The future of life insurance – Risk.net

As the world constantly evolves and changes, so too does the life insurance industry, which is preparing for a multitude of challenges, particularly in three areas: interest rates, regulatory mandates and technology (software, underwriting tools and distribution platforms). In a Risk.net roundtable convened in collaboration with Milliman, life insurance leaders discuss challenges and strategies to future-proof the industry while creating the greatest possible value for policy-holders

Today, more than ever, life insurers must innovate on how to navigate a complex and uncertain macro environment, while ensuring they are delivering on their number-one priority – promises to policy-holders. 

As insurers search for new avenues to seek yield amid a lower for longer rate environment, adjust to a changing regulatory landscape and adopt next-generation technology, they confront a plethora of risks. Among them are operational, compliance, competitive, technological and business model risks. How insurers innovate, while planning to overcome these risks and future-proof themselves, will determine who will be successful and shape the future of the industry. 

According to a November 2021 Milliman report, as government support programmes wind down over the coming months, “The true impact on businesses and jobs will become more apparent” and “other things equal, should economic recovery prove robust, the scenario that interest rates will rise becomes more likely.” 

Roundtable participants discussed the challenges of the financial, operational and compliance risks facing the industry as it looks to a changing landscape in the future. 

In terms of operational and compliance risks, insurers are witnessing an evolution in how they interact with customers with regard to distribution, underwriting and administration. As businesses shift towards greater digitisation, it changes how insurers have historically done business and comes with varied risks that are often heightened – especially compliance risks. 

Transformative business models also raise firms’ inherent operational risk profiles, which includes people, processes and systems. Digital underwriting and distribution also bring a host of changes to the way firms think about compliance. In addition, data and artificial intelligence (AI) have the power to dramatically shape how firms now underwrite risk.

As insurers change the way they interact with potential and existing customers, heightened competitiveness issues emerge. One roundtable participant commented: “Electronic platforms have the potential to change business models and change the competitive landscape, as the cost of entry declines and the size and scale become less important than before in the world of insurance solutions.”

While insurers navigate the challenges and emerging risks in the previously mentioned areas – including a growing need to be more sustainable – their ability to be nimble and agile through the process will be as important as preparing for the next wave of risks their businesses will face.

Uncertainty around lower for longer

The outlook for interest rates creates a particularly difficult challenge for life insurers. 

Interest rates declined significantly for about five years following the global financial crisis that began in 2007–08 before levelling out at historic lows. More recently, interest rates fell precipitously further at the beginning of the Covid‑19 pandemic, with the yield on the benchmark 10-year Treasury dropping to an unprecedented low of 0.6%. In mid-2021, interest rates returned to near pre-pandemic levels, but those levels were at 50-year lows. 

Yet, in February 2022, with inflation at levels that have not been seen for decades, and market expectations that interest rates are set for some significant hikes over the months to come, it may not quite be the end of lower for longer, but it certainly feels like the beginning of a period of great interest rate uncertainty and volatility, as the US Federal Reserve finds where it needs to position monetary policy to maintain the delicate balance between keeping inflation at bay while not restricting economic growth.

Tony Dardis, Milliman

Roundtable participants acknowledged the uncertainty over interest rates and the potential wide range of future outcomes – including scenarios where rates could stay very low or even become negative for long periods, or be high for long periods. The panel also discussed the remarkable change in the life insurance industry with the introduction of private equity and investment specialist firms. Their interest in the insurance industry is access to long-dated portfolios that could be invested for the long term, creating a new challenge to the established insurance community in terms of remaining competitive on rates in a low or uncertain interest rate environment. One of the roundtable’s co-hosts, Milliman’s Tony Dardis, said: “New entrants to the industry have caused all market players to think very carefully about the ongoing viability of an investment strategy focused on commodity-like public investing, from a competitive standpoint.”

All sorts of private investments are increasingly commonplace in life insurers’ asset portfolios. Timber, agriculture and infrastructure debt, once unheard of, are now the norm. If nothing else, broadening the investment horizon into more alternative assets enables insurers to diversify, gaining covariance benefits. 

But there are two sides to the coin: investing in these new categories of assets undoubtedly introduces new complexities and risks that life insurers need to manage. As life insurers expand their portfolios and strive for yield, they will also need to understand the risks a new asset portfolio brings, while addressing the regulatory constraints.

“The broadening of the potential asset mix creates tremendous opportunity, but the risks need to be carefully evaluated and gauged against all the key metrics that are important to the corporation,” Dardis said. “Never has it been so important for the investments and risk areas to work together in making strategic asset allocation decisions.” 

Balancing the move to new asset classes with an understanding of new or emerging risks will be key as insurers reach for yield to provide better value for policy-holders in the future.

Buckle up ahead of regulation

Changing statutory accounting and the Generally Accepted Accounting Principles – known as Gaap – create uncertainty and potential volatility, but there are major regulatory changes in the pipeline that could affect cyber security, privacy, distribution and suitability. 

Life insurers need to remain agile and ahead of these changes to adjust to shifting regulatory conditions. Organisations must have a firm handle on the risks and plan ahead for the inevitable next set of changes in the regulations.

Regulatory changes and forthcoming actions mean insurers can anticipate higher levels of accountability and enforcement in the future and that state and federal regulators will not ease their expectations. Among these, data governance will remain a key regulatory focus, with privacy laws and increases in pandemic-related digital customer engagement requiring insurers to increase focus on data governance. 

Some insurance industry experts say focusing on the economic basis helps them keep prepared in this area – for example, hedging profit and loss on an economic basis – as they believe regulation will move towards an economic basis.

Regulations also deal with structure. For instance, with Libor being phased out, insurers will need to assess the potential impact on their contracts.

As with other industries, new technology might also be a focus for regulators. As insurers increase their use of AI to streamline back-office functions and reduce costs, regulators want to understand what goes into new systems being used for processes such as underwriting and claims. In August 2020, the National Association of Insurance Commissioners adopted a set of guiding principles on AI that includes five key tenets, referred to using the acronym “Facts”:

Fair and ethical
Accountable
Compliant
Transparent
Secure, safe and robust

Regulators are trying to ensure AI does not compromise customers’ privacy or foster discrimination through algorithms. Insurers must be prepared as to how they use AI and how their algorithms are configured to demonstrate that the technology is being used responsibly. As discussed in a 2021 Milliman paper: “Ethics and regulations are becoming increasingly important topics, to a point where big companies now have AI ethics researchers and dedicated governance” and “there has been a convergence to several core principles – in particular transparency, fairness, accountability, explainability, data privacy and security.”

A future powered by next-generation technology?

Life insurance is among the few industries considered as being behind the curve in terms of the adoption of next-generation technology. Many firms still operate with legacy systems and the transition will undoubtedly take time. But, as with all industries, insurers must adapt and open their doors to new AI-powered next-generation technology to future-proof their platforms. 

Even prior to the pandemic, life insurers were aggressively building out their technological and digital capabilities, but the pandemic has clearly accelerated these moves – especially in the context of distribution and the overall customer experience. 

However, life insurers are still at varying stages of leveraging technology and data science to permit greater automation, access to customers and more powerful analytics to manage and grow their businesses. 

AI and robotic process automation can transform how business is undertaken in the insurance industry. Next-generation technology can be used in the life insurance industry to more accurately predict outcomes, improve customer service, guide the development of new products, detect risks and cross-promote products. These technological developments will enhance the customer experience and drive the market.

Insurance leaders believe that, on the business side, customer satisfaction and retention is key. Many are beginning to deploy smart systems to conduct data analytics and qualify the key factors to retain clients and keep them satisfied in the long term. On the investment side, insurers are using next-generation technology to develop models that can predict potential default risk in the commercial mortgage space or investigate and explore data for systemic trading strategies on the fixed income side. 

Technology and data analytics can also prove key differentiators between a firm and its competitors. But leveraging technology for differentiation in the insurance industry should be weighed along the spectrum of risk. For example, data allows the industry to put people into risk pools as small as five to 10 people, but this can be risky because there can be a blurred line between differentiation and bias.

On the risk analytics side, next-generation technology offers some mouth-watering opportunities. One roundtable participant noted: “The biggest thing I hear is that risk analytics take too long to come in. By the time you get them, they’re stale and dated.” He described a balancing act of driving things more quickly by sometimes taking smart shortcuts. You then need to be able to explain your processes to senior management in a way they can understand, while making clear that any shortcuts taken will not affect the integrity of the results.

As life insurance business models evolve, balance sheets become more complex and new risks emerge, it becomes increasingly important to be able to quickly undertake more risk analytics. Emerging technology provides incredible opportunities to meet these requirements. As Milliman’s Dardis notes: “Insurers who are able to generate relevant risk reports that facilitate strategic decisions are going to have a major competitive edge. The ability to manage and process huge amounts of data is going to become critical in this regard. It is inevitable we will see increased migration from internal grids to the cloud where, in essence, unlimited amounts of data can be stored and processed. Supplemented with the use of model efficiency techniques, this is going to enable life insurers to do things [that were] previously unimaginable.”

As firms look to expand their use of derivatives in other asset classes or diversify their types of business, they require the deployment of new technologies in order to have a robust platform. As one panellist noted: “One way to fight the low interest rate environment is to go into other types of markets – and that applies on both sides of the balance sheet, new types of assets and new types of products. We need new systems to support that, and the fact the cost of technology is decreasing further opens the door to such expansion.”

Guarding against cyber attacks is a key consideration for deploying new technology. Aligning three lines of defence – risk, legal and information security – and having independence among them is important to safeguard business, insurance leaders say.

Conclusion

The roundtable represented a rare forum for life insurance senior leaders to openly discuss major issues facing their operations, how they are addressing them and the strategic opportunities presented. Interest rates, regulatory mandates and technology were raised by participants as major and common areas of risk and opportunity. Of course, there is always the issue that the world is constantly in a state of flux, meaning insurers must be nimble to adjust to rapid change – recent events in Ukraine coming two years after the onset of the Covid-19 pandemic is a harrowing example of this.

Going forward, the winners will be those able to act quickly and assertively, changing and developing strategies to exploit the resulting opportunities. From an investment perspective, balancing the move into new asset classes with an understanding of the new or emerging risks these assets bring will be key as insurers reach for yield to provide better value for policy-holders in the future. From a regulatory perspective, life insurers need to constantly plan to remain agile and ahead of regulatory change to adjust to the shifting conditions. From a technology perspective, rapid digital transformation, legacy modernisation, automation, and increased adoption of next-generation and cloud technologies are slated to be trends that will have a major impact on the insurance industry over the coming years.

One thing is certain: whatever events take place worldwide in the years to come, there will be change. To paraphrase Charles Darwin: “It is not the strongest or the most intelligent who will survive, but those who can best manage change.”