The COVID-19 pandemic and social unrest in 2020 remind us that the insurance industry’s challenges might change on a year-to-year basis, but they will never end. COVID-19 may represent the vanguard of a series of public health crises arising out of climate change, income inequity, fraying social safety nets, demographic imbalances, resource shortages and increasingly stressed urban infrastructures.

There is an old adage that “adversity builds character.” However, before adversity builds character, it reveals character, and the numerous catastrophes that have occurred over the last several years combined with the ongoing pandemic have clearly revealed the character of the insurance industry. 

The (re)insurance sector is well-versed at navigating market-changing events, and while the impact of previous shock events such as Hurricane Andrew, the terrorist attacks of September 11, 2001, and Hurricane Katrina may have resulted in a loss of capital and reduced capacity in the short-term, the market responded to each occasion by innovating, working with governments and attracting more capital in the long term. Since 2017, catastrophe claims in the United States alone have totaled $214 billion. Despite that, the capital supporting the reinsurance sector has risen to a near all-time high of $471 billion.

Spotting the Unexpected on the Horizon

While it is important to think about outlier events, putting too much time and effort into planning for a specific event at a specific time may be a fool’s errand. Despite being a known risk, a pandemic was not on the risk radar for many people prior to COVID-19. Even in those instances where a rare event is identified, preparing for such a crisis during good times will always look more expensive. Therefore, instead of focusing on a specific event, (re)insurers are best served by maintaining capital resilience, access to liquidity, strong risk management, nimble operations and innovative thinking.

What Got You Here Won’t Get You There

The (re)insurance industry entered 2020 with a strong balance sheet, pricing tailwinds and abundant capital. The impact of COVID- 19 was sudden and violent, and even though the equity markets have recovered from the depth of the crisis, the Standard & Poor’s property and casualty index (down 13% year-to-date) still lags the broader S&P 500 (up 2.4%) recovery. Despite that, (re)insurers have raised approximately $28 billion in debt and equity so far this year, and approximately $4 billion of capital is waiting on the sidelines to be deployed. 

Reserve releases have buoyed (re)insurer earnings for over a decade now. History has shown us that such an extended period of reserve releases usually ends in tears. On top of that, the Federal Reserve has communicated its desire to maintain lower interest rates for an extended period, and rating agency S&P has been sounding the alarm on (re)insurers’ inability to meet their cost of capital for a number of years now. Going forward, in order to meet their cost-of-capital hurdles, companies will need to maintain combined ratios in the low 90s to account for a decline in reserve releases and investment income. At the same time, rating agencies continue to expect companies to hold significant excess capital in the face of macro-level uncertainties.

In response to these challenges, prices are rising, and companies have the opportunity to develop innovative products to address emerging risks.

The opportunities that lie ahead for the insurance sector will require thinking about risks in terms beyond what is currently known and measurable.

The Changing Nature of Risk

The industrial world is in the midst of a series of seminal changes that will radically change the nature of risk. Two of these seminal changes are climate change and the Fourth Industrial Revolution, which both carry the potential to be engines of great promise as well as great peril.

Climate change is nurturing extreme weather events; hurricanes are now more intense and occur more frequently, the polar ice caps are melting, sea levels are rising and threatening coastal cities, wildfires are raging and flooding is commonplace. These extreme weather events are changing the nature of risk and are causing misery and significant amounts of insured and uninsured loss. From an insurance and reinsurance product design perspective, addressing climate change is more of a scale and cognitive bias challenge than a product design problem. The industry has a working understanding of the principles underlying the business model and the associated risks, perils, hazards and insured assets.

The same, however, might not be said of the Fourth Industrial Revolution. The insurance industry, on balance, may not have a deep understanding of the emerging digital technology risks and the associated opportunities, threats, perils and hazards. The insurance industry may also not appreciate the impact that narrow artificial intelligence (NAI) will have on everything, or the inherent risks associated with NAI. NAI will change the future of government, law, wealth distribution, civil rights, war and work; accelerate income inequity; and influence how we live and relate to each other.

In the Fourth Industrial Revolution, platforms have replaced traditional companies and intangible assets have replaced heavy machinery as wealth drivers. Ocean Tomo’s recently released intangible asset market study indicates that intangible assets make up 90% of the S&P 500’s $28.94 trillion market value. Apple’s market capitalization stood at nearly $2.3 trillion on September 2, 2020. The entire market capitalization of stocks in the Financial Times Stock Index (FTSE) 100 was valued at just under $2 trillion.

The intangible asset revolution presents an unparalleled opportunity for the insurance industry to develop new and complementary products and services. The insurance industry currently offers defensive and offensive intellectual property insurance and key person life insurance. More research and development work is ongoing to develop new products to protect the full range of intangible assets, including a company’s research and development, intellectual capital, processes, patents, trademarks, franchises, goodwill, copyrights, IP, business-to-business offerings, brand, data, non-revenue rights, relationships and public rights.

Capital and Innovation Will Lead the Way

Insurers will need a significant amount of capital to support these growth opportunities and rating agency requirements. Companies will have to decide how much capital they want tied up to service the tail versus how much to deploy to capitalize more lucrative opportunities.

Solutions around customized, structured reinsurance products will enable carriers to redeploy capital supporting prior years’ underwriting. By leveraging their existing balance sheets, carriers can essentially access capital in a relatively cost-effective way. 

The opportunities that lie ahead for the insurance sector will require thinking about risks in terms beyond what is currently known and measurable. Intangible risk exposure is different: It is not geographically contained like a natural catastrophe and is not as explicitly calculable as a burning building. This is where insurers have an opportunity to be a leading beacon in the unrest sweeping our country.