Professional Insight

The Case for Innovation — Quantified

How important is innovation for insurers? Next year, AM Best will start grading them on it.

Actuaries got a peek at how the venerable ratings firm will assess innovation, part of a general session called “Innovation’s Contribution to Financial Strength,” at the 2019 Casualty Actuarial Society Annual Meeting in Honolulu last November. Actuaries also got a look at the many types of innovation insurers need to think about (hint: it’s not just insurtech) and why they are important.

Greg Heerde, head of Americas for Aon Benfield Analytics and CEO of the claims consultant Inpoint Inc., laid out the case for innovation. He also gave the state of the art and what innovations await.

The case

Heerde’s PowerPoint displayed the 100 largest insurers from 1987. Of them, 15 have gone insolvent or exited property-casualty insurance. “That feels like a pretty big number to me,” he said.

Further, only seven of the top 30 P&C companies in 1987 still exist in their same form today. Some merged into other firms, though many of those transactions were “not done from a position of strength.” This highlights the need to continually adapt and innovate to remain a viable, ongoing insurance enterprise.

State of the art

Heerde described three primary categories of innovation as technological, operational and product. Technology (think insurtech) is the area that receives much of the attention and where many exciting gains are being made. Companies have also been focused on achieving operational efficiency (including risk pricing, risk selection claims) through better acquisition and utilization of additional data. Companies can also innovate by creating new products, but, as an industry, there has been less successful focus in this area.

“There is a mountain of opportunity . . . to evolve our product mix” to better handle risks in today’s economy, he said.

Actuaries also got a look at the many types of innovation insurers need to think about (hint: it’s not just insurtech).


Two recent examples of successful product innovations are mortgage risks and cyber insurance. Starting in 2012, the government mortgage servicing giants, Freddie Mac and Fannie Mae, started buying protection against default from the reinsurance industry, resulting in greater than $22 billion of limit and $4.5 billion of new lifetime premium to date. Insurers also wrote $4.5 billion in 2018 in cyber insurance — a line that barely existed five years ago and is expected to surpass $20 billion by 2025.

Heerde foresees multiple areas of additional potential product growth, including the broad categories such as climate change and intellectual property.

For climate change, many risks are and will continue to emerge that can present identifiable insurance opportunities. Property risks, including changes in frequency and severity of storms and fires, will continue to evolve. Liability for the problem may find its way back to carbon producers. If so, can insurers offer protection now?

For pioneering entities, intellectual property has to keep pace with the market. Insurers have typically protected tangible assets, but the economy is growing faster in producing intellectual property like patents and copyrights. Innovative companies can find ways to insure those intangibles that now represent more than 80% of total assets.

Scoring and Assessing Innovation

To judge how well insurers innovate today, AM Best has spent the past two years developing criteria for scoring innovation, which it plans to roll out in 2020.

Since 1899, AM Best has been assessing the financial strength of insurance companies, and their methodology continues to evolve. In the last decade, for example, it began to assess the quality of companies’ enterprise risk management programs.

James Gillard, executive vice president and chief operating officer of AM Best, said assessing innovativeness makes sense because “We anticipate that the rate of innovation is going to increase.” Gillard is responsible for Best’s rating operations globally — 3,400 companies in 90 countries.

Industry leaders appear to agree. In a survey Best conducted, 42% said that innovation was extremely critical to their success; another 30% said it was very critical.

“Companies that fail to embrace innovation “will be left behind,” Gillard said. “Ultimately, their financial strength will be challenged.”

In its current framework, Best focuses primarily on four aspects of a company. Gillard provided the chain of logic supporting each part of the review:

  • Balance sheet — A company needs a strong balance sheet to write business and pay claims.
  • Operating performance — If operating performance is weak, the balance sheet will deteriorate.
  • Business profile — If the business profile lacks a competitive advantage, performance will deteriorate (and then the balance sheet will).
  • Enterprise risk management program — Without a strong ERM program looking at risks collectively, a company is at risk of losing its financial position.

The innovation assessment will be part of the analysis of a company’s business profile. Best will not prescribe a right or wrong way to innovate, Gillard said. New products are innovations, Gillard noted, and they don’t have to be high-tech to be considered so.

Best will develop a score for each company, then look at how that score compares with similar companies. Some areas of insurance are innovating faster than others and Best’s assessment will reflect that. Personal auto, with telematics and other technological changes, is evolving quickly, so companies need to be more innovative in that line, Gillard said.

The overall score will be the sum of two components, input and output. Each will be rated on a scale with a maximum of 16 in total for each of these two components.

Four inputs will be rated from 1 to 4 (4 being the highest), then added together.

Leadership. Senior management has to buy into the innovation culture, Gillard said. It has to dovetail with the corporate mission and be communicated clearly.

Culture. The company has to accept the possibility of failure and have that ideal embedded throughout the organization. It is also important to be able to recognize failure fast, Gillard said.

Resources. The focus here is not only on the resources themselves, but also on their strategic management. Key questions are whether the company is creating value with these resources and whether it has the right talent.

Processes and structure. This includes data, Gillard said, but more importantly, a company has to show that the data is of high quality and the company can manage it. Governance also will be evaluated here.

For output, two components will be scored from 1 to 4. The sum of the scores will be doubled to create an output score.:

  • Results. A company should show the return on its innovative efforts over the past five years in a tangible, quantifiable and replicable way.
  • Level of transformation. Best will compare companies with competitors and potential competitors, both inside and outside the industry. It will look at how well innovations address both short- and long-term needs.

Each company’s score will put it into one of five buckets: minimal, moderate, significant, prominent and leader.

The distribution will probably be skewed left, Gillard said, with few companies, if any, in the leader category. The innovation score isn’t expected to automatically result in upgrades or downgrades.

Best has gone through two comment periods in developing the process. The later period ended on October 31, 2019. The criteria is scheduled to go live in 2020.