Late last month, the International Association of Insurance Supervisors (IAIS) released FinTech Developments in the Insurance Industry ("the Report"), an interesting, thoughtful and important analysis of how the growth of FinTech (financial technology) - which has thus far focused mainly on banking and capital markets - is likely to affect the insurance industry. Referring to insurance-focused FinTech as "InsurTech", the 45-page Report considered:
innovation drivers in the insurance sector;
current InsurTech innovations;
the existing InsurTech sector (start-ups, financing, relationships with traditional insurers, etc.);
future scenarios and their likely impact on insurance industry supervision; and
the effects of Distributed Ledger Technology (DLT) such as blockchain and Big Data.
The Report should be required reading for insurers, FinTech businesses and regulators racing to prepare for the challenges and exploit the opportunities of the InsurTech era. In this article, we summarize some of the analysis and key findings of the Report.
The Report notes that "FinTech" is often defined not simply as "financial technology" but as financial technology with the potential to transform the way a financial enterprise conducts its business by enabling new service offerings and new business models. Its authors also observe that, while FinTech has up to recently focused on the banking sector, rather than insurance, as the banking sector becomes more fully serviced there is more incentive to address the specific and often unique needs of the insurance sector. According to the Report, the drivers of InsurTech include:
the proliferation of data and analytical tools, e.g. wearable devices and the Internet of Things (IoT);
FinTech investors' and innovators' need for growth opportunities;
millennials' preference for products that are simple, self-managed, on-demand and online; and
incumbent insurers' desire to improve returns through more tailored products, improved fraud detection and reduced costs through automation.
Current Technological Innovations
The Report surveys a broad range of InsurTech innovations. Examples include the use of smartphone-based technology to permit the provision of time-limited, on-demand products by competitors over platforms similar to Uber or Airbnb (which, for example, is already being offered to cover vehicles only while they are actually in use). In keeping with the growing "sharing economy", such coverages could also be tailored to specific user communities or groups. The Report is less specific about the potential insurance applications of the IoT, but there can be little doubt that the rise of telematics and telemetry in the form of the inter-networking of appliances, houses, automobiles and other physical objects (including people, e.g. via wearable exercise monitors) will produce data that will be invaluable to the insurance sector.
Analytics, "big data" and machine learning will also enable more sophisticated uses of information, enabling other applications of artificial intelligence, including "robo-advisors" that can guide customers intelligently to the insurance offerings best suited to them. Distributed Ledger Technology could also allow those same customers to conclude their insurance arrangements via low-cost automated "smart contracting". As the Report explains, DLT (in the form of blockchain) will be important to the establishment of "peer to peer" ("P2P") and "on demand" insurance models (which the Report describes as a "game-changer" strategy) and should generally improve efficiencies for traditional insurers. Other strategies that could be used to take advantage of the new technology include (i) the "aggregator" model, focusing on customer interaction (e.g. through an app) and offering a range of alternative insurance solutions from a variety of providers; (ii) the "integrator" model, in which an insurance coverage is bundled with or embedded in a non-insurance product or service; and (iii) a "game changer" model, in which completely digital insurers focus on specific audiences or niches and P2P insurance platforms.
The Existing InsurTech Sector
A key premise of the Report is that InsurTech appears set to become a second wave of the FinTech revolution, in the sense that the pattern of growth that has already occurred in banking and capital markets is likely to repeat itself in the insurance sector. Since 2010, over US $50 billion has been invested in about 2,500 FinTech companies, with strong growth in venture capital (VC) interest since 2014. Figures from KPMG indicate that InsurTech start-up funding worldwide more than tripled between 2014 and 2015, rising from $800 million to $2.5 billion in that period. In a study available on its website, CB Insights notes that Canada had a 4% share of deal activity in the sector in H1 2016, as compared to a 63% share in the U.S. (no other country had more than 6%). The 2016 Q4 edition of KPMG's analysis, published too late to be considered in the Report, notes that perceived saturation of the U.S. Fintech market led to a significant drop-off in overall investment in 2016, but that interest in InsurTech is growing "exponentially as the industry starts to play catch up".
Recent market entrants are targeting numerous niches, large and small, within the industry, providing platforms for the distribution of tenant insurance and pet insurance, in addition to more traditional term life policies and annuities. There is already some recognition among incumbent insurers that the best strategy may be to partner with creative start-ups rather than attempting to innovate from within. The Report cites a 2016 PwC study that divided the responses of traditional insurers to the rise of InsurTech into four categories:
exploration (e.g. monitoring or establishing a presence in Silicon Valley or other key tech centres);
strategic partnerships (e.g. providing a start-up with a realistic testing environment for its products);
InsurTech involvement (e.g. making strategic acquisitions or becoming involved in tech incubators); and
new product development (e.g. using its involvement with InsurTech as a means of learning about new insurance niches that could be served with new insurance products).
Scenarios for the Future
The heart of the Report is an analysis of three possible scenarios for the future growth of InsurTech, which are described as follows:
incumbents successfully maintain the customer relationship;
insurance value chain becomes fragmented; incumbents no longer in control; and
big technology firms squeeze out traditional insurers.
The implications of each scenario for insurance supervisors are then considered.
Scenario 1: Incumbent market dominance continues
In this scenario, there is little change to the structure of the insurance industry, with traditional insurers remaining in control of the process, incorporating new technologies either through outsourcing or through in-house units (whether acquired or organically grown). Should this happen, the Report notes that it is likely that the big winners would be large global insurers with the capital to invest in the new technologies (or in the start-ups that created them) as well as smaller, more tech-savvy insurers with the institutional flexibility and culture to adapt. As this suggests, the effect on competitiveness would likely be to crimp the profit margins of the less agile, mid-sized incumbents, reducing competition over time (and possibly also consumer choice). Another effect of the growth of InsurTech under this scenario would be the need to build stronger relationships between insurers and their customers, as insureds would now often be directly choosing insurance providers for limited durations and purposes throughout their lives, rather than (as has traditionally been the case) selecting long-term providers of home, auto and property insurance on just a few occasions in their lives (and through the intermediation of a broker or financial advisor whose involvement can overshadow the insurer's brand).
In this scenario, regulators will also face challenges, as they will be required to keep ahead of rapidly changing technology in an industry that, in the past, has experienced relatively little "disruptive" change. From a supervisory standpoint, the major advantage of this scenario, compared to the others, is that it does not involve the fragmentation of the industry. It also does not require as much familiarization with, or education of, new industry players whose cultures may not be attuned to the industry's unique regulatory environment.
Scenario 2: Fragmentation of the market with significant loss of influence for incumbents
In the second scenario that the Report considers, the traditional insurer would still be the behind-the-scenes risk carrier, but the retail aspects of the business would be controlled by the technology firms, who would typically be marketing insurance as a part of a bundle of services (e.g. an "infotainment" package designed for motor vehicles or a comprehensive "home security" offering for homeowners).
The Report expresses concerns that, under Scenario 2, the competitive nature of the industry would be lessened because customers buying insurance as part of a broader package would be less likely to focus on the stand-alone value proposition of the insurance component. This scenario would also favour large, multinational insurers who were able to provide coverage in many jurisdictions. The Report notes that, no matter which incumbent insurance companies ended up dominating the back-end of this new system, relegation to such a supporting role (with no presence and little influence on the retail side) could leave the insurer in a state of uncertainty about the premium that the customer was paying (which, under this scenario, would typically be embedded in a larger payment for an broader suite of services). This could inhibit the insurer's ability to ensure that the customer was receiving appropriate service - already a potential problem in any scenario in which the customer purchased insurance as part of a suite of related offerings.
For regulators, the second scenario would present considerable challenges. For example, if, as predicted, the dominance of major, multinational insurers would grow under this scenario, the ability of national regulators to influence the delivery of insurance products could be impaired. As the Report observes, national regulators and supervisors would face significant challenges under this scenario at the very basic level of understanding how, and under what terms, insurance was actually being marketed. Moreover, from a supervisory or prudential standpoint, the reduction of insurance company business to that of risk carriers only may make those businesses more volatile as the capacity to "cross-subsidize with other parts of the insurance value chain" diminishes. As the Report also implies, consumer protection regimes may need to be reworked should this scenario materialize, as the direct consumer relationship will then be with companies that are not primarily in the insurance business and whose business models may not be easy for their insurer partners (or insurance regulators) to understand.
Scenario 3: Incumbent insurers squeezed out of the market by big technology companies
The third possibility considered in the Report is extreme disruption, a doomsday scenario in which big technology firms (BTFs, such as the "GAFAs" - Google, Amazon, Facebook, Apple) take control of the entire insurance value chain by integrating insurance into the products they sell. This scenario is most plausible in the property, auto and health markets, where technologies such as automated-vehicle data and human "wearables" can relay real-time information (with immense risk-assessment value) directly to the coverage-providing entity. The Report also notes that any complete takeover would likely follow an extended period of partnership with insurance incumbents.
This scenario appears to be dependent on a proliferation of data that on the one hand would allow for development of highly-personalized products but, on the other hand, would result in significant privacy concerns, such as already exist with respect to individualized genetic testing. For regulators, privacy concerns would become a more central focus and, as in the case of Scenario 2, the borderless nature of the new system would pose challenges for national insurance supervisors. For their part, incumbent insurers might respond to the threat by becoming platform providers themselves - for example, of prevention, repair, assistance and financial services that would increase loyalty and commitment from automobile insurance customers. Even if BTFs did attempt to dominate the insurance value chain, they would probably continue to require reinsurance services in the traditional form, the Report notes.
The Report concludes, among other things, that no matter which scenario emerges, the growth of "big data" will affect every aspect of the insurance business, producing the possibility of major efficiencies while at the same time raising privacy and cybercrime concerns. More broadly, it predicts that the following will be the most significant points of focus for regulators and supervisors in response to changes that are likely to take place in the near term:
understanding technological innovations;
adjusting prudential regulation;
adjusting industry regulation;
collaborating with other authorities, stakeholders, academics and financial regulators with respect to technological change and its various impacts; and
improving supervisory resources to ensure an ability to understand and respond to the risks associated with complex technological innovations.
The Report's broad and deep analysis should make it required reading for all insurance sector participants in Canada and abroad. Annex 1, in particular, provides a useful overview of current technological innovations in insurance, and Annex 2 provides useful examples of InsurTech activities across the insurance value chain.