The End of Insurance as We Know It

by Rob Galbraith

  I STILL CAN’T FIND WHAT I’M LOOKING FOR

  The accelerating pace of technological change in today’s society is rapidly creating new exposures that could benefit from and require insurance solutions. The rise of ride sharing and subsequent response of the P&C insurance industry nicely illustrates some of the challenge that lies ahead. Anthony O’Donnell from the Insurance Innovation Reporter nicely summarizes this point in 2015 in his write-up of a discussion with Jeff Goldberg of Novartica (emphasis is mine):

  “The TNC Insurance Compromise Model Bill represents a successful reaction by the insurance industry to an emerging coverage problem, but it should serve as a warning for insurers to become more proactive about addressing emerging product opportunities created by technology-driven disruption," suggests Jeff Goldberg, VP of Research and Consulting at Novarica (Boston). "The tendency has been for insurers to adapt existing products to emerging market segments, but the industry will need to take a more of a micro-segmentation approach," Goldberg comments. "What an Uber driver needs is similar to existing commercial fleet product, but insurers will increasingly need to create products with specific businesses in mind…” [70]

  This quote brings up significant questions: What is the current capacity of the P&C industry to quickly respond to emerging needs? Is the P&C industry up to the challenge of meeting society’s evolving needs as the pace of technological change speeds up? Or are new market entrants (startups) required to fill the gaps that emerge with new technologies and societal changes?

  The remainder of this book will wrestle with these fundamental questions. As demonstrated repeatedly in the previous chapters, while the P&C insurance industry has a remarkable track record of success and longevity, it is also evident that all of society’s needs are not fully being met - far from it. Insurance coverage is too expensive, too confusing, too susceptible to fraud, a cash drain, doesn’t cover all perils and doesn’t cover all exposures fully. Despite these problems, perhaps the biggest failure of the industry is that many people cannot get coverage at all.

  THE SKY’S NOT THE LIMIT

  Like many professionals in the P&C industry, I did not start out with the intent of working in insurance my entire career: rather, I fell into it. I majored in economics and worked in finance for a few years before moving to insurance. Even after working in the P&C space for a few years, I seriously contemplated a move back into banking. Over time, I came to realize that insurance was a far more interesting, challenging and personally rewarding industry to work in. My choice was cemented by a casual hallway conversation one day with a colleague. I started by telling him about my meandering path to the insurance industry, and he sincerely responded that he had always dreamed of working in the industry. When I asked him how he knew that at such a young age, he spoke movingly about a devastating monsoon rain event that occurred in his hometown growing up in India. Many families and businesses were wiped out with no insurance or other financial resources to rely upon to help them rebuild. It was a stark lesson in the value that P&C insurance provides to millions in their greatest time of need. Because of that tragic event, my colleague vowed to devote his career to insurance where he would be able to help others rebuild and get back on their feet after devastating catastrophes.

  The global need for P&C insurance products and services is clear. So, why do so many uninsured exposures still exist? The answer is complex but can be partially explained by availability and affordability of insurance:

  Availability refers to the general ability of individuals, households and businesses to acquire insurance products to cover their exposures.

  Affordability refers to the ability of individuals, households and business to afford the insurance coverages that they desire to fully cover their exposures.

  Both concepts are important when seeking to develop a healthy insurance marketplace that meets the needs of society and eliminate the problems of being uninsured or underinsured.

  Though insurance has a reputation of being complex and opaque, it is theoretically easy to start an insurance company. To start an insurance company, entrepreneurs mostly need capital to back the venture and lawyers to navigate the legal requirements to operate within a given jurisdiction. Some money needs to be invested in IT systems and labor to generate paperwork, sell and service policies, collect premium and settle claims. Additional capital is set aside to form the basis of loss reserves. The amount of money and paperwork needed is far from trivial, but compared with starting a manufacturing business with large investments in physical capital and infrastructure, starting an insurance company is relatively straightforward given the right ingredients.

  Unlike certain markets, like personal technology or heavy equipment, there’s plenty of consumer demand for numerous carriers to succeed. Insurance is a highly competitive marketplace; there were over 2,400 P&C insurers and 800 life insurers in the United States as of 2017[71] according to the NAIC. While there is brand loyalty among insured, most personal lines carriers provide products to consumers that can reasonably be said to be substitutes for each other. Commercial insurance is a bit more complicated as there are fewer carriers and even a more limited market for specialty risks, but most small- to mid-size businesses with typical commercial exposures can work with their agent or broker to quote with a fair number of carriers competing for their business.

  Since insurance carriers are relatively easy to start and bring to the marketplace, why are a fuller range of insurance products and services not available to consumers? The question is primarily one of price. For starters, the majority of carriers operating in a jurisdiction typically want to do so as an admitted carrier, meaning that they are subject to the rules and regulations for selling and servicing insurance in that jurisdiction. Most jurisdictions, especially the state-based regulatory approach in the United States, require insurance rates to be filed with the governing regulatory body (typically referred to as a Department of Insurance or DOI). Some states require prior approval, meaning that the rates a carrier charges must be approved by the DOI prior to implementing in that states. Other states have a file-and-use approach which helps insurers with speed to market by allowing them to file their rates and begin to use them without formal approval - often with the caveat that the DOI could later disapprove their rates. Some states use a blended approach whereby rate changes up to a certain threshold (say, +/- 6.9%) are file-and-use but above that require prior approval.

  Beyond their mandate to prevent the insolvency of carriers, DOIs also have a broader mandate to protect consumers, which includes ensuring that carriers are transparent with consumers and not charging excessive rates. As a result, regulators can disapprove rate increases that carriers seek if they feel it hurts the consumer. Insurers often must provide actuarial justification for their rates to ensure they are both sufficient to cover expected losses (plus added contingencies) as well as not excessive.

  Over time, insurance carriers gain a sense for the regulatory environment within the states they do business in. This institutional knowledge, along with a carrier’s business strategy and intrinsic appetite for risk, shape decisions by each carrier on:

  •which products to offer - and not offer

  •which market segments (exposures) to target

  •which locations to write

  •what rates to charge

  •what underwriting criteria to apply

  Given the complexity and uncertainty around product, carriers generally specialize in a small number of products and leaves the remaining market to others to compete over. Unlike other industries where the largest companies wholly dominate the entire market, P&C insurance has a plethora of carriers. While there is some consolidation within the top 10 carriers, many more insurers are able to survive and even thrive despite a relatively low market share because the entire market is so vast.[72]

  HEADS AND TAILS

  To summarize: there are many insurance carriers in the P&C marketplace, and barriers to entry are relatively easy for
new market entrants to meet given sufficient capital. Why then, in this highly competitive landscape, are there issues with availability and affordability? Standard undergraduate macroeconomics teaches that, for competitive markets in a capitalist (free) society, the “invisible hand” of economics will match supply and demand perfectly at the market-clearing price. At this price, no consumer’s need is unmet if they are willing to pay that price and no supply is left unsold. If P&C insurance is a highly competitive marketplace and there is demand for insurance by the uninsured, why can’t the supply be provided and a market-clearing price be set?

  The main reason is this: the price at which insurance carriers can profitably insure a certain risk is higher than any consumer is willing or able to pay for that coverage. The inability to charge an “affordable” price is the culprit that leads to the lack of availability. If the price were affordable for consumers, presumably they would be willing to pay it to acquire the insurance that can protect them from potentially ruinous financial loss. However, no carrier is willing to charge a price that is so low that it does not cover the cost of expected losses. Rates must be actuarially sound to avoid financial losses by the insurer and risk possible insolvency. Charging a “proper” rate that is actuarially sounds, however, may sap any consumer interest in the product offering.

  Two of the major reasons some risks are considered uninsurable by carriers in today’s world:

  1.The cost to insure a risk is too great relative to size of market opportunity (high expense hurdle)

  2.The downside risk to insure a risk is too large relative to the capital needed to maintain solvency (capital considerations)

  Some additional reasons why carriers may not choose to offer products for a given market segment include:

  •Insurer’s expenses to develop, sell, distribute, and service the policy exceed the expected generated revenue

  •Fixed costs are too high due to:

  ◦ IT systems

  ◦ Marketing expenses

  ◦ Sales commissions

  •Regulatory costs

  •Losses are expected to exceed revenue due to:

  ◦ Adverse selection

  ◦ Inability to charge proper rate due to regulatory restrictions

  •Lack of historical loss data that can be used to develop reliable actuarial rates

  •Market opportunity is deemed too small to justify needed investment

  •Inability to gain regulatory approval to charge actuarially sound rates

  In addition to carriers not offering products in certain market segments, many people who are not obligated to purchase insurance through state regulations or mortgage requirements do not have proper coverage. The Insurance Information Institute (III) estimates roughly 1 in 8 motorists are uninsured in the United States; in some states the number is as high as 1 in 5.[73] Having drivers be uninsured is so common that there is a specific coverage called Uninsured Motorist (UM) on most Auto policy forms. So even making auto insurance compulsory in order to operate a vehicle does not guarantee that every single person who needs insurance protection has a policy.

  JUST IMAGINE

  Imagine an ideal world where everyone is able to obtain insurance for every exposure and every peril they want to protect at rates that are affordable. Such a system would provide maximum flexibility for individuals, households, and businesses to assume no more risk than they are reasonably able to take on given their financial resources. To the extent that entities are unable and/or unwilling to assume the risk posed by their exposures and self-insure, they would be able to transfer that risk to another party (typically an insurance carrier). This transfer of risk would be in exchange for a predetermined premium would could be fixed for a given time period or could vary with the level of exposure, such as a pay-per-mile auto insurance policy. The system would be wholly self-funding: between the premiums collected, investment returns and recoveries from salvage and subrogation, no additional outlays would be needed from governments (taxpayers) or charitable organizations.

  According to the Red Cross in their 2018 World Disasters Report, over 3,750 natural hazards have been recorded globally over the past 10 years, more than one per day. 84.2% of these had weather-related causes, leaving over 134 million people worldwide in need of assistance according to the United Nations.[74] In the United States alone, over $130 billion is being spent by the federal government in response to the 2017 hurricanes, floods, wildfires and other disasters - a record.[75] Spending on disaster relief is reactive, not proactive and preventative. Often the poorest people live in the most vulnerable areas that are quite prone to large losses.[76] Land is cheap precisely because the risk of loss is so great. Most people living in these areas have little to no insurance coverage and are far from adequately protected against the major perils they face. These people have to hope any disaster is widespread enough that the government will provide disaster relief funds, and even if they do it is likely to not begin to replace all that was lost.

  For other exposures that are not currently covered by insurance, new products could be developed to serve previously unmet needs. This would free up funds either set aside by individuals, households and businesses as a contingency in the event of an anticipated future economic loss or funds needed to service debt accrued from absorbing a financial loss. The new insurance products and services would generate jobs as well as unlock new economic activity in the form of increased consumption and investment by entities who no longer need to fully absorb the cost of uninsured economic losses. Disaster relief funds that are currently spent on recovery and rebuilding efforts could instead be spent on mitigation, resilience and sustainability initiatives, that seek to prevent disasters from occurring in the first place, improving millions of lives in the process.

  These scenarios are win-win-win:

  •a win for consumers who are better served

  •a win for the companies able to meet these needs, and

  •a win for society at large who no longer have to divert resources after losses to help people in desperate times of need.

  P&C insurance has held up remarkably well from its early beginnings in the Lloyd’s of London coffee house and the days of Ben Franklin[77] to meet society’s major insurance needs. Yet, there are major flaws in the current insurance ecosystem.These large failure points provide a major market opportunity for both traditional players and nimble startups to leverage a range of emerging new technologies that together fall under the broad heading of insurtech to remedy - partially or fully - these pain points. Given that these opportunities are so large and obvious to anyone who is familiar with P&C insurance, why hasn’t insurance been disrupted yet?

  1

  PART 2 - THE ARROGANCE OF SILICON VALLEY: WHY CONQUERING THE INSURANCE SECTOR REMAINS ELUSIVE

  CHAPTER 10 - WHY HASN'T INSURANCE BEEN UBER-IZED YET?

  ASK WHY NOT

  My friend, Insurance Nerds co-founder, Tony Cañas introduced me to an acquaintance of his from Silicon Valley when the three of us were attending a CPCU Society Annual Meeting in Anaheim, CA in the fall of 2014. Tony explained that the gentleman (let’s call him Victor) was working on a new startup that was looking to enter the P&C insurance marketplace. I said hello to Victor and asked what he was hoping to get out ot the conference. Victor replied that he was attending for a day or two to “learn about insurance” but that he had already done quite a bit of research and identified that our slow, staid, sleepy industry was ripe for disruption. Victor went on to say that many of the attendees, most of whom were part of the 2% of insurance experts who had earned the Chartered Property Casualty Underwriting (CPCU) designation that touts itself as the premier industry professional designation, would be reeling from the impact of his startup the following year. Victor also went on to say that almost everyone attending the Annual Meeting would be out of a job in 5 years because the industry would be completed disrupted.

  I saw Victor at a couple of the sessions taking a few notes and pictures wi
th his phone, but he seemed more interested in lecturing others about his startup and how ripe for disruption the P&C sector was. I didn’t know whether to be bemused by Victor’s arrogance or scared that I would be out of a lucrative job in the middle of my career with three children to provide for. Wavering between these two emotions, I knew that our industry had major challenges - or opportunities, depending on your vantage point - that made it an ideal candidate for disruption. I also knew that the P&C industry was conservative for a reason: the risk takers generally went insolvent, and a whole ecosystem of legal precedent and a complex regulatory environment provided hurdles to new entrants in our industry.

  It’s been a few years since I met Victor and I recently attended the 2018 CPCU Annual Meeting, which continues to draw thousands of dedicated insurance professionals who seem to still be gainfully employed. I didn’t see Victor this year, just like I have not seen or heard of him since that meeting in 2014. I’m not sure what Victor is working on today: perhaps he is still looking to disrupt the insurance industry or - more likely - he has moved on and set his sights on another industry to disrupt.

  What happened to Victor’s startup that was going to disrupt the insurance industry and put all of us out of a job? I don’t know the specific answer to this question. Perhaps Victor could not secure enough financing or the new bright, shiny object that Victor’s startup was building did not end up working the way he envisioned. I do know that there are many Victors out there outside the P&C insurance world who also see a massive industry that’s sleepy and slow to change that looks ripe for disruption. Will another Victor eventually succeed? It is anyone’s guess at this point, but I’d wager the chances are pretty good that it will happen someday.How soon? Again, this is anyone’s guess - but it will not happen until Victor and others like him spend a bit more time looking closer at the insurance industry and what makes it unique as compared with other industries that have been more easily upended.