Disasters, technology and regulation: what to expect in 2016

As we say farewell to 2015, there’s no shortage of available opinions for what 2016 holds for the insurance market. Published predictions range from the very specific, such as the Willis Marketplace Realities 2016 report, discussing why rates will decrease for almost every one of 22 different lines of business, to the all-encompassing and boldly generic 50 Predictions from DAC Beachcroft. 

Five days into the new year and rain continues to cause more flooding across the UK and storms are heading towards San Francisco. We can expect that El Niño will continue to dominate the headlines; everyone has an opinion on Cyber Risk, and Solvency II will finally arrive in Europe.

Predictions provide a fascinating insight into what we care about (or at least what others think we care about). The greater the stated certainty, the more compelling the prediction. But how confident can we be on what the pundits tell us lies ahead?

Don’t mistake a clear view for short distance

In 2007, Paul Saffo, an associate professor at Stanford University, published his Six Rules for Effective Forecasting in the Harvard Business Review. A common fallacy he sees when forecasting technology trends is to assume technology will evolve a lot faster than the reality.   “Don’t mistake a clear view for a short distance”,  he writes.  Just because we can see a new trend emerging doesn’t mean that it will become dominant in the next 12 months.  Most ideas take about 20 years to take off.  The first US television station was licensed in 1928, but it took until 1948 for one million television sets to be sold in the US. The Apple Newton touchscreen personal digital assistant was first shipped in 1993, but it was not until 2010 and the launch of the iPad, that Apple finally had a successful tablet.

Peer to Peer (P2P) insurance is one emerging trend at risk of being oversold. An intriguing idea, but is it really “a new wave of insurance”?  Start-ups such as UK’s Guevera (wth the tag line “Old insurance is rubbish, use Guevera”) and Berlin-based Friendsurance, which both offer pooling of insurance amongst likeminded people are testing the ground.  Lemonade made the news in late-2015 raising $13m from Sequoia Capital.  This represents one of Sequoia’s largest-ever seed fund investments, despite the fact that Lemonade’s chief executive Daniel Schreiber is not willing to disclose what his new company will actually offer.  Sequoia is “…betting Lemonade will transform the insurance landscape beyond recognition”. Maybe, but don’t expect any breakouts in P2P insurance in 2016.

The Internet of Things (IoT) will undoubtedly evolve further in 2016, as more of our devices become connected to us, and to each other. The South Koreans and Danes already use three times as many interconnected devices than the average Brit.  Surprisingly the Japanese are even further behind, each using only a quarter as many interconnected devices as their Korean neighbours.  

Analyst Gartner predicts 26 billion IoT devices globally by 2020, all generating a lot of data. Big data is going to get much bigger. But privacy threats are enormous, as is the potential for social control and political manipulation. Furthermore, the threat of cyber-attacks on connected devices is real. Last year Wired magazine successfully commissioned two hackers to remotely disrupt a Jeep Cherokee being driven down I-64 near St.Louis, Missouri.  One of the magazine’s writers was left stranded on a busy freeway when the hackers were able to disable the accelerator and stop the car. 

Even if the cyber threat can be addressed,  as I mentioned in an earlier post, insurers  need to have adequate experience data to use for rating before IOT, wearables or the wealth of data being collected through our smart phones willmaterially impact our insurance buying. And IOT is not that new: the term “Internet of Things” was first coined in 1999. Don’t expect much to change in the coming year.

Sometimes wrong, never in doubt

Trying to predict the future too precisely is rarely a good idea. As Paul Saffo points out in his HBR article, prediction is really only possible where events are preordained and no amount of action in the present could influence future outcomes. No one can truly predict the future, but what we can do is make a forecast.   Forecasting looks at how present signals indicate possible changes. The goal of forecasting is to identify the range of possibilities. Saffo goes on to point out that:

“Unlike a prediction, a forecast must have a logic to it. That’s what lifts forecasting out of the dark realm of superstition. The forecaster must be able to articulate and defend that logic. Moreover, the consumer of the forecast must understand enough of the forecast process and logic to make an independent assessment of its quality—and to properly account for the opportunities and risks it presents. The wise consumer of a forecast is not a trusting bystander but a participant and, above all, a critic”.

So on this basis, what strong signals have we seen in 2015 that suggest change and opportunity in 2016?

Cyber Attacks will increase in size and impact, with the potential for the first claim on a property portfolio from a cyber-attack

The majority of recent cyber-attacks have been data breaches, targeted at individual companies. The companies’ reputations have suffered, but with only first party coverage which is intended to cover the loss of digital assets, insurance recoveries have been limited. But what about physical damage resulting from a cyber-attack?

To date, there have been only two significant cyber-attacks that have led to property damage; the Stuxnet attack on an Iranian uranium enrichment facility at Natanz in 2008 and a malware attack that caused massive damage to a steel mill operated by ThyssenKrup AG in Germany in 2014. While direct loss from cyber-attacks to computer hardware and operating systems are now typically excluded from insurance cover, there is potential that losses could be claimed for ensuing losses such as fire or explosion. Furthermore, there has been no true cyber catastrophe yet, where an attack hits multiple stakeholders. The Cambridge Centre for Risk Studies prepared a report for Lloyd’s last year that explored one such catastrophic event:  an attack on the electricity grid in the United States. The estimated impact on the U.S. economy from the so-called Erebos Cyber Blackout Scenario, is estimated at US$243 billion and an insured loss of $21bn – $71bn.

El Nino will continue to contribute to more unusual climate activity causing major insured losses in 2016

According to the World Meteorological Organisation (WMO), the 2015 El Niño was the strongest since 1950, causing both severe droughts and significant flooding in many parts of the world, with a significant increase in hurricane activity in the Eastern Pacific. The National Oceanic Atmospheric Administration (NOAA) believes it’s not over yet. Sea surface temperatures in the Equatorial regions of the Pacific Ocean continue to be well above average and the NOAA is forecasting that El Niño has an 80 per cent chance of lasting into early spring 2016.

El Niño, the periodic warming of the central and eastern Equatorial Pacific Ocean, occurs every 2-7 years and lasts for six to 18 months. It’s not the only driver of weather conditions, and no two El Niño’s are alike, but we can be fairly certain of more disruptive weather over the next few months. California, desperate for water after a period of drought has a good chance of significant rainfall early in 2016; prior El Niño years have seen up to 200% increases in rainfall. But extensive rainfall also comes at a cost, and destruction from flooding and landslides could well follow.

On average, active El Niño years have produced less land-falling hurricanes in the Atlantic, but ultimately it is the path of the hurricane that matters and it only takes one hurricane to create a major loss.  Hurricane Andrew occurred in an El Niño year IN 1992, and caused over $15 billion of insured loss (equivalent to over $25 billion today), the second most costly hurricane in the US, after Hurricane Katrina.

More money will be spent on flood defences in the UK

The New Year hadn’t even started before the UK government committed to spend more money on flood defences in 2016, after widespread flooding across the country. Few would disagree that the insurance industry, policy makers and government need to find a better way to describe flood risk than the commonly used 100 year return period;  a concept that is widely misunderstood. Don’t expect any better alternative in 2016.  Flood Re, the government backed reinsurance company enabling cheap flood insurance cover comes into effect in April this year. This will help alleviate the cost of insurance for some, but flood risk can at best be managed, not eliminated.

There will be more consolidation in the insurance market

This is an easy one: consolidation is going to continue. More mega-mergers are on the way leading to the formation of what Willis calls the “super carriers”. Look out for more Japanese and Chinese companies seeking to acquire Lloyd’s syndicates or other British insurers.

Solvency II becomes real (finally)

By the end of 2015, the Bank of England’s Prudential Regulation Authority (PRA) had approved  the plans of  19 insurers to use their own internal models to calculate how much capital they must hold under the Solvency II regime.  This took effect from 1 January 2016, after having first been proposed in 2002.  As Kurt Karl, Swiss Re’s Chief Economist states in his 2016 predictions, “…it’s not going to be an exciting year…it’s about  consolidation and understanding”.  After 14 years  the insurance market can move from planning for Solvency II to implementation.

But all is not done yet. As the Actuarial Post points out in their 2016 insurance regulatory predictions, culture and data transparency will be a large factor of Solvency II and associated regulation:

  • Individual accountability will be reinforced by the Senior Insurance Managers Regime (SIMR) in 2016, and through that a focus on culture.
  • Insurers will feel increased regulatory pressure for transparency about the data they collect via technological devices, including why they collect it, how it is used, and shared.

I can see clearly now the rain has gone

Whilst none of these forecasts can be considered cast iron certainties, I feel they are fairly safe bets. Nor can I  guarantee that everything will end up as neatly packaged in 2016 as Adam Alvarez’s view of 2015 that appears on his InsuranceLinked.  Adam's alternative twelve days of Christmas  include twelve tropical depressions, eleven rate reductions, ten fund start ups….