Five more challenges the industry must conquer

The first part of this two-part feature covered investment returns, terrorism risk, cyber pools, a global pandemic and food system shock. Some of these challenges are well understood by the industry, others less so.

The challenges raised in this second part might perhaps be cast less as challenges and more as opportunities. One person’s glass is half full; another’s is half empty.

What they all have in common, however, is the changing nature of the risk transfer industry and the requirement for companies operating in this space to innovate and be open to new ideas and trends.

Here, in the second of a two-part series, we examine five more challenges the re/insurance industry must first grapple with and then ensure it understands.

CHALLENGE VI

Seizing the opportunity in talent

The insurance industry should make use of all the talents available to it. It hasn’t done this so far, says William Stovin, president, Markel International.

The capital markets pre-Big Bang, 30 years ago, were peopled by a mixture of white public school brokers and estuary wide-boy dealers, with hardly a woman or a person from an ethnic minority to be seen.

A similar demographic was to be seen in all the other professional and financial services businesses, such as merchant banking and law, which were then clustered in the Square Mile around the Bank of England and Mansion House.

In some of these businesses a university education, if not actually frowned upon, was by no means universally admired.

The Big Bang and the removal of exchange controls—in the 1970s Britain actually had an investment currency separate from the everyday medium of exchange—kick-started the rapid removal of the club-like characteristics of the City.

It was led by the influx of American investment banks with capital bases and scale which dwarfed those of London’s merchant banks. The American houses were integrated, so as well as providing corporate finance advice to companies, they traded equities and bonds on behalf of clients and on their own account.

By the 1970s, London’s stockbroking houses had started to generate good quality equity and bond research, based on intellectually respectable financial principles, but the arrival of the American banks, and the efforts of UK houses to replicate them in scale and approach, rapidly accelerated the professionalism with which they operated.

When a bank’s balance sheet and so the wealth of its partners or shareholders was on the line, management wanted trading decisions to be based on a bit more than “I think the price is about right, old boy”. So they hired the best, brightest, hardest working, most aggressive people they could find to help make those decisions correctly. Those people came from everywhere in the world and from all sorts of academic backgrounds.

If today you look round one of the giant investment banking offices in Canary Wharf, you’ll come across senior members of staff from every continent, educated to Master’s and doctorate level in subjects from maths, physics and chemistry to languages, history and English literature.

This doesn’t mean that all the banks got everything right—we know they didn’t—but this was more to do with boards’ decisions to rapidly accelerate balance sheet growth with sub-prime assets and the failings of regulatory oversight than with the capabilities of their people, who were successful and innovative in the ways they grew the businesses and the products they offered.

Equal Opportunities

Increasingly, the jobs of choice for the gifted graduate are internet-based businesses including those clustered at Old Street roundabout, about a quarter of a mile away from the centre of the City. These businesses care only that the people they recruit are academically and commercially outstanding. They are truly equal opportunity employers.

While the demographic in the London insurance market has moved on since the 1970s, it doesn’t feel as though it’s made progress as rapidly as some other parts of the now expanded Square Mile.

That’s odd, because the roles in specialty insurance share many characteristics with those in other financial services businesses.

The risk modelling, pricing and data analysis handled by our actuaries is as intellectually acute and testing as the financial modelling managed by financial analysts in stockbroking, M&A banking and private equity.

The client relationship management skills and professional global contact networks of our brokers match those of M&A deal-generating investment bankers. At the same time, the transaction skills of our brokers and underwriters match those of banking dealmakers and our appetite for risk and managing it looks very much like that of equity and bond traders.

Going into the Room at Lloyd’s today, however, still feels very 1980s, in its 1980s building. There have been women in the Room since 1973, but it’s still a distinctly white, male environment.

That doesn’t mean there’s been no progress and, away from the coal face, in the boardrooms and management offices, the insurance industry is better qualified and more business-like than it was 30 years ago.

But the whole industry now has an opportunity which it should firmly grasp.

After the sub prime-driven global crash of 2008 and waning interest amongst the best graduates leaving universities and business schools in the UK and elsewhere for careers in the formerly gilded cage of investment banking, the insurance industry has the opportunity to capture this talent for itself.

That's something it must do, so that it has the strategic, management and operational skills it needs as it works through the inevitable development trend of consolidation and globalisation and deals with the increased competitive pressures that will invariably follow.

CHALLENGE VII

Big data, telematics and motor insurance

Data from in-built car sensors and systems will be part of a new generation of real-time motor insurance in the future, and the industry needs to keep up to speed with developments, says Ludger Arnoldussen, member of Munich Re’s board of management.

Innovation is particularly important when developing new areas of business. The world is full of risks, and it is up to us—as insurance industry partners—to make these insurable and generate additional demand for risk solutions.

In the past all the data has been organised in well-defined databases, easy to understand and handle. This will change swiftly: points of contact between insurers, clients and potential new customers have grown exponentially, and we now have an increasingly complex web of data streams, some of great interest to insurers capable of exploiting such ‘big data’.

This new buzzword stands for the totality of structured and unstructured data (social media, photographs, surveys and other data) that are analysed to provide a more detailed understanding of the behaviour patterns of an existing client, to locate new clients or develop new products.

There are 264 million vehicles in China (154.5 million civil vehicles), but only 56 percent of them are insured; 68 percent of new vehicle owners buy insurance (year 2014). Motor insurance represents 73 percent of the whole non-life insurance market (year 2014)

Insurance companies with a strong motor portfolio will have to keep up with the developments surrounding the car industry. New mobility concepts are emerging almost daily. The introduction of hybrid and electric vehicles did not lead to significant product changes when it comes to motor insurance. But the development of driverless cars will have significant impacts, for example on owners’ and drivers’ third party liabilities.

Product liability

Beyond that, car original equipment manufacturers (OEMs) also have to seek sufficient protection for their products from a product liability perspective. Especially as vehicles and mobility services become more interconnected with each other, this can lead to dependencies and unmanageable chain reactions.

Cyber attacks on driverless cars might be just one scenario we have to consider in the future. Insurance companies have traditionally collected information about their customers and risks at the point of sale through the use of a set policy form (often filled out by an agent) and, at the time of a claim, changes of vehicle, address, or even name would also be recorded when needed. There are other predictable variables, like driver age, number of renewals, or claims-free years. Some companies would also include credit score or other external indicators.

While standalone telematics insurance solutions have existed in various markets for a while, data from in-built car sensors and systems will in the future be part of a new generation of real-time motor insurance. Today, emergency rescue services will be informed automatically of the location and severity in the event of an accident. In future, health insurance companies would be notified, first estimations on damaged car parts can be transmitted to insurance companies and repair shops in real time while new black-box generations will allow loss adjusters to better understand the circumstances of the accident.

The insurance industry needs to innovate in order to remain relevant and be able to cover new and emerging risks. It is crucial that we constantly discuss ideas and innovations, examine emerging risks, study new markets, consider the changes due to digitisation, and develop alternative and innovative solutions with and for our clients.

Innovation in insurance, in fact, revolves heavilt around trying to change established practics and products in this digital era.

CHALLENGE VIII

Developing 'cyber resilence'

Dealing with the threat of cyber attack is not just an IT issue, it’s an issue of how cyber is being managed holistically within the sector, from governance to culture, people to process, and technology to third-party partnerships. Daljitt Barn, cyber director at PwC reports.

The global insurance market works on the principles of confidence and trust. An erosion of that principle in the market could lead to a fall in GDP and have a domino effect across other financial services. As cyber threats have increased and become more sophisticated, market regulators, governments and supervisory boards within the sector have encouraged boards and non-executive directors to distil down the cultural changes needed to tackle cyber risk. This is working in organisations where a bottom-up approach is also occurring—either through formal controls-based assessments, or the application of cyber security frameworks such as the one produced by the US National Institute of Standards and Technology (NIST) to tease out overall capability versus maturity.

Making those investments can be difficult when cyber risk is constantly changing. It can also be multi-dimensional in some global insurers—it’s an operational risk and an underwriting risk. With a relatively soft market, it’s no surprise that insurers are looking to speciality lines such as cyber insurance. When considered under the ‘risk versus reward’ paradigm insurers are underwriting cyber insurance because there’s potentially huge financial rewards, but conversely that data is now more interesting to threat actors and also a concern to the market regulator if the risk of accumulation to the cyber book is not understood. Having the right people with the right skills is more important than ever

The threat to the insurance industry as a whole (life and reinsurance) is now so alarming that the Prudential Regulation Authority (PRA) has issued a questionnaire to the global insurance market on cyber resilience. Our understanding of this activity is for the PRA to understand the systemic operational risk in the sector, and to gain confidence in the capability an insurer has to respond to and recover from a cyber attack.

This is not just an IT issue, it’s an issue of how cyber is being managed holistically within the sector, from governance to culture, people to process, and technology to third-party partnerships. Most chief risk officers and chief information security officers in the sector work together to tackle this wider problem, but it’s the overall reporting to the board that needs to be better defined so that the appropriate investment is made.

Using big data

The sector is evolving and looking to connect with its existing and new customers through digital channels and to use big data to drive operational efficiency and knowledge-based underwriting. Innovation in this sector will provide increasingly rich, valuable and personal datasets for the industry to mine, but this also makes them a more attractive target. Protecting that data is therefore paramount, especially life data where the rich dataset can be very valuable not just to hackers with mere bravado motives, but to criminal espionage and financial motives.

In the breach at Anthem, the US’s second largest health insurer, criminals accessed the personal details and Social Security numbers of more than 80 million people. This data wasn’t encrypted, but even if it had been, the process and technical controls around the key management and privileged access had to be bullet-proof as well to delay/deter any focused attack.

With an expanding supply chain and an evolving market, pressure is still being applied to make operational cost-savings and increase profits. This is all happening with the backdrop of increasing cyber risks, so an ability to remain 'cyber-resilient' is what the investors, regulators, and more importantly the customers are all relying on. "

CHALLENGE IX

Leveraging satellite data

In tandem with earth-bound technologies, the ability of satellites has come on leaps and bounds in recent years, something that could be of great use to re/insurers if they know how best to leverage the technology, says Ray Purdy, founder and director of Air and Space Evidence, a start-up company specialising in this field.

The sooner these technologies are integrated into the mainstream of the insurance industry the sooner they will expose large fraudulent claims. What is more, early adopters will benefit more as cases attract international media exposure.

That is the view of Ray Purdy, founder and director of Air and Space Evidence, a start-up company formed with the aim of moving satellite imagery away from the world of intelligence and monitoring by governments and into the world of commerce.

The technology being pioneered by Air and Space Evidence has been named by Fast Company Magazine as one of 12 ideas of 2015 that will change the world. Purdy says since the company was formed, it has already been contacted by a range of bodies from the police to fraud investigators to insurance companies all over the world seeking evidence and satellite imagery for a variety of reasons.

Purdy identifies four initial areas in which the technology could be of use to insurers.

The first is in instances of overstated claims. “Satellite imagery might be able to help if there is a genuine loss but this is overstated,” he explains. “One example could be using images to check the volume of goods destroyed in an outside storage area. We would do this by using historical imagery to see what was there beforehand.”

Other examples of this type of usage include assessing the extent of damage to crops, overstating the size, condition and thus true value of a fire-damaged property, and inflated business interruption claims.

The second application would be in instances of fraud. “Homeowners might deliberately create storm damage to their home to get more of a settlement,” Purdy suggests. He notes that satellite images revealed that in some claims post-Hurricane Katrina the damage to the property occurred after the hurricane and it was a fraudulent claim.

The third application could be around theft. Satellite images can be used to establish exactly when an item—provided it is large enough—was removed from its original location.

The technology can be used to verify specific conditions in the insurance contract, he says, such as the presence of well-maintained firebreaks, for example, which is a condition included in many European and US forest fire insurance policies. Satellites might offer insurance companies the possibility to verify whether and how well firebreaks were maintained before the outbreak of a forest fire.

Finally, he notes, the technology can be used to save money in terms of checking some types of claims.

“As satellite and drone technologies fall in price they might be used in some circumstances independently of a loss adjuster,” he says. “For example, if a house burns down, it is potentially possible to collect imagery showing this rather than sending a loss adjuster to the premises, and this could then be sent electronically to the insurance company direct to evaluate.”

Purdy stresses that this type of technology has many advantages over free or cheaper versions such as Google Earth. “There are fundamental flaws in terms of using free databases in a legal or investigatory context,” he says. “First, you only have a choice of a few images. If we search archives we might find hundreds of images of a particular site.

“Second, and more important, the data has limited traceability. A person adducing it as evidence might not be able to substantiate the information or even check the date the image was taken.”

Purdy says there are many applications of this type of data and the insurance should embrace its potential to understand the instances where it is of real value.

“The attractiveness of using satellite data will depend very much of the circumstances of each case,” he says. “It is not going to be used in low value claims, as the cost of the satellite and expert report is going to be prohibitive compared to paying out a small claim.

However, in cases involving serious money, then satellite data could mean the difference bwtween exposing a fraud or inflated claim or having to pay out a large sum to the claimant."

CHALLENGE X

The next decade of disasters

While new risks will continue to preoccupy the industry, the world’s traditional threats of natural catastrophes should not be forgotten, especially in the context of growing populations and increased urbanisation, as Robert Muir-Wood, chief research officer at RMS explains.

To forecast the shape of natural disaster losses over the next decade, we can follow three kinds of trends. The first of these concerns trends in where catastrophes will have the greatest impact. Second are trends in how the catastrophes themselves may be changing. Third, we should challenge our perspective on catastrophes to resist the ‘availability bias’, significantly overweighting recent experience and forgetting all those disaster classes we have not witnessed for a long time.

For disaster risk, the most powerful forces of our age are those of urbanisation, and the rapid expansion of economies in Asia. Today, almost 55 percent of people worldwide live in urban areas. A measure of the growing influence of Asia is to look at how disaster losses have shifted through time. Before 2000, the highest numbers of fatalities caused by earthquake, cyclone and river flooding disasters were all in Asia, whereas records for the largest insurance losses associated with these perils were mostly in and around North America. Since 2000, of the four principal perils (earthquake tsunami, cyclone and flood) three out of the four record insurance losses have been in Asia.

Water is the new wind

In terms of the catastrophes themselves RMS sees the increased influence of water. Rising sea levels and warmer sea surface temperatures are raising the proportion of cyclone loss that comes from flood, whether from higher storm surges or more intense rainfall. Cyclones of the future will be more like 2012 Superstorm Sandy and less like a pure wind event such as Andrew. The 2011 floods in Thailand remain highly instructive to the insurance industry. A series of vast industrial parks had been established on undeveloped flood plains, to which some of the highest value manufacturing facilities were enticed. Flood insurance coverage was made very widespread even in the absence of any developed culture of loss control after a catastrophe. Then this hot spot of risk was not made explicit in how the business was transacted through international markets.

Flood losses are much more concentrated than wind losses, in ports and coastal refineries, beachfront housing and hotels. Insurers now need to employ high resolution storm surge and inland flood models and detailed address level geocoding to have a comprehensive and more accurate view of the risk.

In the US, flood risk from storm surge will rise dramatically in the years to come. RMS has studied six of the riskiest coastal cities in the US to evaluate how losses from storm surge are expected to change from the present day until 2100. The top three cities in terms of their expected 100-year economic loss are Miami, New York, and Tampa.

Earthquakes and tsunami

The largest earthquakes of all—‘giant’ Moment Magnitude 9 earthquakes—occur on average around five times each century. As happened with the 2004 Indian Ocean earthquake and the 2011 Japan earthquakes these are accompanied by mega-tsunamis with the potential to cause damage to coastal populations and property over a wide region. That gives a 50 percent chance there will be another giant earthquake and accompanying mega-tsunami over the next decade, most probably on a subduction zone where there has been no such earthquake for hundreds of years, such as the eastern Mediterranean or the Manila Arc to the west of Luzon island, devastating southern Taiwan and the whole of the coastline around the South China sea.

More likely there will be one or more major earthquakes hitting a city. One in 14 big cities worldwide are close to a plate boundary. Another 11 percent are situated in the general region of the plate boundaries. In San Francisco, Los Angeles and Tokyo, the population has increased by half again in the last 40 years. In Karachi, Manila, Bogota, Lima and Tehran the population is now three to four times what it was in 1970. In Dhaka, the capital of Bangladesh, the population has increased 10 times.

Another class of catastrophe to watch for, in particular because we have gone a long time without seeing one, is a major volcanic eruption close to a large concentration of population.