Navigating an uncertain macroeconomic and geopolitical landscape
The insurance market has gone from low inflation, low interest rates and integrated global markets to rising inflation, higher interest rates and increased protectionism.
Looking ahead, core inflation is projected to peak in late 2022 and start cooling quickly in 2023. That acceleration will result from weaker global activity, a housing market correction in various regions, easing supply chain strains, further tightening of monetary policy around the world and the deflationary effects of a likely global recession.
Inflation will have varying impacts across the industry. Inflation-driven increases in claims costs (e.g., repairs, replacement parts, labor) will be a particular problem for property and casualty (P&C) insurers in the US, where regulators have been turning down rate increases. In the Asia-Pacific region, the short-tailed nature of insurance products in many markets gives insurers increased ability to reprice policies quickly, thus correcting for inflation and partially compensating for depleted reserves. Life insurance companies are cautiously optimistic as higher interest rates today fuel future profitability and seem to outweigh the impact of inflation.
While inflation and recession will hurt insurers, in the form of higher claims costs and reduced demand, higher interest rates may provide an earnings tailwind, thanks to improved investment returns. But those returns will require brave decision-making, careful hedging and timely refinements to asset and liability management policies. The bottom line is that insurers will need to monitor a range of metrics, including liquidity and asset valuations, and be prepared to adjust asset and liability management (ALM) policies in line with market developments.
Geopolitical tensions have risen considerably during the last few years. The war in Ukraine has caused the most significant impact on geopolitical relations since the Cold War. The result for business leaders is the increased consideration of geopolitical factors in strategic decision-making and resource allocation.
“War exclusions” may limit claims losses, though that is far from certain, especially relative to cyber, and policies designed to cover political risk. Marine, aviation and transit (MAT) lines of business will likely feel the greatest impacts in terms of price increases. Underwriting for political risk and trade credit insurance will also get much more cautious. Increasing volumes of state-sponsored cyber attacks are another major risk vector that senior insurance leaders are monitoring, largely because their commercial customers may be caught up in the impact.
estimated claims from the war in Ukraine. Source: S&P Global
Insurance firms that focus on the protection gap can do well by doing good
The recessionary environment is not helping the huge and steadily growing worldwide protection gap. In fact, the gap – incorporating climate and cyber protection, as well as retirement savings and life and health insurance – is only going to widen. Demographic trends, especially increased longevity, also point to increasing gaps.
In the wake of the COVID-19 pandemic, social unrest and more natural disasters, consumers and companies have never been more aware of their need for protection. Closing the gap will require insurers to think and act differently – launching new products and services in innovative ways, with new underwriting models and via new distribution channels. Those new revenue streams can address the US$1 trillion protection gap. In other words, insurers that continue to focus exclusively on the risks they’ve always written profitably will not only miss out on the huge potential upside, but also contribute to the expanding gap.
The industry realityUS$1.4t
global insurance protection gap, 2021. Source: Swiss Re Institute
The protection gap opportunityUS$60b+
potential increase in annual industry profits if it narrows the protection gap. Source: Swiss Re Institute
Looking at climate risk, insurers need to develop new products (e.g., parametric products) that protect against physical damage and help lead public-private collaborations for uninsurable risks. But insurers also have a critical role to play in facilitating the transition to a net-zero economy. Cyber risk presents a similar opportunity; insurance solutions should both protect against downside risk and provide support for all types of businesses to reduce their exposures.
As compelling as the growth upside is, insurers must not lose sight of the bigger picture. By addressing the protection gap, insurers can live their purpose of protecting individuals, businesses and communities against the most severe threats. In other words, this is a classic case of doing well by doing good.
The business case for new business models and value propositions
Even if there were no such thing as a protection gap, insurers would have ample reason to develop new value propositions to execute their growth strategies, including:
- Shifting customer needs in every line of business
- Increased awareness of unexpected risks and threats
- Intensifying competition from non-traditional players
- Ongoing industry convergence within financial services
- Regulatory developments, including increased emphasis on open insurance
- The rise of embedded insurance
- The expectations of capital markets
All these factors, which are simultaneously growth opportunities and competitive threats, should provide motivation for insurers to develop new solutions, many of which will be designed to reduce the protection gap. But innovation in the coming era of insurance will not just be about what products insurers sell, but rather the value they provide and the business models they adopt to create that value. Consider how macroeconomic pressures are driving demand for simpler, more accessible coverage, such as that available through embedded insurance.
New value propositions and business models will vary by lines of business. In life insurance, financial wellbeing is what customers want, which means insurers must serve as advisors, providing credible guidance and options to help insureds meet their goals. In non-life lines, with more protection being delivered automatically via embedded and usage-based offerings, the quality of the service and overall experience becomes much more important than the risk transfer itself.
For some P&C customers, insurers will provide access to human agents and advisors, but personalized and digitally enabled apps, platforms and experiences will be the focal point for the vast majority of interactions.
In the digital era, individual insurers are unlikely to deliver perfectly seamless experiences on their own. Rather, collaborations with other players via ecosystems will help insurers reinvent their products and services. Insurers that devise the right ecosystem strategies stand to benefit from better risk management, reduced claims and new sources of revenue.
Despite macroeconomic headwinds and market turbulence, it’s clear that insurers must continue on their transformation journeys. They’ve come too far already, and the future benefits are too great not to press on. Those firms that choose the right investments today will strengthen organizational resilience and gain a sustainable competitive advantage as the economy returns to health.