Risk and Opportunity

The property and casualty insurance industry is in the risk business. As an industry driven by risk, it is reasonable to assume that p&c insurers understand and manage risk better than most. However, only history, and thus hindsight, can prove this assumption right or wrong.

KPMG recently conducted a survey on risks and opportunities in the Canadian insurance sector, seeking to identify the top risks and the top opportunities perceived by respondents as it pertains to their businesses. The first-ever Canadian Insurance Industry Risks & Opportunities Survey, released in May, reflects the views of 172 participants, of which 58% are within the p&c insurance industry and 42% are in the life insurance industry.

TOP RISKS FOR P&C COMPANIES

Not surprisingly, regulatory and compliance burden was identified as the top risk by two-thirds of survey respondents (see chart on page 20). The introduction of Own Risk and Solvency Assessment (ORSA) for federally regulated insurers in 2014, as well as auto insurance in Ontario, are certainly subjects of intense focus at this time.

Furthermore, it is soon expected that the provincial regulators will follow regulatory trends in both the United Kingdom and the United States, bringing market conduct to the fore.

Without doubt, catastrophic loss events that took place in 2013 weighed heavily on the minds of Canadians. Prior to 2013, the increasing frequency and severity of water-related disasters had already begun to make waves. Water Damage Risk and Canadian Property Insurance Pricing, a research paper issued by the Canadian Institute of Actuaries in February 2014, states that the past is no longer predictive of the future, and identifies numerous reasons behind the systemic under-pricing of water damage risk in the insurance industry.

When examining these reasons, it is hard not to ask why industry stakeholders did not already know this. Why could industry not have taken action earlier? Remember, hindsight is 20:20, and although identifying the risk is the first step, it is not necessarily the most important one. The most critical element of risk management is what action is taken and when. Of course, the cynic would say that there are no prizes for acting pre-emptively on a risk that never happens, but then, that is what risk management is all about.

One of the more interesting findings presented in the water damage research paper is the impact of human behaviour on the increasing water-related losses. Human behaviour (often referred to as behavioural economics) is a subject of increasing research, looking to explain how people make economic decisions that are not consistent with conventional wisdom and economic facts.

The number of people living in areas considered to be earthquake zones who do not have earthquake insurance is a clear example of behavioural economics at work. The rational decision would be to buy insurance, but the observed human behaviour provides a different story.

Increasing collective understanding of behavioural economics is an important key to better managing risk in the insurance industry.

EMERGING INDUSTRY RISKS

When asked about risk, people tend to first consider their immediate outlook. It is common to consider what is top of mind, possibly even overstating an immediate risk, while understating future risks. As such, emerging risks or risks with longer timelines may not get the attention that they should – as possibly reflected in the KPMG survey top identified risks. It is best not to forget that at one point water-related loss was itself an emerging risk.

Today, many insurers are focused on the business opportunities provided by telematics and big data. However, in the longer term, the widespread adoption of driverless cars, although not identified as a significant risk in the survey, does pose a significantly disruptive risk to the insurance industry – thus telematics may be just a passing fad on the insurance continuum.

Those in the insurance industry should be considering how adaptive and flexible the current business model is with regard to the insurance industry of the future. The potential for new entrants with disruptive business models, whether auto manufacturers or companies like Google, cannot be ignored. To mitigate these emerging risks in the insurance industry, it is necessary to incorporate time-based scenario planning as part of the risk management process.

TECH AND CYBER RISKS

In an industry bedeviled by legacy technology, 45% of respondents identified the cost of IT investment as a significant risk. Cost overruns, delayed implementation timelines and concessions on functionality delivered are historical truisms of the changing world of technology.

Notwithstanding significant IT spend in the p&c industry between 2006-2012, the industry has yet to see technology investment drive down expense ratios.

Based on KPMG calculations for a select sample of 12 larger p&c insurers, their expense ratio (commissions and general expenses, excluding taxes) went from 26.4% in 2006 to 26.1% in 2012. This is a significant risk for the future of the insurance industry, especially while anticipating new entrants into the industry at some point down the road.

One risk that surprisingly did not gain prominence in the survey was cyber security and the associated reputational risk. It is certainly a risk perceived by the media and broader market, as companies scramble to acquire insurance coverage protecting themselves against the impact of cyber attacks. Despite survey findings, more recent anecdotal evidence suggests this risk is rapidly gaining mindshare with industry executives.

TOP OPPORTUNITIES FOR P&C FIRMS

Turning to the opportunities available to p&c insurers, respondents surprisingly identified the need for improved understanding of risk and capital (ORSA anyone?) as a top opportunity.

This response is likely driven by two primary factors: a better understanding of capital requirements is necessary to fuel more informed decisions, and a broader and deeper understanding of risks across the organization is desired, and may be driven by discussions during the development of Risk Appetite Statements.

Customer data analytics

The other top opportunity identified relates to the use of technology and customer data analytics to enable better underwriting, pricing and marketing. The opportunity to gather data (both structured and unstructured) and then analyze it to identify profitable market segments and better understand the risk profiles – for specific market segments, geographic regions or specific risks types – means that the insurance industry will seek to obtain far more information than it can and does today.

The industry will also need to attract a new breed of employee: the data scientist. This person will have skills in data mining, analytics, math and statistics. They will need to be able to explain the data collected and what it means, in a way on which the business can profitably capitalize.

The main challenges here are two-fold: first, the insurance industry must convince bright young people (the data scientists) that their future lies in the

industry; and second, the regulatory environment must be responsive and collaborative so as to allow companies to take advantage of the opportunities that will be available. Certainly jurisdictions with a “file and use” regulatory approach enable companies to take more timely advantage of the insights gained through data analytics.

Technology and process improvement

Interestingly, technology and process improvement was considered a significant opportunity by more than half of the respondents and, thus, represents both one of the main opportunities and one of the biggest risks in the industry.

It has been clear for many years that p&c companies must improve their business processes. It is a lso clear money invested in new technology has yet to deliver industry-wide reductions in ongoing operating costs.

Despite these challenges, customer preferences are changing and they want services provided differently than in the past. To satisfy customers, new technology that meets these preferences must be deployed. Ultimately, the deployment of technology must be less about cost and more about service.

Generally, in the current environment, managing risks and capitalizing on opportunities is an extremely dynamic process. The question is, can the insurance industry evolve as rapidly as the risk environment that exists today?