The future of insurance - Pre-empting the paradigm shift

Professional Broking and the Broker Network were both born in 1994 - 10 years ago - and the pace of change between then and now has occurred in a way and at a rate few could have predicted (see box p15).

As well as unpredictability, many of these changes share three common features. The first is that a single incident - the terrorist attacks of 11 September 2001 - had an effect that, in the past, organisations may not have been robust enough to withstand. Secondly, the pace at which events moved in many cases was so fast as to defy attempts to control them and, finally, most people's future business planning would not have considered the possibility of the occurrence of any of these events.

The UK insurance industry is not accustomed to this pace of change. It was founded in a post-industrial revolution 19th-century age of cities, defined workplaces and secure employment, nuclear families and a strong sense of nationhood, in which the organisations that succeeded and grew, the products that were sold and the risks insurers faced, were all grounded.

But, that is changing and there are various reasons for this.

Firstly, the traditional manufacturing sector, measured as a share of the gross national product and numbers of those employed in it, has continued to decline in all mature industrial economies. By contrast, the service sector, which includes insurance, has expanded strongly. Secondly, in parallel with this, the information and communications technology (ICT) sector has innovated and changed at a pace. Thirdly, the world economy is increasingly disconnected from the nation state. There is a trend for national trade tariff barriers to be removed and deregulation of some financial markets such as foreign exchange and derivative markets.

With less than eight months until the Financial Services Authority takes control of regulating brokers, it may not seem that way but, outside of that minor local matter, there is a heightening of international competition and constraints upon the economic, social and employment policies of national governments and even supernational organisations like the European Commission.

The predictions

These factors - namely a more 'weightless' economy, globalisation and technology development - will affect the next decade at least as much as the last. Against this background, making predictions for the next decade is complicated. When the 21st-anniversary edition of Professional Broking is published in 2015, these predictions can then be measured against what actually transpired.

Personal lines insurance will become less price-sensitive. Most say that direct writers have won the battle for motor and household insurance based on price and economy of scale. Predicting that the market will become less price-sensitive runs counter to that view and there are two reasons to think it might.

Better use of ICT will mean the cost advantage enjoyed by direct writers that have achieved critical mass will be eroded over time. There may also be an increased polarisation of the UK population and workforce between those who can benefit from the so-called third industrial revolution and those who can not. Economist Diane Coyle calls these two groups 'operatives' and 'superstars'. For the superstars, the price of commodity items such as motor insurance is not important, while service and differentiation of product is.

Employers' liability insurance will be unsustainable. In the last decade, the EL market has struggled to apply insurance principles to the 'tail' in its long tail. This is because insurers end up picking up the tab for changing social attitudes as well as true risk. Consider industrial deafness as an example. Part of the reason the EL market has suffered is not because the risk of work-induced deafness has changed, but because the attitude to compensating for it has.

Social attitudes will not cease to change. For example, remote access to an office server outside of normal working hours offers access to information and the freedom to work at times other than conventional office hours.

But, it will lead to an expectation by customers and hence employers not that it can be accessed late in the evening, but that it will be. There will be the resulting problem of information overload-induced stress or information used to replace mutual trust between employer and employee and there is bound to be a backlash and claims for compensation. The insurance industry can not cope with rapid change of enormous magnitude and, sooner or later, will decide that it is time to stop. Compensating employees is a fundamental risk, not a particular one.

Product liability insurance will be sustainable. The picture may not be so bleak even though the point about changing social attitudes still applies. Firstly, injuries are largely self-inflicted. People have to work but they do not have to smoke, drink or eat fast food. Secondly, this dilemma is not new - the products liability crisis was still in full force at the beginning of the last decade but the tide turned when Western economies were threatened with the loss of indigenous industries and importers and distributors of foreign goods could make themselves stateless.

Two examples will serve to support this prediction. The world's largest producer of light aircraft, Cessna, ceased all production in the US for many years because product liability insurance was uneconomical. Production has now recommenced. Even the drug thalidomide, is now again licensed for use; something that would have been inconceivable a decade ago.

Risk carriers

There will also be yet more outsourcing and more flexible organisations among risk carriers. Work such as insurance is now less geographically restricted than it has been in the past. ICT developments mean that people who work together do not necessarily have to be in the same location.

Opportunities for new decentralised intracompany work are increased. Inter-company co-operation also potentially becomes easier and thus a higher proportion of tasks can be outsourced economically. This inevitably will change the structure of insurance organisations, increasingly partitioning the tasks of providing the risk capital and administering the risk.

Premium aggregators will lose their so-called advantage. The idea of a 'buying club' is one that has a long history. In the insurance industry, it usually denotes brokers trying to present a common face to insurers to squeeze more commission.

The next prediction is that this will no longer be enough. This is because mobile capital makes the hard/soft premium cycle turn more rapidly. At times of soft market rates there will barely be time for premium aggregators to exploit them before the opportunity ends. Secondly, the clever risk carriers will control their costs so that merely aggregating premium will not be enough to add value to them and, in the long run, money can only be earned if value is added.

Network propositions will mature. Increasing opportunities for flexible organisations, outsourcing and a reducing impact of mere premium aggregation mean that networks will have to understand how they add value to the constituencies they serve and be able also to demonstrate and communicate that added value. This is the greatest challenge facing the established and newer network organisations. Inevitably, not all will have the knowledge, skills and resources to meet this challenge.

Risk will, in the future, be redefined. Risk in the 20th century, whether it was corporate or personal, was understood. At the corporate level, there was a clear distinction between what was the domain of insurers, entrepreneurs, financiers and government. Insurers carried the stable 'pure' risk, protecting against factories from burning down, employees being injured at work and motor vehicle collisions. At the personal levels, insurers provided unexciting but reliable investment policies; managed secure pension schemes and household policies were there to be claimed against only as a last resort.

Of course, there was innovation but, generally, the elements insured were solid, stable, predictable and trustworthy, and so were the insurance companies. Defining risk is not so clear cut. The prediction is that the concept of risk will be redefined with the emerging concept of alternative risk transfer becoming an issue for most practitioners, not just a few.

The demographic watershed

Another issue is in defining the demographic watershed. This is the demographic shift that will see community brokers leaving the industry in droves in the next 10 years - or not as the case may prove to be. Correspondingly, the next prediction is that 10 years from now we will wonder what all the fuss about a demographic watershed was. There are three reasons for suggesting this. The first is that 50-somethings cannot afford to retire as early now as they could 10 years ago. The second reason is that research consistently shows that customers who run small and medium-sized enterprises prefer to deal face-to-face when it comes to buying professional services.

The regular Datamonitor surveys present no evidence of an emerging trend suggesting this change over the last decade. Finally, when the Broker Network provides an exit route to one of its members, it has so far not failed to find an entrepreneurial manager willing to take on the business as long as they are provided the support infrastructure.

The entrepreneurial spirit has not evaporated and once the barriers to running your own business are removed - which networks can achieve - there are plenty of skilled people in the industry able to meet the customer demand for a local face-to-face professional service. There will be fewer community brokers - maybe only one for every 30,000 of population or so - but the community broker will not disappear.

How successful will these predictions be? The past is not a reliable guide to the future. The current environment is changing rapidly and becoming increasingly uncertain. Factors that play a part in this uncertainty are industrial and social restructuring but, above all, the pace of technological development. ICT developments mean that functions that were once expensive to undertake have become cheaper by orders of magnitude within the last decade, for example, mobile telephony. It is barely a decade ago that the internet was transformed by the adoption of HTML (and now XML) into the worldwide web and only recently that the total number of email addresses in use in the UK first exceeded the number of households.

The development and application of these technologies is changing faster than can be measured - much less predict their future impact. There is a paradigm shift taking place. Rules, attitudes and values that applied in industrial-age society are not adequate or appropriate to a post-industrial wired world.

SELF-TEST

How many of these events of the last 10 years could have been predicted?

- Icons like Commercial Union and General Accident would all but disappear.

- The newest general insurer to list on the London Stock Exchange would fail so badly that no one was prepared to take on the business or buy the 'book'.

- The largest loss in insurance history would be caused by a single act of terrorism.

- Lloyd's would enjoy its highest capacity ever, bearing in mind that the base year is 1994 when the full horror of the aggregation of losses of the 1989-1992 years of account were still becoming apparent and 'reconstruction and renewal' was a gleam in the eyes of Sir David Rowland and business consultant Ron Sandler.

- There would be only four Lloyd's motor syndicates and the role of a guaranteeing broker would be decimated.

- The Insurance Brokers' Registration Council would have disappeared, the General Insurance Standards Council come and nearly gone, along with the Personal Investment Authority, the Financial Intermediaries, Managers and Brokers Regulatory Association, the Life Assurance and Unit Trust Regulatory Organisation, the Securities and Futures Authority, the Securities and Investments Board and a former partner in an accounting firm would have more power in the UK than the chairman of the Securities and Exchange Commission has in the US - and that is a lot of power.

- The commercial insurance broking businesses of two of the clearing banks would be completely outsourced.

- At least 75% of endowment assurances linked to mortgages would not cover the outstanding loan at maturity.