Innovation: reinsurers prefer collaboration

Innovation might not have a direct or immediate impact on reinsurance, but reinsurers remain actively involved because it affects their clients directly. An AM Best survey published in a September report, Insurers Agree Innovation Is Critical for Future Success, revealed nine out of 10 respondents from more than 450 of its rated insurers globally view innovation as being at least moderately critical to their organisation’s success. Almost half of the reinsurance companies that responded view innovation as either extremely (8 percent), or very critical (41 percent) to their organisation’s success.

Twenty-four percent of respondents believe that gaining a competitive advantage is the primary reason innovation is important, while 21 percent cited expansion into new markets/products and improved risk selection. These results are not surprising and reflect current market conditions.

It is important to note that almost all reinsurers have some presence in the primary insurance market, either in standard commercial lines, through their specialty divisions or from ownership of Lloyd’s syndicates. The results therefore, need to be interpreted in light of this context.

Catastrophe pricing in reinsurance markets is experiencing pressure, following the unrealised expectation of rate hardening despite incurring natural catastrophe losses totalling over $100 billion in the third quarter of 2017. Some loss-affected business lines had more meaningful rate increases at the January 1 and June 1 renewals in 2018, but the majority of reinsurance prices experienced little to no increase.

Prevailing sentiment is that rates will not fare much better in 2019. Competing on price alone seems to be a thing of the distant past, and has forced reinsurers to think outside the box to gain market share and stay competitive while remaining profitable.

Top challenges

Reinsurers overwhelmingly believe that the segment’s top three challenges are system/process inefficiencies (94 percent), disruption of business model (76 percent), and underwriting risk (70 percent). Transferring legacy systems to newer, more efficient platforms is a top priority for many in the industry, with more and more migrating from centralised servers to cloud computing.

‘Alternative’ capital is converging rapidly into reinsurance risks, especially catastrophe risks, and nimble reinsurers have been tackling the disruption in the business models through partnerships, collaboration, and mergers and acquisitions. They are growing products in areas such as cyber, mortgage, flood, and taking measured steps into new geographies where the protection gap is more pronounced.

Although the AM Best survey results indicate that all technological innovation will affect reinsurers, big data, cloud computing, and the internet of things (IoT) were identified as having the biggest impact. Companies are accumulating more data than could ever be analysed by humans alone, which may require the hiring of data scientists and engineers to analyse patterns and help develop innovative business solutions. Companies can also leverage big data for data-driven decision making, leading to automated underwriting of increasingly complex lines of business and potentially generating claims management efficiencies.

With the adoption of cloud computing and big data, disruption of the business model may be viewed as less of a threat, and for some a competitive advantage. Companies are focusing on cloud computing and big data analysis, with 61 percent of respondents investing in cloud computing and one third investing in big data.

Blockchain is coming

Blockchain has the potential to enhance the efficiency of claims processes while providing greater transparency and can be used to re-imagine the current facultative reinsurance workflow by allowing transparent sharing of common data and automating contract management.

By connecting reinsurers, primary insurers, and service providers, a shared ledger can facilitate a more efficient transfer of data among all parties. By leveraging blockchain capabilities, insurers and third parties can easily access and update relevant information.

Giving reinsurers limited access to claims histories can improve transparency in an automated and auditable way. Sharing information from different data sources on a blockchain would enable various parties to collaborate, detect, identify, and mitigate fraudulent activity.

Reinsurers seem more bullish about blockchain technologies compared with other sectors, but issues such as scalability, computing power, and security need to be addressed convincingly before widespread adoption.

Blockchain can improve efficiency, and there are exciting industry initiatives related to its use. For example, the B3i blockchain initiative formed among some top European re/insurers including Swiss Re, Allianz, Zurich, Munich Re, and Hannover, will explore the potential of using distributed ledger technologies for the benefit of all stakeholders in a re/insurance value chain.

Reinsurers’ views of innovation are at least partly reflective of how satisfied each company is with its own innovation efforts in a number of areas. There are challenges to developing an innovation process and strategy. Significant proportions of reinsurers cite a lack of human capital/specialised talent (88 percent), IT limitations (52 percent), and their own organisational culture (52 percent), as the three biggest obstacles to developing their innovation process (Figure 1).

Working together

When innovating to address these challenges, reinsurers take a more collaborative approach than other segments. Sixty-one percent of respondents said that they would prefer to improve or create better products/processes/services by partnering with another organisation. This is more than double the responses for building in-house 
(27 percent), while just 12 percent would purchase from an outside source.

Insurtech companies could provide cutting-edge solutions to the primary market and further enhance efficiency and improve data quality. Reinsurers need to understand how the risk profile and processes of primary insurers are changing as this will help them be better partners in risk management with their clients.

Reinsurers’ boards of directors seem in tune with their organisations’ innovation strategies and focus, as more than 90 percent of respondents discuss innovation at board meetings at least once a year, with one-third saying that they discuss innovation at every board meeting. Many boards discuss innovation throughout the year.

Further, those that discuss innovation more frequently tend to view industry implementation of innovation more favourably and have stronger opinions about clearly defining and communicating the innovative process throughout the organisation. A commitment to the innovation process throughout the organisation is essential.

Although corporate management teams and board members need to demonstrate leadership and buy-in at the top, all of a company’s employees can contribute ideas regarding day-to-day tasks, as they can directly see the obstacles in their daily functions and the potential benefits that a structured innovation strategy could bring.

As with any endeavour, implementing a project of this importance requires proper planning, preparation, and execution. However, allocating a portion of the annual budget to invest in innovative improvements does not seem to be a major concern for the segment, as only a quarter of reinsurer respondents stated that funding was a challenge.

More than half of reinsurers allocate between 1 and 5 percent of their annual budgets to innovation; the segment has the highest proportion (6 percent) of organisations allocating more than 10 percent of their total annual budget to innovation initiatives (Figure 2).

Just over half of reinsurer respondents have cross-functional personnel teams focusing on innovation. Twenty-one percent have dedicated innovation teams, the same proportion as those that have none. Only 9 percent of respondents have a chief innovation officer; another 15 percent outsource that function to a team that focuses on innovation (Figure 3).

AM Best notes that some companies may use a multi-pronged approach towards innovation, which includes using an outside provider and a dedicated internal team. However, we would expect that companies with fewer resources might rely on outside providers for innovation. Larger companies may develop technology in-house, but also use outside consultants to keep track of where the market is heading.

Catastrophe modelling has been limited historically by the lack of available data and investment in catastrophe risk quantification. Building robust catastrophe models is expensive, and premium volumes must reach a critical mass to make the investment commercially viable.

The evolution in technologies such as IoT, cloud computing, and AI has facilitated advances in analytical capabilities for reinsurers, allowing for stronger partnerships with cedants by enhancing their risk management.

Reinsurers typically have exposure to high severity, syndicated risks that are typically more complex. While machine learning and big data techniques help, these efforts will need to be supplemented by experience-based underwriting and human judgement.

This article and survey results are part of an extensive AM Best special report on innovation, Insurers Agree Innovation Is Critical for Future Success, published on September 24, 2018.

Sridhar Manyem is a director, Industry Research & Analytics, at AM Best. He can be contacted at: sridhar.manyem@ambest.com

Victoria Ohorodnyk is a financial analyst at AM Best. She can be contacted at: victoria.ohorodnyk@ambest.com