But for many, this promise is being hindered by a foundational legal concept: The Principle of Indemnity.

By insisting that property insurance must always be a contract of indemnity (meaning you cannot recover more than your actual, audited loss) regulators have forced the industry into a structural kludge known as the “Dual Trigger.” It’s a legal “fix” that satisfies the status quo but creates a cascade of inefficiencies for insurers and consumers alike.

The Mechanism of the “Dual Trigger”

In a rational parametric model, the data event is the payout. In the regulated world, however, two hurdles must be cleared:

1. The Data Trigger: The physical event occurs (e.g., wind speed, rainfall).
2. The Indemnity Proof: The policyholder must provide evidence that their actual loss equals or exceeds the payout.

This second trigger creates what we might call the Indemnity Trap. It caps the payout at the lower of the two values, fundamentally changing the nature of the risk.

Where the Principle of Indemnity comes from – and why it is a good idea in traditional insurance

Traditional insurance needs indemnity. It ensures the contract restores you rather than enriching you. In the non-life market, we insure the uncertainty of a loss. We don’t just insure the occurrence of an event.

If you could collect a payout that far exceeded your actual loss, you’ve moved from a safety net to a lottery ticket. This “Lotto Effect” turns insurance into a legally sanctioned wager. That windfall potential creates a toxic moral hazard. It invites fraud like arson or staged theft. It also rewards negligence. Why protect an asset when you are worth more if it burns?

By capping payouts at the Ultimate Net Loss, we align the policyholder’s interests with the asset’s survival. Insurance remains a stabilizing force. It protects wealth. It doesn’t generate profit from destruction.

The Problem: Asymmetric Basis Risk

This structure creates a profound misalignment. When we layer an indemnity cap onto a parametric trigger, we create a one-way street of risk:

• When the data misses: If the storm causes massive damage but the sensor doesn’t hit the trigger, the policyholder gets nothing. This is the “Negative Basis Risk” everyone acknowledges.
• When the data hits: If the sensor hits the trigger but the physical damage is light (perhaps because the owner invested in resilience), the indemnity rule steps in and caps the payout.

The result is a structure where the payout can be lower than the data suggests, but never higher. This isn’t a malicious choice by insurers; it is a structural constraint that leaves the risk transfer incomplete. It also reintroduces the very thing parametrics were meant to kill: payout delays. The moment you require a loss audit, the “instant cash” benefit of the parametric model is lost to the administrative friction of the indemnity process.

The Pricing and Underwriting Friction

This isn’t just a headache for policyholders; it complicates pricing.

To price a “clean” parametric policy, an actuary only needs weather data. But to price a policy with an indemnity cap, they must also predict the probability of the cap being hit. This requires traditional, granular underwriting of the asset. We’ve replaced a low-cost, scalable model with a high-cost, bespoke one, simply to satisfy a legal definition.

Assessing the Regulatory Responses

Why do regulators cling to the indemnity requirement? While the intentions are often centered on market stability, the logic behind these defenses deserves a closer look.

Argument 1: The Mitigation Incentive The traditional logic is that indemnity prevents moral hazard. The fear is that if people “profit” from a disaster, they will want the disaster to happen. However, this overlooks a critical reality of resilience. Traditional indemnity insurance actually discourages mitigation. If you spend your own capital to save your factory with sandbags, your indemnity payout simply drops to match your lower loss. In a parametric model without an indemnity cap, you are rewarded for that foresight. You keep the surplus as a “resilience dividend.” The current rules are, in effect, a structural barrier to climate adaptation.

Argument 2: Speculation vs. Insurable Interest There is a concern that without a proof of loss, insurance becomes a “Lotto” or a wager on the weather. But the gatekeeper against speculation should be Insurable Interest, not Indemnity. If a buyer demonstrates a legitimate economic exposure to the event at the point of sale, the speculative element is already addressed. We do not need a cumbersome audit at the back-end to solve a licensing and gatekeeping question at the front-end.

Argument 3: The Life Insurance Precedent It is often argued that property must be treated differently from life insurance because assets have a market value that must not be exceeded. Yet, the Life, Disability, and Critical Illness sectors function perfectly well as “valued contracts.” These are multi-trillion dollar industries that rely on Insurable Interest and a Reasonable Sum Assured. There is no fundamental logical reason why a crop, a solar farm, or a retail business could not be treated with the same “valued contract” logic we already apply to human life.

The Path Forward: The “Ought”

We shouldn’t be trying to “fix” parametric insurance by adding indemnity caps. We should be updating the regulatory framework to recognize Index-Based Insurance as a distinct legal category.

A modern, rational framework would require three things:

1. Provable Insurable Interest (Ensuring the buyer has skin in the game).
2. Reasonable Sum Assured (A cap based on total economic exposure, not just physical damage).
3. Objective, Independent Data Triggers that are demonstrably correlated with the risk exposure

The current “Dual Trigger” system isn’t a design choice; it’s a symptom of a regulatory system that hasn’t changed fast enough. I’d argue the regulations are focused too much on the potential cost and risk of change, while glossing over the downsides of not changing.

Is it time to stop forcing 21st-century risk tools into a 19th-century legal box?

Hyperinflation, Currency Crises & Insurance Industry Collapse

Hyperinflation destroyed Zimbabwe’s insurance sector, and decades later, it still hasn’t recovered. Currency crises in Lebanon, Argentina, and Venezuela have crippled financial institutions, showing how fragile financial systems can be when trust in money itself disappears.

A recent discussion started as a tongue-in-cheek debate: Is inflation a more efficient way to raise revenue than taxation? But it evolved into a broader debate on monetary risk, Bitcoin, inflation, and long-term economic trends—and why so many common arguments deserve scrutiny.

How Inflation Impacts Insurance

Premiums & Inflation Risk
High inflation makes level premiums unworkable, erodes the real value of cover. Optional benefit increases create adverse selection problems in life insurance. Even constant percentage increases fail under volatile inflation, and real wage stagnation worsens affordability pressures.

Monetary Instability & Insurer Solvency
Currency collapses create huge challenges for insurers trying to meet liability obligations in real terms. When inflation spikes, reserves built on past assumptions become grossly inadequate, leading to solvency concerns and even industry-wide failure.

Crypto & Smart Contracts in Insurance
Blockchain has potential for parametric insurance, automated claims processing, and fraud reduction. But much of the excitement outpaces practical application—or solves problems that were already solved while not addressing key remaining challenges.
(And let’s be real—just because a smart contract auto-executes doesn’t mean lawyers won’t find ways to argue intent and “meeting of minds.†)

My (Cautious) View on Blockchain

I spoke at the 2016 ASSA Convention on Seductions of the Blockchain, and my position remains:

• Cautiously optimistic
• Interested in opportunities
• Frustrated by the lack of rigorous debate from both fanatics and skeptics

The fanboys see blockchain as a cure-all, while the status-quo-invested skeptics dismiss it entirely. Reality, as always, is more nuanced.

Key Arguments & Concerns

1 Inflation as an ‘Efficient’ Tax?

Some argue that taxes are administratively complex, difficult to collect, and inflation acts as an “invisible tax† that transfers wealth to the state with less friction.

The Problem? Inflation isn’t a neutral mechanism:

• Distorts price signals and makes long-term contracts unreliable.
• Increases uncertainty and raises borrowing costs.
• Disproportionately harms those without inflation-protected assets—often the poorest.
• Erodes trust in government’s ability to manage financial stability.

Hyperinflation isn’t just caused by overspending—it requires excessive money printing to cover deficits. Many governments (e.g., Japan, the US, and EU countries) have run huge deficits for years without hyperinflation because they borrow responsibly instead of monetising debt.

Friedman’s famous quote:
“Inflation is always and everywhere a monetary phenomenon in the sense that it cannot occur without a more rapid increase in the quantity of money than in output.”

2 Bitcoin as a Predictable Alternative to Fiat?

Bitcoin proponents argue that a fixed supply prevents inflation and provides monetary certainty. But there’s a flip side:

The Problem? A rigid money supply is deflationary, which discourages spending and investment:

• BTC expansion (~0.9% today, falling below 0.5%) is well below global population and economic growth.
• Fixed-supply currencies have historically failed because economies need monetary flexibility to adjust to shocks.
• A deflationary currency discourages productive investment. If BTC’s price is expected to rise, why spend it? Why take out a loan?

This is why almost all mainstream economists—from Keynesians to monetarists—support some level of controlled monetary expansion.

Academic reference: Friedman advocated rules-based money supply growth, not a hard cap. Even Hayek, a proponent of free-market money, acknowledged the need for adaptable monetary systems.

A bigger issue: Some crypto coins have fixed supply, but the total universe of crypto coins is unlimited. New projects, forks, and tokens emerge constantly, meaning there is no true scarcity at a system-wide level.

3 Credit Risk & Smart Contracts – Who Pays When the Funds Aren’t There?

Smart contracts don’t solve credit risk. Traditional insurers must hold capital reserves and meet solvency requirements to ensure claims can be paid. Smart contract-based insurance lacks an equivalent safety net—yet.

Key Risks:

• No Guarantee of Payouts: If a smart contract is underfunded, it can’t issue emergency capital or negotiate claims—it just fails.
• Over-Collateralization Isn’t a Perfect Fix: Many DeFi protocols require excessive collateral to mitigate risk, but this limits scalability and locks up capital inefficiently. Actuarial approaches to capital adequacy could provide a smarter balance.
• Cascading Failures in Market Shocks: A major market downturn can cause mass liquidations, leading to systemic failures—just like traditional financial crises, but with fewer stabilizers.

Future Opportunity:

• As DeFi regulation increases, some form of capital adequacy requirements (like Solvency II for insurers) may emerge.
• Actuaries and insurance risk experts could play a role in designing smarter DeFi risk models.

Final Thought: Smart Contracts Are an Exciting Tool—but They Need More Work

Smart contracts introduce new efficiencies, but they also introduce new risks:
They remove intermediaries—but also eliminate safety nets.
They change fraud risk—but introduce oracle manipulation risk.
They enable fast, automated transactions—but don’t guarantee funds will always be there when needed.

For insurance, finance, and risk management, blind reliance on smart contracts is dangerous. But recent advancements show promise:

• Regulators are starting to provide legal clarity.
• Hybrid smart contracts (automated + human oversight) are emerging.
• Decentralized oracles & improved collateral models are evolving.

The real opportunity? Combining smart contract automation with actuarial risk management principles to build more resilient decentralized insurance solutions.

Would love to discuss with those working in insurance, risk management, DeFi, and blockchain regulation.

#Inflation #Blockchain #BTC #ETH #DeFi #DistributedLedger #MonetaryPolicy #FinancialRisk #Insurance #RiskManagement #Actuary #Economics #LegalRisk #ParametricInsurance

With a hefty additional dose of approximations, I get about the same figure all the way back to 1998.

This amounts to an insurer failing every other year.

The primary causes? In every case it’s more than one thing. Here are some of the recent common causes – I’ll expand on each of these in a series of posts.

1 Underwriting risk and pricing

Mispricing, particularly when moving into new markets or new lines of business is a common starting point.

Funeral insurers feeling competitive pressures are looking for new markets – typically semi-underwritten life products, misguided savings products, niche legal expense cover products, or further afield into non-life proper. Here be dragons.

For all the benefit of diversification from a statistical perspective, the research says that focussed insurers fail less often.

Climate change is going to break underwriting and pricing models, meaning that even previously well understood risks increase the chance of failure.

Non-life insurers need to get claims inflation under control – or at least continue the unpopular premium and excess increases to restore sustainability to premium rates.

2 Cost of customer acquisition outstripping funding and VNB

Rapid growth may be many insurers’ dreams.

However, too rapid growth can strain capital adequacy. Rapid growth can also be a telltale sign of under-pricing, leading to large volumes of unprofitable business. Selling many policies that don’t cover their acquisition expenses is a short cut to real trouble.

A worrying sign here is the reduction in VNB margins across broad sectors of the underwritten life insurance space. This ramps up pressures to dilute new business metrics, which is a terrible idea.

3 Misuse, and misrepresentation of (financial) reinsurance

Reinsurance is a fundamentally important tool to manage risk, manage capital requirements, gain expertise in a new market, and to provide liquidity.

Reinsurance, especially financial reinsurance when misused, can obscure the deteriorating solvency position of an insurer and lead to a false sense of security for risk managers, NEDs, and regulators.

The principles on how to treat financial reinsurance and contingent commissions are about right – but the detailed rules and the rigour and honesty with which those principles are implemented sometimes are not.

The overall lesson is – the improvement in your solvency should reflect the actual risk transferred and economics of the transaction.

The most egregious error is claiming that a FinRe deal has resulted in an increase in assets without an increase in liabilities. Tricks of claiming that repayment of the commission (a loan) is contingent on future profits and therefore isn’t a liability are invalid. Games with contract boundaries include recognising the upfront commission (which is to be repaid over many years of renewing contracts), but not recognising years of future reinsurance premiums because the in-force policies have annual contract boundaries.

On contingent commissions, the key question to ask is “has my SCR gone down by more than the risk transferred?”. If one reinsures 70% of the portfolio using QS, but 90% of that risk comes back through contingent commission, then applying the FSIs blindly can result in a 10x overstatement of the benefit of reinsurance. You have shared 7% of the risk, not 70%.

My rule of thumb is not to take advice on the regulatory, solvency, or accounting treatment of the reinsurance from the one selling you the reinsurance.

4 Complex, incestuous asset transactions, and poorly controlled ALM

Aggressive asset valuations, typically of unlisted, illiquid investment that have some related party in the mix, are one of the clearest red flags for an insurer about to fail.  There is always the next Warren Buffet wanting to “invest the float† and make money in some undeveloped property, associated business, or beautiful basket of tulips.

Careful ALM is critical for long-tailed policies. There it needs to be managed carefully and regularly. Monitoring isn’t enough – there needs to be a mechanism to change the portfolio when mismatch parameters breach thresholds.

For other portfolios, sometimes a simpler portfolio that introduces less complexity, fewer tax risks, less operational and liquidity risks, is better than a supposedly more ALM-tuned portfolio that actually increases risks of catastrophic failure.

Asset concentration has been a primary cause of at least one major South African insurance failure before too. Although, as always, this wasn’t the single cause.

5 Taking large (binary) risks when already in trouble

As solvency positions decline, some CEOs, seeing the writing on the wall, choose to take significant risks that will either solve their solvency problem, or increase the impact of insolvency to policyholders.

Something as simple as continuing to write business, especially long-term business, when the solvency capital isn’t available to support this business places existing and new policyholders under additional risk.

Pinning hopes (and management bandwidth) on big-bang investment deals without addressing underlying operational concerns usually don’t pay off.

6 Failed corporate governance

Corporate governance failures are usually the second or third thing to go wrong. Poor internal controls, ineffective or insufficiently independent risk and compliance teams, and outright financial statement fraud mean that serious problems are overlooked, sometimes for years.

Fraud is more often a response to problems (especially where management believes they are in the right and it’s just a matter of time before markets/the cycle/business turns). In select cases, insurers are used as vehicles to instigate fraud as first step

Some boards and shareholders deprioritise good governance. When times are good it’s easy to emphasise good governance. What about when governance gets in the way of decisions executives want to make? Or when it raises awkward questions about pet projects? Or where the business is struggling but management is confident they can trade out of the difficulty as long as they are given the space and time?

It’s easy to do the right thing when it doesn’t come with costs.

7 Slow regulatory intervention

Too often, regulatory intervention is too slow and not targeted at the underlying causes. It’s hard to blame the regulator entirely, given the massive opposition to statutory managers and curatorships.

There are many amazing, skilled, and experienced individuals at our regulator. Are there enough? Is the quality and approach consistent? Are they hamstrung by insurers under resourcing their own control functions and lines of defence?

Can anything be done to decrease failure rates?

Having a strong, experienced, and independent actuary who pays close attention to the regulations and guidance is crucial. Your head of actuarial function should provide good advice on business issues. They should also occasionally constrain your options and make you rethink your positions.

A solid, experienced, and independent Head of Actuarial Function goes a long way.

Appropriate risk management and governance practices are defined in multiple different places, and they can all work well enough if followed diligently. Making sure the teams are experienced and skilled and empowered to tell truth to power is rather more difficult.

That’s the ballpark figure I usually work with as the minimum number of micro insurance policies required for scale. The expenses of running even a micro insurer are not that trivial.

For underwritten products within a full life licence? Larger premiums per policy but definitely more complexity. Competition is tougher too. Hyper local brands don’t translate into trust at this level. Viable niches may exist, but at what volumes?

You might wonder if there is scope to sell greater value products at higher premiums that can bring that number down in some contexts?

The rise of embedded insurance

Turns out this has been given plenty of thought already – “micro” insurance is the less popular name these days from a product and provider perspective. Inclusive Insurance certainly sounds better and more inclusive (!)

I think part of that push though was recognising the challenges and limits of truly “micro” insurance, at least at an individual level in providing commercially viable options that meet needs at the scale necessary.

Inclusive Insurance has been eclipsed in some words for “embedded insurance”, a term that talks less to the needs and objectives for society, and more to one that is practical and viable commercially. Embedding insurance in other products are services can drive down some of the costs, but then by virtue of being embedded, the absolute amount of premium is even further limited. Volumes may go up – and there have been some success stories here – but margins typically remain fine so I’m going to guess that my 40,000 may be too low in these instances. The success stories are in the 6- and 7-digit volume space.

Microinsurance licence restrictions

Back to “microinsurance” and the regulatory restrictions that apply in South Africa:

• Savings elements might seem attractive to increase premium size and provide “value” rather than a set price point. But savings elements are not permitted in microinsurance policies in South Africa.
• Loyalty schemes or cash back may be a way to attach greater value to a product, but again are not permitted in the microinsurance framework.
• Fairly large sums assured are possible within microinsurance – often attracting increased adverse selection or outright fraud.

Can product tailoring increase average premium?

Product tailoring can be expensive and can counter plans for
economies of scale while simultaneously targeting a smaller market. I’d still like to see more of this rather than pure commodity products. I’d be happy to be wrong if this approach meant a viable micro insurer could provide genuine value, see strong demand, and require fewer than 40,000 policyholders or comfortably sell more than that.

Microinsurance pros and cons – an important choice

A key point here is whether a standalone microinsurer is the right vehicle for a truly niche insurer? The increased governance and compliance policies effected by the major cell providers have frustrated cell owners and entrepreneurs, slowed down innovation and led them to look elsewhere. A microinsurance licence is a great option for some, but not a panacea for everyone.

I’ve helped insurers apply for licences, buy licences, consider alternative arrangements, and I’m sure at some point I’ll be working with micro insurers to transfers portfolios to other insurers and close down licences.

There is also opportunity to apply to the Prudential Authority for scope to do more with the licence, with careful consideration of the risks and capital.

Does digital fix everything?

Digital sales is a complex area. Some insurers have had some success with purely digital sales. But when these distribution channels are owned by someone else, the costs are not as low as “digital† might make you think. If NTUs are high, and premium collections are low, it can quickly become expensive. There’s a fine line between removing friction from a sales and underwriting process (which definitely improves sales) and making it so easy to “sell† that the customers haven’t really decided that they want what they’ve bought.

Parametric insurance – watch this space!

We should be doing far more with parametric insurance in South Africa. Thinking around climate risk and the positive role insurers can provide in this space (rather than only worrying about the risks it poses to them) may present some new opportunities. Insurers can apply their expertise in understanding and pricing risk, while providing a socially and economically beneficial product at a price that shows value and profit.

A distribution channel that has never quite got off the ground is even more challenging. With confidence shaken, it’s easy to wonder whether success and scale will ever be possible.

Over the last couple of years, I haven’t engaged with a life insurer that hasn’t experienced some of this. You might be surprised by how ubiquitous this is:

• Yesteryear’s giants of funeral products struggling against the compelling advantage of bank branch, app and call centre distribution. This shakeout has probably benefitted customers with more attractive pricing at the cost of margin for providers.
• Organisations with strong brand and huge existing customer base struggling to generate meaningful volumes of commodity products, becoming reliant on expensive aggregators to achieve some amount of scale.
• Insurers seeing their market attacked by banking competitors investing significant sums into their banking operations – looking for a share of banking revenues and profit, but very much also looking to defend their insurance customers from extremely competitive banks. Some of the success of banks relates to their better digitalisation of distribution systems and related processes. Digitalisation is necessary but not sufficient – as evidenced by the banks slow progress in distributing complex underwritten products.
• Established insurers with success in non-underwritten products, and others with success in complex fully underwritten products, both struggling for scale, persistency and profitability in simplified issue / lightly underwritten products. Maybe it’s only a matter of time before someone cracks this, but for now I’m pretty wary of impressive sales volume projections.
• Insurers with impeccable track records of successful distribution feeling unfamiliar pressure on margins and volumes. (Increasing prices to improve margins can be self-defeating if volumes drop and fixed expenses burn margins further.)
• Life insurers urgently looking for new markets to expand to, including non-life, in order to keep growth going as their core market stagnates. (There are opportunities, but it’s not a simple transition. A key message is that what works for one market segment quite likely won’t work for another.)

I’ll be posting more on this theme in the coming weeks. If you have questions, post below and I’ll try to work them into future posts.

If you are a master of the dark arts of distribution, what do you see as the common or recent failings? What is the key to focus on? Is there just one?

Here are the Micro insurance sessional 2018 slides for anyone interested, provided of course without warranty or guarantee at all and with the understanding that the views expressed are not me employer and are not even all mine as this was partly the output of committee debates.

The larger insurance players seem reluctant to enter the market. Why do you think this market has been slow on the uptake? The regulatory barriers to entry certainly don’t appear to be that restrictive so either existing insurance companies are not flexible enough to offer the products required or it’s a poor business decision/larger risk that they’re unwilling to take on. Do you have an opinion on what is causing the low number of microinsurance players in the market?

So here goes. Certainly a far from complete or perfect answer, but a starting point based on my discussions with many people and entities actively interested in pursuing the market over the last few years.

What do we mean by micro insurance in the South African context?

The issue with micro insurance is scale, particularly of distribution and distribution costs. Okay, followed closely by premium collections (and that is about maintaining scale so that you don’t lose insurance policies as quickly as you sell them). These are the two issues that need to be solved for real success for any new micro insurer or a new platform for micro insurance.

Micro insurance and funeral insurance

Whether micro insurance is big in South Africa or not comes down to how one defines “micro insurance†.  There are major life insurance players that have funeral products with modest premiums, below R100 or even R50 per month. So those large insurers (major traditional insurers plus the bancassurers) are operating in this space already, but as “assistance business† as the current licence category is termed.

Under some definitions, South Africa is already one of the largest micro insurance markets in the world. On other measures, there are still plenty of excluded people who could benefit from appropriately priced, appropriate value insurance on a micro scale. I still hope to see viable products with premiums below R10 per month (and not on some misleading bundled basis) or even less on a micro-transaction basis.

These players are less interested in the particulars of a micro insurance licence because they have yet to see a material benefit. Product restrictions and the complexity of an additional licence don’t warrant lower capital since they aren’t actually constrained by regulatory capital but rather by their own view of economic capital.

Distribution innovation

Some of these players have tried innovative products (pre-paid funeral plans, allowing skipping premiums) with low, no or at best moderate success. The bancassurers push heavily into ATM, USSD and call centre sales rather than branch sales because they are lower cost, and sometimes lower risk of anti-selection. Getting life insurance via the banking apps is an easy step (and some have taken it) so probably the view is that a dedicated app just for insurance is unnecessary.  The banking brands (target of popular complaints as they sometimes are) are still generally well trusted.

The traditional insurers have invested in their own distribution channels, more typically broker- or agent-driven, for decades and this has carved them a good, profitable niche. Changing that for revolutionary distribution has risks.

Fraud and anti-selection are key concerns when you have the ability to turn coverage on and off.  I think many insurers are quite nervous about this. I’d love to see someone dedicating a small pot (R25m or something, so significant enough to do something with, but small enough for major players not to declare a national emergency if I doesn’t work) and experiment with something and see how it goes.

Micro insurance for assets

On the non-life side it’s more a definite gap. Acquisition costs, risk selection, differentiated pricing, claims underwriting and fraud risk (very serious fraud risk!) are non-trivial things to overcome.

Underwriting / risk assessment at policy inception is an expensive exercise. Claims stage underwriting can be problematic from a customer experience perspective if the policyholder genuinely expected to be covered and wasn’t (in which case even refund of premiums paid doesn’t help them, and with that the insurer has likely already incurred a loss based on the claims assessment and administration costs).

Credit insurance and micro insurance – but are we doing it right?

Credit insurance is the one area that sidesteps many of these issues. Clearly established need, assessment of ability to pay, distribution and lower fraud. It’s a pit this is also one of the areas that has achieved such a bad reputation (much of it deserved) for charging high premiums and making super profits based on the lack of a good market. It feels like we should be doing better here.

It would be amazing if someone could also consider what sort of loss they’d be prepared to take on a pilot programme to see if our worst fears are realized for asset insurance outside of the credit insurance space.

All the other hot trends

I’m staying close to developments on what I term “hyper selection† and also peer-to-peer insurance.  Some of this may present opportunities to unleash micro insurance from its current constraints.  I haven’t yet seen developments that seem ready for prime time and which solve what I view as the fundamental problems. Hopefully someone is already quietly working on something incredible in this space.

Micro insurance – opportunity for society, opportunity for business or both?

But the real answer to your question is that the supposed huge potential of micro insurance is a little difficult to pin down in pure commercial terms. Most of the success stories of micro insurance in emerging markets and public-private partnerships, NGO programmes etc.  Many of these also fail even with an explicit return on capital requirement.  Solving these issues on acceptable commercial terms for insurers who already have a successful business is a big question mark.

So even with my belief that micro insurance and inclusive financial services is a good thing for society, it’s less clear to me that it’s an easy buck to make for insurers.

This is particularly relevant given the ambition of some InsurTech players to hyper select risks or price on many more factors than are traditionally used in order to gain a competitive advantage.   Thomas doesn’t argue that it will be individual insurers’ interests to allow adverse selection, but if these companies are successful it may then have implications for policy makers.

Incidentally, there are some interesting reasons for insurers themselves (with commercial interests) to be wary of selecting too well, counterintuitive as that may seem, but more on that for another time.

The book itself is a mixture of qualitative arguments and gentle reasoning with enough maths to keep you interested if you are that way inclined. I struggled to finish the book and found the points belaboured after a while.

The main reason I struggled with the book though is that I believe from the start it assumes its conclusion.- that “increased loss coverage is universally a good thing”.  I’m going to explain a little bit of that here. If you are going to read the book, it might be useful to have these thoughts in mind going into it and see whether you agree.

The premise of the book

Loss Coverage is defined as the expected amount of claims covered by insurance. They demonstrate that, under certain pricing and behavioural assumptions, more adverse selection leads to higher loss coverage.

The rationale is that without accurate pricing, some premiums will be set a level too high and some too low for the specific risk. Some good risks who feel the premium overstates their will decline cover. Since more of the higher risk customers are getting a good deal and recognise the good deal, they will retain cover. Since some of those high risk customers will have felt an accurate price was too high, there could be an increase in high risk customers with cover. They contribute disproportionately to loss coverage given their higher probability of claim and therefore overall loss coverage can go up.

These assumptions are not particularly robust and the book even deals with examples “taken to the logical extreme” that show no increase in loss coverage and a substantial decrease in the number of lives covered.

A limited view on the value of insurance

An increase in the loss coverage measure means that more claims are expected to be covered by insurance as a result of allowing some adverse selection. However, this is at the cost of fewer individual risks being covered by insurance in total.

The argument thus neglects part of the value of insurance. Having insurance, even if one is fortunate enough not to claim, allows a less anxious existence, and the ownership and use of precious assets that would be irrational without having transferred the risk to an insurer.

This not merely a “peace of mind” value. The ability to optimise one’s risk budget by reducing certain risks and taking on others allows for risk-taking and economic growth. Insurance exists in the first place because it is not efficient for individuals to bear their own risks without pooling or transfer.

Questionable measures on ultra high probability claims

Why is the “risk greatest for those with the highest probability of claiming”? Under certain definitions of risk that is the case. But it’s not universal. If the probability of claim is 100%, I’d argue there is no “risk” at all. That might be a trivial case, but what about where the probability is 75%?

This reminds me of a product idea I never liked – insurance for taxi tyres. Taxi tyres are a consumable item that are replaced sometimes two or three times per year. The risk of having to replace them slightly earlier than planned hardly feels like a risk worth insuring. The probability of claim is too high and the cost of the claim too low. Would optimal loss coverage have all of these tyres insured?

And the book?

The book should have been a paper. There isn’t enough there to warrant the length or the price, nor is it sufficiently interesting or amusing to want me to finish it.

Take deductibles for example. A deductible in an insurance claim decreases the number of claims an insurer has to deal with. More than that though, it reduces the claims where the administration costs of checking out the claim and paying it are large relative to the benefit to the policyholder. Sometimes these costs would have been larger than the claim itself.

In that case it does not make sense for the insurer to be processing and paying the claims – the increase in premiums required would be more than reasonable to policyholders.

Lemonade’s new “zero everything” removes the deductible and guarantees no premium increases for up to two claims per year. The reporting on this innovation has generally been silent on the practical reasons why this is hard for traditional insurers and easier for Lemonade.

Lemonade on the other hand explicitly recognise (or at least claim) that due to their AI-based claims underwriting process they can drive down costs and therefore manage small claims cost effectively.

This is important. Many complain about the lack of innovation in insurance. Removing deductibles isn’t innovation. Reducing costs to the extent it becomes viable is the step that enables differentiation and better value for customers.