Parametric insurance: A captivating solution
Parametric policies, which pay based on the magnitude of an event, can bridge coverage gaps that are difficult to insure with a traditional indemnity policy.
Big data, technology, and demographic changes have increased competitive pressures to the point where innovation has become essential for insurers. Nevertheless, innovation is often at odds with many insurers’ governance structures. Governance seeks to define a framework under which business decisions are determined and executed. In contrast, innovation by definition seeks new methods, ideas, and products. Viewed by many as a natural, or even acceptable, state of affairs, this tension can edge out a potentially profitable initiative, recasting it into a familiar mold with few growth possibilities. However, does the process really have to be that way?
Governance and risk management typically dominate many insurers’ corporate cultures and with good reason. Insurers have a hefty regulatory burden, especially with the implementation of the Own Risk and Solvency Assessment (ORSA) and other enterprise risk management (ERM) regulations in recent years. Current events have no doubt highlighted the value of continual monitoring and stress testing business within a governance framework. In tandem with regulatory requirements, insurers need to balance shareholder and consumer demands as they consider the ever-present specter of reputation risk caused by some inadvertent misstep. A poorly designed or implemented innovation can bring about severe consequences.
The consequences of "standing in place" can also be severe. Changing consumer preferences and technology are driving much of the need for innovation and, as the emergence of COVID-19 has shown, the most vulnerable parts of an industrial sector can be quickly brought down by an unexpected event. “Adapt or die” has become an urgent call to action.
This “adapt or die” mandate is often assigned to an innovation team, which is charged with generating a flow of ideas that will differentiate the company. Meanwhile, a governance team is often charged with evaluating every nuance. Whether it’s entering a new product space, upgrading an existing product, or bringing to life a novel idea, innovations carry risk that, in some organizations, may undergo a heavy vetting process with multiple layers of actuarial, legal, and tax review. This governance, most often, uncovers genuine vulnerabilities in product innovations.
Unfortunately, overly cautious governance can also create a continual, recycling loop of reviews. Each layer of review requires the innovator to balance the trade-off between the desired innovation and the potential negative review outcome of being sent back to the drawing board. This dynamic negatively affects innovation in two ways:
This outcome often stems from a corporate culture that sees itself as innovative, but in reality is less so. The perception of the insurer’s culture as a risk taker can be out of touch with the reality of its operation. This disconnect often results when the development and evaluation of innovation and governance practices are isolated from one another. It can also fuel conflict between innovation and governance. (See below, A cold, hard assessment.)
|Innovation-dominated organization||Governance-dominated organization|
|Does the insurer have a culture where the primary question is “why” things are done a certain way?||Does the insurer have well-documented project parameters and expectations?|
|Does the organization have the flexibility to try new ideas, even if they might fail?||Does the company have robust audit and peer review procedures in place, and broad market expertise to perform them?|
|Does the company have proprietary ideas or technology?||Does the organization prefer to be an influencer or “early adopter” of regulatory change?|
|Does the company value creativity?||Does the company heavily weight tail risk in its in-force and new business management?|
Regardless of the culture, change and innovation carry some level of risk that needs to be managed. Operating otherwise is undoubtedly perilous. However, the tension between innovation and risk management does not need to be divisive or counterproductive. This dynamic can instead be a positive force that promotes innovation as long as the shared goal is to manage an acceptable level of risk rather than completely eliminate it.
Rethinking the dynamic between innovation and governance can follow a number of strategies. At its core, a successful strategy needs to abandon the idea of innovation and governance as two positions along a cultural spectrum and instead establish an integrated process that links innovation and governance. Taking this approach avoids many of the drawbacks that spring from formal reviews during which an idea must suddenly overcome a major regulatory or compliance hurdle. This system could take the form of more informal communication between the two functions, for example. An alternative strategy could include the recruitment of a person or team with a governance background but with an innovation mindset who can move seamlessly between the two functions and participate in discussions about a new or emerging concept as it arises. Integrating the process could help avoid the pass-fail milestones of a formal review process or ensure that issues likely to cause failure in review are minimized in advance. This increases the flexibility and agility of the development process.
Other supporting strategies might include:
Rather than standing at opposite ends of the development process, innovation and governance need to be closely integrated. Like gears of a wheel, these connections can move the process forward, instill confidence in product development, and increase the possibility of bringing a successful product to the market.
Insurers tend to fall along an innovation-governance spectrum rather than at one end or the other. Identifying a company’s dominant risk culture can help to establish risk parameters that can guide innovation and avoid unnecessary conflict as ideas move forward.
Innovation versus governance: Can they coexist?
Changing consumer preferences and technology are driving much of the need for innovation and, as the emergence of COVID-19 has shown, the most vulnerable parts of an industrial sector can be quickly be brought down by an unexpected event.