Innovation in Asia's Reinsurance Market

Just as energy is the basis of life itself, and ideas the source of
innovation, so is innovation the vital spark of all human change,
improvement and progress. - Theodore Levitt
An old clich goes: innovation and insurance are found together only in the
dictionary. In reality, the (re)insurance industry is required to be innovative by
the very nature of its purpose. Our fundamental obligation is to understand, even
anticipate, the needs of our customers and effectively respond to those needs. 1It
can be argued that the conservative reputation the industry enjoys has served to
camouflage a tremendous track record of innovation, from the first written
insurance contract inscribed on Babylonian columns by King Hammurabi's men
to the industry's current use of big data and telematics to lower costs and
improve results. Innovation in (re)insurance has long been rightly married to a
certain conservatism that ensures that companies do not get carried away by the
latest fads, but preserve their capital for its intended purpose. This conservatism
served most carriers well during the 2008 financial crisis, but may also hinder
the flexibility needed to survive and thrive in a post-crisis environment, as the
rate of change appears to be accelerating. 2
Our industry is, in many ways, a prisoner of the past. It relies on data to assess
and manage risks and to create new products. We are very good at expanding
the boundaries of the current business model; tweaking and optimizing the
product to meet the needs of our customers. 2 A quick look at some of the new
products made available over the past few decades shows numerous examples
of incremental innovation. Where we do lag are the market-creating innovations,
the third category of innovation outlined in the article-"The Capitalist's Dilemma"
by Harvard professors Clay Christensen and Derek Bever. They categorised
innovation into the following:

Performance-improving innovations which replace old products with new and

better models. These are sustaining innovations with the resource allocation
processes of all successful firms tuned to produce them repeatedly and
consistently.

Efficiency innovations help companies make and sell mature, established

products or services to the same customers at lower prices. Some of these
innovations are called low-end disruptions and involve the creation of a new
business model. For example: Geico in US.

Market-creating innovations transform complicated or costly products so

radically that they create a new class of customers or a new market. Look at
what happened with computers: The mainframe computer cost hundreds of
thousands of dollars and was available to a very small group. Then the
personal computer brought the price down to $2000 which made it available
to millions. In turn, the smartphone made a $200 computer available to
billions of people throughout the world.

A look at the percentage of available market buying various insurance policies

may lead one to be concerned about the lack of movement toward expansion of
that market penetration. There's a reason why the (re)insurance industry invests
primarily in efficiency innovations rather than market-creating innovations; it's
what the authors call: the orthodoxy of new finance. Because we were taught to
believe that the efficiency of capital was a virtue, we began measuring
profitability not as dollars, yen, or yuan, but as ratios like RONA (return on Net
Assets), ROIC (return on invested capital), and IRR (internal rate of return). All of
this makes market-creating innovations appear less attractive as investments
because they have a gestation period of 5-10 years; in contrast efficiency
innovation typically pay off within a year or two. Where market-creating
innovations use capital which must be put onto the balance sheet, efficiency
innovations take capital off the balance sheet. More importantly, efficiency
innovations always seem to entail less risk because a market for them already
exists.3
However, it is no longer true that capital is scarce. A recent Bain & Company
analysis captures this point nicely, concluding that we have entered a new
environment of "capital superabundance." Bain estimates that total financial
assets are today almost 10 times the value of the global output of all goods and
services and that the development of financial sectors in emerging economies
will cause global capital to grow another 50% by 2020. We are awash in capital. 3
Nowhere is this more true than the reinsurance sector where abundant capacity
has led to downward pressure on reinsurance rates. Low correlation with the
broader financial market continues to attract alternative capacity (from ILSinsurance linked securities and pension funds). "Excess" capital, then, is really
just a solution screaming for a problem. It calls for innovation- access to new risk
areas, tools for improving the analysis of difficult lines of business. Excess capital
isn's the problem; it's the answer to one that hasn't arisen yet. 4
We need to see a much stronger drive towards fighting the problems of
our clients. The sector does not spend enough time talking about
underinsurance. We need to insure the huge amount of risks that are
currently not insurable. - Massimo Reina, Guy Carpenter
Right now, the greatest challenge the reinsurance industry faces-albeit indirectlyis getting more people around the world to buy insurance. Thin rates of adoption
make all the advanced capabilities that insurers and reinsurers bring to the table
unnecessary. On the other hand, rapid growth in insurance buying in a
developing market leads to challenges that insurers and reinsurers are great at
addressing. Over time, loss histories accumulate, the volume needed for
advanced analytics develops and capital management becomes a concern.
Primary insurance distribution is fundamental to the creation of new markets that
would ultimately drive the increased demand for reinsurance. 4
This is why innovation in Asia should be on the reinsurance industry's collective
mind. Asia remains woefully under-insured. Western countries typically spend 78% of GDP on insurance; in 2013 Asian ones excluding Japan, spent 3% on

average. That is all the more inadequate given that governments have no plans
to develop public safety nets. Instead, they are opening up their insurance
markets to help shoulder the growing cost of healthcare and retirement. The
convergence of three key trends will further compound the problem. The first
trend is demographic change. Asia's population is growing rapidly. Over the next
5 years, the UN expects Asia's population to increase by a further 5%, or 200
million more people. This population is also ageing rapidly. The number of people
over 65 in the region is estimated to increase threefold to almost 1.3 billion by
2050. The second key trend is rising affluence. The spending power of the Asian
consumer is increasing. In fact, ADB (Asian Development Bank) expects average
household expenditure in developing Asia to almost triple over the next two
decades. The third trend is rapid urbanization. Asia will account for 54% of all
growth in the world's urban population over the next four decades. Risk
mitigation measures will need to keep pace with economic growth. Despite
growing by an average of about 15% per year over the last decade, insurance
penetration rates in emerging Asia still hover at 1-3%, or less than half the global
average. Asia's experience in 2011 was evidence of the consequences of underinsurance. Only about 50% of Thai flood losses and 15% of Japanese tsunami
losses were insured. Self-insurance by the Government was the key mode of risk
mitigation. As a result, national economies were burdened with hefty recovery
costs.5
However, as its economy grows, Asia's risk landscape is also increasing in size,
complexity and interconnectedness. More than 70% of Asia's GDP is derived from
cities, and two-thirds of the region's population is expected to live in cities by
2050. Many of these cities are situated in locations prone to natural hazards.
Rapid urbanization will give rise to more complex underlying risks. Asia, and the
world as a whole is only getting more interconnected. This has resulted in loss
events having unexpected domino effects. For example, the Thai floods and the
Japanese tsunami disrupted global supply chains. 5 Many reinsurers instinctually
look for ways to cope with these developments using practices and technology
already at their disposal. Catastrophe models, economic capital models and
enterprise risk management are few of the advances made by reinsurers in
addressing this ever-evolving risk environment. The emergent risk will eventually
outpace the capabilities of these tools as risk and capital management will only
grow in complexity, a trajectory that is likely to continue and probably
accelerate.6 It is in Asia that the lag in innovation of reinsurers will be most
visible. While it is important for the industry to have a better understanding of
the current risks we are facing, it is equally crucial to have a forward-looking
mindset, technical vision and commitment to master emerging risks and come
up with innovative solutions for turning these risks into business opportunities.
Innovation is not only needed for staying competitive, but also necessary for
survival.6
Reinsurers, it seems then, are on the brink of a major opportunity. The question
to ask now is, "Where can i add value? How can i grow my potential market?"
The challenge in writing more business is now about reaching and educating
potential insurance customers in regions where financial education has never

existed. This opens up vistas for the reinsurance industry to grow by adding a
broad array of value-added services that could transform how primary insurers
perceive their reinsurers. It would require attracting new talent and developing
new capabilities- investments that would have the potential to drive long-term
opportunities around the world. The key is for reinsurers to start thinking
differently about the business they're in. 5 Radical adjacency- the move to
redefine core competency and to create a platform for extreme market
adaptability, should be part of the playbook. . Apple is the classic case (from
computers to music players to smartphones, advertising and TV). Consider
McLaren, one of the leading Formula One teams, which is using its skills in real
time data analytics learned on the race-track to address remote health data
management.7 Reinsurers must be at the fore-front of developing risk mitigation
strategies for the following risks: 8

Climate Change along with the intertwined issue of food security

Natural or man-made disasters such as terrorism, cyber-terrorism, viruses,

spyware that could cause business disruption and human catastrophes

Rapidly shifting demographic patterns that could cause talent shortages in

certain labor markets or within certain capabilities

Increased volatility in asset prices and commodity markets that could cause
fluctuations in cost structures that cannot be readily passed onto the
consumer or otherwise absorbed

Technology and communications disruptions such as internet blackout or

system failures which could lead to business disruptions and economic loss

Pandemics and other health crises which could jeopardize the supply chain,
consumers, employees and others

Increasing natural resource constraints such as loss of fresh water reserves,

depletion of energy sources and development of renewable energy

Rise in anti globalization sentiments and protectionism which could cause

retrenchments from global trade and investment

Decline in recognition or enforcement of intellectual property rights which

could cause unlicensed commercial activity or loss of proprietary information

Changes in Laws and Regulations that could cause an overhaul in the manner
by which businesses are run or affect the source of their profits

"Markets that don't exist can't be analyzed" - Clay Christensen, The

Innovator's Dilemma
Innovation has become the buzzword of the decade in the worlds of business and
education. Like Miss Universe contestants wanting world peace, the term
"innovation" has become the default response of executives, politicians, and
educators to the question, "What do we need to be successful?" The word has

been overused to the point that the discussion has become circular, "to be
innovative, we have to encourage innovation." 9 Innovation may be among the
most desired but least understood of all corporate goals. For a successful
business, a commitment to innovation represents a gamble as to whether the
innovation, if successful, will adversely affect the existing business, or represent
a substantial increase or improvement in the business. And the gamble does not
always pay off. But in today's world of big data and rapid economic and
technology changes, can reinsurers risk not being innovative? 2 So the key
question then becomes how? Let's take a look at three major opportunities in
front of reinsurers:

Climate Change- Reinsurance must remain at the heart of disaster and

climate risk reduction. The reinsurance industry must play a critical role in
helping to ease the financial burden associated with disasters and to protect
the vulnerable. Reinsurers need to collaborate with the scientific community
and governments. There is a massive opportunity for the industry to take
leadership in the field of catastrophic modelling. Climatewise, a collaboration
of more than 30 leading global insurance companies is a case in point.

Renewable Energy- Multi-year products and weather derivatives are examples

of the sort of innovation that renewable energy firms expect from reinsurers. 10
The industry could create an innovation fund for the sector to scale-up
adoption.

Micro-insurance- There is a need to innovate more cost-effective insurance

products suitable for emerging markets. One example is the Card Mutual
Benefit Association in the Phillipines which has successfully designed a life
insurance product now used by more than 11 million people, 80% of whom
are below the poverty line. A group of Thai insurers is selling basic accident,
fire and health policies via scratch cards sold at 7-Eleven stores. 11

All the above efforts must be supported by reinsurers and in fact, they should be
the ones leading them. AXA has created a separate VC fund to fuel far-reaching
innovation.12 It is bringing its expertise to help these companies grow by
connecting them to their portfolio companies. MetLife has set up a first-of-itskind disruptive innovation centre- LumenLab staffed with dedicated innovation
experts to develop new business models in the areas of wellness, wealth and
retirement.13 By leveraging tried-and-tested innovation processes, LumenLab
aims to build businesses that help Asian consumers achieve richer and more
fulfilling lives. Reinsurers must bring about what Entrepreneur Frans Johansson
calls the "Medici-effect" referring to the creative explosion in Florence when the
Medici family brought together people from a wide range of disciplines
sculptors, scientists, poets, philosophers, painters, and architects. As these
individuals connected, new ideas blossomed at the intersections of their
respective fields, thereby spawning the Renaissance, one of the most inventive
eras in history.14
The existence of innovation and its potential to build and serve a thriving
reinsurance marketplace depends on the industry's willingness to understand its

nature, the necessary investment, and the inherent risks- as well as rewards.
This is the double-edged sword of innovation, one which the reinsurers must
tread.6

References:
1. Innovation in the insurance industry: Risk & Compliance Magazine, AprilJune 2014 Issue
2. Innovation in insurance: The path to progress- Deloitte University Press
3. The Capitalists Dilemma- Clay Christensen & Derek Bever, Harvard
Business Review
4. http://www.verisk.com/blog/capital-markets-2/reinsurance-industrysgreatest-challenge-emerging-market-distribution/
5. http://www.mas.gov.sg/news-and-publications/speeches-and-monetarypolicy-statements/speeches/2013/opening-keynote-address-by-amd-ngnam-sin-at-the-asia-ins-and-reins-conf-17-april-2013.aspx
6. https://mmc.dppl.com/knowledgecenter/viewpoint/Reinsurance_Innovation
_Committing_to_the_Leading_Edge.php
7. http://www.forbes.com/sites/haydnshaughnessy/2011/07/14/the-rise-ofradical-adjacency/
8. http://www.zep-re.com/index.php/component/content/article/13-media/35publication-emerging-risks
9. http://www.wired.com/insights/2013/11/innovation-the-most-importantand-overused-word-in-america/
10.http://www.globalsurance.com/news/2012/07/04/insurance-innovation-andinvestment-to-play-major-role-in-renewable-energy-future/
11.http://www.cisl.cam.ac.uk/news/blog/rethinking-insurance-sustainabledevelopment
12.http://iireporter.com/category/features
13.http://www.financialexpress.com/article/companies/metlife-launcheslumenlab-the-first-of-its-kind-innovation-centre-in-singapore-for-the-lifeinsurance-industry-in-asia/102522/
14.Create the Medici Effect- HBS Working Knowledge