will be challenging, if not impossible, to get ahead of new threat sources and changing business dynamics. From dashboards for improved decision-making, to sophisticated tools for monitoring employee compliance, to training informed with data from compliance monitoring, technology-based capabilities are now cornerstones of effective compliance management. By using the best available tools and information to protect their organizations and to scan the horizon for new requirements, trends and risks, compliance functions can keep pace with their organizations’ changing compliance needs.

But as a group, insurance sector compliance functions have some work to do on the technology front. According to the PwC 2018 State of Compliance study, only 41% of insurance organizations use policy management technology within the compliance department (compared with 44% across industries and 54% in banking, for example). Just 47% use technology to monitor employees’ compliance with ethics and compliance-related policies and procedures (compared with 50% across industries and 52% in banking). While progress is being made, it lags that of certain other industries.

See also: How to Collaborate With Insurtechs  

However, our study identified 17% of insurance survey respondents as “Leaders,” where executives were very satisfied with the effectiveness of their organization’s compliance program. This is on par with other industries in the study. The study’s overall Leader group shares a common denominator: Leaders take a more comprehensive and current approach to compliance risk management as enabled by technology. Leaders differ substantially from their peers in many of the operational aspects of compliance risk management, including executing differently in four key ways.

Leaders invest in tech-enabled infrastructure to support a modern, data-driven compliance function. Technology helps organizations manage compliance in a dynamic and expansive risk universe. Leaders more often use data analytics tools, dashboards and continuous monitoring than their peers. More than half (54%) of Leaders in the study use data analysis tools, and nearly half have dashboards (49%) and engage in continuous compliance monitoring (48%). The effective use of cloud infrastructure, machine learning, advanced analytics and natural-language processors help organizations quickly analyze vast amounts of data and gain insights into business and customer behaviors, assess potential compliance issues and cost-effectively meet risk and regulatory challenges.

Leaders increase compliance-monitoring effectiveness through the use of technology and analytics. Analytics, together with automation technologies, make the continuous monitoring of employee compliance across many areas of the business far more feasible. Two-thirds (66%) of Leaders use technology to monitor employees’ compliance with ethics- and compliance-related policies and procedures. And they more often use technology to monitor specific risk categories, such as fraud, gifts and entertainment, privacy, social media and trade compliance. Leaders are also gleaning more benefits from technology use in monitoring efforts – compared with their less effective peers, they are more responsive and even proactive in mitigating compliance issues.

Leaders streamline policy management to increase responsiveness and boost policy and procedure effectiveness. Leaders take several steps to strengthen their policy management. They more often keep their codes of conduct, policies and procedures current and make them easily accessible across the organization. They also more often enable this streamlining through policy management technology, such as GRC tools, and measure the effectiveness of policies and procedures more comprehensively. Nearly two-thirds use technology to facilitate the policy management process.

Leaders take advantage of information and technology to provide targeted, engaging and up-to-date compliance training. Leaders’ compliance training and communications are more comprehensive and current. They are often using multiple sources of information to inform and target their training and are thinking creatively about new ways to digitally engage employees in training activities. Leaders’ approaches to training positively affect their organizations’ overall risk profile as they aim to minimize activities that potentially place the organization at higher risk.

See also: Guide for Insurtech Work With Carriers  

Effective compliance risk management must be grounded in strategy and business engagement. Establishing the right tone at the top, assessing compliance and ethics risks and building governance structures that provide high levels of confidence in regulatory matters are all critical to effective compliance leadership. But operational aspects of compliance are where the rubber meets the road. With multiple new, highly motivated watchdogs now providing their own forms of oversight, the case for strengthening compliance risk management through technology is strong. Technology is more critical than ever in building programs that boost compliance program value, better manage risks and drive cost-effective compliance.

Gradually and Then Suddenly…

Excerpted from MSA’s Q1-2018 Outlook Report (June 2018)

The insurance industry has been compared to the proverbial frog in the pot of ever hotter water. While things appear on the surface comparable to what they were like 10 years ago, perhaps with some nuanced variations, there appears to be little in the way of differences. Yes, mergers continue happening at the carrier level, and direct insurers are slowly gaining market share, but the band plays on. Industry associations continue holding conventions, insurers, reinsurers and brokers continue their traditions and year-end pilgrimages to London, Monte Carlo, Baden-Baden, NICC and the Aon Rendezvous, and the various other stations still welcome a familiar crowd. But signs that fundamental changes are afoot are becoming ever harder to ignore.

In Ernest Hemingway’s 1926 novel, “The Sun Also Rises,” there’s a snippet of dialogue that seems apropos:

How did you go bankrupt?” Bill asked.

“Two ways,” Mike said. “Gradually and then suddenly.”

The primary driver of the change is technology. The less noticeable catalyst, but no less important, is changes in regulatory mindsets. Let’s tackle both.

The two most influential market conduct regulators in Canada are readying themselves for technological disruption of the industries they oversee.

Quebec’s regulator, the AMF, has publicly expressed that it is “open for business” in terms of insurtech/ fintech under CEO Louis Morisset and Superintendent of Solvency Patrick Déry.

FSCO has recently moved to be more flexible within the tight bounds of its mandate, and its successor, FSRA, will be a modern independent agency purposely built for adaptability; it emerges from its cocoon under the guidance of a professional board and the stewardship of its CEO, Mark White, in April 2019.

FSRA and the AMF are positioning themselves to allow experimentation via regulatory sandboxes, whereby players can test initiatives in the field. This sandbox methodology is modeled after the Ontario Security Commission’s LaunchPad initiative.

See also: Global Trend Map No. 19: N. America (Part 1)  

You may not have noticed it, but the regulatory ground in two of Canada’s largest provinces has shifted, and the stage is being set for ever-faster innovation in the Canadian insurtech space. In fact, in conversations with Guy Fraker, chief innovation officer at California-based Insurance Thought Leadership and emcee for the InsurTech North Conference in Gatineau in October, he advises that Canada is being looked at as a regulatory innovation hub by the global insurtech community.

Even under the old FSCO regime, Canada’s largest insurer, Intact, pulled off what might be a master stroke in July 2016 when it issued a fleet policy to Uber, providing coverage to tens of thousands of Uber drivers when engaged in Uber activities. So, in one fell swoop, a single insurer swept up tens of thousands of drivers. Intact pulled another coup by partnering with Turo in Canada. Turo is a peer-to-peer car-sharing marketplace that is busy disrupting the sleepy and sloppy car rental industry. This again gives Intact access to thousands of drivers with the stroke of a pen. Further, Intact may be able to leverage the access it has to those drivers to provide full auto coverage and even residential coverages. When these risks are gone, they’re lost to the rest of the market. Striking deals with the likes of Uber and Turo changes the game. In the U.S., Turo partners with Liberty Mutual, and with Allianz in Germany. Uber partners with Allstate, Farmers, James River and Progressive in the U.S. Aviva has pulled off a similar deal in Canada with Uber’s nemesis, Lyft.

Further afield, B3i, the industry blockchain initiative has been established with the support of 15 large insurers/reinsurers. It is just starting up, but its mission is to remove friction from insurer/reinsurer transactions and risk transfer. When friction goes, so will costs. It is starting out slowly, but things may change suddenly – reshaping whole segments of the market. In addition to the original 15, the initiative has been joined by 23 industry testers.

In the U.S., The Institutes (the educational body behind the CPCU designation) launched a similar blockchain consortium called RiskBlock, which currently counts 18 members:

  • American Agricultural Insurance
  • American Family Insurance
  • Chubb
  • Erie Insurance
  • Farmers Insurance
  • The Hanover Insurance Group
  • Horace Mann Educators
  • Liberty Mutual Insurance
  • Marsh
  • Munich Reinsurance America
  • Nationwide Insurance
  • Ohio Mutual Insurance Group
  • Penn National Insurance
  • RCM&D
  • RenaissanceRe
  • State Automobile Mutual Insurance
  • United Educators
  • USAA

There is talk of establishing a Canadian insurance blockchain consortium, as well. You can hear from leaders of B3i, RiskBlock and parties involved in the Canadian initiative at the NICC in October.

Even further afield, if one was to look for an industry that makes the insurance sector look futuristic, one need not look further than the global supply chain shipping industry, with antiquated bills of lading, layers of intermediation and massive administrative overheads. Well, that industry is getting a serious wakeup call thanks to determination and drive of the world’s largest shipping company, Maersk. The company is taking its industry by the scruff of the neck and pulling it into the future whether it likes it or not – long-standing tradition, relationships and methods notwithstanding.

First, in March 2017, Maersk teamed up with IBM to utilize blockchain technology for cross-border supply chain management. Using blockchain to work with a network of shippers, freight forwarders, ocean carriers, ports and customs authorities, the intent is to digitize (read automate/disintermediate) global trade.

More recently (May 28, 2018) and closer to home, Maersk announced that it has deployed the first blockchain platform for marine insurance called insurwave in a joint venture between Guardtime, a software security provider, and EY. The platform is being used by Willis Towers Watson, MS Amlin and XL Catlin (got your attention?). Microsoft Azure is providing the blockchain technology using ACORD standards. Inefficiencies, beware! Microsoft and Guardtime intend to extend insurwave to the global logistics, marine cargo, energy and aviation sectors.

See also: How Insurance and Blockchain Fit  

Insurers that find themselves locked out of these types of large-scale initiatives will be left out in the cold.

We’re witnessing “SUDDENLY,” and we’d better get used to it.

Global Trend Map No. 14: Regulation

Following on from last week’s post on investment management, today we tackle that omnipresent question for carriers old and new: regulation. Regulation affects absolutely every part of the insurance business, from how customer data is held and used to how insurers reinsure themselves and invest the premiums they gather.

The time and money cost of complying with regulation is often significant, with recent estimates suggesting that 10% to 15% of the total workforce in financial organizations is currently dedicated to governance, risk management and regulatory compliance. The opportunity for greater efficiency here is so large that a whole new tech-powered industry – regtech – has sprung up around it. And, with demand for regulatory, compliance and governance software expected to reach a massive $120 billion by 2020, this is a space to watch.

The following stats and perspectives are taken from our Global Trend Map; a full breakdown of our survey respondents, and details of our methodology, are included as part of the full report, which you can download for free at any time.

See also: New Regulations for Disability Claims  

Assessing the Impact of Regulation

Regulation is a serious issue not just for (re)insurers but for the insurance ecosystem more generally. Out of all our survey respondents (unfiltered), 20% indicated that regulation had impeded progress “a lot.” As we see from our our burden chart below, the impact is evenly spread across different ecosystem players.

Here, 24% of brokers and agents state that regulation has impeded progress “a lot” within their organization, along with 17% of technology partners and 22% of insurers. The trend is the same when we use a weighted score (one point for “a little,” two points for “somewhat” and three points for “a lot”), giving us an overall “burden score” of:

  • 186 for brokers/agents
  • 159 for technology partners
  • 175 for insurers

While regulation is a concern for insurance companies across the whole globe, it manifests itself differently in different regions. Our stats suggest that regulatory burden is above trend in Europe and below trend in Asia-Pacific (in terms of respondents answering that regulation is impeding progress “a lot”). Regulatory compliance certainly remains a daily issue in APAC but may, for structural reasons, be easier to deal with there on a big picture level.

In Asia-Pacific, industry participants have the advantage of dealing, in the main, with large national markets (bigger than any U.S. state, for instance) but without the complexities of an overarching regional regulator (like we find in Europe with the E.U. and Solvency II). That said, carriers wishing to be active across the region still have a multitude of different regimes to comply with.

Additionally, we asked survey respondents to indicate, via an open-text response, which regulations were currently the greatest cause for concern. There were too many responses to list everything, but some that stood out were Solvency II and the Insurance Distribution Directive (IDD) from respondents in Europe, and the DOL fiduciary rule from respondents in North America.

“Currently the focus is on protecting personally identifiable information, personal health information and personal credit information. Regulations in the future may evolve, requiring companies to ensure that they are using information in a fair and just fashion. For example, much can be inferred from the data from an individual’s smartphone, but it may not be fair and just to act on those inferences.” — Cindy Forbes, EVP and chief analytics officer, Manulife Financial

Regulatory Burden: A Growing Challenge

There is a marked trend toward rising regulatory burden, and we found this to be consistent across our different ecosystem players and regions.

89% of insurers and reinsurers believed regulation was posing a greater challenge to their organizations than during the previous 12 months.

“Increased regulation” was one of the external challenges we explored in our industry challenges section, coming in sixth place out of 12 (based on all respondents). Drilling down into different carrier departments reveals that its impact is not evenly distributed across the business: “Increased regulation” was among the top three external challenges for carrier staff working in actuarial, analytics, capital management (where it took the top slot), investment, risk, senior leadership, strategy and treasury.

The overall balance of these departments suggests the greatest burden from increased regulation within (re)insurers is falling on the investment and risk-modeling side of the business. Europe has certainly been a case in point over the past couple of years, with Solvency II subjecting carriers to more rigorous capital requirements.

See also: Aggressive Regulation on Data Breaches  

Regulation’s growing prominence in the eyes of high-echelon staff (senior leadership) indicates just how seriously it is viewed within the ecosystem. This, along with the other measures we have presented in this section, creates a perfect storm for the rise of regtech over the coming months and years.

Why Not to Buy a Startup

The startups are the talk of the town today. Fintech, insurtech, retailtech, regtech, autotech, edtech are the new vocabulary for enterprises. Innovation is on the priority list of most executives globally. Many are getting worried about the risks, disruption and impact of startups.

With more than $80 billion of investment funding already injected into the startup ecosystem in the last three years, it would be foolish for companies to overlook startups. There are more than 4,000 startups globally active at the moment across various categories that are challenging incumbents across industries.

A good number of companies across financial services, insurance, retail, travel and healthcare segments are already exploring partnership with startups. But many executives are confused about how to deal with startups.

Buying a startup not the right answer for innovation

There are still questions on how effectively companies can leverage and integrate startups into their ecosystem. A few companies are exploring selective startups for purchase while many others are keeping their options open.

While buying a startup may sound like a good move, it does not guarantee success. Companies can buy a startup — but not the innovation.

Companies must innovate internally first. While startups can help to bridge the innovation gaps to some extent, they cannot solve the basic innovation challenges. There is a need to build innovation culture.

See also: Startups Take a Seat at the Table  

Many large organizations today struggle with innovation. If a startup coming from nowhere can innovate, drives passion within teams and delivers incredible value, what is stopping the large companies to excel?

The problem is with the traditional, tactical approaches. Many executives, used to stringent financial measurements, measure innovation with a similar yardstick. The results are obvious. When innovation initiatives fail to deliver quick results, executives back away.

It is time for executives to revisit their approach on innovation.

Get the basics right before fixing the organization

Innovation demands commitment, agility, perseverance, collaborative culture, hard work and passionate teams. Innovation is mostly achieved as a result of failures and continuous learnings. There is no company in the world that has delivered disruptive innovation without witnessing failure. 90% startups fail, proving that innovation is not easy.

Today’s dilemma is that executives hate failure. The quarter-on-quarter pressure, macro-economic conditions and competitiveness in business hinders them from committing 100% to innovation. Organizational complexities, silos, bureaucracy and rigid culture add more pain in delivering innovation.

Startups are no longer a bubble, but an ongoing challengers

Many see the growth of startups as a bubble that may bust soon. But startups are not going away, so companies must exercise caution and develop a symbiotic relationship with startup ecosystems.

The best strategy is to partner for co-existence. While many startups operate on the periphery of business, they will move into the core part of business across industries. We are already seeing many examples in banking and insurance, where startups are getting licenses to manage end-to-end business. London-based startup Monzo, Berlin-based Number26 (N26), Atom and Tandem in the U.K. and Klarna in Sweden signal the backing of banking regulators for startups globally. Similarly, Lemonade in New York, Oscar in New York, Zhong An in China and Acko in India are examples of insurtech startups licensed for business.

Soon, companies will find startups snatching portion of their business. The only way to respond is to become a startup. Companies must start thinking like startups and act and deliver value like startups.

Without building an innovation culture, this is not going to happen.

Innovate or pay the price: Choice is yours

Startups will continue to be a challenge for companies of all sizes. Companies must innovate continuously and develop tailored strategies to manage the growing influence of startups. While partnership with startups or even a purchase of a startup can fast-track innovation efforts, these are not sufficient to transform a company or ignite its culture.

Companies must simplify complexities and structure and invest in people to develop an innovation-centric culture.

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

Innovation is not a commodity that can be purchased using financial muscle. Innovation will never be up for sale and cannot be purchased or mimicked. It has to be built from the ground up.