The End of Insurance as We Know It

by Rob Galbraith

  Another major telematics challenge: What do you do with consumers who are unwilling to share their data by using telematics? The example of some carriers suggests that, over time, the “good” drivers will choose to self-select and “earn” a lower rate by demonstrating through telematics data what a superior driver they are. The remaining drivers are thus presumed to be “bad” drivers who should be paying more in premium as they represent a greater risk of incurring losses. However, it takes a core number of drivers in your book of business to reach enough segmentation between “good” and “bad” drivers to achieve scale and make a meaningful difference in the profitability of the book of business.

  Finally, consider auto insurance in the broader context. Standard business school theory of a product life cycle articulates 4 fundamental phases: startup, growth, maturity, and decline. Auto insurance is a highly mature market that has been exceedingly stable for decades. With the advent of ride sharing and societal changes in the desire to drive and own a vehicle along with stagnating population growth, are we soon reaching “peak auto” - the point at which the most vehicles are owned and on the road?[122] Current statistics on vehicle purchases globally and in the United States do not indicate so as records continue to be set in 2018.[123] However, the percent of the population that holds a driver’s license is declining[124] among multiple age cohorts. Depending on how you choose to measure it, we may have already reached peak auto in the United States back in 2006, which was the year that vehicles per person topped out at 0.786 and vehicles per household topped out at 2.05.[125]

  If we are soon to be at peak auto beyond which the number of vehicles owned and on the road declines, there are a number of implications for the P&C insurance industry.

  •First, each vehicle may be operated for much longer and on the road much more frequently (think rideshare drivers).

  ◦ As a result, the exposure for these vehicles is rising as they are driven more intensely and have more opportunity to be involved in an accident.

  ◦ More miles driven will drive up losses and push up premiums as those increased losses flow through into actuarial rate indications.

  •Offsetting these trends are a declining customer base (or one that is growing slower than population growth).

  ◦ This is especially true for carriers who choose to limit exposure for rideshare drivers if not outright exclude coverage (which is already covered under commercial policies when a passenger is in the vehicle.)

  A shrinking market for auto insurance would push the industry into the “decline” phase of the market cycle and likely lead to lower revenues and profits. Specifically relevant to this discussion is that a major investment in telematics goes against the logic of transitioning a declining business line to a “cash cow” status and reinvesting in other lines to smooth the transition away from the declining auto insurance market. For inspiration, auto insurers need look no further than General Motors. CEO Mary Barra and GM’s leadership team have chosen to pursue an “ambidextrous” strategy according to Fortune: simultaneously helping the core business grow and continually improve while making large investments in autonomous electric vehicles for a “post-car” future. While the future mashup of auto manufacturers alongside hardware makers, software development, ride-share network operators and entertainment options for a driverless future remains foggy, was is clear to everyone at the 110-year old GM is the need to radically change how they operate[126] - now.

  I CAN SEE CLEARLY NOW

  The story of GM’s ongoing transformation makes one thing clear: Rarely do we as a society have the benefit of so clearly seeing a “leapfrog” technology in the way that we do today in the automotive space. Autonomous vehicles (AV) (aka driverless cars) continue to show exponential growth in the number of vehicles on the road and miles driven.[127] While there have been, and will continue to be, setbacks such as the first pedestrian death involving a fully autonomous vehicle in 2018,[128] there are a number of forces that are rallying behind the growth of autonomous vehicles. These forces pushing for adoption of AV technology make it hard to view driverless cars as anything but an inevitable part of our future.

  •The explosive growth of ride sharing (from $0 a decade ago to $60B today)[129]

  •The biggest source of liability to ride sharing firms is the driver (roughly 90% of accidents involve some form of human error)[130]

  •The desire of auto manufacturers to find new markets (e.g., ride sharing firms)

  •The push by governments to reduce fatalities due to accidents, possibly by up to 90% [131]

  •The promise to conserve the most precious resource people have - their time (as much as 50 minutes per day according to McKinsey & Company)

  The convergence of these powerful actors and strong incentives has already led to a number of technological advancements. Some manufacturers such as Tesla, Mercedes-Benz, Volvo and Toyota equip the majority of their new vehicles today with crash-avoidance technologies,[132] according to the Insurance Institute for Highway Safety (IIHS) that reduce the likelihood of getting into an accident (and, thus, filing a claim). The expected benefit is a reduction of 28,000 crashes and 12,000 injuries by the year 2025. (To date, these technologies have not helped reduce auto insurance premiums as reduction in crashes has been offset by the higher costs to repair these technologies when they are damaged[133]). Telematics, at its core, has one primary purpose for insurance purposes: to provide data on the actual driving experience of every driver. This data is the “holy grail” that auto carriers have sought for decades as a replacement for the proxy variables they have had to settle for previously. But telematics data is only valuable to auto insurers if there is someone driving the car! Having a human driver behind the wheel looks to be an increasingly rare occurrence in the future.

  As an insurance industry insider for two decades, most in my professional circle acknowledge the disruptive force that truly autonomous vehicles will have on the auto insurance industry when “that day” comes. However, in most people’s professional opinion “that day” is 15-20 years off - conveniently far off enough that they will have been long since retired. While this certainly may prove to be the case, there are many reasons to be much more paranoid about “that day” being here sooner than all of us realize. To understand why, we need to examine some common myths about autonomous vehicles:

  Myth: It will take decades for the auto fleet to “turn over” and be composed primarily of autonomous vehicles.

  Fact: This would be valid if vehicle ownership patterns remain the same, but they may already changing today. Some speculate that peak auto was achieved in 2016 with record new vehicle sales of 17.5 million in the United States, which fell slightly to 17.2 million in 2017 and is on pace to drop another 2% in 2018 through October 2018. Fewer young people are getting their driver’s license, much less outright owning a vehicle. While 92% of 20- to 24-year olds were licensed to drive in 1983, only 77% were in 2014.[134] Instead, more and more will “summon” their vehicle through a ride sharing app or vehicle “subscription” service. Lyft reported that in 2017 alone, about 250,000 of its riders report selling their vehicle and solely relying on ride sharing. 50% of those surveyed stated they drive their personal vehicle less due to ride sharing, and 25% report that owning a personal vehicle is no longer important to them.[135]

  Myth: It will take a decade or more to sort out the legal ramifications of liability and other laws that will govern the insurance landscape for autonomous vehicles.

  Fact: Vehicle manufacturers and ride sharing companies are already stating that they will assume much, if not all, of the liability associated with autonomous vehicles. Ride sharing firms already cover much of the liability associated with their drivers today through commercial carriers. Although not fully determined, it is quite conceivable that the amount of accidents and related liability will be reduced by roughly 90% since this is the estimate of human-caused accidents.[136] The remaining liability can easily be seen as one more of products li
ability rather than traditional auto liability, especially if autos remove the steering wheel, brake pedal and gas pedal so that humans do not have a mechanism to control the vehicle ever. In fact, for a fully autonomous vehicle the biggest exposure that requires insurance may be the cyber risk associated with hacking the vehicle’s software.

  Myth: There will be a smooth, linear pace of transition to autonomous vehicles, just as with other new technologies such as anti-lock braking, electronic stabilization control, lane change warnings, etc.

  Fact: Unlike these other technologies, the suite of technologies that comprise an autonomous vehicle represent a radical change unlike any of these others - precisely because they remove the need for a driver some (or all) of the time. Removing the need for a driver changes the game entirely when it comes to auto insurance. This change, for the reasons cited above, may be equally likely to be represented by an S-curve transition if AVs are quickly adopted at scale. Such a transition could be driven by ride sharing firms and consumers choosing to save time and money by selling their cars and choosing to adopt this new “summon or subscribe” method of personal transportation. If a radical shift happens as opposed to a smooth linear path, the threat to auto carriers becomes less of a “managed” transition and more of an existential threat to the very existence of the 100-year old traditional auto insurance business model.

  The future may already be here. As this book was going to publish, Waymo announced that a new (yet to be named as of this writing) commercial driverless car service will launch in the Phoenix area in early December, according to Bloomberg. This first-of-a-kind service will directly compete with other ride-sharing services such as Uber and Lyft.[137]

  MASTER OF THEIR OWN DEMISE

  With such a looming threat of irrelevancy, why are insurers so aggressively pursuing telematics? For starters, auto insurance is still the dominant line of business in the personal lines space, accounting for roughly two thirds[138] of the $288 billion personal lines industry.[139] For monoline auto carriers, there are no obviously alternatives to invest in (such as home insurance). In addition, internal funding for IT investments are often allocated based on the premium each line brings in to the carrier. This may be a reasonable approach in a stable marketplace, but it is absolutely the wrong thing to do for a market in the last product life cycle stage of decline.

  Telematics advancements using smartphones overcome much of the hurdles to adoption.Value-added services help incentivize consumers to see this technology as beneficial to them, not merely a way for their carrier to be more intrusive in their lives. The potential for faster return on investment (ROI) is out there with gamification and the ability to influence driving behavior through other “nudges” beyond simply lower premiums is real albeit unproven on a large scale for personal lines. Success for telematics is more measurable for commercial fleets and these case studies can provide important insights on the benefits that are possible in the personal lines space. The costs to develop and roll out a telematics program are lower than ever before and the time period needed to see benefits is shorter than ever before. These reasons justify the sustained interest by insurers in telematics despite the uneven track record to date.

  What if these newer telematics programs prove successful? In the short run, telematics may provide a competitive advantage, helping to reduce auto losses (possibly accelerating the long-term trend of declining frequency, notwithstanding the recent spike in the mid-2010s).[140] Telematics may also attract new customers and improve policy retention due to program incentives. On the other hand, too much success in reducing losses will lead to negative rating indications and competitive pressures to reduce premiums. Reduced premiums (revenues) in a stagnant (or declining) market for auto insurance will exacerbate the pain for insurers. Many key performance indicators (KPIs) in the insurance industry are tied to premiums: loss ratios, combined ratios and expense ratios. In particular, if auto premiums are flat or negative but underwriting expenses remain constant or are increasing, this will force insurers to make difficult choices in managing their operational expenses to keep their expenses ratios from ballooning.

  Bottom line: while telematics offers some benefits for carriers, there are substantial opportunity costs and an apparent limit on potential upsides if losses are greatly reduced and/or driverless autos become commonplace sooner than anticipated. This “success” will likely come at the cost of alternative investments in other technologies, such as smart home, AI, blockchain, etc. as well as mobile development and digital transformation efforts because each takes considerable investments in money, people and dedicated resources to do well. Investing heavily in a potentially game-changing technology such as telematics for a large market opportunity may be the right strategy for some players, but many more will be jumping in at exactly the wrong time. A shrinking market that has the potentially to fully implode faster than expected if ride sharing, car subscriptions and fully autonomous vehicles become a reality sooner rather than later makes the decision on whether to pursue a telematics strategy loom large.

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  CHAPTER 17 - OUTSMARTING THE HOME (INSURANCE)

  I SENSE A DISTURBANCE IN THE FORCE

  Smart home technologies such as doorbell cameras, automated thermostats, WiFi-enabled smoke detector batteries, adjustable lighting, and motion-activated security cameras that allow homeowners to customize their home life are becoming increasingly popular with consumers. Slightly less popular today but big from an insurance perspective are water leak detection devices, ranging from a simple alarm when water is detected all the way to shutting off the main water valve if an unusual pattern of water usage is detected. Homeowners find it natural to leverage their smartphone to manage all of their “smart” household devices: setting room temperature, adjusting lights, monitoring package drop offs, etc. The potential for property insurers to leverage these Internet of Things (IoT) devices to obtain meaningful learnings in the form of Big Data is enormous. Gaining previously unknown data from the home in real-time has the potential to reduce the likelihood of damages that result in paid claims. A reduction in both loss occurrence (frequency) and amount of damage (severity) will translate into lower loss costs for insurers. If downward trends in frequency and/or severity are sustained over time, this will eventually result in lower actuarial rate indications and ultimately premiums for insureds.

  Unlike the existential threat of autonomous vehicles people will continue to live in homes and protect them with insurance coverage. Home ownership trends have changed since the 2008 recession, which has resulted in lower rates of homeownership and more people renting while the number of houses bought for investment purposes is much higher.[141] Homes are becoming less affordable, interest rates are rising, mortgages are more difficult to qualify for, student debt overhang is delaying home purchases;[142] all are reasons millennials are purchasing homes later in life relative to other generations.[143] Real estates trends aside, the basic business model of property insurance is still quite relevant even if lifestyle choices between owning, renting and what society values are changing. The same statement cannot be confidently said of the basic business model of auto insurance, where technology and societal changes are threatening the entire paradigm over the next 10-30 years.

  Much of the smart home technologies that have driven consumer demand are more related to lifestyle, especially the new “personal assistants” such as Google Home or Amazon Alexa. The landscape is changing rapidly: Amazon recently announced the development of an Alexa-controlled $60 microwave that responds to voice commands. This is just the start of what could be an entire ecosystem of voice-controlled, Internet-enabled devices in your living space. IHS Markit estimates that the world market for smart home connected devices will grow from under 100,000 IoT devices in 2016 to over 600,000 in 2021, a 6-fold increase with most of the change occurring in the consumer electronics and lighting & controls categories.[144] The driving force behind consumer adoption of these IoT enabled devices will be con
venience and lifestyle. However, technologies such as the doorbell cameras, automated locks, tracking of movement in and around the house, water leak detection sensors, smoke detector batteries that notify you ahead of time when they are running low all hold potential benefits for insurers and consumers in preventing losses from occurring.

  INSIDE OUT

  Smart home technology is generally thought of as a series of devices inside the home. However, there are increasingly a number of new technologies, not as of yet considered in the “smart home” space, that should be. There are essentially extensions of smart home technology deploy outside the home. To cite a couple of examples:

  •A hail “pad” similar to a solar panel that is attached to the roof and records data from any hail that may occur (and possibly predict unseen damage)