Insurance Outlook 2018
Chief Financial Officer, Hamilton Insurance Group
Insurance Risk & Capital
October 20, 2017
Hamilton Princess, Bermuda
Insurance Outlook 2018
Good morning. It’s a pleasure to be with you today.
I’m going to be giving you my observations on three topics this morning:
- I’ll talk about some current dynamics facing our industry as well as the market cycle;
- I’ll take a look at risk management in the 21st century; and
- I’ll give you an overview to what I’m calling the peril and promise of the protection gap.
I know each of these areas will be discussed in some detail during today’s conference, so hopefully my comments will give you some food for thought.
Let’s start with what’s shaping our industry as we head into the closing months of this year.
It goes without saying – and I’m not the first to say it – but we’re doing business in a new normal.
Even without the impact of this season’s storms on the current cycle, our market is undergoing a transformation.
There’s no mystery to how we got to where we are today: a prolonged period of low-to-no interest rates, a lack of catastrophes, reserve releases and the influx of alternative capital. At the same time, we are facing a potentially explosive increase in new risks such as cyber security and climate change. This market cycle is forcing our industry to face some inconvenient truths.
M&A, restructurings, reserve releases, collateralized vehicles for fee income – most companies have pulled all the traditional levers that can be pulled to cut costs, expand product offerings and stay out of the red.
The reality is this: we’ve let a lack of catastrophes mask our sector’s inefficiencies for too long. Disruption in other industries has created an expectation of what the customer experience should be like in the 21st century. The cumbersome, costly and time-consuming processes that have hindered our progress won’t be tolerated by today’s or tomorrow’s clients.
A competitive future lies in the ability to be nimble and responsive. And it’s not going to be enough to be data-driven. We have to be data-savvy. This isn’t easy if you’re a carrier or reinsurer with several decades of cumbersome legacy systems and a traditional corporate culture.
Our industry has been a laggard in embracing the digital age, but I believe that 2018 is going to be the year when robotics, artificial intelligence, machine learning, and the Internet of Things move quickly from the abstract to the concrete as we work to meet the needs of our customers.
The new normal doesn’t just apply to insurers or reinsurers. It applies to brokers and agents, too. Everyone’s role in the insurance value chain is in transition.
A number of our sector’s leaders are pretty blunt about this: the company with the best talent and the best tools is the company that has a chance of survival.
For some, the road to salvation is paved with partnerships between insurance and technology. In other words, insurtech.
Investment in insurtech has exploded this year.
The InsureTech Connect conference in Las Vegas earlier this month attracted over 3,700 attendees. This was only the 2nd year of the conference and it was not just techies – the event was loaded with CEOs and, frankly, just about all the movers and shakers of our industry. Everyone is taking InsureTech seriously.
Here in Bermuda, if we’re not leading we’re usually not far behind. Global Reinsurance, working with the Bermuda Business Development Agency, is producing our very own inaugural Bermuda InsureTech conference on November 6.
An important point to make is that being data-driven has often in the past been viewed as better leveraging the huge quantities of claims data and underwriting performance data and being able to use that data to select and price better and be more predictive.
That’s all good, but those efforts can be dwarfed by utilizing the seemingly unlimited amount of data that is literally tracking and measuring human behavior and the planet in new ways every day.
If you accept that data and the ability to use it smarter, faster and better is going to drive change in our industry, then you already know that there are two ways this will play out.
One is that technology is going to reduce the costs and streamline the inefficiencies that plague our industry.
The other is that data science and analytics are where real innovation will be found.
I’ll use the company I work for as an example. Hamilton’s focus is on using technology and data science to create a nimble, responsive, client-centric company that can succeed in any market.
In the four years since Hamilton was founded, we’ve developed a platform that’s disrupting a market segment. Behind the scenes, we’ve developed technology that’s improving how we write business.
On the market-facing side, Hamilton owns one third of Attune, the US-based MGA doing business in the small commercial insurance segment.
Attune arose from research and development that we initially did at Hamilton USA with our technology and investment partner, Two Sigma. It caught the attention of AIG and the result was Attune, which was launched just over a year ago.
For most of Main Street USA, insurance is, of course, necessary to have but painful to secure.
The pain comes in the massive amount of paperwork required to get basic coverage like Business Owners Policies, or BOP.
For distributors and for the insured, getting a BOP policy executed is a headache.
Enter Attune. Using proprietary as well as publicly available data, we’ve been able to reinvent how these policies are priced, written, issued and bound.
Inside Hamilton, we’re making sure the right IT foundation is in place to streamline our processes and strip out inefficiency. This is a key priority at Hamilton Re, our Bermuda-based operations, and at Hamilton Underwriting Limited, our platform at Lloyd’s.
At Hamilton Re, we’re enhancing our proprietary Risk and Analytics Platform, which we call HARP. HARP stands for Hamilton Analytics and Risk Platform.
HARP lets our underwriters examine 200,000 scenarios of risk simulation in a matter of seconds, and perform portfolio rollups and analytics in a matter of minutes. The speed of the analysis and the richness of the data give our risk analysts and underwriters astute insight into trends and helps them develop better products and services.
At Lloyd’s, we built an end-to-end processing platform supporting our operations faster than any syndicate ever has. Lloyd’s is a restrictive market where innovation continually bumps up against four centuries of tradition – but even in that context, Hamilton is delivering added value to the brokers we do business with.
However, in the new normal, cost cutting and efficiencies through technology are table stakes. We all have to be able to do that.
As I said earlier, to transform our industry into one that’s relevant and competitive, you don’t just need the right tools. You need the right talent. Attracting that talent to our industry isn’t that easy.
We’ve done a terrible job in selling our value proposition.
Our industry is purpose-driven: we exist to provide protection and recovery. We enable businesses to launch and homes to be purchased. We help communities and countries rebuild after disaster strikes.
In the recent press releases regarding Harvey, Irma and Maria’s impacts, many of our Bermuda insurer and reinsurer CEOs recognized the human suffering and delivered good messages about how were are enabling recovery, but some still really missed the boat and only spoke about their organization’s balance sheet capability and book value impact. What a shame.
Our former CEO Brian Duperreault once said insurance should be catnip to the Millennial generation, who care so much about having a job that makes a difference.
But in most of the world, our image is woeful. In the US and the UK, less than 5% of high school and college undergrads even consider a career in insurance. In the US, there’s a looming talent crisis as more than 300,000 managers approach retirement in the next three years.
No one is clamouring to take their place. In fact, if every student currently studying for a degree in insurance or risk management was hired when he or she graduated, there’d still be a massive talent gap in the US industry.
In Bermuda, it’s a bit different. The insurance and reinsurance sectors have a high profile here. This is one place where it’s sexy to be an actuary. But our market isn’t labour intensive, there aren’t a lot of entry-level jobs and we have a ways to go before we can say it’s diverse. The challenge we have is to make sure Bermudians are trained in the right fields with the right skills, and understand the criteria for getting a job.
The good news is that the skill sets we need are expanding dramatically, which broadens the career prospects for Bermudians. We still need underwriters, actuaries, accountants and lawyers. However, as the industry transitions from analog to digital, most insurers and reinsurers are casting their recruitment net far beyond the confines of the traditional skill set.
At Hamilton, we’re hiring software engineers, data scientists and systems developers. These employees don’t necessarily know much about insurance but they know how to build the programmes we need to interpret the data we produce.
These types of employees bring a fresh perspective to the underwriting process. They’re helping our industry respond to the needs of today’s clients.
While we’re on the subject of talent, it’s widely known that today’s Millennial generation is diverse. I attended the Bermuda Human Resources Association conference last week, and one thing I learnt is that the Millenial generation, as well as being more diverse, is the most educated generation ever. When they consider what company they’d like to work for, they put a lot of weight on how diverse and how inclusive the organization is.
I’m very proud of what Hamilton is doing with respect to gender diversity. We have a significant number of women at the top levels of our company, including several Bermudians. As a male executive working in a tradition-bound business, I know that our company is far stronger because women are well represented at our executive table.
Yesterday, we announced that Pina Albo has been appointed as our new CEO of Hamilton Insurance Group. Pina was a member of the Executive Board of Munich Re, and I am thrilled that she will be our new leader.
Like many other companies, we have a ways to go with the gender balance of our Board and we need improvement in broader forms of diversity. These are issues we need to solve.
While the factors influencing how our sector operates are changing profoundly – almost in real time – there’s growing consensus that, after this year’s storm season, the market is going to shift.
The three big hurricanes that devastated so much of the US and the Caribbean, as well as the earthquakes in Mexico, are expected to result in $100 billion of industry losses.
There’s no question that rates are going to harden in some lines of business. Terms and conditions are going to tighten. You can call it what you will – a market turn, a hardening – but 1/1 renewals are going to be different this year.
The main reason for an improved rate environment is that there’s been inadequate, even irrational, pricing for too long. As I said earlier, a lack of cats has subsidized the broader market.
So, how do we frame the current state of play in the context of history? I would draw parallels between this year and 2001.
Prior to the attack on the Twin Towers, the industry had been in a deep and prolonged soft market dating back to the mid-90’s in most lines. In the context of turning the market, 9/11 industry losses weren’t that high. They were about $40 billion dollars (which is perhaps $60 billion equivalent in today’s dollars).
But the market hardened almost overnight. In Bermuda, we saw the formation of at least five organizations who became the Class of 2001.
For further perspective on 2017 versus the 2001 cycle turn, consider that one of the large cat writers in Bermuda, RenaissanceRe, reported $625m of net impact from the recent cat events. Compare that with 2001, when RenRe reported $48m of net losses from 9/11. Even adjusting for time value, that’s a huge difference. Indeed the 2017 estimate is about 13% of TBV versus about 6% for 9/11.
It was the deep soft market preceding 9/11 that required the correction, with 9/11 being the catalyst. The similarities to the current environment are clear, but there’s some key differences too.
Leading into 2001, there was far less transparency on reserves and a sense that industry reserves were deficient. This “sense” was ultimately proven, as billions of reserve charges were reported in 2002 and 2003. This is in contrast to today where confidence in the adequacy of reserves is generally high. Note that I use the term “generally” as I have no doubt there are companies and segments of the market with deficient reserves
In 2001, investors looking at the sector didn’t want to lose 10-20 cents on each dollar to reserve charges. That built the appetite to invest in new formations.
In the years since 2001, a well-documented and robust ILS industry has emerged and provided many new ways to invest in the industry, and at the same time the traditional companies are far less leveraged in terms of net catastrophe risk. So there isn’t the same need or desire for significant new organizations to form, but there is still the same need to restore rationale pricing.
We need to provide better coverages and solutions, and I’ll get to that later when we speak of the protection gap, and we need to be paid appropriately for the risks we do take.
Margins in most lines of business are wafer thin or non-existent. Retro pricing has already increased significantly, so there are no other levers to pull. And fixed income earnings are not helping either with 5-year Treasury rates yielding half of what they offered in 2001.
Prices have to improve. Furthermore, the naiveté created by a sustained period of below-average cat losses has been wiped away. Nate was admittedly a small event, but it was the fourth hurricane in a matter of weeks to hit the US or Puerto Rico.
Ominously, we had four US hurricanes in 2004, only to experience perhaps the most significant cat year of all in 2005 with Katrina, Rita and Wilma. It’s hard to explain, but these catastrophe events do seem to cluster, just as the international cats did in 2011.
What will 2018 bring?
We don’t know for sure, but the capital depleted will be restored mostly through the ILS sector and special purpose entities. Why those entities, you may ask? Because they worked best after KRW. Investors always return to what worked best last time.
In 2001 there was a desire to repeat the incredible success of the Class of 1992, and even though the Class of 2001 was not as lucrative they enjoyed enough success to inspire the Class of 2005, but after KRW it was the alternative capital and the various temporary structures that allowed investors to most effectively get in and out, while the permanent companies generally struggled to deliver on exit liquidity.
For example, Ariel and Ironshore failed to IPO and even the companies that listed quickly had limited public float for a time, so most of the large founding investors in all these companies suffered through the 2008 Global Financial Crisis.
Now let’s take a look at risk management.
Risk management is at the core of our value proposition. Here in Bermuda, it’s fitting to use the success of the captive industry to explain.
The captive industry came to being 40-50 years ago, and captives provide fantastic risk solutions, but the captive concept was not initially embraced by the industry. The big brokers initially saw them as a threat and literally tried to crush the fledgling industry, which is ironic because today those same firms are the champions of captives.
But captives flourished not because they more efficiently facilitate the flow of risk to capital providers (they do); not because they allow companies to retain investment income on float (they do); not because companies can optimize their coverage structures (this is obviously a major benefit); the big win is that they fully facilitate risk management by enabling their parent organizations to retain the data and the risk awareness of what’s driving loss experience. So the captive industry flourished, nurtured by innovative leaders right here in Bermuda, and the success was because captives are by design customer focused.
In this global, digital age, risk management is incredibly complex and we need to be more customer-focused. So what are the concerns of our customers?
AON’s 2017 Global Risk Management Study surveyed 2,000 public and private companies and found that the number one risk that kept executives up at night is damage to brand and reputation.
Here’s the list of the top 10 risks that concern today’s global C-suite.
Most of these have been on other lists in previous years. The global economic, social and political events that are shaping our perception of risk make this year different. This is the first year that “Damage to Reputation/Brand” is at #1.
Think about what the past 18 months has been like. The UK voted for Brexit. The US elected Donald Trump as President. Nuclear war seems possible. The frequency and nature of cyber attacks ramped up. There were product recalls by major manufacturers with some, like Volkswagen, admitting to fraudulent activity in the very area they claimed to be leading. The rise of nationalism and populism has led to protests and violence in countries where once there was political stability.
These developments are shared around the world in split-second bursts on social media – sometimes accurately, sometimes with deliberate distortion or “fake news.” A tweet or a post can trash a good name and reputation, with serious financial implications.
Risk is interconnected in ways that would have been hard to imagine just a few years ago. The challenges facing those responsible for risk management are enormous.
The good news is that as we develop sophisticated assessment capabilities, we can harness the massive amounts of data available to us to make objective decisions about risk, both for our own companies as well as for the companies we insure and reinsure.
Finally, let’s look at the protection gap.
I referred to this as the peril and the promise.
Let’s look at the peril first.
Recent statistics indicate that there’s a 68% gap between insured losses and economic losses from catastrophic events.
Risks associated with disasters are on the rise because of population growth, economic development and climate change. But insurance coverage hasn’t kept pace. The gap keeps getting wider.
In the ‘80s, the cost of natural catastrophes averaged $30 billion a year. In the ‘90s, it was $104 billion a year. Over the last decade, the figure has increased to $182 billion a year.
There’s a perception that the protection gap is a “third world” problem. It’s not. The gap between insured and uninsured is as prevalent in the US as it is in Asia. The US has the most uninsured losses of any country.
In earthquake and flood prone zones in the US, communities generally don’t believe they get value from insurance. They trust that government will provide disaster relief and recovery. Most people don’t understand the products related to this type of protection, and they’re often expensive.
Consumer awareness and buying behaviour are real issues in the US. Surveys in New York after Hurricane Sandy in 2012 showed that only 54% of residents whose homes were less than a block away from a body of water had flood insurance through the National Flood Insurance Programme or NFIP.
The NFIP was near $40 billion dollars in debt until Congress passed a bill last week to forgive $16 billion.
Earthquake insurance take-up in California is only about 10%, which is far lower than other high earthquake risk regions like New Zealand.
In the developing world, there are significantly higher and more complex challenges because of the disparity in education levels, communications capabilities and governance at the local level.
Also, a growing number of the world’s population live in areas exposed to extreme weather and natural disasters.
The threats the protection gap represents to the developed and developing world are indeed perilous. The cost in communities destroyed and lives lost is astronomical.
But while there’s peril, there’s great promise, too. The silver lining in storms like Harvey is the chance to begin a dialogue about how the private and public sector can work together to build resilience in unprotected communities. We’re already closely watching developments with the NFIP and it’s encouraging to see the White House Budget Director, Mick Mulvaney adding his voice to those of reform advocates:
“The NFIP requires immediate financial relief to fulfill its obligations to its policyholders, but the program must also be reformed to place it on a sound financial footing and to enable the private market for flood insurance to expand.”
The insurance industry doesn’t just have the capital. We have the data to help inform better decisions. We can help educate and raise awareness. We can develop affordable products that are customized for earthquake and flood-prone regions. We can participate in discussions that focus on risk mitigation and risk management, not just risk transfer.
About two and a half years ago, Hamilton was one of eight insurers and reinsurers who formed a consortium called Blue Marble. A ninth company has just joined. Blue Marble was established to provide protection in the form of microinsurance to the underserved.
Ten projects in developing regions have been identified and two pilots are already underway.
The premise of Blue Marble is that the learning from these highly efficient, tech-based micro transactions can be applied to the developed world. The result: better products, at a lower price, with a more efficient distribution system. Blue Marble’s focus is not on pushing a product but on meeting the customer need.
We need more of this type of initiative in our industry. While the global protection gap is massive, and the effort to close it is formidable, it’s in this work that our industry can prove its greatest value and contribution.
In closing –
I’ve presented my comments in three sections, but they all share some basic truths.
Our world, and our industry, has changed. Everything about the way we live has been affected by technology. We’re in the fourth industrial revolution.
Insurance has been far too slow to respond to these changes. We serve a great purpose, but most people either don’t know or don’t believe this to be true.
So, what is my outlook for insurance in 2018?
I see leaner, more efficient companies. I see greater diversity in our workforce. I believe that we’re going to see some genuine breakthroughs as a result of investments in technology and in new partnerships.
There is no room for luddites. 2018 might very well be the tipping point- where our industry leaves the analog behind and takes that final step into the digital age.
It’s a great time to be working in insurance.