Where are the new products?

When one considers a 300-year-old product, it’s easy to assume it’s either so different from its original intent that it’s unrecognisable from its initial form, or it’s outdated, unused and collecting dust in a museum. It’s fair to say that neither is true for the insurance industry. The original concept of the losses of the few being shared amongst the many for payment of premiums, remains largely unchanged. Insurance continues to play a critical role in the oiling of the wheels of industry, providing companies the opportunity to offload risk to provide capital relief and allow companies to direct their capital to the benefit of their business through the likes of product development, investment in process efficiencies or expansion.

The development of all risks policy wordings, a contract certain approach to deals and improved analysis of risk information have all provided the opportunity to improve the product, but at the end of the day it remains remarkably similar to the original. Sure, new ideas around intangible risk have developed significantly over recent decades as business models change, the rise of tech, outsourced models and virtual environments. Those changes have brought different product requirements such as Reputation Risk, Brand, Cyber Attack and Data Fraud. However, inevitably the bulk of many buyers’ budgets still goes towards very traditional products. It is true that extensions of coverage may in some way reflect a Client’s general needs, but do these products genuinely consider the risks which may sit beyond the standard wording and do they fully reflect the issues sitting on a Client’s risk register?

We can see that the penetration of insurance across the risk landscape still has a significant way to go. One only needs to consider the protection gap, i.e. the difference between economic loss and insured losses, of a broad spectrum of major events to highlight this issue. A Lloyd’s study from 2018 concluded that the global protection gap was some $162bn, a reduction of just 3% over its previous report in 2012. What is obvious is that the gap is not exclusively in developing territories, but across geographies and industries. Indeed, in the same study the manufacturing industry was determined to have the lowest insurance penetration of all sectors at 0.17%.

With an ambition to achieve lower costs driving the need for Insurers and Distributors to standardize products, we reach a potential downward spiral in the specificity of products to address Client exposures. So how do Clients ensure their risk transfer budgets are spent in the most effective way for their business? A parametric product is one such solution. The key here is placing value on the areas of concern which have the greatest impact on the business. The value of much of what is priced into a generic product may be difficult to quantify for an Insured, however if more focus is placed on those risks which will impact a business more fundamentally, perhaps greater value may be achieved. The principle of Parametric products has been around for many years, in cat bonds for example, but with the development of open source data sets and sophisticated modelling techniques, the principle can be broadened across a universe of risk.

Parametric products have the ability to target specific risks, based around defined indices with payouts based on agreed trigger points. The risk adjustment is effectively carried out in advance of any loss, so allowing for swift payment as the result of a triggering event. This allows the Insured to focus both on the consequential impact of any events, as well as having a product which is more focused on the specific causes of those events.

What if, for example, your business was impacted by rainfall, such as the hospitality industry? Many traditional products will provide coverage if your facilities are flooded as a result of rain, but not if Customers simply fail to book because of poor weather. Or you own a construction company. You may not suffer actual damage if the temperature falls below 10 degrees Celsius, but this is the accepted minimum temperate at which poured concrete will set and could introduce significant delays to your operations, thus potentially introducing additional logistical costs or even contract penalties. Agricultural farmers may be reliant on a certain minimum temperature to achieve optimum yields for crops – again there may not be obvious physical damage, however specific conditions may have had an impact the business, affecting the optimum return the farmer was expecting.

Such risks may have previously been considered to be business risks, or at least accepted as one of the general hazards of running a business, but their prevalence may have the potential to be far greater impact than the 1 in 500 year winter storm for which they’ve always bought insurance, but never claimed.

Much of the burden of responsibility here relies on the business to understand their business, to really consider the external factors which influence the success of their operations and to determine whether a credible index can be developed into a product. The role of the insurer here is to determine loss curves, trigger points and payouts, considering the consequential impact of events on the business, to maintain the principle of indemnity. The development of open sources means data is rich in quality and quantity. Technology allows us to view the impact of events like never before, whether it is measuring the water content of soil through satellite imagery or the size of hailstones with remote electronic gauges.

So it is clear there are many risks which perhaps don’t naturally fall within the scope of the traditional insurance purchaser. Perhaps they don’t even feature on the risk register of the Risk Manager, but fall within the scope of responsibility of other functions, such as Finance or Operations. If a suitable index can be found and a correlating business impact established, essentially a product is born which hits the balance sheet protection button. This approach relies upon broad thinking, beyond that which we have traditionally considered insurance products. There are obvious ones such as low river heights generating increased costs for transportation, inadequate wind or sun meaning lower returns of renewable energy sites, poor temperatures affecting drinks sales, even the weather being too good and reducing footfall at cinemas.

The examples used so far are all representative of weather-related risks, which has traditionally been the bedrock of parametric products. But what if we could develop products based around a much broader range of risk? Aon’s Global Risk Management Survey from 2019 highlighted 23 out of 30 top risks which are considered to be either uninsurable, or partly insurable, suggesting there is scope for opportunity. The 2020 WEF Global Risks Report shows that whilst infectious disease was firmly in the top 10 of risks in terms of impact, it didn’t even make the top 25 in terms of likelihood. It is hard to conceive a risk which is more broadly reaching than the current Covid-19 pandemic economically. It is also hard to determine the adequacy of insurance products in reaction to that impact. There is a significant amount of expectation on the insurance industry in its reaction to the current crisis. This is a moment in which we should all be considering how we can develop products which truly reflect the risks in today’s society and for today’s business.