Umbrella insurance protects worth and assets, such as property, investments, savings) or the potential for high future income from potential lawsuits.
Insurance 2.0: Elements for the future
Discover why the future of insurance needs to be in alignment with a 4 step risk management strategy, have a holistic approach and be more cost-efficient.
Insurance 2.0: Elements for the future
Life is risky! Insurance helps us gain and sustain financial security, especially during times of uncertainty.
Risk exists whenever the outcome is uncertain. In insurance terms, pure risk is the chance that something harmful could happen, which results in loss or damage to property or involves injury of people. In today’s demanding and unpredictable world, identifying risks must be done with an evolving and agile approach.
Discover why the future of insurance needs to be in alignment with a 4 step risk management strategy, have a holistic approach and be more cost-efficient.
Insurance was started by communities to help one another. Being that if a community member suffered a loss, the entire community would come together to help and support that member. Insurance is about the pooling of risk to take advantage of diversification and to protect people against losses beyond what they can individually afford.
Still to this day, 20% of the insurance industry is held by mutual companies based on the NAIC, such as State Farm and Liberty Mutual These are companies that are owned by the policyholders and are not supposed to be for profit.
The concept of insurance has always been about helping one another in the darkest of moments. Insurance is there to protect the health and wealth of individuals while providing stability for businesses to progress. However, this fundamental mission often loses it’s visibility as insurance companies grow.
So when we talk about the future, it’s important to go back to the roots of why insurance exists. Insurance is as old as time, it made sense back then, still makes sense today, and will make sense in the future. So while we don’t imagine the core concept can be disrupted, we do believe it is time for it to be reimagined for this century.
Thesis 1: Risk Management, Not Just Financial Indemnification
Currently, insurance broadly operates by a group of people paying into insurance company premiums and, if a loss occurs, they will pay that member the full or partial amount of the assessed loss, assuming that loss and scenario are covered in the policy contract. This is what is called financial indemnification. This is an effective form of risk management as it really is sharing the amount of risk with one another and not holding one person totally accountable. Most of the insurance industry has operated this way for centuries. However, not all have been this way. Many of the regulations around fire protection and measures like the sprinkler system were innovations that the insurance industry played a role in. And it makes sense. If there is no loss, there is no need for claims to be paid. It is a win win.
Successful Risk Management – The Cyber Insurance Example
Though traditional, financial indemnification is an effective approach to insurance however for the needs of today’s world, it needs to evolve. Take commercial cyber insurance as an example. Commercial cyber insurance is an emerging niche part of the industry solely focused on the digital world and the implications of it. The unique characteristics of the cyber market including, rapid growth, newer digital market, lack of sufficient historical data, and complicated risk dynamics have resulted in a different breed of innovation compared to the rest of the insurance industry.
Many cyber insurance experts reflect at the evolving ecosystem or affirmative cyber 1 as follows:
- Transparent risk assessment: Companies focused on identifying and quantifying different risks and loss scenarios. There are usually two types of companies here: some are mainly helping insurance companies focus on price better, and some are focused on helping the customer better understand their own risk exposure and predictions. Many do both.
- Cybersecurity: Most experts believe that cyber insurance is meaningless without proper security in place. Many companies might not even provide cyber insurance without it.
- Cyber Insurance – financial indemnification must be defined for different types of financial loss that can happen as a result of a cyber breach or loss, this may include (but not limited to):
- Customer & Employee Data Loss
- Business Interruption & Extortion
- Third-Party Lawsuits
- Payment Fraud
- Reputation Loss
- Cyber recovery – companies that assist in the recovery and forensic analysis post a cyber event. The objective is to minimize the damages, find the responsible parties, and to assist with the recovery process as quickly as possible. This includes but not limited to: notifications of customers and regulators, restoration of personal identities, repairing damaged computer systems, etc.
In more simple terms, traditional insurance for the cyber world is not enough to provide full coverage and protection. Other services are needed to create ALIGNMENT. The idea is that you pay a company to help manage your cyber risk and to indemnify you if a loss happens. Many companies act as or collaborate with the Chief Security Officer.
Examples of this are in the Healthcare HMO model for companies like Kaiser Permanente. In Kaiser, individuals pay a subscription (membership) fee as a member. Kaiser collaborates with you to keep you healthy and covers your healthcare costs if the need arises to align objectives.
The 4 step risk management approach
The 4 step risk management approach is the new basis of our modern insurance approach. Risk management and not just old school financial indemnification. In summary and to align objectives, insurance companies should:
- Dynamically identify, quantify, and communicate different risks that can result in harm.
- Find ways to mitigate, or eliminate the risk if possible.
- Cover the costs associated with the recovery as the result of:
- Failure of the safety and mitigation system
- Risks beyond the scope of the safety system
- Fix the problems caused by a loss event and assist with full recovery
To properly execute this, budgets, complete financial pictures, risk appetites, and compliance of the insured have to be fully taken into consideration.
Let’s now imagine if there was a different way of doing auto insurance using this 4 step risk management approach with the idea of aligning the customer with the insurance company. In this scenario, the insurance company is there to manage the risks associated with driving the car and not just pay for the loss. In this future, the risk manager constantly identifies the risks associated with driving a car – fully autonomous or not and seeks ways to lower the risks and provide help. Meaning instead of asking the customer to drop the car to a mechanic, the insurer picks up the car, and drops off the fixed car once ready.
The world is underinsured.
Thesis 2: Providing Personalized, Dynamic, and Holistic Protection
The world is underinsured. This is a known fact. In California, it is estimated that only 13% of the homeowners carry earthquake insurance. This number is down from 33% from 1996. Based on COVU’s internal survey, only 25% of people have Disability insurance, from which only 9% have an individual policy with the majority purchasing typically insufficient amounts through their work. Swiss Re estimates the life insurance coverage gap in the United States to be upwards of 25 trillion dollars [Source].
On top of the insurable losses, the world is full of uninsurable losses that go beyond the scope of what the insurance industry is prepared to cover. Terrorism, Acts of War, and now a more recent example, aspects of the Covid-19 pandemic, are examples of such events. Most business interruption coverages exclude pandemics for business interruption and as such, many businesses became very vulnerable to the consequences of the mandated shutdowns.
There are several reasons why this problem can exist:
1. Education, Attitude, and Trust
Often people have no idea what or how likely their relevant risk is, or what their current protection or insurance actually covers. A recent survey shows that only 21% of people got a passing grade on their knowledge of their auto insurance policy [Source]. If people don’t understand the policy, it is unfair to expect them to choose the right coverage.
When individuals face a complex judgment such as a statistical probability, frequency, or incomplete information to face risks, they use heuristics to reduce the decision to a simpler task. Cognitive psychology examines how people don’t follow the principles of probability theory when judging the likelihood of uncertain events, but rather use heuristics or “rules of thumb” that sometimes lead to reasonably good estimates of the probability of an event. Often, though, average customers don’t do this. Pairing that with unintentional biases as well as emotions, for many not thinking about risk is the best way to cope with it.
The insurance industry has centuries of experience in understanding risk, but we believe there is a gap in how the industry is sharing that knowledge with the consumers. It is fair to expect that brokers and agents play a role in consulting customers and are supposed to fill this gap. But, the truth is that often even brokers and agents don’t have access to this information. The license education for agents is typically around learning how insurance works and not on how to do need assessment and evaluate risk profiles. As a result, the way advice is provided can be very inconsistent.
On top of that, factoring in how the insurance incentives and the commission structure works, can contribute to compromised quality advice.
The current way that risk is measured on a consumer-level typically tends to be in silos resulting in gaps.
2. The Risk Reason
The current way that risk is measured on a consumer-level typically tends to be in silos resulting in gaps. Risks do overlap and should be looked at holistically. Especially when we want to measure its impact on an individual’s finances and as part of a financial plan.
Another major flaw is that the current approach considers the risk to be quite static. This reflects in how often changes are assessed and solutions are adjusted which can result in major over or underinsurance over time.
Lastly, some risks are hard to measure (e.g. cyber-attacks) and the insurance industry is still trying to better understand the dynamics of it through getting access to new data sources and models.
The insurance industry often lacks the agility to offer products that are a better fit for more modern risks and needs.
3. Solutions: Products, Flexibility, and Cost
The insurance industry often lacks the agility to offer products that are a better fit for more modern risks and needs. The way that risk analytics usually works is to look at the past and see how the dynamics of different risks have worked as a measure of predicting the future. In an ever-evolving world, this might not always be the best way to assess risk.2
Many of the current policy languages might have not evolved in decades and as such customers might be paying for risks they might not have, or not get the coverage for what they need. In addition, policies are often not flexible in the way that different coverages can be chosen.
On top of this, insurance can get quite expensive and for many, it might just feel unaffordable with no clear return on the investment.
For some risks the magnitude of the potential loss can be so significant that the insurance premiums become unaffordable for almost everyone, and as such the obligation falls on the government to step in to support the losses. War is an example of this. However, for some events such as earthquakes in California, many have mixed feelings due to the high premium costs and the potential large magnitude of the loss across the state. This has resulted in most expecting the government to step in the case of loss rather than purchasing an Earthquake Policy.
Solution 1 – Unbiased transparency and education for customers
Transparent, holistic, and unbiased advice can help people understand what risks they have, and how different policies help them cover potential losses.
Transparency in this context means to simplify insurance and risk in order to help them fix it. Transparency correlates with the first step of the risk management process: identify the risks and communicate it in layman’s terms.
In addition, communication should be broadened beyond legal policies and verbiage so that the customer understands the policies in simple terms.
Lastly, to assure unbiased and quality guidance there are two main options:
- Change of incentive structure
- Providing consistent automated advice based on data and not opinions.
Due to the complexity of risk management, it seems the best option would be a combination of both with the future moving more towards the latter with time. Meaning, as much as possible, the core advice should be provided automatically based on risk data of the user with the support of non-commissioned experts wherever human expertise is required.
Risk should be measured holistically, and on-going, and certainly not limited to only insurable losses.
Solution 2 – Better risk and gap analysis
Risk should be measured holistically, and on-going, and certainly not limited to only insurable losses. The goal should always be to minimize the impact of different losses in the customer’s future, with or beyond insurance.
This would require:
- More advanced predictive risk models.
- New data sources and seamless integration in an individual’s life while respecting their privacy to monitor their ongoing risk profile for real-time responses.
- Measuring risks beyond the scope of the insurance industry and finding alternative or complementary ways to finance and manage them.
- Measuring protection to assess gaps by considering government benefits, employer benefits, self-insurance, and even other forms of financing and protection beyond just insurance.
Solution 3 – Holistic solutions that are built for modern risks
The traditional insurance concept is all about financing the recovery from a loss. Insurance began as a peer-to-peer model where communities pooled their risk as non-profit. Between new creative ways to finance risk, as well as new insurance products and policies that offer more flexibility as well the possibility of covering modern risks there is a lot that needs to be changed.
There are certain advantages for focusing holistically on protecting the customers at scale:
- By real-time tracking of data, new opportunities are presented to measure and dynamically offer solutions that fit a specific customer need.
- Providing data back to carriers to create new solutions to better match the need of modern customers.
- Lowering the cost of insurance by leveraging alternatives to insurance for financing risk such as: self-insurance, lending, warranties, or even donation-based funding.
- Eliminating overlaps and better personalization by designing the full protection package.
- Better integration into financial planning, prioritizing budget and optimizing ROI.
- Lowering the cost of distribution by holistic acquisition and retention, which can result in cheaper products.
- Risk management as opposed to only financing which allows for mitigating the loss.
Thesis 3: Making Insurance More Affordable Without Compromising on Protection
In the article on why self insurance is a smart move, we discussed how the insurance unit economics works and how policies are priced for common personal lines like Auto Insurance. As a summary, the two main components of the price consist of the expected loss for specific risk and the overhead of the operational costs of an insurance company. These overhead costs usually include the costs of acquiring, underwriting, and servicing a customer.
Looking at the priority of what are the typically the root causes for a certain price, here what should hopefully result in cheaper insurance in the future across markets:
1. Loss Control
As mentioned, for the majority of the insurance products and lines, the bulk of the cost is in the claims that an insurance company expects to pay back, and for a specific individual what is called “expected loss”.
As a result of this, finding cost efficient ways to reduce the likelihood of different risks happening, as well the lowering the costs of recovery or dealing with them can result in savings on the insurance premiums. That is a big reason why the healthcare industry has put an emphasis on preventive measures to lower the risk of major medical issues and subsequently the expected loss.
In today’s world and using modern technology there are many ways to do this. For auto insurance this can mean safer cars. In life insurance, this can mean encouraging policy holders to live a healthier lifestyle. In workers Compensation insurance this can mean real-time analysis of worksite hazards. With the increase in the use of such technologies, many insurance companies have started to reward their customer by providing discounts and sharing some of the profit back to them.
Another major factor is to eliminate moral hazards leading to unjustified claims and to identify fraudulent behavior. The FBI estimates that that cost of insurance fraud (non-health insurance) is around $40 billion dollars a year, meaning each cost each American family $400-$700 due to increased premiums [Source]. There are companies such as Lemonade who are looking at new ways of providing insurance and aligning the incentive of the insured and the insurer to lower fraud. On top of this, with targeted marketing, KYC (know-your-customer) initiatives, and machine learning for pattern recognition, many companies are looking at other ways to tackle this.
Lastly, it is very important to note this is all while making sure the customer’s best interest is in mind and the process of how that claim is handled is transparent. We have already covered both alignment as part of risk management, and transparency as part of user centricity. Loss control should not result in less protection for the customer.
2. Improving the operational efficiency in operating a risk pool or an insurance company
There are many ways that technology is working on lowering the cost and improving the efficiency of insurance. A holistic and centralized approach to risk and insurance management can potentially result in much cheaper distribution costs which should ultimately result in major savings on the overall cost of insurance.
The big factor in the cost of insurance is the expense ratio or the costs associated with acquiring, underwriting, and servicing a customer. Insurance, pooling of risk, is an efficient way to finance risks and hence fosters economic progress. Insurers need to have a growing capital base to absorb the volatility they assume, else financial ruin is just a matter of time. They earn a margin beyond what is necessary to cover all expenses else access to capital dries out. Hence a fair and sustainable insurance offering is one that pays as much as possible of the premium back in the form of loss indemnifications, while still allowing the insurance company to earn a bit more than the marketing costs. This means a close to very minimal expense ratio.
Furthermore, until insurance can be run at a closer to 100% loss ratio, evaluating alternatives financing options to insurance may at times result in better returns on the premiums paid.
Lastly, at COVU, we believe risk and insurance management can be democratized for everyday people if insurance is in alignment with a 4 step risk management strategy, has a holistic approach and is more cost-efficient. The power would be in the hands of the insurance consumers and the real foundation of insurance would be at the forefront: helping one another.
1. [Affirmative cyber refers to insurance policy language that covers or excludes cyber-related losses. As opposed to“Silent cyber”, which is also known as “unintended” or “non-affirmative” cyber, where the unknown or unquantified exposures originating from cyber perils that may trigger traditional property and liability insurance policies [Source].]↩
2. [Not even mentioning the work of Nasim Taleb and “The Black Swan” events.]↩
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