(Re)insurers: Prepare for the Market Turning Connected Risk Event

As the number of connected devices rises exponentially, the frequency of connected risk cyber breaches has attracted significant media attention and is regularly headline news. What is changing is the severity of the breaches as what was considered a game changing cyber breach two or three years ago – Target, for example - is dwarfed by more recent data thefts like Yahoo.

Yahoo says "state-sponsored" hackers stole information from about 500 million users in what appears to be the largest publicly disclosed cyber-breach in history. Rewind only a couple of years to the Target incident which “only” resulted in the loss of 70 million customers’ information - the Yahoo theft is more than 5 times the size of Target, which demonstrates that the connected cyber risk is on a steep upward trend.

The Yahoo breach included swathes of personal information, including names and emails, as well as “unencrypted security questions and answers.” The hack actually took place in 2014 reportedly –  more or less at the same time as Target - but has only now been made public. As of August 2016, the global human population was estimated at 7.4 billion so it only requires another 14 or so similar sized Yahoo breaches before we can all expect to be the victim of an online data burglar.

That is a slight simplification but the reality is that as the commercialisation of space continues apace - with the frequency of new satellites in orbit steadily increasing - every individual on the planet is likely to be connected sooner rather than later. It means that everyone from an African farmer earning two dollars a day – but newly empowered with a cheap mobile device – to a UK consumer showing off their new IPhone 7 is a connected risk.

Those same UK consumers now make more than 70 million bank transfers every month – compared with just over 100 million in a whole year a decade ago. But protection standards haven’t kept pace, and – unlike many other payment methods – those conned into transferring money by bank transfer to a scammer currently have no legal right to get their money back from their bank.

As scams become increasingly sophisticated, consumers can only protect themselves up to a point. Director of Policy and Campaigns at Which? Alex Neill said: ‘We all now regularly use bank transfers to pay for things, but what most of us don't realise is that if you're conned into paying out money to a fraudster, you stand to lose all of your money, unlike when you use your credit or debit card. ‘With scams on the rise, consumers can only protect themselves so far, and we believe that banks must do more to tackle bank-transfer fraud and safeguard their customers from scams.’

Which? research found that three in five people didn’t realise they had no consumer protection from their bank if they are scammed into making a bank transfer. Eight in 10 people said they’d used bank transfers to make payments and, alarmingly, one in 10 either knew someone that had or had themselves made a bank-transfer payment to a fraudster’s account.

Such research shows that we are entering into an era of extreme or hyper connectivity with new rules, opportunities and risks for (re)insurers. According to Vicky Carter Vice Chairman of International Operation, Guy Carpenter who was speaking at a recent Pre Monte Carlo briefing organised by Insurance Insider magazine:

“Hyper connectivity is a staggering trend which means that the possibilities are endless for growth and innovation. These types of connections were paused following the recession of 2008 and have recovered steadily since then but the links formed by technology have marched on uninterrupted at increased speed ushering a new phase for globalisation with the potential for disruption.”

Carter’s premise was that many core products are now seen as undifferentiated commodities. New entrants are coming into the picture from across industry lines. Technology will make some aspects of insurance obsolete. But it will also breathe life into us.

Carter said: “As our industry is being re-defined by a shift in economic activity, technology, the changing profile of our workforce and increased global connectivity our opportunity is to innovate, change and adapt so we can transform these disruptive forces into opportunity and embrace and become part of the future, which we can re-define with our customers.”

At the same Pre Monte Carlo briefing, Jay Nichols, CEO, Axis Re focused on the connected – though highly inefficient - insurance value chain. According to Nichols:

“We have to spend more time on building better portfolios and four dimensional underwriting.

It’s not enough to know how much profit we’re making and it’s also not good enough to know how much profit we’re making compared to the risk we’re taking, we have to figure out the correlations to those risks. We have a value chain issue," Nichols said.

"We're pulling a lot of dollars out to transport risk to capital." He pointed to the fact that transferring risk from insurance buyers via a lengthy chain of agents, insurers, reinsurance brokers, reinsurers and sidecar investors to the ultimate institutional investors strips on average $0.61 out of every dollar of premium.

In comparison, distribution costs in other commoditised industries might be less than 5 percent. Nichols said that although he believed some steps in the (re)insurance chain would collapse in the future, the problem didn't lie with the brokers, instead suggesting: "It's a system issue."

According to the reinsurance executive: “That got me thinking back to what happened in the industrial age? There are some useful analogies between the industrial age (or revolution) and the information age of our digital revolution. Back in the year 1700, it cost 1.2 shillings to ship coal from the mines to steelmakers in England then fast forward to 1865 and that decreased over 165 years to 0.06 shillings. That is a 95% decrease in the cost of transporting that material.”

The reason it decreased was because of government investment in infrastructure as well as commercial investment and it created a specialisation where you could actually ship goods all over the world much cheaper. Nichols believes that the insurance system is going to come under pressure in the digital revolution.

It has started to repeat itself in the information age. If you look at the cost of stocks, for example, if you are an individual and you wanted to buy $4,000 of stocks in 1992 according to Money Magazine it cost about 2.5% of the trade so it was anywhere between 1.5% and 2.5% depending on how important you were. That is a lot of money but now it is $4.95 for a block trade – once again a 95% decrease from 1992 to 2014.

Crucially, and this is the key point, as far as Russell Group is concerned: “We have a value chain issue and the whole value chain needs to be rationalised and needs to provide for the customers,” says Nichols. “The industry knows the value chain is inefficient. Data flows through this very poorly and that accentuates accumulation concerns which is magnified by connected risks.”

What is accentuating those accumulation concerns? A number of connected risk trends are worrying. The connected credit risk is a major concern. In 2014, according to the CIA's World Factbook, the world’s GDP totalled approximately US$107.5 trillion in terms of purchasing power parity (PPP), and around US$78.28 trillion in nominal terms.

At the same time, global debt has grown by $57 trillion to $199 trillion and no major economy has decreased its debt-to-GDP ratio since 2007. High government debt in advanced economies, mounting household debt, and the rapid rise of China’s debt are areas of potential concern, according to a McKinsey Global Institute (MGI) report, Debt and (not much) deleveraging”.

As Russell Group has mentioned previously, the connected cyber risk is also a mounting concern and one that is being fuelled by today’s increased geo-political tensions that some reports attribute to state sponsored cyber hacks.

In this volatile connected risk environment, UK (re)insurers will be expected to provide a realistic recovery plan to the Prudential Regulation Authority (PRA) in preparation for a market-turning event, Chris Moulder, the regulator's director of general insurance, has said.

In a speech during The Insurance Insider's London 100 event, Moulder said that given the changes that have occurred in the insurance industry since the last large-scale event over a decade ago, "we think it is sensible to devote some time now to planning for how we might collectively respond if such an event happens".

Firms must also consider what actions might be required in the event that further capital was not available as quickly as assumed after such an event.

"We will expect firms to be able to explain to us the judgements that firms' boards have made on these issues, including the assumptions they have made when coming up with their initial loss estimates, and the information available to underpin their judgements," Moulder explained.

He continued: "Whatever the event, we will clearly wish to assess the ability of individual firms to continue to operate in line with their solvency requirements and other minimum standards, and to assess what actions should be taken if a firm cannot identify or implement steps to recover within the timescales required by our rules."

In these volatile times, the (re)insurance industry is grappling to understand its dark and unknown risks, which becomes a considerable concern for accumulation control, as events increase in coverage complexity and become multi-class. 

Post Date: 10/10/2016

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