Insurance has its fingerprints on everything, so much so that most business can’t be done without out it. It would be awesome if insurance could provide perfect certainty and a 100% indemnification 100% of the time. There are too many factors to produce these ideal results including a fallible human element. A few years ago I wrote an article The Really Hard Market is Coming to Insurance where I envision a future of insurance where clean and perfect data meets transparency and immutability. Risk transfer is what insurance is at its core and by understanding risk financing we understand how insurance works.
It is impossible to live without taking on risk. Businesses need to take on risk in order to grow. Risk financing and risk management go hand in hand. If the goal of a business is to obtain profit, then typically the greater the profit the greater the risk. Not all risk is obvious. Insurance professionals should be experts in understanding and explain risk. Some of the questions that help create an understanding of the risk include what risks do the individual or organization have? What losses may occur? How do you deal with the losses as they occur? What insurance is available to transfer the risk? Will an alternative be a better solution or does the existing marketplace provide a viable and satisfactory option? To answer the last question, it really boils down to cost.
According to a recent RIMS Benchmark Survey total cost of Risk continues to rise year after year. Cost of risks includes the cost of insurance plus the cost of the losses that are retained instead of or as part of your organization. This includes risks an insurance policy doesn’t cover, deductibles or self-insured retentions, and administrative costs of the risk management department. These costs will continue to rise as new and emerging risks manifest. The next generation insurance professional will look to new methods of risk transfer. The insurance companies that evolve with the risk and learn of new ways to predict risk will succeed. Historical data is going to be replaced by real time data and those looking to transfer risk will happily provide it.
We are in an exciting time in the insurance industry. Thanks to InsurTech and the digital transformation new methods of risk transfer are allowing companies to grow at an unprecedented pace. One of these methods is the use of contingent capital. The Law Dictionary defines Contingent Capital as “Funds used when a contract lists a specific event occurs or a line is crossed. A second party takes the payment to get a loan extended or debt payed. The risk still exists but is injected with cash so it doesn’t look weak.”
Another method is the use of Derivatives by Insurance Companies. An article written by Mayank Raturi explains how “Derivatives are important risk management tools that have made it possible for financial and non-financial institutions to buy and sell exposure, thereby diversifying their risk portfolio and reducing earning volatility.”
Insurance-linked securities are another method currently used as described by the NAIC “Insurance-linked securities (ILS) are products of the rapid development of financial innovation and the process of convergence between the insurance industry and the capital markets. The securitization model has been employed by insurers eager to transfer risk and tap new sources of capital market funding. Insurance-linked securities-both from the life and property/casualty sectors-hold great appeal for investors.”
Peer-to-peer and tokenization of risk are even newer untested and unproven methods but will revolutionize the way insurance is transacted. Companies like Lemonade, Friendsurance, PeerCover, Teambrella, and VouchForMe are using Big Data, AI and Blockchain technology to change the insurance landscape. I talk with innovators in this space regularly and the industry is ready for new and innovative ways to transfer risk. It has been amazing to see ideas we talked about 10 years ago become desired and accepted. If you have something amazing that would solve an insurance problem then lets talk about it!
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