In 2021, the Institute and Faculty of Actuaries (IFoA) published their ‘Great Risk Transfer’ report, which looked at the overall question of 'financial resilience and increasing personal responsibility' from a number of angles. One of the outputs from their report was the suggestion that some form of mandatory minimum insurance cover be considered.
In preparing to take part in a roundtable discussion about (let’s shorten it to) mandated cover, I pulled together a number of thoughts from what I have written over the years. This article summarises those thoughts, but does not cover the discussions that took place yesterday at the IFoA roundtable. Those discussions will be reported by the IFoA sometime in Q1 of 2024.
The Great Risk Transfer
I think it’s worthwhile being clear about what IFoA calls the ‘great risk transfer’ (GRT). In the round, it’s about the trend to “transfer risks from institutions – such as employers, the state and financial services providers – to individuals.” This is how they illustrated this trend…
“Prominent examples of the GRT trend include the steady shift from defined benefit (DB) to defined contribution (DC) pensions and from annuities to drawdown, fewer investment products with guarantees, and insurance products that are increasingly priced based on the risk profiles of individuals as opposed to groups.”
Another way to look at this is to see organisations moving from providing risk transfer mechanisms, to helping individuals manage their own risk. And the core underlying reason for this is that carrying risk can be volatile and expensive if it’s not done right.
There’s a somewhat ironic situation here, in that those traditionally seen to be in the ‘risk business’ are wanting to de-risk their businesses. Not a great sign of confidence there, especially if they expect individuals to do better. It feels a bit like the sector at some point lost confidence in its ability to manage moral hazard.
Let’s turn to mandated cover and its capacity to address financial resilience. Here are four thoughts that I took to the mandated cover debate.
The Fundamental Flaw
The fundamental flaw in proposing mandated minimum levels of insurance cover is that it would constantly be being eroded by the onwards march of personalisation in insurance pricing. You can provide the cover, but ever more granular pricing will continue to push more and more people out of its reach. So what you have is mandated cover being considered because of the impact of personalised pricing, but at the same time being eroded and made ineffective by the impact of personalised pricing.
As underwriting becomes ever more granularised, the more the market becomes stratified; and the more it is stratified, the more people will be detached from the market. More and more types of risk, more and more perils, more and more types of people, will become uninsurable. This then pushes financial resilience in the wrong direction.
Financial resilience costs money. The key question associated with it is who is going to pay for it. There are two options: the Government and the consumer. That’s because insurers send out lots of signals about it not being their problem. Their narrative is based upon the sector being a private market and not a public service. It’s a narrative with flaws that will become apparent in a minute.
The Flood Example
The Government is naturally reluctant to expand its role as a form of insurer of last resort. You saw that in the early 2010s with regard to homes in areas seen to be at high risk of flood. As more and more people became uninsured, and researchers counted up the social and welfare cost of this, politicians quite naturally reacted. Out of those negotiations emerged Flood Re. In short, a dedicated reinsurance vehicle for high flood risk on existing homes. So the solution to stratification in the market for flood cover was one big risk pool standing behind fronting insurers charging only a small band of premium rates.
This was effectively a mandate to the market to provide cover and limit the range of premiums that could be charged. Consumers paid, not the Government, and the market was told to stop personalising pricing of flood risk and go back to pooling. Why this pressure though? It was because of the social success of insurance – it’s embedded across our lives. This means that warning signs of it disappearing trigger political reactions. So insurance may be a private market, but it is also one that needs what is often called ‘a licence to operate’, and it’s politicians who decide on them.
In the context of mandated cover, bear in mind these two thoughts. Firstly, Flood Re does not provide some minimum level of cover. It provides full cover, subject to a typical excess. A minimum cover approach wouldn’t work, for you can’t do a minimum repair of your flood damaged home. It will still be unliveable in.
And secondly, the negotiations around flood insurance didn‘t conclude with agreement on a bit of tinkering of the cover (which is what mandated cover amounts to) but a change in underwriting practice. In short, stop personalised pricing and restart pooling. And it turns out to have been a very successful move.
Lessons for Life
The ‘protection gap’ is an oft quoted phrase in the long term market. It’s used in relation to the inadequate penetration of products like life insurance into some consumer segments, with low income families being the most obvious.
You’ll recall this recent Swiss Re report about inclusion in the markets of various countries for life and health products. Their assessment of the UK market was that it had the products and expertise, but the distribution side left much to be desired. So in approaching the question of mandating minimum levels of life cover, one has to ask whether it’s a manufacturing problem or a distribution problem.
The Swiss Re report pointed firmly to it being a distribution problem, and I agree with them. In round terms, I see the life market designing products that were best fit for their distribution arrangements. No great surprise there though: why design a product that doesn’t fit their distribution arrangements?
The problem though is that the life market was largely distributing to employers on a group basis. And employment trends plus economic pressures meant that low income families had decreasing access to such provision. They were falling off the life market’s radar.
Let’s stand back and draw a conclusion here about mandating cover. It is not rocket science to design simple insurance products. The challenge lies more in distributing them: in other words, getting them to the people that need them. Mandating cover is a manufacturing step that won’t work unless it’s accompanied by a distribution solution.
Packaging Always Matters
Group life has succeeded as a market because it packaged up risks in ways that simplified their transfer and underwriting. There are other examples of this in general insurance too, the Motability fleet being one of them. People with disabilities had been seen as difficult and expensive risks to underwrite on an individual basis. Packaged as a fleet, those risks became attractive and accessible, but only if the insurer took the lot. How you package risk influences the market’s reaction to it.
This is something that the market has always known, but it needs to be spelled out in relation to issues like personalisation and mandated cover. It is important to weigh up the notion of mandated cover, but at the same time, you need to remember that the way in which you package the notion influences how the idea is received, both by the market and by politicians.
Flood Re was in effect a vehicle that packaged flood risk in a way that made it attractive to the reinsurance and retrocession markets. The risk stayed within the overall market, but was redistributed differently. Such arrangements are the bread and butter of places like the London market; it was what I used to work in.
Good News Times Ten
Solutions to the problems created by what IFoA call the ‘great risk transfer’ will require numerous different solutions. One size will not fit all the problems. Mandating minimum levels of cover to rebuild financial resilience may seem to be an option, but it will fail unless the much stronger tide of personalised pricing is addressed.
It is on the fairness of personalised pricing that the focus must be put, as happened with Flood Re. And for that to progress, there needs to be a framework established to bring those discussions about (as I explained in this recent paper on fairness for IFoA).
I will now go one step further and emphasise the need for a common language for use in those discussions. If I mention anything about the roundtable on mandated cover that I just attended, it is that that common language seems to be developing, which is a good thing times ten.