Insurance: Cost or Catalyst?
Since Lloyd’s was established in a London coffee house in 1688 by Edward Lloyd, the insurance industry has always had a property akin to gaming. In fact an insurance policy and a lottery ticket have a similar payoff property – little down for a potentially large, probabilistic payoff. While the concept of insurance predates Lloyd’s by many centuries, with Chinese merchants separating their cargo to avoid catastrophic losses, Lloyd’s succeeded in both industrializing and globalizing this vital industry. The original wagers were made on whether or not insured vessels would make their treacherous ocean journeys to their far flung destinations with their hull, cargo and crew intact.
The original insurers at Lloyd’s, the ‘underwriters,’ would write their names on a sheet of paper indicating the percentage of their financial support for the downside risks of a particular shipment. When the shipment made the journey successfully, the underwriter received their premium – or prize – for absorbing the economic costs of any losses. If by contrast a ship faltered or came across some calamity or storm and was a total loss, the underwriter was on the hook for their given share of the loss. This property of betting and the human underwriting process remains largely unchanged at Lloyd’s. The broader change in the insurance market is whether this class of financial service remains a catalyst as it once was to seafaring traders or whether it has been reduced to a commodity, or merely a cost for an undifferentiated product category.
When you think of insurance as a catalyst, not unlike the original insured’s at Lloyd’s, the advent of a risk-transfer process enabled journeys and shipping routes that would have otherwise never occurred. The real or perceived risks associated with shipborne trade in the late 1800s heralded the industrialization of insurance, which in turn rode alongside the maritime traders from Europe to all corners of the world – in effect making bets of increasing size and sophistication that ships would make it.
Lloyd’s, like the original multinational corporation, the British East India Company, was formalized by Parliamentary appointment. As such, it served the the national and commercial interests of the British empire, in effect being the first financial institution that was too big, or better still, too systemic to fail. When seafarers and insurers both took risks they understood, profitable trade resulted benefiting both sides of the financial transaction. When losses occurred, and they did during the early days of maritime trade before advanced navigation and storm tracking and during the golden days of piracy (and through the occasional wars), Lloyd’s underwriters picked up the financial obligations of the doomed shipping houses, making them and their debtors whole. Thus was born the principle of indemnification in insurance, which holds that the policyholder shall not profit from a loss, but the insurer or underwriter can while making their bets.
Just as well-placed insurance bets gave rise to the commercial maritime industry as we know it – marine cargo insurance remains one of the mainstays at Lloyd’s – insurance also stood at the cusp of and helped catalyze many industries and ventures. Where human ingenuity and entrepreneurialism met with risk-transfer, entirely new industries flourished. As the era of maritime trade gave way to the industrial, automotive and jet ages, risk-transfer remained a pivotal force driving these industries forward and enabling them to survive the many setbacks along the road to progress. Today, set against the era of man-made risk and vastly complex and correlated global systems, many aspects of the insurance industry seem ill-prepared or unwilling to meaningfully tackle emerging threats and opportunities. Few customers seem prepared to pay the appropriate risk-adjusted premiums for risk-transfer to move away from being a mere cost of doing business rather than a catalyst for taking on new risks. The result is a predictable battery of undifferentiated “vanilla” insurance products offered by the major players, all largely competing on price.
Finding unmet risk-transfer needs in an increasingly chaotic and under-insured world is not difficult. Finding opportunities to apply insurance in a truly catalytic manner, as in the early days of maritime trade, requires new thinking from market participants on what can be catalyzed with the advent of insurance. Catalytic insurance, as it is defined herein, is a risk-transfer solution without which a venture, project or initiative would not occur. To be the clear, while this process is entrepreneurial, it is not altruistic. All sides of these transactions are typically in it to make money or to embark on a potentially risk-prone venture. Applying this lens to modern times, there are a number of large-scale market opportunities for catalytic risk-transfer solutions. In a time defined by anthropogenic risks, such as climate change, cyber risk, socio-political upheaval and drug-resistant diseases, among others, well placed insurance bets can help spur long range solutions while cropping up an entirely new set of industries, asset classes and investments, all with resilience as their core focus.
Unconventional times call for unconventional solutions. Where it was once suitable for the insurance industry to set aside financial reserves for predictable calamities or long-tailed liability events like U.S. asbestos litigation, which nearly brought Lloyd’s to its knees in the 1990s, today more capital needs to be pre-invested in risk mitigation than in claims reserves. For example developing highly speculative insurance to spur the medical industry to tackle drug-resistant diseases or pandemic threats will help mitigate unfunded losses to health insurers while improving public safety. One need only look at the spread of Zika and the ensuing business losses that swept through much of Latin America and the Caribbean. While no “smoking crater” risks emerged, many in the tourism and hospitality industries and, by consequence regional economies, suffered dramatic revenue declines due to public health fears. The business continuity threat posed by Zika is readily insurable using today’s solutions, however, it requires closer collaboration between the public and private sectors, as well as a more robust assessment of a region or industry’s threat matrix. Unfortunately, by the time Zika fears were in full swing, trying to insure this risk was like buying a homeowner’s policy while the house was on fire.
Other areas that can be catalyzed by the insurance industry include the coming wave of drones, artificial intelligence and autonomous systems, like cars, trucks and industrial processes. The challenge, however, is that many of these sectors have grown to view insurance as an after-thought or something merely to help combat litigation – in short a cost of doing business. The so called Tech Titans, such as Google, Apple, Amazon and Facebook, have such robust fortress balance sheets that for many of their most pioneering initiatives they can readily absorb downside risks on their own – although their Achilles heel is their Enterprise value of Data (EvD), for which insurance is a key hedging mechanism. The comparatively stodgy insurance world will have to shake some of its long-held beliefs about risk and calculating risk premia if we are to get a seat at the table in Silicon Valley and other innovation hubs – many of which have the insurance industry in their crosshairs for tech-enabled disruption.
There are, however, some sure bets where the insurance industry can regain its original catalytic features. For example de-risking North-South investment flows moving from billions to trillions, in spurring true risk-capital to early stage ventures and in responding to climate change, are but three areas desperately wanting for insurance innovation. Against these bets the investor and insurer would be wise to go long. Ironically, the innovations in these respective areas are not as much about designing new products, but rather in making existing solutions more readily accessible and, in many ways, cutting the red tape in the underwriting process. Like the early days in a bustling London coffee house that launched one of the world’s most enduring institutions, it is now time for risk-makers and risk-takers to join forces in tackling emerging threats, unlocking new markets and in creating value.