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Fitch Ratings Insurance Roadshow 2019
Providing Confidence in an Uncertain World
Introduction
We gather today for this Insurance Roadshow at the same time as a more famous gathering in Davos. While the differences between our respective gatherings may be marked, I was struck how relevant the World Economic Forum’s official risk analysis is to the challenges facing the insurance market which are reflected in my remarks today. The Global Risks Report opens by saying ‘The world is facing a growing number of complex and interconnected challenges from slowing global growth and persistent economic inequality to climate change, geopolitical tensions and the accelerating pace of the Fourth Industrial Revolution. In isolation, these are daunting challenges; faced simultaneously, we will struggle if we do not work together.”
I couldn’t agree more which is why my remarks today centre around five ‘macro areas’ that I believe are driving many of the changes and challenges facing the General Insurance and Long-Term Savings market.
These five areas are those I see most often in my role leading the ABI, the UK’s principal association representing its world-leading insurance & long-term savings market. Areas that I see shaping our sector’s interaction with both its customers and the political, regulatory and stakeholder spheres that are so critical to its operations. I will speak for 20 minutes and allow time for questions and discussion.
1. Digital Revolution
- The first macro area is, of course, the Digital Revolution (aka ‘The Fourth Industrial Revolution’) sweeping through every area of our professional and personal lives, our workplaces and our customers. The stats tell their own story; 15bn connected devices in our world, estimated to rise to 50bn by the early 2020s, 90% of data in the history of the world created in the last two years (most of it seemingly pointless) and in the three minutes since I started speaking 12m YouTube videos viewed and 300m spam emails sent.
- We know conceptually what has changed us so dramatically from the world we inhabited just two decades ago; exponential growth in processing capacities, the micro chip, a connectivity revolution. But we are still very much grappling with the digital revolution as a dynamic process, not a static set of outcomes:
How?
- In our use of data; what we collect, how we use it and the permissions that regulate it.
- In our systems and operations, whether in the emerging use of AI, our ability to reduce subjectivity in underwriting and claims activities and capacity to speed up delivery for customers. Also in being able to develop pensions dashboards for customers; something unthinkable even a decade ago.
- In our products, both increasing the use of services-based insurance, pay-as you-go insurance, claims settlement and in products, like Cyber, that insure against the risks created by a more connected world.
- And in our distribution chains, where people utilise digital technology to buy insurance in different ways, a potentially very significant area for the future.
Our response to this as an industry has been instructive but is still in formation:
- Investing and scale. We have seen the need for large scale investment to underpin some of the recent consolidation in the sector. To get your corporate head around the scale of change and understand the future world enough to be able to judge risk effectively requires serious levels of investment. That is why it is not a coincidence that some of the biggest investments to date - Allianz in AI, Aviva in its digital garage and Axa in its futurology work have come from major European insurers.
- Specialism. As risks relating to Cyber and Autonomous Vehicles illustrate, it requires a fresh set of strategic decisions by insurers whether they are going to choose to specialise for the long-run in these and other fast-changing areas. The only thing guaranteed is the need for almost constant evolution as the product and risks do. This means committing to a specialism in areas like these is a medium-long term commitment. We are also seeing this focus on specialism in the very large risks insured and reinsured in the London Market where challenging market conditions require real strategic focus and where the process of syndication often looks to the particular expertise of market specialists to lead successful placement.
- We have seen the distribution and value chain begin to condense with the rise of the ‘mega brokers’ offering a wider range of services under one roof.
- We are beginning to see a necessary debate about how we use data, including the distinction between what is legal and what is ethical. It is not illegal to use propensity modelling to identify inert customers, nor (yet) to price accordingly but it is hard to make it look good on the front page of the Daily Mail. Similarly, firms that use thinly disguised data proxies for protected characteristics - as identified by the recent FCA study - are asking for trouble. We have a modernised legal data framework in the GDPR and the UK Data Protection Act 2018 but these are the legal set of basics, not an exhaustive list of what will be considered appropriate by either regulators or the public at large as the digital revolution continues. I think, over time, the industry has to take the lead in trying to resolve some of these issues.
2. The second macro area is the ongoing impact of the Financial Crisis 10 years on.
- In some respects, the dramas of 2008 seem a long time ago. The dramatic bank crashes, stock market dives and frantic recapitalisations and the personalities of the time; Fred Goodwin, Gordon Brown, Hank Paulson all seem far in the rear view mirror.
- But the real truth is that the financial crisis is as much a series of processes that are still ongoing as an event that crystallised 10 year ago, a phenomenon that will be recognisable to any of you who have been History students in the past.
- The first wave of the crisis saw the rescues, insolvencies and forced sales of the troubled institutions. The second wave saw the focus on stabilisation with the TARP programme in the US, QE in the UK and Eurozone and the recapitalisation of the major banks.
- The third wave is the one we are in now in the UK where the crisis is still very much driving the prudential and conduct regulatory framework for insurers as it will be for decades to come whether in Solvency II, the focus on SMCR & culture, the increasing use of price regulation powers including GI market study and greater scrutiny of the beneficiaries of value chains.
- And of course, we are still living with the political upheaval caused as well. If anything it is getting more profound as a decade-plus of public sector austerity, wage stagnation, low investment and sluggish, uneven growth helps drive the anti-establishment populism we have seen across Europe and in the US. I’ll come back to this.
How do we respond to this?
- Well, of course the market is already responding in its customary way through M&A, some of it driven by weakness in capital when looking through – as firms must – the Solvency II lenses as well as the highly depressed investment returns resulting from the crisis. It is easy to forget that although over a decade in the making, the key decision-making on Solvency II was in the period immediately after the crisis. This drove the introduction of the long-term guarantees package of measures – ensuring a regime more fit for purpose and less sensitive to what the European Commission called ‘artificial volatility’ in the markets – but this also undoubtedly added to the capital burden involved. As Solvency II beds in, we see general insurers and would-be insurers attracted by the MGA model and it has also clearly driven consolidation in the Long-Term Savings market towards two models; capital-heavy, diversified providers on the one hand and capital-lite providers offering long-term savings without guarantees.
- On the wider regulatory agenda on culture, I think we have to ‘lean in’ and help shape the regulator’s perception and understanding of what healthy cultures look like in practice in an insurance setting. Much of the SMCR has been imported across wholesale from the banking sector, as regulators will privately admit. But what best practice looks like across our whole market is still being developed. As the FCA’s senior executives have made clear at recent ABI events, regulators are looking for signs that groupthink can be challenged, that the Board is independent in its judgements and mindsets and they see a linkage between commercial culture and internal behaviours. Put crudely, a firm that treats its customers poorly is unlikely to have a great internal culture. This is not a debate we should be afraid to have collectively and within firms.
- As for Solvency II, all eyes will be on the 2020 Review to see if the set of highly sensitive compromises hammered out five years ago can survive the first formal review – and without the UK in the room. While opinions vary on potential outcomes, I don’t think anyone has ground for expecting game-changing revisions to either the capital or reporting elements of the directive.
- As for the wider political climate, the main imperative is to remain sensitive to the environment in which we are operating. When public sector workers have had the worst decade of pay stagnation since the Napoleonic Wars, our industry - and FS more widely - should never be moaning in public about remuneration or how tough life is.
3. This brings me seamlessly to my third area; big business in the spotlight.
- Like regulation, my view here is that these levels of pressure are set to continue and we need to be especially prepared in the insurance sector for much greater scrutiny as recent coverage of the gender pay gap and climate change attitudes have demonstrated. Some people say this is because insurance - for most retail consumers, at least - is a grudge purchase. In my view, it is more likely a function of size; as one of the essentials of personal and commercial life and a major and visible part of the economy, we are a natural target.
- As I have said, this scrutiny is partly driven by the financial crisis. But it is also part of the wider pattern of western societies becoming less deferential to authority and traditional establishments, whether political, religious or commercial. This is a long-term trend but it has been fuelled in recent years by the rise of social media, giving more power to consumers and bringing challenging news stories to the attention of the mainstream media more quickly. We have also seen it with the use of reviews and power of Feefo or Defacto ratings on comparison websites, driving the obsession with Net Promoter Scores.
- Whatever the causes, the frame of judgement for big business, including insurers, has altered for good. Most academic research agrees that millennial customers - and employees - value social conscience as one of the most important qualities in big business. This belief system can typically cover ethical supply chains, attitudes to climate change, focus on Diversity & Inclusion and internal culture. If you add this to a renewed political focus on ESG investing and the aforementioned Senior Managers Regime, you have a major challenge.
- But if you expect the scrutiny this brings to come in the form of a constant, penetrating spotlight, I think this is mistaken. Even very big businesses can go for long periods of time with relatively little scrutiny beyond that exercised by regulators and auditors. Better to think of a lighthouse with a beam that can land on a firm or sector suddenly with intense focus, illuminating everything. At that point, as BHS, VW, Nissan, RBS, Facebook, Oxfam or the audit or outsourcing sectors can testify, your inner workings can suddenly be subject to very intensive examination.
- The best response to this is to embrace a healthy culture, top, middle and bottom. Companies that employ decent people who operate to high ethical standards and take their responsibilities seriously have little to fear systemically from this relentless focus on big business. But while culture is set from the top, it cannot just stay there. Middle management and customer-facing colleagues who are empowered to do the right thing by their teams and customers in an operational mindset that value diversity and team work are much less likely to come up short in this challenging new world.
4. The fourth macro area is our changing society; just as our sector’s own employee and customer base is changing, so is the wider society we serve in quite profound ways that will affect the products we offer and environment we operate in.
A few examples:
- Our society is ageing; the number of over-85s will double by 2035 and the number of over-65s is predicted to rise by a fifth by 2030.
- Millennials will form the majority of the workforce from 2020 onwards. In addition to their typical value set, they also have very different attitudes to work-life balance, seeking to accelerate the workplace culture shift begun by their Gen X predecessors.
- Intergenerational differences are becoming noticeably profound in UK and other advanced western economies; Gen Y and Z far less likely than Gen X to own their own home before 40, high levels of student debt and focus on ‘living for today’.
- More broadly, the next few decades will be critical for our environment and climate change; if the Paris accords are not implemented in full, our planet is very likely to reach irreversible tipping points in global warming by the 2040s. This is the Number 1 global risk identified in the official Davos report I referred to earlier. The examples are many but it is worth noting that in the UK, we are already seeing many more incidents of heavy flooding this century than in the preceding decades.
- Other types of changing risk include the digital revolution seeing more SMEs and enterprises run from home while larger businesses are evenly spread, terrorism risk calibrated increasingly around business interruption rather than physical damage, energy risk that incorporates the decommissioning of energy infrastructure as well as its construction and operation. And the risks of people given ever-more responsibility to manage their own income in retirement at the same time as employers seek to transfer their pension scheme institutional risk to insurers.
- Our response to this as an industry has to be to embrace the insurance opportunities and changes this brings, harnessing the entrepreneurial spirit that ensured this industry has thrived during previous major changes such as the development of the motor car and aeroplane 100 years ago.
So….
- With an older population, more people will be working for longer so Liability and Motor policies need to reflect that reality, not unnecessarily penalise it.
- With autonomous features becoming mainstream in both commercial and personal motor vehicles and the growth of the shared economy in urban areas, the underwriting behind Motor insurance will have to continue to change significantly.
- People living longer will want travel insurance policies that do not penalise automatically for age or for illnesses in the distant past; we are seeing some of this pressure already with the recent focus on cancer. Younger people with fewer fixed assets will continue to fuel demand for experience-based insurance rather than inflexible expensive contracts.
- On climate change, our industry, with its huge investment power, has a vital role to play in catalysing the transition to a low carbon economy. So we need to be at the centre of policy conversations on Green Finance and looking to play a leading role.
- Businesses and workplace risk will continue to widen; more people running micro-businesses from home, yet risk often concentrated in very large warehouse units serving the digital economy.
- With data underpinning every areas of our lives, the protection afforded by Cyber insurance will have to evolve constantly to provide the cover we will need.
- When I look around the industry, I see elements of this in many places but it is far from clear yet who the winners will be and how far this insurance activity can be kept within the insurance sector rather than be done by tech giants, manufacturers or alternative capital providers.
5. My last macro area is the relationship between our industry and governments & policy makers.
- Now you may say that every major sector of the economy has to have a relationship with governments and policy-makers; why is this a macro factor for the insurance and long-term savings industry, in particular?
- For me, the answer lies in the range of relationships we have and just how closely tied our products are to the full breadth of the public policy arena. Because our industry insures just about every form of commercial and human activity, we are exposed to a vast range of public policy from transport to environment, from civil justice to trade policy, from taxation to welfare rules. That is why - for the UK industry alone - the ABI routinely deals with nine government departments, three devolved governments, four UK parliaments and decision-makers in the EU and US. The relationship between Insurers and governments will always be symbiotic.
- Just a quick skim through the ABI’s worklist over the last year illustrates this; successfully dealing with the Ministry of Justice and HM Treasury over the Ogden Discount Rate and personal injury reform, lobbying the US Treasury over secondary legislation related to the BEAT tax reforms, working with the Department for Transport on the future of green cards post-Brexit, pushing forward the pensions dashboard with the Department for Work & Pensions, arguing with the Department for Housing, Communities & Local Government about post-Grenfell fire regulation, working with the Scottish Government on its reforms to the statute of limitations for historical child sex abuse cases.
- This is a busy period but not a unique one. Therefore as an industry, our best response to these challenges is invariably to ‘lean-in’ to politics, to explain our arguments and engage in solutions rather than to carp from the sidelines or engage in shrill vested interest lobbying.
- I’ve deliberately not talked about Brexit but it would be a mistake to think that governments will use any ‘post-Brexit’ capacity - whenever that may be- to have a quiet life. In my view, we are entering into a period of more interventionist government, whatever party, Labour or Conservative, is in government in Whitehall and elsewhere as the focus grows on systemic inequality, the losers of globalisation and those who feel economically or geographically remote from centres of prosperity. This is apparent throughout the Western world and the answers that may emerge could easily impact our sector both as risk managers and employers.
Conclusion:
Inevitably a speech like this is subjective in its assessment of the major areas that will shape our sector. You may have others or would organise them differently. But I hope I have provided some food for thought on the trends which will shape our sector over the next two decades, whatever the outcome of the current extraordinary political events.
So let me conclude with a final few points:
- This is an industry that is eminently investable. It faces major challenges but has a track record of meeting them over its 350-year history. The changing nature of risk in the modern world presents significant commercial opportunities as well as an imperative to change. And it has a leadership - that I work with on a daily basis - that is committed both collectively and individually to building sustainable growth based on excellent customer experience.
But lean-in to solutions we must.
- We are at our best as an industry with our sleeves rolled up focusing on ways forward and behaving as a team, both within firms and across our sector. We see this when we respond to floods, combat fraud together and reinforce high standards through our industry codes.
- Devoting time to step back from the pressures of day to day business or P&L targets to examine and consider the major changes which are shaping our world. This is not a business as usual time to be living in given the speed of transformation of so many aspects of our lives. We have to allow ourselves time to understand it and plan how we can embrace it. As part of this, we have to embrace the need for much greater Diversity & Inclusion in our sector so we tackle groupthink, ensure the best access to talent and deepen our ability to adapt and innovate.
- Finally, I would come back to the importance of acting in good faith. At the heart of our business is a contract of trust, that we will be there for the insured when the worst happens to them and that we will help them provide for retirement. The more we prioritise and reinforce a healthy culture within our industry - at every level - the better we will treat our customers and our reputation will be enhanced. Very few businesses have got into fundamental political or economic trouble by looking after their customers well. Amid all the complexity of the modern world that I have touched on today, I firmly believe that simple maxim to be as relevant as ever.
Thank you for your time today.