We all know insurance is a great product, but sometimes it is completely magical.
The magic comes from adding value. The smarter the product, the more value it adds.
And the more sophisticated we get the more intangible the value we can add becomes.
At any generic insurance conference, a speaker always stands up and makes the extremely valid point that insurance needs to evolve radically if it is going to maintain its relevance in the commercial world of the 21st century.
They explain that in 1969, some 90 percent of the S&P 500’s value was made up of tangible stuff – plant, equipment, stock and the like and the rest was intangible stuff like intellectual property, brand value and goodwill.
They then tell us that these days the poles have almost reversed. This explains our industry’s steadily lower premium take out of the world’s GDP and inexorable march to long-term oblivion lest we get our heads around intangible risk.
Most people accept this. We all agree that barring a bit of precious and rare earth metal in its circuits, the scrap value of an iPhone is almost zero. Yet we are happy to pay hundreds of dollars to put the latest model in our pockets. We all nod along when we are told that Apple is a manufacturer with no factories, Uber is a cab company with no cars and Airbnb is a hotel company with no hotels.
We say we get it – except we don’t yet practice what we preach.
For example, we still measure our own industry’s value add in an antediluvian way. When we decide if we are doing well or badly we still add up the tangible numbers. We tot up the losses, admin expenses and acquisition costs, subtract them from the net earned premium and give ourselves a percentage score called a combined ratio.
How dumb is that in the 21st century?
If Steve Jobs thought like that the iPhone would retail for $25 and instead of exceeding the GDP of most medium-sized sovereign nations, Apple’s market cap would be close to zero.
The insurance of the 21st century is going to add value in epic proportions and we had better get used to the idea.
Take the brilliant emerging class of warranty and indemnity (W&I) or M&A insurance. As an industry our biggest worry about this class is that it is far too profitable! Single-digit loss ratios mean we worry that one day the conduct regulators are going to come for our blood and demand we give more tangible value to the consumer.
What nonsense! M&A insurance is magical like an iPhone.
Using this product, a seller can own a company worth $50mn and by spending a $500,000 premium can make the company worth $60mn to a buyer. Now that is magic!
The $9.5mn value created is real but it is intangible. It is also wholly fair. The people manufacturing W&I are really smart tax lawyer types and the people buying and selling the product are investment banker types. They add value through their expertise – they took away a big tax problem for the parties to an M&A transaction.
Doing that is difficult, so it is worth a lot.
They have nothing to be ashamed of – they earned their money.
Do the clients care if there is no claim? Of course not – the underwriter has already given them a 20-fold return on their premium invested!
We need to get our head around this. In a world where most value added is intangible, we need to accept that almost all of the insurance value-add of the future will also be intangible.
If you think Apple’s market cap is crazy today just imagine what it would be like if its currently fragile intellectual property were underpinned by rock-solid insurance that everyone could trust?
If that were to happen the only firms with higher valuations than Apple’s would be the mighty insurers!