The coming revolution in insurance

Technological change and competition disrupt a complacent industry

IN THE stormy and ever-changing world of global finance, insurance has remained a relatively placid backwater. With the notable exception of AIG, an American insurer bailed out by the taxpayer in 2008, the industry rode out the financial crisis largely unscathed. Now, however, insurers face unprecedented competitive pressure owing to technological change. This pressure is demanding not just adaptation, but transformation.

The essential product of insurance—protection, usually in the form of money, when things go wrong—has few obvious substitutes. Insurers have built huge customer bases as a result. Investment revenue has provided a reliable boost to profits. This easy life led to a complacent refusal to modernise. The industry is still astonishingly reliant on human labour. Underwriters look at data but plenty still rely on human judgment to evaluate risks and set premiums. Claims are often reviewed manually.

The march of automation and technology is an opportunity for new entrants. Although starting a new soup-to-nuts insurer from scratch is rare (see article), many companies are taking aim at parts of the insurance process. Two Sigma, a large American “quant” hedge fund, for example, is betting its number-crunching algorithms can gauge risks and set prices for insurance better and faster than any human could. Other upstarts have developed alternative sales channels. Simplesurance, a German firm, for example, has integrated product-warranty insurance into e-commerce sites.

Insurers are responding to technological disruption in a variety of ways. Two Sigma contributes its analytical prowess to a joint venture with Hamilton, a Bermudian insurer, and AIG, which actually issues the policies (currently only for small-business insurance in America). Allianz, a German insurer, simply bought into Simplesurance; many insurers have internal venture-capital arms for this purpose. A third approach is to try to foster internal innovation, as Aviva, a British insurer, has done by building a “digital garage” in Hoxton, a trendy part of London.

The biggest threat that incumbents face is to their bottom line. Life insurers, reliant on investment returns to meet guaranteed payouts, have been stung by a prolonged period of low interest rates. The tough environment has accelerated a shift in life insurance towards products that pass more of the risk to investors. Standard Life, a British firm, made the transition earlier than most, for example, and has long been primarily an asset manager (see article).

Meanwhile, providers of property-and-casualty (P&C) insurance, such as policies to protect cars or homes, have seen their pricing power come under relentless pressure, notably from price-comparison websites. In combination with the stubbornly high costs of maintaining their old systems, this has meant that profitability has steadily deteriorated. The American P&C industry, for instance, has seen its “combined ratio”, which expresses claims and costs as a percentage of premium revenue, steadily creep up from 96.2% in 2013 to 97.8% in 2015, and to an estimated 100.3% for 2016 (ie, a net underwriting loss). Henrik Naujoks of Bain & Company, a consultancy, says this has left such insurers facing a stark choice: become low-cost providers, or differentiate themselves through the services they provide.

One fairly simple way to offer distinctive services is to use existing data in new ways. Insurers have long drawn up worst-case scenarios to estimate the losses they would incur from, say, a natural catastrophe. But some have started working with clients and local authorities on preparing for such events; they are becoming, in effect, risk-prevention consultants. AXA, a French insurer, has recently started using its models on the flooding of the Seine to prepare contingency plans. Gaëlle Olivier of AXA’s P&C unit says the plans proved helpful in responding to floods in June 2016, reducing the damage.

Damage control

Tech-savvy insurers are going one step further, exploiting entirely new sources of data. Some are using sensors to track everything from boiler temperatures to health data to driving styles, and then offering policies with pricing and coverage calibrated accordingly. Data from sensors also open the door to offering new kinds of risk-prevention services. As part of Aviva’s partnership with HomeServe, a British home-services company, the insurer pays to have a sensor (“LeakBot”) installed on its customers’ incoming water pipes that can detect even minuscule leaks. HomeServe can then repair these before a pipe floods a home, causing serious damage.

The shift towards providing more services fosters competition on factors beyond price. Porto Seguros, a Brazilian insurer, offers services ranging from roadside assistance to scheduling doctor’s appointments. In France AXA provides coverage for users of BlaBlaCar, a long-distance ride-sharing app. The main aim of the policy is to guarantee that customers can still reach their destination. If, say, the car breaks down, it offers services ranging from roadside car-repair to alternative transport (eg, calling a taxi).

Insurers face many hurdles, however, to becoming service providers and risk consultants. Maurice Tulloch, head of the general-insurance arm of Aviva, admits that such services are yet to catch on with most customers. So far, his firm, like its peers, has focused on enticing them to adopt the new offerings by cutting insurance premiums, rather than on making money directly from them. It reckons it can recoup the cost of, say, the HomeServe sensors and repairs from the reduction in claims.

One example of what the future may hold comes from the car industry. Carmakers have traditionally bought product-liability insurance to cover manufacturing defects. But Volvo and Mercedes are so confident of their self-driving cars that last year they said they will not buy insurance at all. They will “self-insure”—ie, directly bear any losses from crashes.

Some think that such trends threaten the very existence of insurance. Even if they do not, Bain’s Mr Naujoks is not alone in expecting the next five years to bring more change to the insurance industry than he has seen in the past 20.

This article appeared in the Finance and economics section of the print edition under the headline “Counsel of protection”

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