Faye Lageu: 

Hello and welcome to today’s ICMIF webinar. If you’ve joined us in the hope of hearing about how AM Best scores and assesses innovation, you’re in the right place! We’re delighted to have this presentation delivered by Stefan Holzberger, who is Senior Managing Director and the Chief Rating Officer at AM Best. Stefan, I’m going to pass it over to you straight away.  

Stefan Holzberger: 

Thank you very much, Faye, and thank you to those who have taken time out of your busy schedules to attend this webinar, and also a special thanks to my friends at ICMIF for allowing me and AM Best to spend some time and go over with you our approach to assessing the innovativeness of insurance companies around the globe. 

I have to say, I’m quite pleased to be able to take a break from focus on COVID-19. I think for the last six weeks or so, I’ve spent about 90% of each day analyzing the implications of COVID-19 on the insurance industry, so this is a nice opportunity to focus on something else. We released our innovation criteria in early March, so a little bit over six weeks ago or so, it feels like a long time ago. I think it will be a good opportunity for me to kind of go through that criteria with you and kind of give you a perspective on how we’re approaching a somewhat qualitative aspects of our rating analysis. 

Then, at the very conclusion of my presentation, I’ll pivot and give you an update on some of the work that AM Best is doing assessing the implications of COVID-19 on the insurance industry, on our financial strength ratings and, indeed, on the solvency of the different segments of the insurance industry. 

So the agenda today on the subject of innovation, I’ll start off by giving your perspective on how we’re approaching the scoring and assessment. We’re going to go into really how AM Best is going to be evaluating the insurer’s level of innovation across the different markets. We’ll go into the innovation assessments themselves to really give you an idea of how we go about that scoring system. We’ll be spending some time on some benchmarking that we’ve been able to do as we’ve run all of our ratings globally through this criteria. So we’ll take a look across different segments and geographies, we’ll focus on which segments of the market are leading, or lagging, when it comes to innovation capabilities. And then finally, we’ll conclude with the innovation outlook, talk about how we expect innovation to evolve over the near to medium term. 

One question that always comes up as we’re talking about this is really why is innovation so important? Why is it important now? And the answer to that is really we feel that there are structural changes taking place in society that will require insurance companies to improve their innovation. 

What we mean by these structural changes, for example in terms of external forces, we’re talking about demographic shifts. We see more and more of the gig economy, or collaborative consumption trends taking place in business and industry. There’s certainly climate related trends that are very applicable to the insurance industry. And add to those climate trends the ongoing migration to coastal regions in many countries as well as the urbanization trends which are concentrating more and more assets in more, again, concentrated geographies certainly has implications for the insurance sector. 

Then, last but not least, technology itself. The Internet of Things, artificial intelligence, the advances in cloud computing allowing for big data analytics, predictive modelling. We see these technologies becoming more and more prevalent in certain lines of business and in certain insurance markets, but yeah we really feel that that’s the trend that’s going to continue. 

Then there’s the internal forces that are making innovation more and more important. Insurance is a highly competitive market where there’s ongoing pressure on profitability. You’ve got the focus on the customer experience and more and more customer demands in terms of the way that they interact with the businesses that they choose to do business with, so that’s going to be a clear focus for the insurance industry. It really needs to be is what kind of customer experience they’re providing. 

Then finally, the need to improve operating efficiency. This is something that’s been talked about for many, many years. Certain segments of the insurance market are just running too high of an expense ratio which is really just kind of begging for the potential disruption if insurance companies in certain markets aren’t able to provide their products and services more efficiently. 

Before we jump into the innovation criteria, there’s a lot of definitions out there, and I wanted to provide to you AM Best’s definition of innovation just to kind of level set so you know where we are coming from, what innovation means to us in the context of our rating criteria. So I’ll kind of go through this slide, read it through with you. We see innovation as a multi-stage process that transforms ideas into new or significantly improved products, processes, services or business models that have a measurable positive impact over time, and enable an organization to stay relevant and successful. And these capabilities can be grown organically, or they can be adopted from external sources. I know that’s quite a lot, quite a lengthy definition. But a couple of key takeaways and in terms of the way we see innovation and the importance of it, it’s not just something for the largest companies with the most vast resources. In fact, you’ll see later on in the presentation how companies of all sizes and scales can be successful with their innovation. 

Then focusing on areas for improvement through innovation: products, processes, services, business models. One important point is we’re really not just talking about adopting new technologies here. There’s lots of ways organizations can be innovative beyond the technological capabilities that we know are out in the market. And then finally, talking about the measurable positive impact. Measurable is a key word in our definition because, as you’ll see, the output of these efforts is really important. So being able to quantify what the results the company has been able to achieve from their innovation investment is very important in the context of our criteria and our assessment. 

So there are two prongs, or two steps, to our approach to innovation. As you can see here on the left, the first one … And this is really our starting point, and that is all rated companies are going to be scored and then given an innovation ability assessment. And this should be seen as an absolute assessment of a company’s level of innovativeness. Here we’re really not talking about the relative innovation of Company A in relation to its peers, its competitors, the broader market geography where it operates. This is an absolute assessment of their level of innovativeness and it’s really not just confined to what we see within the insurance industry; this is more of a view of innovation across all industries. 

The reason we take this broad approach is we feel that its disruption to the insurance industry doesn’t have to just come from within. So I think that’s an important point where when we’re talking about that level of innovation on an absolute basis, we’re really looking across different industries to see what are the best practices out there right now, and how do these insurance companies fit in terms of what their capabilities are in relation to a broader view like that? 

The second step of our innovation initiative is then to include this innovation view as part of our business profile building block, and I’ll give you a brief summary of our rating methodology for insurance companies in a moment. But really what we’re talking about here is we’re considering whether the company’s innovation efforts have had a demonstrable impact on its financial strength. 

This side of the assessment is really the relative view of a company’s innovation we say in relation to its particular circumstances. And what we mean by that is the company’s innovation compared to its competitors, compared to its customer expectations, and so this is really the relative measure of innovation which ties into the rating assessment itself. 

I think it should be noted that these two prongs can actually diverge from one another. So you could have an example where you’ve got a company that has a moderate level of innovation, so not a particularly advanced, but a moderate level of innovation some level of capability. But the peers that that company is competing against are actually quite far behind when it comes to innovation and you might be in a market where customer expectations are rising. 

So this company that doesn’t have a great innovation capabilities, actually compared favourably to its peers and, as a result, that would be perceived positively in our rating analytics in the business profile building block as we call it. 

 Just to give you a brief overview of our rating criteria, this slide is focusing specifically on the business profile building block. But if you look at the first four blocks going from left to right, and three of them are shaded out. But for those of you that aren’t overly familiar with our rating methodology, the way we approach the rating analysis is we start with balance sheet strength and we do an assessment of risk adjusted capital, liquidity, quality of assets, quality of the reserve position, etc., and that gives us a baseline rating. 

 The next three building blocks will either increase or decrease that baseline assessment, or leave it exactly where it is. So as an example, we might have a baseline balance sheet strength assessment for an insurance company at the BBB+, and operating performance might be perceived as positive, so that might be scored as a +1, so kind of a favourable view of operating performance which would bring that rating from BBB+ to A-. 

Business profile might also be a +1 favourable assessment, so that A- would go to A. And you could, potentially, see some weakness in enterprise risk management that might be scored a -1; so bringing the rating back down to A-. So that’s kind of a quick overview, very high level overview of the way we work through our rating methodology and produce the insure credit rating that you can see there at the end. 

The reason we’ve highlighted business profile here is because this is where our innovation assessment will reside. And you can see, there are a lot of other aspects to the business profile assessment; they’re quite qualitative in nature. You’ve got the market position of the organization, is it a leader or follower product risk? How risky or volatile are the products that the company is writing? 

Management quality. What we mean by that is management’s ability to meet its plan, its financial projections on a consistent basis. And then innovation is going to be the ninth component of business profile, so you can kind of see where it fits in to our rating analysis at this point. 

And what was our premise is, when it comes to innovation, is it will become more and more relevant and more and more important, over time, based on those societal demographic changes that are taking place. So that’s kind of where we are right now in terms of our view and how innovation fits into the methodology, but we do feel it’s going to increase in importance over time. 

So now let’s jump into the criteria for scoring innovation, so we’ll get into kind of the nuts and bolts in terms of what our analysts do to arrive at that innovation assessment. And at AM Best, we very much like extremely complicated formulas, but I’m happy to report that this is not one of them. 

So our scoring for innovation is very simply the innovation input score, we add to that the innovation output score, and that gives us our overall innovation score. Okay, so bearing that highly complicated formula in mind, let’s start off with the innovation input score. And there’s going to be four sub-components to the innovation input score, and each of those sub-components will be graded from one to four; one being the lowest grade, four being the highest. 

And probably not surprisingly, our criteria and our assessment for the innovation input starts with leadership. Leadership is going to be the driver of success or failure of the organization. We’re not just talking about senior management, we’re talking about the board buy-in when it comes to the importance of innovation. So leadership has it as a direct influence on the other sub-components of the innovation input score. 

We also have culture. The culture can either stimulate or suppress innovation. One important aspect when it comes to culture is kind of the tolerance for risk really needs to be well defined. Employees really need to know and business unit leaders, up the down the organization, really need to know whether they can take a chance, bring in the new technology try to launch a new product. 

Some of these ventures will succeed and some will fail, but if you don’t have a well-defined tolerance for risk and an acceptance of risk, to some degree, you’ll find that employees are very hesitant to take a chance on it and pursue an innovative new idea. And we add to that the resources in the organization, and there’s three aspects to the resources. There’s the technical resources which is really systems and data, there’s the creative resources such as the ideas, again, that the staff is generating and then, of course, the financial resources that will fund these projects. 

Finally, we call it process and structure. And what we mean by that is kind of the data management, the strategy around innovation and how well aligned that is to the corporate objectives. And then finally the governance around innovation projects and endeavours. Because you have to have good governance, you need to know when to kind of cut off a project or promote it and give it additional funding because you feel like it’s going to be successful. So these are the four components of innovation, and the innovation input score, each of these components is scored one to four for possible score of 16 on the innovation input side. 

From there we will move over to the innovation output scores, and that’s very simply made up of two sub-categories: results and the level of transformation. Again just like with the innovation input, each of these assessments is scored, or each of these sub-categories is scored from one to four. And we multiply that combined score by two so that the output score is given the same weighting as the input score. 

What do we mean by results? I think it’s fairly straight forward, but as I mentioned, in the context of our definition of innovation, it’s very important that tangible results are produced. It’s one thing to have an innovative culture and buy-in from leadership, but if those efforts are not producing tangible results, it begs the question really what is the return on the investment being made? 

Another important component of the results is that the output should be replicable; it’s not just a once and done exercise. If we’re really to get a high score for this subcategory of results, we really need to see that there’s a system in place to continue to produce this level of results that are replicable. 

The level of transformation here, we’re really talking about how much value is created by the innovation efforts. How material or critical are the improvements in the business that are achieved? And to take a step back in terms of really what we’re seeing in the market today, we see very few companies that are able to score highly in terms of their level of transformation. 

So we have the potential score of 32, you got 16 potential points for the input score, 16 potential points for the output score, so the highest possible score is 32. And as you can see here, companies will receive an innovation score and it will be bucketed into these five groupings: minimal, moderate, significant, prominent, or leader. 

Just to kind of level–set, right now for the insurance industry most companies are scored in the moderate category. And this really ties to the survey results that we launched a global survey at the start of our innovation initiative, and we asked insurance companies, “How do you see yourself, or how do you see the industry in terms of its level of innovation?” 

And the results from that survey indicated that something like 80% of the industry said that they felt that they were behind the curve when it came to innovation. So the industry recognized that there was some work that needed to be done on this subject and our assessments are kind of proving that out. Now this gives you another view of the distribution of scores in the different of the five buckets across universities figures are our global in nature, so this is really a view of all of our ratings and how they’re scoring for innovation. 

As you can see here, these are percentages. 50% fall into the moderate assessment and very few companies today are receiving the top marks as prominent or leader in terms of innovation. And just to recall my comment from before, remember we’re looking at innovation across all industry segments. We’re looking at technology, pharmaceuticals, aviation; we’re really trying to assess this score on an absolute basis. And in terms of what are the top tier players not just in the insurance market, but across all markets? 

So what are some of the commonalities or how descriptors that tie to these different assessment categories? So leaders being the very top of pyramid, you could say these companies typically operate in highly competitive markets where there’s intense pressure to innovate. So they’re the external factors that are really pushing these companies to innovate based on competitive trends, customer expectations; this is really driving a focus on innovation for these companies. These companies are able to achieve a very significant return on investment, a return on their innovation investment and, generally, they’re achieving top tier results driven by those innovation endeavours that they’re involved in and that are very successful. 

Moving down to the prominent category. I think it’s important to remember that this is still a very high assessment per our innovation criteria. I think the main difference here is that you’re going to see a lower level of transformation in the result, but these companies are still very much focused on innovation they feel it’s critical to their success. And as you can see, they have a clear track record of using innovation to improve their business and achieve or maintain a competitive advantage. 

Moving on to the significant scoring. The third bullet here, these companies are focused more on incremental or an accumulation of multiple maybe smaller improvements through innovation in terms of their business, rather than that kind of transformational, very material shift in terms of their capabilities. But still a very strong score for innovation based on where the industry is today. 

And here you have the moderate score which is where most of the companies reside in the insurance industry. These companies are focusing on the inputs right now, they’re trying to get those inputs, the leadership, the culture, the resources systems, etc., trying to get them where it needs to be so that they can achieve replicable innovation outputs and results. Right now for companies scored in this area, they may have some successes when it comes to innovation. But, generally, they’re not as replicable as you might see for those companies scored in the higher categories. 

Finally, those companies scored marginal the lowest assessment, right now they’re probably much more focused on the, as we would say, the blocking and tackling of running an insurance company. They probably have a fairly limited business profile, they’re in markets where there’s not a huge amount of competitive pressure or customer demand for innovation or a more nuanced experience. So go back here for one second. There we go. So right now these companies that are achieving this marginal assessment, they’re probably not operating in a segment of the market that’s demanding a level of innovation. 

I think one of the themes that we’ve seen as we’ve done the scoring exercise across our rating portfolio, is the output score is lagging the input score here. And looking at these scores and sub-assessments, you can see that the input score, which is in blue, is higher across the board, across all five assessments than the output score. And that kind of ties to the view that the companies really are currently working on their inputs and that they’ll be achieving more outputs in the near to medium term as they build out that internal capability. 

Another way to look at the return I think as AM Best being a credit rating agency, we look at a lot of financial metrics and ratios. And one way to look at the return on the effort is to kind of take a ratio of the input score to the output score. So a score of 1.0 would kind of almost indicate a dollar for dollar return on investment. 

Based on where the industry is right now, you can see that very few companies are getting close. They’ve got a very small percentage of our rated universe and the prominent or leader where the output is getting closer to the input. But for minimal, moderate, and significant you can see it’s still a ratio of much higher scores for the inputs and much lower scores for the outputs, and that’s what’s driving that ratio. 

We say it starts with leadership. You can see here there are a higher scores for leadership than there are for the other categories. Most are scoring in the score of two or three; again these are the four sub-categories for the innovation input score. And yes as I mentioned, most of the scoring is coming in to a score of two or three. But, clearly, from what we’re seeing and in dialogue with the companies that we follow, right now it’s really a focus on leadership as well as culture as the starting point to progress that to where it needs to be. 

Most innovation is not transformative, at least not yet. Again on the results side, or the results in the level of transformation which comes together for the innovation output scores, here you can see the vast majority of scores for output are in the one to two range; so below where they are for the innovation input. And clearly here, this is really where the work needs to be done to get to the point where, say, the insurance industry is catching up with other industries in terms of leveraging that innovation capability to move the business forward and make it more successful. 

There’s a correlation between innovation and the rating level. Here you see in these pillars our different rating assessments. A superior rating would equate to a financial strength rating of A++ or A+, excellent A, or A-, good B++, B+, and so on. And so the higher rated companies are the ones today that are able to leverage innovation to improve their competitive advantage and that is reflected in their financial strength rating. 

It’s these higher rated companies that get more results from their effort. So the return on investment from innovation is key in terms of our overall assessment. And, again, going back to those higher rated companies that would be in the superior or excellent category, these companies are receiving higher scores in the results subcategory than the lower rated companies; kind of going back to that concept that there is a correlation there. 

There’s a clear link with business profile. So these are the different assessments that we would give under the business profile building block which is one of the four key building blocks in terms of our rating methodology. And a very favourable business profile would move the baseline rating up two ICR notches; so that could take a B++ baseline up to an A rating. 

We’re here indicating that business profile really matters to the overall rating assessment. A favourable assessment would add one notch to that baseline rating and, potentially, bring an A- up to an A rating. And for those two categories under business profile, very favourable and favourable, we see that there are more high innovation scores for these organizations that score very well in the overall business profile assessment. And the lower business profile, the weaker business profiles, at limited or very limited you see much more ultra-low innovation scores. 

Innovation is not just for large companies. I think if you look across these different financial size categories at the top policyholder surplus where equity of $2 billion or greater, kind of going all the way down to the smallest financial size category of equity of less than $10 million. The point here is that every one of these financial size categories has some percentage that are achieving, say, a score of significant. And significant is a score that is ahead of the broader insurance industry which we see today is scored at moderate. So there are advantages to be had using or leveraging innovation regardless of the size of your organization. 

It’s also clear that it’s a global phenomenon here, we’ve kind of looked across our rated universe globally and the takeaway here is that all geographies, all regions are focused on innovation. It was noted in our industry survey where we saw that companies in all geographies felt that innovation was going to be critical to their success, to their organization’s success. Looking more closely within the insurance industry, there are some segments where we feel that they’re ahead of the game, and they really kind of stand out in terms of what they’ve been able to achieve through innovation and that’s reinsurance, the health segment, and auto or motor. 

The reinsurers have developed innovative risk transfer mechanisms whether it’s ILS, side cars, transformers, and they really put significant resources into understanding what technologies are out there and often use that knowledge to advise their clients, the primary insurance companies, in terms of what technologies, or what partnerships might improve the primary company’s businesses the most. 

On the health front, we see some very impressive technological advancements, whether it’s wearables, or something sophisticated diagnostic tools, or even telehealth which today is probably more important than ever. Being able to get that medical advice and support without having to go to the doctor or the hospital. 

And then auto, of course, probably at the forefront of leveraging innovation and technology with complex pricing algorithms, leveraging big data to improve risk segmentations as well as achieving cost efficiencies and improving the customer experience. It is a highly competitive market, auto or motor is, and with I would say rising customer expectations in terms of the way customers, policyholders, claimants expect to interact with their insurer. 

If you look at the property casualty line of business, or the non-life line of business, you can see here that it’s a fairly tight scoring across the different main lines of business. But as I mentioned, our composite of private passenger auto and homeowners companies so this composite group of non-life insurers is really driven by the builder specialists, as well as we would call it, that personal lines companies that focus on auto and home. They have the greatest pressure to innovate and, as a result, they have the greatest innovation capability. Move down a couple to workers compensation, where we feel there’s been some really strong movement there when it comes to predictive analytics, a lot of good improvements, and we feel that there’s certainly potential for more. 

Getting closer to the bottom end of the moderate scoring, moderate scores are between 12 and 17, you have the medical professional liability companies that are under pressure to innovate. And there’s some improvements there certainly we see, but a lot of work to be done on that front. And then non-standard auto kind of an example of a line of business where there’s really not a lot of pressure right now for these companies to innovate; but of course, that could change over time. 

Distribution of scores by line of business or by main segment. You got the P&C, which you can see clearly 60% of companies in that segment are scored at moderate. For the life and annuity companies, it’s a bit more of an even split between moderate and significant, though A lot of work to be done on the life annuity side in terms of the way they interact with their customers. And then again, health and reinsurance examples of segments where we’re seeing the best level of innovation today. 

So we’re getting to kind of the end of my prepared statements on our innovation criteria. We feel that the outlook is positive, companies are going to be focusing more and more on enhancing the customer experience to meet rising expectations. Unlocking operating efficiencies, again the expense ratio is just too high in certain segments of the insurance industry which could bring on competition from external sources. 

Improving underwriting performance. Those improvements go straight to the bottom line deepening our relationships to drive transformation. Most insurers in terms of their relationships with the vendors and insure tech companies is really to take a partnership approach rather than kind of a grassroots build it yourself effort, so we see a lot of successful partnerships forming in the market with insure tech providers. 

Finally, expanding digital capabilities critical for leveraging big data, leveraging advanced analytics, and that kind of digitalization. And in the environment we’re in now with most all of us working remotely, you can see how critical that digitalization is becoming, particularly in the environment we’re in today. 

That concludes my comments on innovation. I’m going to spend a few minutes talking to you about COVID-19, and clearly it’s on everybody’s mind. Huge amount of uncertainty, but not really anything positive to tell on that front, so it’s really a question of how deep on the downside are we talking about from an economic standpoint, from a financial market standpoint. So I thought I’d share with you for a couple minutes what AM Best has been doing in terms of getting our arms around the implications for the insurance industry. In early March we sent out, or mid-March I think it was, we sent out a questionnaire to all of our rated clients globally, really asking them how prepared they were for this from an operational standpoint. 

We asked questions concerning what kind of internal stress testing the company may be doing as part of its risk management program, including sensitivity analysis, and then also looking for a financial update in terms of projections for 2020. Again recognizing that there was a huge amount of uncertainty and that it might take some time to really get a proper assessment of the financial implications of what’s going on in the economy and for the insurance industry. On this front, I’m very happy to report that most every insurance company rated by AM Best has pivoted to a remote working environment extremely well, and is continuing to serve policyholders and claimants without skipping a beat; quite a strong testament to that risk management disaster recovery for the insurance industry broadly. 

In addition to that questionnaire, we’re currently undertaking an extensive stress testing of risk adjusted capital as well as liquidity, and we’re haircutting certain investment classes looking at potential spikes and loss ratios for some lines of business, increasing mortality assumptions. And so that’s something we’re working through right now, we expect to have some results of those stress tests in the coming weeks. Part of that stress testing, of course, is discussing the challenges with companies looking through what kind of mitigating effects they have in terms of managing through this crisis, access to liquidity, hedging that’s in place and things of that nature. 

We’ve been busy updating our various market segment outlooks, and I think if you look at those market segment outlooks, it’s really talking about the operating environment for companies in these different markets. So these market segment outlooks are not an indication of where specific ratings might be going. If we have a negative outlook on UK non-life, it’s not to say that our ratings in that markets are downgraded. Really what we’re saying is that the economic and the operating pressures, the financial market volatility is going to make it a difficult market for companies to compete in that market and achieve reasonable results. 

But our feeling, in light of these market conditions, actually is that our companies, particularly our non-life companies, are quite well placed to manage through this crisis. A little bit more downside risk on the life and annuity side, purely based on the level of risk adjusted capital as well as, say, the asset leverage that you see in that segment of market. But that said, our life and annuity ratings, as we’re going through these stress testing these companies, by and large, are holding up quite well under the stressed look as well. 

And finally you can expect AM Best to release ongoing market segment outlooks across the globe in terms of our different markets, and we will also be releasing a good amount of research in the coming weeks and months. For example, we’re exploring the issues around business interruption in the U.S. in Western Europe in terms of that contract language, what it might mean as some of these cases go through the court system. 

Right now where our view that where there is exclusions and the wording is clear, those exclusions will hold when it comes to business interruption coverage, but it is something, as an example, that we’re looking at very closely. And that does conclude my prepared comments. Fay, I’m happy to hand it back to you at this point in case there are any questions. 

Faye Lageu: 

Thank you very much. Stefan. Yes there certainly are a few questions that have come in. I’m going to stick actually with the COVID-19 issue first so we can get back to the innovation one afterwards. You mentioned that some of the industry sectors like annuities might see some downgrades. Are there any particular geographies where you suspect that there might be some downgrades in ratings on the horizon as a result of COVID-19? 

Stefan Holzberger: 

Yeah, so thanks, Faye. If you look across our kind of three main segments within the insurance industry, you’ve got the non-life, life, and annuity, and the health segment. Early evidence from our stress testing kind of at a broad level is that on our non-life rated companies, although they’re seeing some negative volatility around the equity portfolio and other asset classes like real estate, their starting point from risk adjusted capitalization is actually very strong. And we see actually, despite a fairly severe stress test on capitalization, we see only a modest movement downward through this quite severe stress. So we feel overall that that segment is quite well positioned. 

Health is a little bit of a different story, they’re not quite as strongly capitalized particularly in the U.S. where we have a pretty extensive private health industry rated. Those companies have a little bit higher underwriting leverage, but they also have significant non-regulated cash flows. So these companies, although they may have a bit more of a hit to risk adjusted capitalization than the non-life side, their coverage ratios and their liquidity remains very strong. So there we see a modest amount of negative pressure on some ratings but really not across the board. 

On the life and annuity side, it depends a bit on the profile of the company. So the public companies that have access to capital and liquidity, by and large are holding up quite well to our stressed. You might say that maybe some of the more private equity owned companies, where it’s a little bit less clear what kind of access to capital they have, and the companies that have a greater allocation to alternative investments, those are the ones that are less liquid more volatile; there you see a little bit more in terms of negative consequences of the stress test. 

Not to say that that’s going to equate to downgrades, it’s something we’re working through right now, discussing with both companies what kind of mitigating plans and options they have to shore up capital and liquidity. The one point I would make on geographies would be it’s really, unfortunately, the emerging market economies and the weaker economies that were struggling before this crisis, they’re likely to be the hardest hit as investors move assets to more safe haven sort of investment classes. 

Faye Lageu: 

Absolutely. And do you think that the regulatory capital requirements are proven to have been adequate, given what’s happening right now? Have you seen any signs that maybe regulation is going to tighten or get worse, whichever view you want to take, on capital requirements? 

Stefan Holzberger: 

Yeah, that’s an interesting question. And it really kind of comes down to the different regulatory domiciles. I think the solvency to barometer in Western Europe as well as, you might say, in Japan, Bermuda and the equivalent territories; very robust, very sophisticated view of capitalization and solvency. 

So there, we feel it’s a high bar for companies in those markets to begin with. And so I think the regulatory hurdles for capitalization are quite appropriate and those companies should hold up quite well similarly to RBC in the U.S. where have a pretty high bar for companies in terms of the capital they need to hold to manage their risks and uncertainty. 

If you get more into the emerging markets where the regulation is still kind of getting built out, and whether it’s the Middle East or Latin America to some extent, really there you have to look at it market by market. And, frankly, in some emerging markets the threshold for us, it’s really actually the capital required for our financial models and capital models more so than the regulatory view. 

Faye Lageu: 

Sure and we’ll see how that all pans out across the world as you say. So we’ve received a question that links the two topics actually quite neatly: How do you think that the COVID-19 crisis is going to potentially have an impact on how insurers can continue to innovate? So at this time when there’s a lot of pressure on organizations, how do you think that might impact on their ability to continue to invest as much in innovation? Or what are the effects going to be on that do you think? 

Stefan Holzberger: 

Yeah, I was thinking about that. As it turned out these two topics do kind of fit quite nicely together; innovation and the environment we’re in thanks to the pandemic. And I would say that there’s going to be an extremely strong drive for enhancing and improving innovation capabilities. Being able to have that digital infrastructure, being able to run the more data driven aspects of an insurance company’s operations remotely. Access to customers, responsiveness to customers is going to become hugely important during this crisis and probably beyond it. 

In terms of the ability of the insurance companies to continue to innovate, there I think we’re going to see some pressures. A lot of these insure tech companies that are eager to partner with insurance companies are in the delicate start-up phase of their operations. They require funding, they require ongoing direct capital investment to grow and build out their products and sweeten their capabilities. 

Frankly, some of them may have brought in leverage into their businesses, into their capital structure that could be difficult to support as liquidity becomes harder to access as the economic situation deteriorates. So I think for insurance companies, they’re going to have to be quite careful in terms of who they partner with and the financial health of those insure tech vendors that they do choose to partner with to make sure that they’re able to kind of get through this crisis. 

Faye Lageu: 

Absolutely. Let’s go a bit more into some of the issues around getting that level of transformation that you spoke about. You mentioned that it’s very hard for companies to get a particularly high score when it comes to the level of transformation. What, in your view, are some of the key barriers or, conversely, some of the key enablers to changing that to getting that higher level of transformation? 

Stefan Holzberger: 

Right. So where we see the insurance industry today is focused on the infrastructure, the inputs to innovation that really are required to get that level of materiality and that transformative capability from the innovation. If you’re battling with legacy systems that don’t talk to one another, the organization’s going to have a hard time leveraging the data that it even has in-house to improve predictive analytics or risk segmentation. 

So until the insurance companies have the systems, the processes, the culture around identifying a good innovative idea, moving that through the organization so it can really be leveraged and put into practice, breaking down the silos so you don’t have an innovation team that is getting pushed up against barriers from the business segments because they just want to kind of run the business the way they’ve always run it, if you don’t break down those obstacles and build the infrastructure to be innovative as an organization, you’re just not going to achieve material and meaningful outputs. 

Not to say that organizations aren’t achieving some level of return on their innovation of investment; they are. But to be able to do it in a replicable fashion and really transform the business that’s going to take some time, and it starts with getting those inputs and the infrastructure in place. 

Faye Lageu: 

Yes, and you talked about the four components on the inputs. You mentioned culture and leadership which is, obviously, something that ICMIF members are quite interested in. Could you tell us a bit more some of the key characteristics you look for when it comes to leadership? 

Stefan Holzberger: 

Right, so it’s not just paying lip service to innovation being important, it’s allowing employees to bubble up ideas and then there’s somebody listening to those ideas. It’s making it clear that somebody’s not going to lose their job, or their budgets are going to get cut if they have an innovation initiative that’s not successful. You want to have this fast–fail environment where you learn from your mistakes but the leadership of the insurance industry leadership is generally quite conservative; we’re very circumspect about taking on risk. We’re in the business of taking on risk, but it’s done very methodically and carefully because it can have direct implications for financial strength. 

But for leaders to be successful in their role, they need to champion and support all the way through the organization so that it’s clear that every employee can be a change agent, and that there’s room and risk tolerance for some of these initiatives to not be successful. And that’s where you get the entire organization looking to say, “Okay, here’s my role, here’s how I fit into the organization, here’s how I can make it better.” That sort of approach. 

Faye Lageu: 

Excellent. And I think you might notice innovation was one of the key themes at the most recent ICMIF Biennial Conference. Do you have any sort of insights as to how mutuals and cooperatives compare to the industry, generally, in terms of their innovation levels? I don’t know whether you have; I’m putting you on the spot. 

Stefan Holzberger: 

You know, Faye, it’s a great question and we’ve sliced, and diced, and benchmarked in so many ways. I’m sure there is some data that I could, if I had time, put my finger on. But my perception is the simple fact that mutual companies are not driven by quarterly earnings, and you don’t have the same level of external pressure to right size capital and achieve a certain target ROE. 

Obviously there’s pressure on profitability for every company and pressure to put capital to work, but my sense is that the mutual companies could have an advantage because they’re able to take a long term view, they’re able to go down a path, devote resources where you may not see that return in the next quarter or the next half year figures. So it’s that long-term view, maybe an ability to allocate capital to these longer term projects I think that will give mutuals an advantage on that. So that would be kind of my thought on that in terms of mutual versus stock kind of differentials. 

Faye Lageu: 

Good advice for all our members who are listening to think of the opportunity, certainly, that they have in being a mutual structure. Okay so now we’ve got the industry embracing innovation in so many ways right now, and now that AM Best is incorporating innovation criteria into your rating analyses, are you expecting to see some upgrades or some downgrades across the industry? What do you think? 

Stefan Holzberger: 

Yeah so today, we feel that innovation is probably going to be neutral to the overall rating of insurance companies in the market. You can see where it’s placed with a business profile, it’s one of nine sub-components to the business profile building block. And I think we’ve said publicly that today we don’t think that innovation in and of itself is going to drive ratings upward down; although there is a correlation between the innovation capabilities of higher rated companies and the lagging capabilities of lower rated companies. 

I think the main point that we would make is that based on these societal changes, innovation is going to be more critical to the successful operation of insurance companies over time. So it’s not going to change ratings today, but as its importance increases over time, it will become more of a differentiator and it will, very likely, serve to change ratings up or down over time. 

Faye Lageu: 

Wonderful, thank you very much, Stefan. We’re going to wrap the questions session up with you now because we have taken up already an hour of your precious time. And there’s some really interesting things that are coming through. I think it’s a topic that ICMIF would love to continue working with you on. Obviously innovation is going to, as you say, make or break potentially the future of companies and that’s what we’re all about. So thank you very much for your presentation and your very thoughtful answers as well to some demanding questions. 

Finally, if you do have any further questions, comments, or if you want to get in touch with Stefan then drop us a line at ICMIF, and we will gladly put you in touch. And meanwhile we wish you all a very safe and happy rest of the week, and we look forward to seeing you next time. Thank you very much everyone. 

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