After 2017, which was an annus horribilis for the world with an unprecedented wave of man-made, natural and emerging risks, two critical flaws in the insurance industry’s operating model were revealed. The first is that basing a business model solely on the cost of capital will engender a race to the bottom commoditizing even novel products, such as cyber insurance. The second, is that while insurance is generally understood as a proven form of protection, the fact that it is a terrible form of liquidity affects insurers and customers alike in some insidious ways. Rectifying these imbalances will be challenging for many of the largest players, thus creating an opportunity environment for entrepreneurial approaches that leverage technology, such as blockchain, artificial intelligence and parametric solutions, to make insurance a nimbler form of assurance in a complex world.
2017 produced anywhere between $300 and $500 billion in economic losses. Of this number, the typical sum that is covered by insurance is around 21%, begging the question what happens to the rest of these economic losses? What happens to the people, households, businesses and communities that are affected? In effect, they fall through the cracks and are either saddled with the economic and reconstruction costs on their own, or as is the case with Gulf States, such as Texas, which has had 3 500-year flooding events consecutively, or Puerto Rico, people are displaced by the hundreds of thousands. Herein, the fact that the typical insurance claims process labors under so much mistrust, red tape and the need for third-party verification, such as loss adjusters, multiple repair estimates, among others, reveals the human toll of the global insurance gap. It is all the more crippling as many cities and communities face widescale threats, from the smoking crater variety to the intangible, such as Atlanta’s ransomware attack and the spread of communicable diseases and fear, which can render all productive assets in an economy useless.
Driving more insurance penetration, according to Lloyd’s, can have a significant impact on enhancing national resilience. A compelling report by Lloyd’s indicates that a 1% rise in insurance penetration, equals a 22% decrease in the tax-payer burden of economic losses. Indeed, this revelation, combined with the heavy financial burden response agencies like FEMA incurred on the public balance sheet, informs the agency’s strategy to crowd-in more private sector risk capital to hedge against natural disasters bridging the insurance gap. It is worth noting that FEMA entered the 2017 calendar year – one with 137 disaster declarations across the U.S. – with insufficient liquidity to respond to Hurricane Harvey’s “nuclear” rain bomb. But for an 11th hour “line of credit” from Congress, the agency’s response budget was immediately exhausted in Harvey’s wake. Proving that risk, being such a capricious force, does not respect quorum or budget allocations, FEMA’s Hurricane Harvey earmarks were quickly diverted (and depleted) as Hurricanes Irma and Maria wrought their devastation across the Caribbean, levelling Puerto Rico, the USVI, Florida and Georgia. While record-breaking hurricanes lashed the eastern U.S., record-breaking floods drowned the Gulf region and record-breaking wildfires hobbled California. The U.S. has had more disaster declarations in the last 17 years, than in the preceding 47. Since 2000, the average national disaster declarations jumped from 39 to 124 per year.
Many affected (and insured) households are still waiting for claims payments more than a year after these initial losses were incurred. While theoretically these communities are covered, the fact that the claims process is so burdensome only adds insult to injury greatly challenging the value added by the insurance industry when people need them most. Part of the challenge is that most insurance policies are recorded using analog methods. Excel spreadsheets called bordereaux are one of the predominant models of recording insurance policies at Lloyd’s. The Excel spreadsheet in these examples is the enemy of moving swiftly, providing transparency and, perhaps most importantly, ensuring error-free protection at the time of a claim. Just as the advent of insurance keeps many attorneys busy. Analog policy records keep many auditors gainfully employed. When an insurance claim is initiated it triggers a wave of activity from insurers, the first questions being: who is insured and what is the possible economic loss? The customer meanwhile, to the extent they are insured, probably has no access to their paper-based, analog insurance policies, let alone an intimate understanding of their rights in these contracts, such as the claims notification period, their obligations to protect property to stem further losses, among others.
The evidentiary burden alone following a claim creates a gaping hole in which insurers and response agencies can deny a claim or grind a response process to a halt. Along these lines, 60% of FEMA claims in Puerto Rico have been denied or slowed down due to the lack of evidence of property ownership or title. Puerto Rico, like many places on the planet, labors under an analog, one-sided property registration system, with high degrees of informal housing and land parceling adding to FEMA’s burden and Puerto Rico’s misery. However, the model highlights the challenges in the protection versus liquidity gap. In 2017, nearly the entire Florida pan handle was under an ordered evacuation due to the advance of Hurricane Irma. For poorer residents, even if they were insured against property risks, this evacuation order may have been impossible to heed due to the lack of money. Perniciously, most Americans are a check away from bankruptcy, but generally well “protected” by a wide range of compulsory insurance programs from auto coverage, to worker’s compensation, homeowners or renter’s insurance, among others. The informational asymmetry in this protection greatly favors the insurance industry, while adding to the cost and complexity insurance labors under.
Enter the world of blockchain and the insurance advancements from protection, to speed of response and liquidity, and a wholesale rethink of the insurance value chain is possible. Parametric claim triggers (wherein a claim is acknowledged and recorded in an automatic fashion) are already de rigueur in the high finance side of the insurance market, such as catastrophe bonds, which follow seismic and meteorological triggers to acknowledge a claim, thus releasing liquidity. Reinsurance contracts are also interrelated in an analogous way, which is how the advent of properly structured reinsurance agreements can have credit enhancing qualities on even under-funded insurance companies. Taking these innovations “down market” to the household and business level creates a great environment for innovations.
Indeed, Etherisc, a blockchain-based insurance platform, is pioneering parametric micro-insurance in Puerto Rico to respond to wind-events, such as hurricanes and windstorms. Rather than shielding a claim behind red tape and a slow-moving claims process requiring in-person verification, Etherisc’s model follows designated windspeed thresholds at an insured, geo-referenced location as the claims trigger. Without blockchain or embracing technology as a part of the insurance value chain, these innovations would not be possible. The world needs more of them and insurers would be wise in accelerating their technology prototyping. A business model based solely on the cost of capital and outmoded actuarial models that are geared to maintain status quo while funding predicable claims seems to be a recipe for disaster, as 2017 proved. Global insurers are caught in an insidious trap between chasing low-interest efficient capital, while being saddled with high-cost inefficient claims processes, which in turn fuels the insurance gap and a wave of client-side litigation yielding higher costs of capital.
Indeed, for many life insurance policyholders where more than $7.4 billion in unclaimed life insurance proceeds are gathering interest without being paid to beneficiaries, customers may need some form of insurance on their insurance to guard against this asymmetry. At scale, the global insurance gap, the slow, inefficient claims process borne out of distrust combined with the informational asymmetries and agency issues that plague the insurance value chain adding to costs but not outcomes, scream for more efficient models. Technology alone is not a panacea, but it is a better start than waiting for another 2017 to pass before the insurance industry begins to take the calls for risk innovation seriously. Each unfunded loss arising from an insurable risk that ends up on the public balance sheet is at once a market failure moving national debt clocks closer to midnight, as much as it is a chance for the industry to adapt and respond. The future belongs to those insurers and brokers that get this recalibration right.
