InsurTech (insurance technology) is going from strength-strength. However, in light of the recent natural disasters, one has to consider whether natural disaster insurance policies are suitable for InsurTech companies, and what the potential benefits of this disruption would be.
What is InsurTech?
To explain InsurTech, we must first understand what it is not. Put simply- legacy insurance companies use actuarial tables to assign policy seekers to a risk category. Individuals are then moved between risk categories to ensure that the insurance company profits. These legacy companies come with lots of legal baggage, making it difficult for start-ups to compete. Yet, Jason Brown, GCRO at the QBE Insurance group has warned that…
“InsurTech … will destroy the industry as we know it today […] if we ignore it and treat it as disruption”
InsurTech is especially appealing to Millennials because it removes costly middlemen. InsurTech also facilitates highly customisable policies. In 2016, InsurTech was a $2.6bn sub-industry, and has continued to grow since, with 68% of insurers taking steps to address the rise of Fintech. Despite this growth, InsurTech companies are yet to issue insurance policies for damages incurred by natural disasters.
Insurance for Natural Hazards
Individual homeowners need a mix of policies to be fully covered against natural hazards. Those living in coastal areas may be required to purchase, for example, separate policies for wind damage, and wind-blown water damage. In the United States of America, the Federal Emergency Management Agency (FEMA) have been forced, by the withdrawal of private insurers, to implement a National Flood Insurance Program (NFIP) to cover flood damages to buildings and personal possessions.
The NFIP program will buckle under the weight of Hurricane Harvey and Hurricane Irma as it will hit its $30.4bn federal borrowing cap. Moreover, further confusion could occur if Congress doesn’t approve it in the federal budget. Despite the weak public insurance policies in the US, both public (and more often private) insurance policies are better than those in developing countries. Some low and low-middle income countries’ insurance only covers 3% of losses in the event of a natural disaster.
Who is Lacking Coverage, and Why?
There are two general groups of people lacking coverage: those impoverished communities within developed countries, and groups of people within countries who are poor. Dr. Anna Hartnell has underlined that, in the USA, cities and towns are not equally resilient, and within these hubs there are factors such as wealth and status that affect how resilient communities are.
Houston has witnessed historic flooding following Hurricane Harvey. Here, 30% of residents live below the poverty line. In Houston, it is minority communities who are disproportionately in penury: 25.8% blacks, 27% of Hispanics and 27.7% American Indians live in poverty in Houston compared to the 8.5% whites. These impoverished groups often don’t have access to the necessary vehicles to get away from areas at risk, and if they’re able to afford their own properties, it’s often the case that they cannot afford to insure them. Even the economically enfranchised struggle to get insurance for losses incurred by natural disasters. As seen in the graphic below, produced by Bloomberg, there is a long-standing loss-coverage gap between damages and insurance payouts.
The Coverage-Loss Gap
In more developed countries, such high losses are incurred because of the value of infrastructure and buildings. In developing countries, the actual damages are relatively low as infrastructure and residences there have a low value. In the past 15 years, the average cost of natural disasters in the world’s poorest countries has been just under $30bn. However, those in these less developed countries are often not insured and the lack of capital means victims remain trapped in poverty. As aforementioned, only 3% of damages incurred by natural hazards in low to low-middle income countries are insured.
Without a doubt, impoverished people and poor countries struggle with natural disasters. Furthermore, they’re threatened by anthropogenic climate change. Climate change driven by human activity is, as can be seen in the below image, resulting in an increased frequency of hydrometeorological and climatic events. Further, the graph doesn’t show that these hydrometeorological events are most likely increasing in magnitude as a result of climate change. These high-intensity events will lead to even more damage.
Can InsurTech Improve Coverage?
So, what role does InsurTech have in improving coverage in the face of climate change for all, and why would it benefit those who are vulnerable to natural hazards? One envisions that specific InsurTech companies will emerge to deal with natural disasters considering the capital required, the expertise needed, and the gap in the market for providing reasonable insurance policies for natural hazards. InsurTech companies would benefit individuals in a number of ways, disrupting the current system.
Firstly, InsurTech businesses would make information about insurance more accessible to individuals. Buying insurance policies for natural hazards is a complicated process, one that those who are under-educated or simply lack the time to follow will become frustrated with. InsurTech could allow customers to be better protected, and encourage the poor to purchase, or plan to purchase, insurance against natural hazards because the customer-centric model should make it easier for individuals to understand what policies they need to buy.
Secondly, InsurTech operators would be able to easily adopt parametric policies. These are policies that use predetermined triggers, such as water reaching a certain height, to initiate payments. Here, smart contracts would be particularly useful. In a smart contract, the option contract is written between the insurer and then insured on the blockchain, viewable on the public ledger.
When the trigger event (the water rising above a certain level) takes place, the contract executes itself. Such a system will certainly leave many, especially those who are disadvantaged, feeling more secure about being insured against natural disasters. The victims know that they will receive a previously agreed lump sum payout to get back on their feet before they can negotiate other aspects of insurance policy later.
Finally, InsurTech would reduce the pre-disaster hassle of documenting valuables, and the ex-post facto struggle to record expenses and damages. Victims would be able to record photo and/or video evidence of their valuables and damages to their property on the InsurTech company’s app, and deliver it right to the insurer to minimise the chances of later conflict. Moreover, if the insured were to connect their bank account to the insurer’s mobile app, then all their post-disaster expenses could be recorded, with relevant ones being reimbursed at a later date or even immediately with smart contracts.
The process will not be plain sailing for disruptive InsurTech companies. Legacy insurers are well aware of the risks of climate change. ClimateWise- a coalition of insurers including Allianz and SwissRe- have expressed concerns about the ‘loss-coverage’ gap discussed above. A SwissRe flood peril assessment found that within the next 40 years, a combination of rising sea levels and more frequent storms would raise average annual losses to by 170%. Legacy insurance companies are combatting this by increasingly investing in renewable energies and technologies to mitigate climate change. It may simply be the case that InsurTech companies do not break into the natural hazards market because they lack the necessary capital to cover the pricey damages incurred by natural disasters.
The African Risk Capacity (ARC) has established a framework in which InsurTech might thrive in developing countries. A branch of the Africa Union (AU), ARC is a mutual insurance company resulting from public private partnership (PPP) between Arc Agency (A Specialised Agency of the AU) and Arc Ltd (Sovereign Risk Pooling Facility). ARC uses the parametric method described in the section above, relying on objective and independent data that is more certain that traditional indemnity insurance, to cover losses. The AU’s ARC initiative has insofar been successful. The ARC has assisted 2.1 million people and made 900, 000 livestock payments since its inception in 2013. Examining the ARC risk pools in the image below, it is clear that ARC will have to engage with InsurTech companies if they’re to expand risk pools. There are avenues for doing so.
At present, attempts to implement InsurTech in Africa have met little success. Earlier this decade, Safaricom launched a health insurance initiative through M-Pesa. This eventually fell through in September 2015 when Safaricom failed to increase efficiency by successfully targeting chamaas (village funding pools) and SMEs.
Moreover, microinsurance – closely tied to InsurTech – has had trouble taking-off in Africa. Microinsurance has been most successful in Latin America and the Caribbean where 7.89% are covered. Africa is the developing continent with the lowest cover, where only 5.43% have micro-insurance. However, ARC could help turn microinsurance and natural hazards insurance around. Mobile payment platforms in Africa such as M-Pesa and WeChatPay should facilitate the purchase of mixed insurance policies due to the prevalence of their use in Africa.
It is most likely villages would achieve this by pooling their money together. Certainly, reinsurers are enthusiastic to partake because expanding into natural hazard insurance policies will diversify their portfolios. Furthermore, once people on the ground realize the long-term benefits of insuring against natural hazards, they can purchase InsurTech companies supported by ARC. As seen in the below image, buying mixed insurance policies will be good for the growth of individual companies, communities, and the whole economy.
Other Factors to Consider
Having effective insurance against natural disasters is great, but it is better to manage the hazard to reduce damage in the first place. InsurTech firms must follow the example of ClimateWise, who are investing in technologies that reduce the risk of climate change through mitigation and adaptation.
Moreover, many countries invest in strong disaster preparation strategies so they can deal with natural hazards. Given that Cuba recently endured the wrath of Hurricane Irma, it is perhaps best to consider how successful their preparation for Hurricane Ivan was in 2005. The UN praised Cuba as a model of efficient disaster preparedness. Despite the 124mph winds and 2 million evacuees, no one in Cuba died. Furthermore, aid accounts for 8% of the costs of damages in low and low-middle income countries. Post-disaster management and support for affected communities are vital, and insurance policies, issued by InsurTech companies and legacy insurers, have an important role to play in this.
Deciding on insurance policies for natural disasters is complicated, especially when one has to decide which mix of policies they want to use, and what deductibles they desire to pay. Highly personalised policies available with InsurTech companies would make this process much easier thanks to their customer-centric focus. Whilst impoverished countries and poor groups within countries might struggle to access InsurTech, the growth of InsurTech could eventually benefit these poorer people. InsurTech’s highly personalised nature makes information and finance more accessible to the insured, whether they’re rich, comfortable or poor.
Despite this, there remains a significant loss-coverage gap, that is being dealt with in part by legacy firms who are funding the mitigation of and adaptation to deal with climate change. Moreover, in developing countries (which are especially at risk from climate change) the AU’s ARC demonstrates that insurance against hazard risk is needed. It could also be made available to the masses through an InsurTech company using the M-Pesa or WeChatPay platforms, especially since there is economic incentive to do so for reinsurers and the insured. However, we must keep in mind that InsurTech is not the only key component for dealing with hazards in the future. Successful pre-hazard and post-hazard management strategies must be utilised.
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