The Future of Insurance Vulnerability - A Climate Change 'Stress Test'
The Future of Insurance Vulnerability - A Climate Change 'Stress Test'
TMT risk management has been, in effect, put to a stress test in recent years with a combination of events that include digital transformation, rising trade tensions and the global COVID-19 pandemic. Results are mixed.
The pandemic caught parts of the industry unprepared. Some risk managers found themselves digging through insurance policies to find what might or might not be covered when employees were forced to set up home offices. Bigger risk management challenges arose as business models and operations seemed to change by the day.
Finance executives, risk managers and other business leaders have learned from this experience, but they are left now to consider what the future risk landscape will look like and, importantly, what steps they can take to anticipate, mitigate and finance these future risks of unknown shape and scope, including the global implications of climate change.
It is useful to consider climate change from a risk perspective because addressing change of this magnitude will require every tool in the risk management toolbox plus risk financing arrangements that may spur the growth of alternative risk transfer (ART) options while accelerating change within the insurance and reinsurance industries.
Climate change will profoundly reshape each of the five risk megatrends that we have identified in this report, including risks surrounding business models and operational complexity to more exacting regulations, technological advancements and talent. Recognizing and explicitly considering the interconnections is the approach the geopolitical risk practice uses. In an increasingly connected world, many of the drivers of risk are interrelated, and effects often cascade beyond local geographies or individual industry sectors.
For a more detailed discussion of climate change risk, see a Willis Towers Watson perspective, “Why climate change is a particularly challenging risk for strategic CROs.”)
To assess the applicability of ART solutions, risk managers should approach the renewal process with robust analytics and clear risk tolerance analysis. This will allow them to effectively determine the value of these products in minimizing total cost of risk scalation in this challenging insurance market.
To put it bluntly, there may not be enough traditional insurance and reinsurance capacity to deal with a profusion of windstorms, coastal flooding, fires, droughts and other possible consequences of climate change even if leading sources of pollution and environmental damage where scaled back tomorrow. So, what is a company to do?
Your risk appetite
More effective data mining and analytics also enable companies to build a model for the total cost of risk. This involves identifying exposures and risks and modeling the loss frequency, severity and volatility of each. Risk modeling outputs can then be examined within the context of risk appetite, cost of capital and the cost of transferring risk. This way you define the optimum balance between risk retained on the balance sheet or captive and risk transferred to the commercial insurance or capital markets.
Data can also work its magic if a company designs a single integrated program that typically sits in excess of a balance sheet or captive retention. These can accommodate different attachment points of each line of business depending on the exposure, modeled losses, desired balance sheet or captive retention and any required mono-line participation.
The upshot is that knowledgeable risk takers, leveraging data, can maximize stakeholder value and empower key decision makers to build bolder business visions and resiliency.
Insurance/reinsurance
Insurers are often seen as slow to change. Clients and consumers are sometimes exasperated by seemingly sluggish or opaque underwriting practices, or perhaps client services that fall short of buyer expectations shaped by on-demand services and same-day parcel deliveries. Insurers, however, will change — they will have to.
Willis Towers Watson has identified several healthy signs within the industry. In the non-life segment, we are seeing trends that include:
More effective use of data and analytics, including artificial intelligence, in their work insureds and their advisors to identify, measure, mitigate and finance risk.
Product innovations, such as parametric solutions or usage-based insurance.
More efficient and profitable operations from modeling and analytics to distribution and from talent development and rewards to investment strategy.
Consider underwriting. Fueled by an explosion of data, low-cost data storage and open-source technology, artificial intelligence has the potential to help underwriters analyze an incredible amount of information, find red flags and help make more accurate underwriting decisions.
In the not-too-distant future, underwriters will be expected to work alongside AI systems to ensure all risks are accurately measured and priced. As underwriters increasingly interact with automated AI systems, there will be a need for new skill sets to develop, with some old skills potentially becoming obsolete. The progress we see in underwriting is evident in other core insurer functions, such as claims handling.2021 outlook survey said the pandemic “showed how unprepared our business was to weather this economic storm.” However, a major reinsurer notes that the insurance industry entered the pandemic well capitalized with global premiums expected to return to pre-pandemic levels by the end of 2021, non-life leading the way.
Potential disruption faces life and non-life insurers from alternative insurance providers, including Google, Apple and other big tech companies, though possibly in partnership with insurers. CB Insights , a business analytics platform, notes that smart home devices can alert owners and insurers to, say, a broken pipe. It is easy to see this example on a far greater scale, leaping to the broader Internet of Things with commercial application to monitor any number of potential exposures. This is all the more reason for insurers to step up the pace of their digital transformation to stay in the game.
Alternative Risk Transfer
Alternative risk transfer (ART) solutions, have been the vanguard of insurance innovation for decades. Captives, integrated risk, catastrophe bonds, insurance-linked securities and other products that are now widespread started as customized solutions for certain narrowly defined exposures, such as windstorm or earthquake or non-damage and potentially uninsurable business interruption risks.
When insurers withdraw coverage, ART solutions can provide cover, capping per claim volatility or aggregate volatility, obtaining desired limits and deductibles. While sometimes difficult to structure, these alternatives can provide protection that might otherwise be unavailable for catastrophic risk while mitigating the financial impact.
Willis Towers Watson expects relatively new parametric solutions to become a more popular ART option. Parametric solutions differ from traditional coverages because they respond to movements in an index or the occurrence of a pre-agreed event, such as extreme weather. Advantages include minimal proof of loss requirements and prompt claims settlement.
We find parametric solutions of greatest potential value for organizations exposed to uninsured natural catastrophes or large aggregations of risk within catastrophe deductibles, industries impacted by weather generally, and businesses with non-damage and potentially uninsurable business interruption risks, such as failures in their supply chain.
For insurers, robust independent data, vetted analytical models, new technology and greater client awareness are leading to favorable combined ratios. We see insurers continuing to allocate more capacity to parametric solutions.
Other sectors of the ART market are challenged or contracting. Portfolio programs (or integrated risk programs) are attracting less capacity, driven by carrier uncertainty, coverage limitations, increased deal committee conservatism and long processing times. These markets are moving toward structured programs where they can limit downside risk.
For those buyers who face limited traditional options and can absorb significant risk, a captive insurance company can be a strategic alternative used in conjunction with other ART solutions to provide efficient fronting, or to control volatility and protect capital and surplus.
To assess the applicability of ART solutions, risk managers should approach the renewal process with robust analytics and clear risk tolerance analysis. This will allow them to effectively determine the value of these products in minimizing total cost of risk scalation in this challenging insurance market.
