The law of large numbers and big data. Digitizing and re-vitalizing the Brazilian re/insurance industry.

 by Paul Meeusen and Paulo Botti

Abstract

Capital markets and reinsurance strengthen insurance. In turn insurance is a strong engine that powers the economy. With the opening of the reinsurance market 10 years ago Brazil started modernizing its reinsurance marketplace, connecting it more strongly to the international markets. It now has a great opportunity to digitize this marketplace as the next logical step to further improve its risk management practices. This will enable the Brazilian reinsurance industry to use the power of risk data and analytics. Smart use of digitization can help grasping this opportunity and close the insurance protection gap. Missing the opportunity may lead to increased self-retention by risk owners. This is an opportunity for the Brazilian re/insurance industry to demonstrate leadership domestically and in the Latin American region. It will create a modern market place that is attractive to groom a new generation of digital native insurance/reinsurance professionals, who master risk management and digital practices.

Article

 Brazil has strong economic pillars across the commodities, manufacturing, agriculture, energy and service industries. An efficient insurance market allows such pillars of the economy to take risks and flourish. Insurance companies however do not function in isolation and increasingly operate in a competitive, international environment. This requires well-functioning re/insurance and capital markets. A very low percentage of the Brazilian population however buys insurance, presenting an unlocked potential for insurance to grow into a true engine for economic development, with strong technical reserves for fixed capital formation. Societal and economic development further strengthens this window of opportunity, as the Brazilian middle class is growing and the need for infrastructure investment remains high. This increases the need and appetite for risk protection. Insurance is no longer considered as only an optional luxury good. Altogether, this presents attractive growth opportunities. 

Equally, the Brazilian reinsurance industry appears to have significant growth potential. Several metrics indicate a substantial room for growth. For example, in Brazil the ratio reinsurance/insurance premium ratio is less than 15%, the reinsurance share of total technical reserves is below 5% and the insurance share of total assets of the national financial system is lower than 10%. This presents strong opportunities to further develop and renovate the industry. Brazil’s risk management practices and service offerings have already benefited from opening to the international reinsurance markets. It has improved its professional qualifications, with improved risk management and pricing capabilities. This enhances its competitiveness and local offering of international conditions. A key factor to successfully grasping this growth opportunity, will be the smart use of data and technology.

Re/insurance typically develops positively with economic growth, as measured by income. The better the economy performs and the higher the income level, the more re/insurance is typically purchased. The entry of digitization in the daily life of policyholders however, can have an opposing impact on insurers and reinsurers. Positive when the re/insurance industry utilizes technology to assess, underwrite and price risks in a much more efficient and customer friendly way. Negative when customers, in reinsurance, as well as personal and commercial lines, use advanced risk data aggregation and analytics to increase self-retention or strengthen their purchasing power. Networks such as Air BnB or Uber, equipped with rich data, can start acting on behalf of policyholder cohorts in the insurance market. Consumer groups aggregating their buying power is not new. The big change comes from the possibilities for network operators to control the relationship with the customer and policyowner. Data is no longer a barrier to entry and the influence of network operators will not be limited to the underwriting process, but can span across the entire value chain from product design, to claims and cash settlement.

Reinsurance is well placed to lead such digitization effort for the entire insurance industry. As a wholesale industry, it can lead the institutional and structural renovation that will ultimately also benefit the primary insurance sector. The modern, “digital native” customer and policy holder will expect digital service offerings. Rather than individual insurance players purely competing to develop own proprietary, digital solutions, a collective effort to establish a common ecosystem will benefit the entire Brazilian re/insurance industry. In economic theory such structural advancements are described as an upward shift of the efficiency frontier, which today’s fifth technology revolution brings about. The democratized computing power (the PC), combined with networked users (the internet), now experiences a third advancement, by ways of the ability to digitally undertake safe and legally enforceable business transactions and value transfers (blockchain). This is a systemic advancement but requires a trusted, digital market place such as for re/insurance. A minimum set of standards will enable greater efficiencies in data integration and automation for the various players, like air traffic control for aviation and SWIFT for banking. As a result, the entire market place will benefit from reduced information asymmetries, increased contract certainty, better loss and fraud prevention, operational efficiencies, lower operational risk and friction-less contract settlement.

There are several reasons why it is of specific interest to launch digitization efforts in a nascent industry such as Brazil in order to maximize its growth potential:

• Structural solutions can be introduced from the outset and prevent old, legacy procedures to get so firmly embedded that inertia prevails, and change become difficult. One example is identity management, including digital procedures to identify, authenticate and authorize a counterparty and increase transparency in a business transaction. This can massively improve insurance transactions, from customer acquisition (including “KYC”), to underwriting to claims handling. Other developing countries have proven that such a fresh start can provide a nascent economy with a strong, competitive advantage. Distributed ledger technology has the advantage of increasing transparency without compromising security or privacy of data.
• Contract certainty increases when the underwriting process no longer depends on paperwork  or semi-manual (email) exchange of multiple data files for modelling, pricing and quoting. Brokers have much improved these processes by introducing data stores for their clients. However, in a fast developing IT landscape, it is challenging for brokers to keep such applications relevant with rapid modernization such as cloud computing and distributed ledgers. And what do we do when multiple brokers take part in large reinsurance programs? This makes the current process cumbersome, inefficient and full of operational risk. The worst case is when a claim arises before the issuance of a final contract. If cedent, broker and reinsurer use a common electronic marketplace to exchange contract and underwriting data, the process would run much smoother.  All re/insurance markets are faced with this phenomenon. The Brazilian market however is at a key pivoting point, where it can set new standards and market practices for local and foreign reinsurers to apply and establish a baseline that will make the market much more efficient and competitive.
• Digitizing asset ownership and claims evidence, can dramatically improve both claim verification, approval as well fraud prevention processes in the claims handling. The Brazilian insurance market currently suffers from high insurance fraud rates. Introducing such changes, such as for example a digital proof of insurance or first notification of loss for motor vehicles, would require collaboration across the industry, as well as with authorities. Today’s technology can simplify and accelerate such collaboration and standardization process, whilst quickly bringing tangible benefits. It will only work however if all actors in the process, such as claimant, claims adjuster, merchants, broker and insurer are digitally identified and connected.
• Cash settlement is the obvious final step for premium collection or claims settlement. The banking and payment industry is undergoing significant disruption in this area. This will benefit merchants and consumers who will see increased liquidity and transparency at decreased costs and settlement latency. Many financial markets today get confused, not knowing where to start first in this fintech and insurtech revolution. This is a matter of timing. Exchange of cash is an outcome, not the core of insurance. The insurance industry is well advised to fix its core processes first: underwriting, contract management, premium and claims handling.  This provides a solid basis to connect with the newest payments systems once the fintech disruption stabilizes. If re/insurance remains stuck in its old world, the payment revolution may become a Trojan horse when entering. This is the time for re/insurance to be a leader, rather than follower. Making dust, not eating.

Conclusion

Why should the Brazilian reinsurance market act know? It helps to take some lessons from the other BRIC markets. Certain of these markets benefit from a strong top-down governance and regulatory environment which enforces and accelerates standards and digitization. More relevant for Brazil may be that with “regtech” it will be able to integrate procedures for compliance and regulatory supervision in a digital market place. A regulator can for example hold its own node on a distributed technology platform and automatically obtain relevant data from the various carriers. Having already significantly upgraded its regulatory supervisory procedures, such technology enablement will further modernize insurance regulation by benefiting from the “regtech” evolution.

Other markets have also seen the concentration risk when digital platforms hold and misuse large data sets, in particular private or sensitive data. Timely direction and intervention by insurance supervisory authorities can avoid this and ensure that innovation risks are mitigated and outweighed by benefits. Insurance has its origin in collective, mutual thinking, with economics and benefits resulting from the law of large numbers. It is time for insurance to benefit of the law of big data and collective actions.

Going forward, a well-functioning digital insurance market place can become a unique selling point to attract local and foreign investment, energize innovation and retain top talent.