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The Insurance Industry must open Mind to the Energy From Insurtech

By Clive O'Connell, Partner- Head of Insurance and Reinsurance, McCarthy Denning

Clive O'Connell, Partner- Head of Insurance and Reinsurance, McCarthy Denning

The advent of insurtech has brought many fresh ideas to the seemingly staid world of insurance. In London, the centre of the world’s international insurance activity, middle aged men in dark suits, ties and black shoes (never brown in town) now rub shoulders with much younger men and women dressed in jeans, branded t-shirts and trainers and with markedly different educational backgrounds.

While the insurance industry must open its mind to the energy that comes from insurtech, it is equally necessary for insurtech to seek to understand the way in which insurance operates and the constraints that it can impose upon the carrying on of business.

While it may appear, at first glance, that the seemingly outdated methods of the insurance industry are mired in the mental inf lexibility and conservatism of the grey haired, mostly, men who run the industry, the reality is that they themselves are bound by a legal and regulatory infrastructure that is much older than the guardians of the market.

Insurtech products are bound by the existing regulatory framework and law. It will take considerable time to change either. Therefore, insurtech products must conform with the existing infrastructure. This may be frustrating and the barriers imposed by it may appear artificial, but if law and regulation are ignored, the insurtech product will fail.

Insurance law in England, and by extension to many other parts of the world, has its orgins in the eighteenth and nineteenth centuries when sailing ships were insured as they crossed the oceans and, in time, homes and businesses obtained cover. Regulation is a more modern concept and owes its origins, in large part, to insurance company failures and scandals in the latter half of the twentieth century. That said, the dominant insurance regulation in Europe, Solvency II, which took over ten years to develop, was largely effected before insurtech was known or understood. Insurance law, to a large extent, therefore is framed in terms of issues that may be over a century old and insurance regulation in terms of issues that are a decade or more old.

While both law and regulation are developing, they will not change overnight. Insutech must acknowledge the current restraints while arguing for modernisation. Insurtech must also seek to understand the issues that gave rise to current restraints and ensure that, in the drive to modernisation, these are not overlooked and the errors of the past repeated.

At the core of insurance law and regulation is the definition of insurance. Insurance companies, generally, are restricted in what they can do and they are generally restricted to selling insurance. Therefore, if an insurtech enterprise must design products that are insurance. There must be fortuity and there must be insurable interest.

Insurable interest is an aspect of insurance that is easily overlooked. The person of company buying insurance and who will receive payment of claims in the event of a loss, must have an interest in the subject matter of the insurance. To insure a house, one must either own it or have lent money secured on it and stand to lose if the house burns down. One cannot insure one’s neighbour’s house.

"The essential step for developers of insurtech products to take is to seek advice at a very early stage from those with knowledge and experience of the arcane and somewhat perplexing world of the insurance market"

Not only must one have an insurable interest but it is also essential to be able to prove loss. Therefore if my house is damaged, I can only claim to the level of the damage and not to the maximum limit of the policy.

This all seems fairly simple until one looks at some insurtech ideas which short cut both the underwriting and claims processes. A product that can be bought on a phone and which pays automatically on the happening of an event, potentially requires neither an insurable interest nor proof of loss. As an example, a product sold by app to businesses in the vicinity of a beach resort that pay out to compensate for the loss of business caused by the temperature dropping below a benchmark for a number of consecutive days, could be insurance, if the purchaser operated a business that relied upon good weather but, in the hands of a business that benefitted from people staying inside, becomes a simple bet or, at best, a form of derivative.

This is not a distinction without a difference. Betting, insurance and the sale of derivatives are separately regulated. Insurers cannot act as bookmakers nor can they sell derivatives. A simple product, easily distributed and which pays automatically once an objectively determined parametric trigger is attained, may seem very attractive and efficient but may not be insurance.

While it may seem that this is a semantic point, it must be remembered that the requirement of insurable interest is one that was created for a reason. It prevents people having an interest in causing a loss. It is a protection against moral hazard. It is also a requirement that has protected insurers in the past from their own folly. The distinction between the Lloyd’s crisis on the early 1990s and the banking crisis of 2008 rests largely with insurable interest and is the reason Lloyd’s exists today without having to seek a governmental bail out.

This is but one example of an issue of insurance law and regulation that can create a frustration to concepts of efficiency emanating from the fertile minds at work in insurtech. There are many other. The essential step for developers of insurtech products to take is to seek advice at a very early stage from those with knowledge and experience of the arcane and somewhat perplexing world of the insurance market. T-shirts and ties must co-exist in symbiotic harmony.

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