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Robert P. Hartwig, Ph.D., CPCU

Society of Insurance Research 2019 Annual Conference Charlotte, NC October 21, 2019. Research Renaissance: Rewriting the Rules of Research in an Era of Innovation, Disruption and Ambiguity. Robert P. Hartwig, Ph.D., CPCU Clinical Associate Professor of Finance, Risk Management & Insurance

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Robert P. Hartwig, Ph.D., CPCU

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  1. Society of Insurance Research 2019 Annual Conference Charlotte, NC October 21, 2019 Research Renaissance: Rewriting the Rules of Research in an Era of Innovation, Disruption and Ambiguity Robert P. Hartwig, Ph.D., CPCU Clinical Associate Professor of Finance, Risk Management & Insurance Darla Moore School of Business  University of South Carolina Robert.Hartwig@moore.sc.edu  803.777.6782 www.uscriskcenter.com

  2. Research Renaissance: Rewriting the Rules of Research in an Era of Innovation, Disruption & Ambiguity Renaissance: New Approaches to Insurance Research Insurance is the original “Big Data” industry with roots tracing back to antiquity DeitiesDataDisruption The Fourth Industrial Revolution: Success requires a rebirth Innovation: Current Period Is One of Rapid Technological Innovation Data: Production, Collection, Storage, Analysis Next Frontier: Artificial Intelligence, Machine Learning Disruption: Not Solely Technology Driven Social and Demographic Economic Geopolitical Ambiguity: A Necessary By-Product of Rapid Innovation & Disruption Implies Uncertainty: Human, societal struggle to manage risk 2 12/01/09 - 9pm eSlide – P6466 – The Financial Crisis and the Future of the P/C

  3. Insurance Research An Examination of Scale and Scope Positive vs. Normative Research 3

  4. Research in General: Positive vs. Normative Approach • Positive Analysis • Describes the world the way it is • Normative Analysis • Describes the world the way it should be Connects Cause & Effects Based on Tested Facts Descriptive Objective Makes Recommendations Not Based on Tested Facts Prescriptive Subjective Sources: The Economist, Market Business News; Risk and Uncertainty Management Center, University of South Carolina.

  5. Insurance Research: Positive vs. Normative Approach • Positive Analysis in Insurance Research • Describes how insurance markets work • Normative Analysis in Insurance Research • Describes how insurance markets should work Health insurance is unaffordable Insurance rates should be capped Gender-based underwriting should be banned Insurance is systemically risky Are credit scores predictive of loss? Tort reform lowers casualty claim severity Does distracted driving impact auto claim frequency? Restrictions on underwriting criteria lead to adverse selection Sources: The Economist, Market Business News.

  6. Insurance Research: Positive vs. Normative Approach • Positive Analysis in Insurance Research • Describes how insurance markets work • Normative Analysis in Insurance Research • Describes how insurance markets should work Which best describes the state of insurance research: Currently? Historically? Sources: Risk and Uncertainty Management Center, University of South Carolina.

  7. Insurance Research: Positive vs. Normative Approach Positive Normative Elements of Both

  8. Insurance Research: Exploring the Sources of Research Academic Institutions Consulting Firms Ratings Agencies Technology Firms Insurers & Reinsurers Regulatory Agencies Agents & Brokers Venture Capital Firms Legislators Trade Associations Law Firms Think Tanks & Public Policy Orgs. Media Investment Analysts Industry Critics Sources: The Economist, Market Business News.

  9. Recent Personal Research Projects (Actual and Proposed) Genetic Testing: Ban of use in life insurance underwriting Affinity Group Pricing: Does its use result in disparate impacts? Penalty Interest Rates: What is the appropriate rate of penalty interest? Tax and Reinsurance: Is the playing field level? Tax and Reserving: Is excessive reserving reducing tax burdens Mutual Insurers: Financial/operational distinctions from stock insurers China’s Silk Road Initiative: Impacts of energy insurance markers Distracted Driving: Impact of “hand’s free” legislations InsurTech: Financing of insurance technology investment Talent Development: Educating the next generation of insurance talent 9 12/01/09 - 9pm eSlide – P6466 – The Financial Crisis and the Future of the P/C

  10. Insurance Research: From the World of Academia Sources: Risk and Uncertainty Management Center, University of South Carolina.

  11. Insurance Research: From the World of Academia Sources: Journal of Risk and Insurance, September 2019; Risk and Uncertainty Management Center, University of South Carolina.

  12. Insurance Research: From the World of Academia Types of Research Explicitly Encouraged by the JRI’s Editors • Health Insurance: The JRI encourages submissions on a range of topics related to the economics, market dynamics, and regulation of health insurance and more broadly to the financing and management of health care risk. • Behavioral Research in Risk and Insurance: The JRI encourages research on behavioral aspects of risk and insurance, especially those that contribute to or are grounded in behavioral-economic theory. The editorial team is particularly interested in applied behavioral research that informs practice, policy-making, or regulation in insurance markets and broader risk-management activities. • Quantitative Risk Management:We encourage papers on risk management and modeling techniques, with the qualification that the focus is on their relevance and application in insurance practice and policy rather than the techniques themselves. • Big-Data Techniques, Digitalization, and Insure-Tech: The rapid expansion of data and advances in computing are transforming risk management and insurance. Predictive techniques are expanding and changing the ability to classify risk, but also raise new regulatory and ethical issues. Sources: Journal of Risk and Insurance, September 2019.

  13. Insurance Research: From the World of Academia Sources: Risk Management and Insurance Review, Fall 2019; Risk and Uncertainty Management Center, University of South Carolina.

  14. Insurance Research: From an Actuarial Perspective Sources: Risk and Uncertainty Management Center, University of South Carolina.

  15. Insurance Research: From an Actuarial Perspective Sources: Casualty Actuarial Society website accessed 10/19/19: https://www.casact.org/research/index.cfm?fa=currentresearch

  16. Insurance Research: Broker/Agent Perspective Council of Insurance Agents and Brokers Sources: Council of Insurance Agents and Brokers website accessed 10/19/19: https://www.ciab.com/market-intel/

  17. Insurance Research: Agent & Broker Perspective Leading Topics for CIAB “Market Intel” Reports: 2014 - Present Sources: Council of Insurance Agents and Brokers website accessed 10/19/19: https://www.ciab.com/market-intel/ tabulated by the Risk and Uncertainty Management Center, University of South Carolina.

  18. Insurance Research: From a Commercial Lines Broker Perspective Sources: Marsh, WillisTowersWatson, Aon.

  19. Insurance Research: From a Reinsurer Perspective Sources: Marsh, WillisTowersWatson, Aon.

  20. Insurance Research: From an Analyst’s Perspective Sources: Barclays Capital, Bank of America Merrill Lynch.

  21. Insurance Research: Ratings Agencies and Regulators Sources: A.M. Best, NAIC.

  22. Scale and Scope of Insurance Research Scope: Scope of Insurance Research is Broad and Growing Research Silos: Industry Segment, Line, Motivation Research is largely directed and is a function of needs of researcher’s employer Broadening to include more focus on technology, business solutions Explosion in data and analytical capability also broadens scope Scale: Scale of Research Conducted is Growing Insurance is a vital, highly regulated industryguarantees a high volume interest As research volume scales up, question of quantity vs. quality Objectivity vs. Subjectivity 22 12/01/09 - 9pm eSlide – P6466 – The Financial Crisis and the Future of the P/C

  23. Moral of the Story… When it comes to insurance research “Where you stand is where you sit.” It’s whatever is important to you/your organization E.g., Client Facing? Public Policy? Legislative/Regulatory? Internal? The scope of insurance research is extremely wide and is expanding Researchers in many cases will find their work overlaps with the work of others, but over the course of one’s research career it is possible to work on issues that are entirely (or almost entirely) mutually exclusive of one another E.g., (i) Potential impacts of single-payer health insurance system on WC line and (ii) Effects of regional geopolitical risk on energy insurance mkts. 23 12/01/09 - 9pm eSlide – P6466 – The Financial Crisis and the Future of the P/C

  24. Worldwide R&D Expenditure for Non-Manufacturing Industries, 2016 ($ Bill) Perhaps unsurprisingly, global R&D in Finance and Insurance lags far behind the leading non-manufacturing sectors, which are technology-driven industries Source: National Center for Science and Engineering Statistics; University of South Carolina, Risk and Uncertainty Management Center.

  25. A Brief History of the Origins of Insurance (Risk Management) Research Statistics vs. the Whim of the Gods 25

  26. Data Driven Research in the Management of Risk is a Relatively Recent Phenomenon • For the vast majority of human history, what happened to people, the socio-economic groups to which they belonged and the environment in which they lived was attributed the will or whim of the gods • The view that humans are not passive before nature is a relatively new human concept! • Dates roughly to the early Renaissance (14th – 17thC) • “[N]ature has established patterns originating in the return of events, but only for the most part…” • --German mathematician and philosopher Gottfried Leibniz in a comment to Swiss scientist and mathematician Jacob Bernoulli, 1703 Bernoulli Leibniz

  27. Risk: It’s Everywhere and Always—Why So Hard for Humans to Understand? • 17th - 18th Century Lightbulb Moment: If risk results in patterns it is therefore measureable (Origins of Insurance Research!) • If risk in measurable it must be treatable (i.e., we can do something about it) (Origins of Risk Management Research!) • The language, measurements and methods to evaluate risk (modern probability theory) are recent inventions • Institutional Resistance • Religious, cultural and political barriers to the interpretation of nature through the lens of science (including advances in mathematics and statistics) remained significant for centuries and to some extent exert influences even today • Humans are often terrible at risk perception; For most of history as a species we have been exceedingly superstitious • Scientific methods for mitigating against risk are largely 20th century concepts (very recent)

  28. Risk Management Through Most of Human History… Had this eclipse happened over the Yucatan Peninsula about 1,200 years ago—this might have been how risk management was practiced—a human sacrifice to the Mayan sun god, Kinich-Ahua Total Solar Eclipse: Aug. 21, 2017 (Picture take from the rooftop of the Darla Moore School of Business, University of South Carolina)

  29. Research Renaissance: Innovation An New Era of Innovation 29

  30. Number of US Patents, 1836 – 2018: The World in Which Insurance Operates Is Changing Rapidly It took only 27 years for the 10 millionth patent to be issued in 2018 It took 155 years for the first 5 million patents to be issued in the US: 1836 - 1991 Patent # 10,000,000 Raytheon Corp., for “Coherent LADAR Using Intra-Pixel Quadrature Detection,” which describes a method of bouncing lasers off of targets to figure out their range and velocity.  Source: US Patent Office from The Verge; https://www.theverge.com/2018/6/19/17478898/uspto-utility-patents-10-million-issued; USC RUM Center.

  31. The Pace of New Data Creation is Growing Exponentially Zettabytes* By the early 2030s, Real Time Data creation will exceed Non-Real Time for the first time ever—mostly automatically, inexpensively and non-intrusively via sensors, transaction records and social media platforms CAGR (2019 – 2025) Real-Time Data: 39% Non-Real Time Data: 24% *A zettabyte is 1021 bytes of information and is equal to 1 trillion gigabytes. Source: IDC, Swiss Re, Sigma 4/2019 at: https://www.swissre.com/institute/research/sigma-research/sigma-2019-04.html; USC RUM Center.

  32. Example:Autonomous Vehicles: Will Insurers Drown in the Data? • The average human by 2020 will generate about 1.6GB in data every day • The average autonomous vehicle will process about 4,000GB per day—as much as nearly 2,700 humans • Are insurers ready for this? Source: Intel Corp. 32 12/01/09 - 9pm eSlide – P6466 – The Financial Crisis and the Future of the P/C

  33. Estimated Distribution of P/C Insurer IT Spend, by Category, 2019 Zettabytes • Global P/C and L/H IT spend is estimated at $220B in 2019 (Gartner) • Of that $220B, 8-10% is estimated to be outlays for data and analytics (Swiss Re) • Equates to ~3% of global insurance industry’s expense base (expense ratio assumed to be 15% of global premiums of $5.3 trillion) Data and analytics projects account for an estimated 15% of P/C insurer IT spend in 2019 Source: IDC, Swiss Re, Sigma 4/2019 at: https://www.swissre.com/institute/research/sigma-research/sigma-2019-04.html; USC Risk and Uncertainty Management Center.

  34. Research Renaissance: Disruption An New Era of Disruption The Entire Insurer Value Chain is Being Challenged 35

  35. The Internet of Things and the Insurance Industry Value Chain Who owns the data? Where does It flow? Who does the analytics? Who is the capital provider? Source: Willis Capital Markets & Advisory; Risk and Uncertainty Management Center, University of South Carolina. 36 12/01/09 - 9pm eSlide – P6466 – The Financial Crisis and the Future of the P/C

  36. InsurTech Funding Volume, All Stages2012:Q1 – 2019:Q2 InsurTech funding remains close to historic highs P/C accounts for ~70% of InsurTech funding Source: Willis Towers Watson, Quarterly InsurTech Briefing, Q2 2019; Risk & Uncertainty Management Center, University of South Carolina. 37 12/01/09 - 9pm eSlide – P6466 – The Financial Crisis and the Future of the P/C

  37. InsurTech Funding Volume, Early Stage2012:Q1 – 2019:Q2 Has early stage InsurTech funding reach a plateau? P/C accounts for the majority of early stage InsurTech funding Source: Willis Towers Watson, Quarterly InsurTech Briefing, Q2 2019; Risk & Uncertainty Management Center, University of South Carolina. 38 12/01/09 - 9pm eSlide – P6466 – The Financial Crisis and the Future of the P/C

  38. InsurTech Transaction by Subsector2012:Q1 – 2019:Q2 P/C L/H P/C InsurTech B2B funding is rising while Distribution funding is falling Source: Willis Towers Watson, Quarterly InsurTech Briefing, Q2 2019; Risk & Uncertainty Management Center, University of South Carolina. 39 12/01/09 - 9pm eSlide – P6466 – The Financial Crisis and the Future of the P/C

  39. Global Private Technology Investments by (Re)Insurers2012:Q1 – 2019:Q2 Private technology investments by (re)insurers in 2019 should be comparable to the record investments of 2018-19 Source: Willis Towers Watson, Quarterly InsurTech Briefing, Q2 2019; Risk & Uncertainty Management Center, University of South Carolina. 40 12/01/09 - 9pm eSlide – P6466 – The Financial Crisis and the Future of the P/C

  40. Wide Variety of Investors in InsurTech Sampling of Traditional VC Investors Source: CB Insights,QuarterlyInsurTech Briefing,, Q1 2018; Univ. of South Carolina, Center for Risk and Uncertainty Management.

  41. Wide Variety of Investors in InsurTech Sampling of (Re)Insurer Investors Sampling of Other Corporate VC Investors Source: CB Insights,QuarterlyInsurTech Briefing,, Q1 2018; Univ. of South Carolina, Center for Risk and Uncertainty Management.

  42. 6 Observations on Venture Capital Investment Patterns, Practices and Preferences • Actual Risk-Bearing Insurer Start-Ups Are Rare and Nobody Including VCs Is Clamoring for this to Change • Implication: The near-term likelihood of a major tech usurper invading the traditional P/C or Life insurance industry and bearing actual insurance risk is remote • The economics of such a transaction would likely destroy shareholder value in the tech firm • Such a transaction would likely be rejected using traditional NPV or IRR methods • Nature of InsurTech Investment Is Far More Complimentary to Insurer Operations than it Is Disruptive • Implication: Much of what InsurTechs are doing can viewed as an outsourcing of tech R&D. Insurers will adopt (acquire) or copy these technology if NPV is positive. • This is a very efficient way to manage tech investments • Options increase, less likely to be stuck with in a tech dead-end

  43. Observation on Venture Capital Investment Patterns, Practices and Preferences • InsurTechs Prefer to Partner with “Smart Money” Investors • Implication: Over the longer run, (re)insurers/large brokers could account for the majority of InsurTech deals, along with some of the largest VCs with in-house insurance industry expertise • Increased presence of incumbents suggests a widening “Kill Zone” for insurance startups • InsurTech Start-Ups Go Where (They Think) the Money Is • Implication: With ~40% of premium dollar going to something other than pure losses, it’s easy to see how InsurTechs would be drawn to areas such as Distribution • But these solutions are easily replicated or acquired • Data Analytics, Business Process Enhancement offer ongoing opportunities to gain competitive and efficiency enhancements Source: University of South Carolina, Center for Risk and Uncertain Management.

  44. Observation on Venture Capital Investment Patterns, Practices and Preferences • Valuations Are Likely Inflated: Pain to Come • Implication: Over the longer run, (re)insurers/large brokers could account for the majority of InsurTech deals, along with some of the largest VCs with in-house insurance industry expertise • Increased presence of incumbents suggests a widening “Kill Zone” for insurance startups • “Cool” Ideas Aren’t Enough* • Implication: Shift toward practical applications with an emphasis on measurable results (ROI) • Neither InsurTech firms nor investors have endless time or money for experimentation *This point adapted from: PropertyCasualty360.com, InsurTechstarups wane, but funds still pour into maturing market, Sam Friedman, April 10, 2018. Source: University of South Carolina, Center for Risk and Uncertain Management.

  45. Are Valuations for InsurTech Firms Doomed to Fall? The Curious Case of Softbank, Masayoshi Son, Silicon Valley— and Swiss Re 46

  46. Unicorn Sightings: New and Total Number of US-Based Unicorns (all sectors), 2008 – 2018* The total number of Unicorns appears to be declining in 2018 The peak of the unicorn bubble is already passed. This is one (of several) signals that many tech startups are overvalued. *Through May 15, 2018. Source: CBS Marketwatch, May 23, 2018: https://www.marketwatch.com/story/why-the-end-is-coming-soon-for-the-biggest-tech-bubble-weve-ever-seen-2018-05-22 eSlide – P6466 – The Financial Crisis and the Future of the P/C

  47. Unicorn Cash: Cash Raised by Unicorns and Number of VC Funds Closing, 2008 – 2018* Capital raised by unicorns peaked in 2016 No. Closed Funds Capital Raised ($ Billions) Unicorns not only becoming more rare, they’re ability to raise cash is stalling *Through May 15, 2018. Source: CNBC.com, May 22, 2018 at https://www.cnbc.com/2018/05/22/tech-bubble-is-larger-than-in-2000-and-the-end-is-coming.html

  48. Reasons Why Start-Up Valuations Are Falling and Will Continue to Fall • Higher Interest Rates: Low interest rates coming out of the Great Recession made risky investments of every variety more attractive—including tech start-ups. With yields of risk-free and corporate debt higher than they were at the start of the InsurTech boom, VC investments are less attractive • IPO Busts: A number of companies that have gone public (or plan to) have seen their valuations plummet (pre- and post-IPO; e.g., Peleton: -15%; WeWork: IPO postponed; Lyft/Uber: -30%+; SNAP: $17$14; Blue Apron: $10$3, FitBit: $45$7) • Profits Matter: 76% of companies that went public in 2017 were unprofitable, the highest since 81% at the peak of the dot-com boom in 2000 (Ritter, 2017) • Entrenched Incumbents Are Learning: Sector leaders are learning to quickly copy or adopt new technologies, allowing them to sustain their competitive advantage through disruption *Through May 15, 2018. Source: CNBC.com, May 22, 2018 at https://www.cnbc.com/2018/05/22/tech-bubble-is-larger-than-in-2000-and-the-end-is-coming.html

  49. IPOs with EPS<0 Is at Post Dot-Com Bust High Proportion of IPO firms with negative profits rivals Dot-Com era bust Source: Initial Public Offerings: Updated Statistics, Jay Ritter, University of Florida, Warrington School of Business. Data as of 1/17/2018 accessed at: https://site.warrington.ufl.edu/ritter/files/2018/01/IPOs2017Statistics_January17_2018.pdf 50 12/01/09 - 9pm eSlide – P6466 – The Financial Crisis and the Future of the P/C

  50. INSURTECHS MOST ARE DOOMED TO EXTINCTION Six Reasons Why Most InsurTech Firms Will Fail Note: Parts of this section are adapted from: PropertyCasualty360.com, “Hey InsurTechs: Here’s Why You Will Likely Fail,” KarlynCarnahan,June 8, 2018, accessed at:https://www.propertycasualty360.com/2018/06/08/hey-insurtechs-heres-why-you-will-likely-fail/ 51

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