Tag Archives: reinsurer

Headwinds Facing the ILS Market

Hurricane Andrew’s devastation and lasting financial impact created a need for an alternate means to access capital and transfer risk. Enter the Bermuda market, and, on its heels, the insurance-linked securities (ILS) market.

The latter has been growing steadily ever since the mid-1990s. Fast forward. and some traditional reinsurers now offer ILS fund management. Other reinsurers have purchased prominent ILS fund managers, as was most evident with the well-publicized Nephila acquisition by global re/insurance giant Markel. This recent mainstreaming had brought about all sorts of acknowledgment.

However, while everyone was patting each other on the back, various catastrophes were occurring on a global scale. From earthquakes, floods and typhoons in Asia to hurricanes and fires in North America, the industry incurred increasing losses in 2018. Coupled with the 2017 loss creep, these losses have affected several ILS vehicles, and investors/fund managers are rethinking their respective capital allocation strategies in the coming renewal season.

ILS plays an important role in providing efficient capital to insurers and reinsurers (through retrocession) that sponsor the deals, but it is not without risk. Recent developments in the marketplace have the collateralized funds space facing headwinds. For these important investment vehicles to continue as beneficial components of ceded reinsurance programs or investor portfolios, some things need to change.

Perhaps the greatest contribution from ILS has been its ability to smooth pricing volatility in the regular reinsurance underwriting cycle. Every time there has been a large storm, or series of storms, reinsurers respond by raising prices in a phenomenon known as “payback.” This cycle went on for many years until the recent ILS “coming of age.” With an abundance of capital, reinsurers are pressured to keep their rates down to compete for shares of a given deal. Reinsurers are also able to take advantage of this downward pressure in pricing with their own reinsurance known as retrocession.

Along with helping insurers/reinsurers access capital for additional capacity, ILS are a means for institutional investors to diversify their portfolios to non-correlated risk. What this means is that rather than their funds being tied to financial markets, where they’re subject to things like credit risk, the funds are tied to triggers from catastrophic natural disaster events. In addition to this diversification, the returns also make ILS an attractive investment to the sophisticated institutional investor. In the absence of considerable aggregate loss totals, these transactions are a “win win” for all parties involved.

Followers of reinsurance industry news in 2018 know there’s no shortage of praise directed toward the ILS space. But a shift in attitudes occurred very recently, months or even weeks ago.

The industry was so impressed with the resilience of the ILS market following the 2017 HIM losses (Harvey, Irma and Maria) and the “reload” of capital that followed. However, this “reload” of capital occurred prior to realizing the additional effects of the 2017 loss creep from the HIM storms. Loss creep occurs when the final loss amounts from an event aren’t known and the reserves must be increased due to changes in projections.

Along with the 2017 loss creep, 2018 shaped up to be another year of catastrophic losses. The California wildfires, Typhoons Jebi and Trami in Japan and Hurricanes Florence and Michael in the southeastern U.S. all added to the problem seen in collateralized reinsurance deals.

In a collateralized reinsurance transaction, collateral is put up by investors to cover the full limit of the reinsurance contract. As a result of the catastrophes piling up, much of the collateral on the deals has become “trapped.” While the final loss number is being determined, the trapped funds cannot be moved or re-allocated into new deals. We’re seeing that this has led to some fund managers having difficulty renewing core components of their portfolios. This could lead to reinsurers being more aggressive to take back their market share with traditional capital. Perhaps this is just a short-term correction, but one thing is for sure: The trapped collateral issue needs to be solved sooner rather than later.

See also: Fixing the Economics of Securities Defense

These recent changes in the ILS marketplace have only affected a few funds and strategies. According to market intelligence sources, most are renewing as planned. However, the changes highlight the potential for disaster down the road if nothing is done to correct these issues.

In my mind, there is an excellent opportunity for sponsoring insurers and reinsurers to collaborate with the investor base and fund managers. Collaboration could lead to outcomes that better provide sponsoring organizations with the efficient capital/collateral that they’ve come to rely on while simultaneously providing investors with greater flexibility in the deployment of their capital. Insurers, reinsurers and institutional investors have demonstrated their needs for ILS, and it’s up to all parties involved to continually improve the space.

Insurance-linked securities are the present and future of risk transfer, but recently their vulnerabilities are being exposed. The negative effects of trapped collateral threaten to disrupt more funds if enough capital is tied up.

Thankfully, ILS experts are reportedly working diligently to solve this problem. ILS provides sponsoring insurers and reinsurers an efficient source of capital while providing diversification for institutional investors. I’m inclined to believe that, for these reasons, ILS arrangements are here to stay in some way, shape or form.

Throughout this piece, I’ve put myself at the risk of oversimplifying a very complex subject. There are different types of ILS vehicles, fund strategies and investor types currently in existence. In fact, you’ll notice that I didn’t even touch on the potential impact of rising interest rates; that’s a discussion for another time. My hope is that these thoughts will provide additional dialogue on the headwinds facing the ILS space. These difficult times are a test and an opportunity for improvement that could lead to a more efficient, capital-rich market.

Who Will Win: Startups or Carriers?

Who will win: carriers or startups? It’s a question that has dominated conference panels, opinion pieces and many of the conversations I’ve had with insurance industry friends and colleagues throughout 2018. On the surface, this question feels appropriate. For many consumer-facing insurtech startups, their valuation is rooted in the promise of capturing market share from large carriers. While this has led to a major boom in the number of direct-to-consumer (DTC) insurtechs, in reality, 2018 hasn’t yielded any new startups that are able to make a significant dent in the collective portfolios of the large insurers (Lemonade aside). As many carriers are awaiting the fruits of their multiyear organizational transformation programs, the lack of inroads may prompt a sigh of relief. If the trends we have seen this year continue, perhaps there will be enough time for the product innovation to spring from within the old guard, keeping the industry pecking order intact.

Not so fast.

Reframing the Debate

Before breathing their sigh of relief, carriers might start asking themselves another question: If not carriers, then whom? As far as innovation goes, we continue to see resistance across the large carriers to properly invest in a “test and learn” approach for their internal product development teams. At the end of the day, standing up a new product that would generate only $10 million in additional annual premiums just doesn’t get the runway it would for a startup. Instead, we’re seeing the rise of venture groups, innovation labs and incubators (Metlife Techstars, NYLV, SOMPO Digital Labs, etc.) that are to innovate, then potentially bringing the work in-house.

Adrian Jones, who leads investment and reinsurance terms to insurtech startups for SCOR, recently wrote about changing market conditions for reinsurers and their increased exposure to getting “disrupted.” Jones outlines how simpler and leaner startups have eaten away at the markets with the highest profit margins for reinsurers. This has the potential to become one of the most significant factors affecting the consumer space in 2019. Given their new financial exposure, reinsurers will be highly motivated (in a way that carriers currently are not) to adapt and discover new ways to increase their returns. This very well could be the fuel needed to truly ignite the customer experience (CX) advancements the industry has been promising. For a reinsurer, $10 million in annual premium from a startup is not only $10 million. It’s a path to diversify their risk portfolio and, more importantly, to develop an acquisition channel that can yield much higher margins than the current carrier model.

See also: Insurtech: Revolution, Evolution or Hype?

In the larger conversation, reinsurers are generally seen as key observers in the carrier vs. insurtech showdown, not major players. But given their advanced underwriting capabilities, global footprints, lack of direct customer acquisition workforce and substantially less technical debt compared with their carrier siblings, with the right set of partners reinsurers can provide the scale and expertise the new players typically lack. This enables startups to focus on their differentiators: seamless customer experiences and innovative acquisition strategies.

You may or may not be surprised to learn that this trend isn’t new. Many insurtech “darlings” are already taking advantage of this partnership model. Jetty is backed by Munich Re, Root Insurance by Odyssey Re and Ladder Life by Hannover Re. Noteworthy is what these startups can offer consumers outside of the coverage itself. Jetty offers financial resiliency for renters. Root has an IoT-powered auto insurance underwriting model based on mobile data. Ladder Life has significantly trimmed their underwriting questions for term life. Yes, there may be flaws in each value-add example, but that is beside the point. These startups are able to experiment with modified underwriting parameters, and, once they fine tune these products for the masses, the major carriers will pay heavily either by losing market share or by acquiring the startups.

In a recent conversation with an executive from one of the largest P&C insurance companies, the executive told me that he sees reinsurers like Munich Re as very strategic partners, yet an ever-growing risk because, in his words, Munich Re could “start cutting us out.” The threat is real.

What Should Carriers Do?

For starters, carriers need to identify how to enable a top-notch customer experience (CX). In 2018, there has been plenty of talk about improving customer journeys, but few incumbents have released anything remarkable. The time is now for mid-sized insurers and MGAs. There is no reason not to take a cue from the reinsurer playbook. Whether it’s backing an insurtech, creating a direct-to-consumer channel (like our friends at ProSight) or forming platform integration partnerships (as AP Intego is doing), there are opportunities to jump into the fray because the space is perfectly fragmented. Identifying a similarly positioned insurtech is a promising strategy for carriers with a wealth of data in niche markets. But working with an insurtech or building a DTC offering requires underwriting customization and collaboration. If that’s not something a carrier excels at, determining how to leverage existing technology or marketing capabilities is critical. For those with a technology strength, parametric insurance, such as Jumpstart and Floodmapp, may be a better fit. It’s an emerging market I especially have an affinity for.

See also: How to Partner With Insurtechs  

Regardless, it’s important that carriers develop a set of hypotheses on what will make them successful in whatever their new venture may be. At Cake & Arrow, we heavily rely on design thinking and qualitative research as a low-cost approach to validate strategies. Overall, being nimble, cross-functional and exceptionally tactical will be critical to success, which is why I consider large-scale organizational transformations not applicable here.

If all else fails, get the pocketbooks ready, because we will see no shortage of bidding wars in the coming year.

This article originally ran at Cake & Arrow

What Is Really Disrupting Insurance?

In a recent SMA blog, Karen Furtado, SMA partner, posed this question: “Have you ever found yourself hearing a word so frequently that it begins to lose its meaning?” The word she was referring to was “transformation,” but I think that everyone who reads that question immediately has a specific word of their own that pops into their heads. For me, it is the word “disruption” or any iteration of it – disrupt, disruptor, disruptive, etc. In the insurtech movement, those “disruption” words surface again and again.

At SMA, we love the word “transformation.” It’s this year’s umbrella theme of the annual SMA Summit. We spend a significant amount of time with our insurer customers helping them with transformation strategies. We help our technology customers dig deep into their transformation messaging and outcomes. But disruption – well, not so much! SMA believes that it is very difficult to truly disrupt the insurance industry (even though there is a tendency among some people to throw the word about with unwarranted abandon). So, you can imagine how surprising it was that, after a long and detailed research initiative earlier this year, we actually hung the “disruptor” tag on Munich Re!

See also: How Analytics Can Disrupt Work Comp  

The goal of the research was to analyze annual reports, quarterly analyst statements, magazine articles and public presentations to gain insight into, and maybe some best practices from, the innovation and transformation journeys of some of the largest insurers – Munich Re among them. SMA’s recent research brief, Who Is Really Disrupting the Insurance Industry? And What You Can Learn from Munich Re’s Journey, reviews the findings. There are many lessons to be learned from their journey, but three things in particular resonate:

  • Munich Re did not let traditional reinsurance roles place rails around their innovation strategies and tactics. For example, they worked with a broker (Marsh) to develop a pandemic product. Neither of the participants is a traditional player in the product development process.
  • Munich Re has stayed true to its heritage and traditional competencies of risk knowledge and risk management but approached change through a new lens of innovation and brave technology exuberance. We also saw this with Chubb as it has stayed true to its deep underwriting heritage in its innovation strategies.
  • Business units are focused on specific innovation and emerging technology initiatives. They have not cordoned off these responsibilities within IT or stand-alone innovation organizations. Business is an active force, not simply a recipient of innovation outcomes.

It’s a bit surprising and even inspiring that a reinsurer is an industry disruptor. Insurers need to study innovation and transformation activities at all industry levels because the traditional (or hyped) competitors may not be the ones that are changing the industry landscape.

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

To be clear, Munich Re is not the only reinsurer that is on an innovation and transformation path. Others are, as well, most notably Swiss Re. However, early on, Munich Re noted unprecedented external forces emerging and, rather than reverting to traditional and frequently successful strategies, the company boldly placed new lenses on business challenges. And the results are – and continue to be – disruptive. (There, I said that word again!)

Healthcare Debate Misses Key Point

As Congress considers another healthcare bill, the conversation continues to be about insurance, even though a form of reinsurance could solve many of the problems we face as a nation. The money for what I call “transparent health reinsurance” is already even in the various bills that Congress has considered; the more than $100 billion that has been designated for stabilizing healthcare insurance in the individual states would simply have to be redirected.

See also: Transparent Reinsurance for Health  

Transparent health reinsurance enables more people to receive better health care at less cost. As I wrote on this site in May 2016, “Transparent reinsurance programs could emerge as significant opportunities for healthcare providers, issuers, reinsurers, technology innovators and regulators to address health insurance.”

Transparent health reinsurance, pioneered by Marketcore, creates robust technologies that enable better, patient-centered health care through predictive analytics.

“Sharing information generates participation and creates cross-network efficiencies to enhance quality, improve delivery and reduce costs,” remarks Constance Erlanger, Marketcore’s CEO. “For healthcare insurers and providers, there are two key value-adds. First, the technologies incorporate any and all specific features a state and insurers in its jurisdiction may or may not include in state healthcare markets. Second, risk lenses clarify quality, delivery, outcome and cost across the 56 states and territories for transparent health insurance and healthcare services. Such robust information symmetry could rationalize healthcare insurance, quality and delivery. Such technologies, created by Marketcore, are already in development for bankers and insurers in multiple markets for complex risk assessments to finance recoveries from large-scale natural disasters.”

Everyone experiences strategic and financial advantage

Transparent health reinsurance supports these innovations by providing incentives that tackle the “widespread lack of transparency about both the costs and the effectiveness of treatments,” as Dr. Brian Holzer calls for in a timely article.

Any state could create a high-claim reinsurance pool managed by a recognized reinsurance operative. With supervision by the Centers for Medicare and Medicaid Services (CMS) and the Department of Health and Human Services (HHS), a state insurance commission or its designee could invite qualified firms to function as a recognized reinsurer. These recognized reinsurers would work with qualified, innovative health service providers that demonstrate abilities to improve health outcomes at reduced expense.

The reinsurers would be part of a matrix solution, where some firms provide health management solutions, while others provide disease- specific solutions and others provide innovations in treatment. A state could, perhaps, elect to focus on the largest drivers of healthcare costs in its jurisdiction, such as chronically ill individuals or those with acute conditions that are difficult to predict.

Due to the technology’s granularity and clarity, a state could just as readily specify participation among all issuers for any plan being offered in its jurisdiction, including every participant in every plan or defining reinsurance participation for individuals with chronic conditions in employee-sponsored or state-managed plans.

Or, states could fund a high-claim reinsurance pool with a payment per covered life, preferably covering everyone in the state, thus lowering the per-life charge.

Pending state decision-making, employers would have the right to move employees into this pool, and would want to do so if it was clear that the innovative approaches reduced costs while improving health outcomes. Clearly, the lowest per-capita contributions would occur with the widest participation.

If a state targets the largest cost drivers, reinsurer and insurers would then work together to assign “high-claim” individuals to reinsurance pools once those individuals cross a defined expense threshold. Each individual would be assigned to one or more innovators under contract to deliver better health outcomes at reduced costs. An innovative tracking mechanism would measure and rank outcomes and savings. Crowd-sourced information would drive confidence scores.

Burgeoning digital applications managing chronic illness would yield voluminous, timely data, and blockchain technologies afford accountability.

Scoring would rank service providers and eliminate failed providers.

A state insurance commission or its designee as reinsurer could manage transparent health reinsurance as states reach management decisions with stabilization funds. A single designated entity could oversee a system that would reward innovative, successful healthcare delivery and quality. To that end, participating firms would be for proposals detailing expected improved health outcomes and costs.

The technology leverages continuing achievement. Some studies indicate 40% cost reductions for some chronic conditions. By adding transparency to these achievements, the technology scales to yield much lower overall healthcare costs, healthier populations and stabilized or lower insurer premiums.

At the end of each year, a new reinsurance pool would be formulated with adjustments based on actual experiences. If the previous pool ended up in surplus, a portion of that surplus would be retained in reserve, and any remaining amount could be returned to individuals, providers or both. If the previous pool ended up in deficit, the reinsurer could choose to fund that, with contributions in the following year meant to provide for recovery.

Several states could decide to form an umbrella reinsurance pool to cover some or all of their high-claim individuals.

All activities focus on improving health outcomes at reduced costs.

No state residents are asked to fend for themselves.

States are encouraged to develop innovative firms.

Overall health of state residents should improve, which would lead to a healthier economy.

Ultimately, state-related healthcare costs would decline.

In the process, transparent health reinsurance would animate highly profitable growth for corporations with domain strengths in mobile data, operating systems, search and social media. These firms could tap data and metadata markets by creating valuable, time-sensitive risk information and metrics. (With such robust technologies, privacy matters, and all platforms are HIPAA-compliant.)

As healthcare reform faltered in the Senate, Govs. John Kasich (R-Iowa) and John Hickenlooper (D-Colorado) called for bipartisan solutions. Technologies and tools are at hand to make those solutions possible.

“If I am for myself alone, who will be for me? If not now, when?” the prophet Hillel remarked centuries ago.

Insurance Technology Trends in ’17, Beyond

Bill Gates famously said that we always overestimate the amount of change that will occur in the next two years and underestimate the change that will occur in the next 10. Looking back 10 years, we find a world devoid of iPads, iPhones, mobile apps, big data technologies, the Internet of Things, viable driverless cars or even social media beyond a niche early adopter group. We also find a world without direct online sales of commercial insurance, without persistent low interest rates, without widespread use of catastrophe bonds and without VCs who could spell “insurance.”

But while most insurers believe that massive changes may occur in the next decade, few believe that the next two years will be substantially different from the last two when it comes to the need for significant product changes, the impact of predictive analytics or the threats of new digital distributors. Insurers devote less than one cent of each premium dollar today to transforming their technology capabilities to thrive in the next decade.

Insurers Making Technological Progress

Although technology spending is essentially flat, and less than a quarter of it is spent on transformational initiatives, on average, insurers are making progress. Use of predictive analytics is growing, and 18% of insurers believe it will have a materially positive effect on their business this year. Big data technology is expanding, as well, even though it continues to be directed not at big data sets but at solving enterprise data problems. And 10% to 20% are already embracing machine learning to improve their rating algorithms. Other AI usage is still in the potential stage, with insurers exploring the possibilities of leveraging machine vision for property underwriting and claims, and natural language processing for customer service.

Digital investments continue, even if there is still little agreement about what constitutes a “digital strategy” for insurers. Portals are enhanced, and mobile is deployed as carriers seek to better engage their customers, distributors and other stakeholders.

See also: 10 Trends at Heart of Insurtech Revolution  

Core system replacements are still painful and expensive but necessary to enhance the speed of product launches, improve digital service and data accessibility and reduce technical risk. Insurers have a new willingness to consider cloud-based core systems, with 20% already having deployed some core capabilities in a cloud environment and the same number planning pilot programs this year. The maturity of cloud providers and the growing awareness of their own limitations are mitigating carriers’ security concerns.

Security, meanwhile, continues to consume 10% of IT budgets, with no end in sight, and additional regulatory requirements add compliance pressure to certify procedures and formalize CISO roles.

A boom in analytics and digital across multiple industries is making it harder for insurers to find and retain IT talent, which is driving new strategies, from partnering with colleges and universities to develop new sources of talent to improving ease of employee return, to reacquire experienced staff.

With flat resources and burgeoning needs, 40% of insurers are improving governance to make sure resources are allocated effectively and aligned with strategy.

Laying Bare the Underlying Structure of the Insurance Industry

Meanwhile, improved technology lays bare the underlying structure of the insurance industry. It’s not only distributors standing between insureds and primary insurers that are intermediaries facing the threat of disintermediation—it’s every link in the value chain between people or organizations with risk and pools of capital willing to take on that risk for a profit. This means primaries and reinsurers, as well. Alternative distribution, distributor-developed programs, reinsurer-funded insurtech startups and catastrophe bonds and other risk derivatives all threaten the traditional insurance value chain. All of these stem from the technology-enabled democratization of the ability to analyze, package and transfer risk.

At the same time, technology offers the opportunity to ask new questions about the structure of insurance offerings. Is there any reason why minimum required coverage should be sold in all cases bundled with additional coverages, advice, service and risk management? Insurers are finding that some market segments prefer only one or two of these, while there are additional opportunities to monetize some of these offerings separately.

Many insurers are unsettled by the emergence of well-funded insurtechs, whether they are new competitors or providing enhanced capabilities to existing competitors. Despite the billions invested, insurtechs will not put major insurers out of business or radically transform the market in the next two years. Many will not even be in business in two years.

The Imperative to Learn from Insurtech

However, insurtechs will raise the bar on customer experience and process efficiency, as well as on the use of analytics to drive product and processes. They will show insurers how to expand the market by profitably serving underserved segments, and demonstrate how to incorporate emerging technology into key business processes. Insurers that do not learn from insurtech will lose out to those that do.

In part driven by the example of insurtechs, insurers are expanding their own formal innovation programs. These may take the form of a small group of educators and evangelists within the company, a dedicated R&D organization with a fully equipped lab and a protected budget or direct investing in startups.

See also: Insurtech: Unstoppable Momentum  

Two Ingredients of Successful Innovation

Whatever innovation path insurers take, the primary determinant of success is the CEO’s and business unit leaders’ commitment to operationalize innovations, and their tolerance for the risk of failure. Without these two ingredients, insurers may perform “innovation theater” but are unlikely to benefit from any discoveries, and are unlikely to be prepared when the next decade of change sneaks up on them.