Revolutionising Fairness to Enable Digital Insurance

This is one of the core themes of a detailed paper that has just been published by the Institute and Faculty of Actuaries. I wrote the paper over the summer of 2022, drawing together a range of themes such as inverse selection, personalisation, the equality of fairness, the embeddedness of insurance in modern society and the market as a form of common good.

My conclusion in part 1 was that actuaries (and other professionals in insurance) need to prepare for fairness being recognised as a multi-dimensional issue needing to be weighed up by a multi-stakeholder audience. Gone are the days of an underwriter doing that for themselves.

It is all very well of course opening up the fairness of insurance in this way and telling people how complex it is. While a deeper understanding of fairness in insurance helps everyone recognise where we stand, more is needed in terms of finding a way of handling that complexity going forward.

What we’re aiming for

An obvious question at this point is around what exactly we’re aiming for, when we talk about insurance, fairness, digital transformation, trust and the like. In the paper, I described this as “…an insurance system that delivers fair policies in a sustainable and trusted way.” Let’s explore that a little.

I describe insurance as a system in order to recognise that it is now made up of a variety of players (both insurance and otherwise) that contribute their own particular specialisation to making it work in a digital setting.

I then bring together three things, around the idea of policies as the sector’s key deliverable. The first is of course that the policies have to be judged as fair. They then have to come from a market that is sustainable. In other words, the fairness of the policy has to take account of the sustainability of its delivery (and vice versa). I then end with the policies being trusted, which both overlaps with fairness but also adds on a bit extra in terms of the overall reputation of the market. Together this seemed to me to represent, in not too many words, what we are aiming for.

Now, I know that some of you will question the policy as the sector’s key deliverable. What about all those loss prevention services that insurers are gearing up to deliver? At the moment, that delivery is still largely in the pipeline. And as per this article, loss prevention services are likely to be delivered through separate vehicles than the insurance firm itself. So for the present, I believe it’s a reasonable key deliverable to work with.

Common Pool Resources

Let’s return to that earlier point about finding a way to handle the complexity of fairness going forward. In part two of the paper, I bring in a proposal that something called common pool resources could be a possible way forward for handling that complexity of fairness. Here’s how I introduce common pool resources (CPRs) in the paper…

“Common-pool resources are self-organising and self-governing forms of collective action. They are designed to deal with an open-access problem, in which people obtain more benefit from acting together, but in which there are temptations to act independently.”

By open access problem, I’m referring to the situation where an asset is exposed if everyone maximised their use of it, but which is itself maximised if everyone acts together. Most obvious examples of CPRs come from natural resources, such as fishing or water. Here in the UK, the historical example is of the grazing of common land, whereby if everyone put their sheep onto that land as much as possible, its utility for grazing would collapse. Instead, commoners learnt to coordinate a sustainable level of use and find ways of handling conflicts.

Insurance policies are not like sheep or fish. However, the paper argues that fairness in an insurance setting is a resource to which everyone should have access, but one for which there also needs to be some ‘give and take’. It is a form of open-access problem not dissimilar to that faced by fisher people and commoners.

Insurance has done it before

As far as I can tell, CPR scholarship has not touched on financial instruments like insurance as a form of common pool resource. Yet when you speak to experts in the history of institutions like insurers, it soon becomes obvious that insurance has seen forms of CPR develop over the last 200 years. My point here is that insurance has developed something like CPRs before, and so could well do so again, the circumstances being right.

So what are those circumstances? What do we need in order for the engagement and narrative framework offered by CPRs to be adopted? I outline five conditions in the paper, but here in this article, I’ll focus on the first, and to me foremost, one…

“Most insurers in the system need to share a common judgement that they will be harmed if they do not work together to deliver a fair insurance system.”

Why work together

Why should they though, I hear you ask. Well, to quote Elinor Ostrom, in her experience… “Individuals frequently are willing to forego immediate returns in order to gain larger joint benefits when they observe many others following the same strategy.” Ostrom was a political economist who won the Nobel Prize for Economics in 2009 for her work on the organisation and governance of common pool resources.

If ever there was a sector used to foregoing immediate returns in order to gain larger benefits later, then it is insurance. It’s the nature of the beast. The key word that still needs to be considered of course is ‘joint’ – in other words, working together. We could perhaps look to reinsurers, as an example of how the market can work together to obtain ‘larger joint benefits’. The lesson here – this is not foreign territory for insurers. It just needs them to stand back, refresh their thinking and see the bigger picture – the fairness landscape as I call it.

Summing Up

I’m not going to cover everything in the paper here – you need to read it to get the full picture of what I’m bringing together and proposing. Will it be difficult? Of course. Will it work? I hope so, although there will be hurdles to overcome (I examine these in the paper). Is there a clear starting point – yes, and, surprise surprise,  it involves data.

Fairness is both simple, in that we all learn about it as children, and complex, in that it can generate all sorts of interests and concerns. What is certain is that it cannot be left to look after itself as the market goes through its digital transformation. Like it or not, the two are too intertwined.