A recent McKinsey report questioned the relevance of the insurance industry in the future, and said it was time for insurers to act. The hard-hitting report warned that the fundamental structure of the insurance industry is coming into question, and even its relevance. It said half the players in the industry do not earn their cost of equity.
Criticising the sector’s structure and focus is one thing, but questioning the relevance of insurance is another thing entirely. It has often been pointed out by risk managers that perhaps the majority of their risks, or some of the biggest, are uninsurable. And of course, many risks are handled through treasury, via hedging and the like, or through contracts. But would the world of risk really be better off without insurance?
Here are ten reasons why commercial insurance is still relevant (just):
1. Nat cats on the increase
As climate change develops, it is clear that natural catastrophes are on the increase, both in size and in frequency. Every year, stories come in about it being the worst year on record for nat cats. Secondary perils are becoming more of a concern than the big cats, and weather patterns are changing, so for example, hurricanes in the US are moving northward. And becoming more severe.
2. Emerging risks continue to emerge
New risks will always emerge as technology and society develops. And while the insurance industry is not the quickest to respond, it usually gets there in the end. Capacity can of course be an issue, as well as price hikes when it all goes pear-shaped (as with cyber currently) but at least some cover is there. The alternative is simply taking all the losses on the chin. And yes, governments can help in the short term, as with the Covid-19 pandemic, but they all want to pull out as soon as possible.
3. Growing need for excess coverage
The current hard market has of course led many organisations to increase retentions and look at self-insurance. Captive formations are on the increase and captives are writing more business than ever before. But this does not preclude insurance. The demand for excess coverage, reinsurance, stop-loss protection and so on is also on the increase as a result. Dollar/euro/pound swapping with insurers makes no sense, but no corporation wants to take the cat risk or the aggregation risk, apart from the insurance industry.
4. Expertise on risk
Insurance as a concept is based on sharing the risk out – the losses of the few are paid for by the premiums of the many. But there is also the sharing of loss information of the many. Market information and benchmarking are an invaluable part of the insurance world. Insurers are spending fortunes on improving their data management and analytics because they understand its value. Insurers are experts on risk – they have to be to stay in business.
5. Smoothing the balance sheet
Without insurance, with losses absorbed as they happen, the finance director would be fuming. The balance sheet would be all over the place and future financial planning would be out of the window. Now, that is not to say insurance is perfect. The underwriting cycle is also a nightmare for finance directors, when premiums rise for no apparent good reason. But in general, insurance is a tool to smooth the risks, smooth the impact of losses and keep board members happy (especially with good D&O cover).
6. What are the alternatives?
The insurance industry has survived and thrived for centuries – it is tried and tested. There are alternatives but they have always remained peripheral, or been used hand in hand with insurance. Capital markets and ILS structures have their place, but usually only for reinsurers and for very large corporations, as they can be expensive and cumbersome. Parametric solutions are much talked about and have their place but they have many limitations.
7. Social inflation
The cost of litigation, the huge awards in the US and the growing litigiousness of the world is a growing concern for companies. It is spreading from the US, and as class actions and litigation funding take hold, companies are unable to cope with the huge financial hit of such actions, when settlements can be in the billions of dollars. Juries distrust large corporations and naturally want to severely punish big business when it gets it wrong. Social inflation is certainly not going away.
8. Innovation is happening (slowly)
The insurance sector is not known for being dynamic, innovative and forward-thinking. But the image of the Lloyd’s underwriter with a quill pen is long gone, and the industry has woken up to the benefits of digitalisation and new technology. Insurers are investing huge amounts in digitalisation, AI, blockchain, APIs and tech generally. And it is engaging with innovators in the form of insurtechs and MGAs to find new ways of working, new solutions and new ways to interact with clients.
9. Unpredictability is the new norm
As someone once said: “The future ain’t what it used to be.” There are now too many ‘unknown unknowns’. Modelling is becoming more difficult, which means risk planning and mitigation becomes that much more difficult. Insurance has always been about the unexpected loss. And in the modern world, the unexpected is now increasingly likely (though not predictable). In such a world, insurance is more relevant than ever.
10. The soft market will return – it always does.