The Future of Insurance

Amidst all the acquisitions and insurtech startups and disintermediation discussions, a bigger issue is being missed. The result is that all these firms are fighting over a dying industry.

The reason the insurance industry is dying –commercial insurance in particular — is because it no longer insures what is most important. This fact is one reason carriers have been so profitable over the last 20 years. Carriers have been truly profitable averaging around $55 billion in profit annually per A.M. Best. Any carrier losing money, of which quite a few exist, is poorly managed because the market forces are otherwise positive.

At this time, a mismatch exists between what needs to be insured and what is insured. Commercial clients do not understand the lack of coverages available, and the carriers are not offering to provide what is lacking. When these situations exist, one should expect moderate rate pressure (premiums have increased at about 4% annually over the last 20 years) and high profits because the true risks are not insured. This climate also explains, to some extent, why over reserving claims have been so continuous over the past 20 years (either that or the carriers have poor actuaries).

Here are some examples (based on A.M. Best data in its Aggregates and Averages benchmarking tool and the U.S. Bureau of Labor Statistics).

Claims per GDP dollar in 2019 were .000005293 (a microspec) vs .000007805 in 2004. There has been a steady decrease in claims relative to GDP for 15 years. To some degree the insured world is safer (carriers have increased deductibles to minimize small claims), but to some extent the decrease is because the industry does not insure what is important. A quick back of the envelope calculation suggests that in 2018 the industry would have incurred an additional 40 million claims had the industry maintained its frequency of 2004 (around 120 million claims were reported in 2018 relative to P/C). GDP has increased about 75% since 2004 and yet the number of claims reported has only increased about 18%. Claims dollars have only increased by about 50%.

Claims per NPW dollar have similarly decreased though not as smoothly. Hail claims seem to be the random factor, but otherwise the downward trends are fairly smooth. Even the average size of claim per GDP dollar is decreasing. Carrier management may not be celebrating all their profits because it seems like every carrier headline forecasts future profitability problems, but they are making extra money for now.

The nut of the problem is that hard, tangible assets are simply no longer that important and yet that is what insurance companies insure. This is a problem not only for the insurance industry but also for many other industries. The accounting industry has an issue because accounting rules and metrics for measuring company health are designed around tangible assets. Many companies have recognized this issue and have figured out how to make themselves look much healthier than their current reality would indicate. Accounting rules need serious updating. Another example of an issue the accounting industry is not adequately addressing is amortization and goodwill and goodwill impairments depending on the type of intangible asset involved. The rules were designed for simpler tangible assets.

The banking industry has an issue because having real estate as collateral is a pretty easy assessment. When one has an intangible asset such as a patent, a copyright, software, or even expirations as collateral, an assessment becomes more ethereal which in many ways makes offering loans and getting loans in today’s economy much more difficult.

Here are some facts. In 1980, around 13.5% of business output was invested in tangible assets and only 9% in intangible assets. By around 2015, the ratios had flipped resulting in a 50% increase in the investment in intangible assets (as reported in The Economist May 8, 2021) which means there are fewer tangible assets to insure.

Aon completed a study in 2019 that intangible assets total $19.8 trillion of S&P’s assets. That is 5.25 times more than all the tangible assets combined. Which seems like the better market: $19.8 trillion or $3.7 trillion? The insurance industry is focused on a relatively small set of assets that keeps getting smaller.

Why Insurance Must Pivot

The insurance industry, like banks and accounting firms and governments, must pivot to accept reality – something none of these industries do well until the last second. The key at the carrier level is to begin figuring out how to insure intangible property.

A fantastic example is that if a building burns down it is replaceable, often overnight, in a slightly different location. If a restaurant is shut down because of civil authority, it cannot reopen anywhere. That is a far worse risk to carriers and something of far more importance to the owners of that restaurant than insuring some stoves, silverware, and plates. Today, we are seeing businesses go bankrupt not because of theft, or fire, or lawsuits, but because of supply chain disruption and ransomware which are all intangible factors.

Insurance companies typically move with the nimbleness of hippopotamuses, with no offense to the hippos. If you are at the agent or broker level and don’t want to wait to insure what really matters in the current economy, many good places exist to start. The easiest place, though quite difficult, is to simply learn your existing coverage options. Quite a few good forms exist that can cover material intangible assets, and frankly, the fact that more insureds do not have these coverages is an agency deficiency and not a carrier issue. A case in point is how few brokers know how to structure business income coverage well. They think it is like a property form when it really is a form that must be specifically tailored to each client. Business income is arguably the most important property form (though it is not really a straight property form) that exists.

Cyber coverages, at least the good forms, provide some excellent coverage for intangible assets.

Do not confuse the forms that provide liability coverage relative to intangible assets with property forms. Again, cyber liability coverages need to be designed, though to a lesser degree than business income, as defensive in case the insured is sued. If someone from another country steals intangible assets (property), these forms do not protect you. However, if your client is sued for stealing with regard to cyber, they might offer some coverage. Your clients need coverage for the theft of their most important assets, not their pots and pans.

There are some coverages available but they are difficult to find. You’ll have to search hard in some cases, but it is worth the effort. In many cases agents and brokers must become much more educated regarding risk transfer, including alternative risk transfer, because that seems to be where most of the innovation is occurring. But anyone thinking they don’t need to know cyber in depth and that the sexiness of the solution eliminates the need to get a great education on the subject is one foolish person.

To remain relevant, the industry needs the products and the education. One without the other is useless. The trends are clear that the industry is making itself obsolete. You have a choice to remain relevant or go the way of the dodo. What will your choice be?