After a series of big mergers at the end of the last century and a period of increasing financial stability, global insurance is now heading for a time of disruption and changing parameters: Climate change, pandemics, war and sanctions are becoming a part of the Western world. Inflation, digitisation, demographics and changes in work behaviour are among the most important factors affecting an industry that is still solidly based on 19th-century economic principles. How will global insurance and reinsurance adapt to new challenges and navigate the stormy waters of the 21st century?
It would be an exaggeration to speak of a “historical turning point” in the insurance industry, a term politicians nowadays use to describe global changes related to the war in Ukraine. Rather, we see a constant flow of changes having been made possible by technical improvements – both in know-how and advances in IT – as well as by management decisions, some of which set new directions in the development of this industrial sector.
A quarter of a century ago, when insurance managers were unsure if their clients’ data would survive the turn of the century because computers might not be able to recognise the new millennium, as the number ’99’ denoted contracts without a specific expiration – a phenomenon called the Y2K bug – there was even greater concern with respect to the level of operating costs. Too many employees administrated contracts and sold insurances only with the help of heaps of paper because IT was far from being fully automated. The answer to this was to merge companies to at least reduce overheads by creating a greater span of control. Statistics based on past premium and loss ratios, the “burning cost” method only considered past losses, and model calculations of future loss scenarios were too complicated and insufficient. Companies could only compensate for this situation with relatively high premiums, lower average wages, and substantial capital gains due to higher interest rates.
Technological transformation of the insurance world
The rapid development of IT office tools in the first years of the new century brought about a revolution (not only) in industrial risk calculation. For the first time, NatCat scenarios could be comprehensively evaluated and forecasts made, at least for catastrophes due to weather events. The tremendous development of access to the Internet made data collection from all parts of the world much easier. This has brought stability to the portfolio as insurers have gained a better understanding of the cost of claims that might be expected in the future.
Of course, losses from natural catastrophes increase further, there is a higher frequency and extent of individual events due to climate change and the concentration of insured goods in exposed areas, such as densely populated settlements on the coasts. These developments can still be included in the calculation of premiums. However, the weather phenomena that have increasingly occurred in recent years are a cause of great concern because their effects are longer lasting than those of individual events. First and foremost, it is the rise in temperature, especially in large cities, and large-scale droughts that claim numerous lives and destroy property every year. Especially in the case of agricultural risks, the limit of global insurance capacities is being reached. Hence, other means of compensating for damages must be found, often by the states themselves.
The insurance industry is therefore quite willing to adopt the efforts needed to achieve the Paris climate goals and other measures specified by EU legislation, such as the Taxonomy Regulation. For the time being, the leverage consists in restricting investments in companies that do not (or no longer) comply with the taxonomy as well as in refusing to insure such risks – the most typical example, at the moment, is coal. This strategy, known as “Net-Zero”, aims to encourage the transition to new processes for generating energy and new production methods in various industrial sectors.
Increased willingness to take over new risks
In the new millennium, great progress was also made in reducing the risk of fire through new, safer industrial processes, but above all through a greater awareness in companies for fire protection measures. This was one of the main drivers of the so-called soft market over the past two decades, which was not only a result of the commercial strategies of insurers. It is astonishing that this market behaviour has lasted for so long, despite insurers facing a constantly declining income from investments. At the same time, the results from sole insurance activities, defined by the “combined ratio” (= premium less claims and costs), have constantly improved.
This has also increased the willingness to take over risks that were previously considered uninsurable or very difficult to insure. These include the aforementioned natural hazards, including earthquakes, but also an ever-increasing expansion of coverage in business interruption insurance to cover risks associated with supply chains. It now seems that there are new restrictions concerning either the cover itself or individual premium corrections that are still pending. Hence, we may see a return to the hard market.
These transformation processes in technical, risk-related areas are not yet that spectacular. In fact, insurers are contemplating whether or not they should continue to have the same structure as in the past – as large, personnel-intensive companies that handle the entire business process from the first customer contact to the settlement of claims, from the maintenance of large office buildings to comprehensive processing of their own data. A number of external factors are responsible for the fact that it is more likely that these organisations will be split into small special units with increased outsourcing. In the core business, capacities are already being shifted back to special companies and outsourced underwriting agencies. Other areas, such as building management or data processing, are also suitable candidates.
Insurance transformation and Covid-19 pandemic
The Covid-19 pandemic – which has led to different financial burdens on individual insurance markets – has fundamentally changed the professional world through the widespread use of home office work solutions. Insurance is a particularly labour-intensive sector of the economy, but it has the great advantage that most of the work does not necessarily have to be carried out at the location of the company. Thus, home office work solutions will, at least partially, become the new norm in the insurance business of the future, with all the consequences, such as fewer office space requirements, more powerful IT systems and a stronger focus on social issues on part of management.
Even before the outbreak of the pandemic, there were intense discussions as to whether the sales process could be shifted to the Internet, just like in other business sectors, which would mean a drastic reduction in sales staff. Findings thus far show that the insurance customer likes to search for information and offers electronically, but still prefers the advice of a physical person when concluding an insurance contract. This can be explained by the complexity of insurance products as well as by the fact that most people interested in insurance would rather entrust their sensitive data to a person than to a machine. However, we can expect that future generations of “digital natives” will increasingly conclude their insurance contracts online. The insurance sector is therefore also investing in expanding its online options, for the time being primarily in products that require little explanation. The number of such products might increase in the more traditional or core areas of private insurance as well. The widespread shortage of skilled workers could fast-track this transformation.
However, insurance advisors do not have to worry that their work and jobs will become obsolete. On the contrary, providing expert advice about products will still remain their main task -, especially in corporate insurance, where the role of the advisor will gradually shift to risk evaluation and risk management. Additionally, they will also continue to provide certain ancillary services.
As mentioned above, insurers have significantly increased their willingness to take on new and additional risks in recent decades. In addition to the property insurance risks, new offers in terms of so-called Financial lines, covers such as D&O and Cyber, and even more special solutions are now a standard, not just for large companies. Currently, some rethinking seems to be taking place, partially initiated by the war in Ukraine. Insurers are rediscovering the possibility of saying “no” to certain risks across the board. An example is the exclusion of entire territories from cover, such as Russia, or the withdrawal from certain exposed sectors, such as Cyber. The principle that “everything is insurable as long as there is an adequate premium for the risk” is overridden when other fundamental factors such as the principles required by governance and compliance come into play.
Other challenges, such as the current inflation and the continued low investment income, which will probably also lag behind inflation in the near future, will not be discussed here due to a lack of space. These challenges have either subsisted for a long time or they keep coming back. The insurance industry has learned to live with them and is still able to report very good economic results every quarter.
In summary, the transformation in the insurance industry can best be described with an image: The market participants are developing from large tanker vessels, which operate with many sailors and use nautical charts made of paper, to fleets of small, largely automated ships, which are heading towards their ports of destination with the help of GPS .
Head of Insurance Mediation Services
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