Insurance in a change of era
This is an edited version of the 2019 Geoff Masel lecture, presented by Michael Gill
We are moving from an era of change to a change of era for consumer insurance.
Over the past 300 years, insurance has covered many different risks. Its customers are no longer restricted to wealthy merchants with business risks who often knew those who were sharing the risk with them.
Today, much of the role of insurance is to protect ordinary people from the risks of everyday life. Our society relies (indeed, is dependent) on insurance. Society generally and consumers individually need more certainty and less risk. Ordinary consumers’ lives can be irreparably damaged by the failure to insure or the failure of insurance to respond to a personal calamity. They may never recover.
The average insured consumer just wants their claims paid. They don’t want to be experts in insurance, or insurance law; to spend a lot of time on the purchase decision; surprises; or to spend more money than is necessary.
However, the reality is that insurance is complex, especially for consumers, and the English language, even before the torture of legal interpretation, is not always precise.
Consumers, for most of their needs, do not have the benefit of knowledge or experience; nor do they have the benefit of personal advice from an expert.
In this era of artificial intelligence (AI) and widely accessible databases of relevant information, insurers are often better informed than insureds about facts relevant to the risk. In perhaps the most important area of household insurance, insurers can easily identify the perils and the most appropriate terms, including the sum insured for proper compensation.
The Australian parliament gives insurers the right to transact insurance business. The authorisation is not granted to enable investors to maximise a profit; it is to provide insurance protection as needed by consumers for their major risks. Insurers thus play a unique role in the life of our nation and its people.
Historically, insurance has been provided by varied different legal structures. Apart from the unique characteristics of Lloyd’s membership, as it was, mutuals and share companies have been used most frequently. In a mutual, the policyholder was also the company owner; so there was an alignment of interest.
In a share company, the two roles are distinct, as are the respective interests. Policyholders want policies at minimum cost and their claims paid. Shareholders want the best return on their investment. A benefit to one group can be seen as a detriment to the other, at least in the short term.
Directors have statutory duties to exercise their powers in the best interests of the corporation and for a proper purpose. They are also bound by the business judgement rule, which depends, among other things, on the director rationally believing the judgement made "is in the best interests of the corporation".
The existing legislative framework, and market pressure, focuses shareholders, lawyers and financial analysts on directors' obligations and attention overwhelmingly on the corporation and its shareholders, not the customers.
If the strongest argument in favour of share companies is their ability to raise capital, what alterations (law reform) should be explored for other structures?
Is there substance to the suspicion the share company is principally focused on attracting capital, meeting profit forecasts, placating financial analysts, outperforming the competition in financial returns and generally presenting itself as an attractive investment? Is there reliable evidence that mutuals give their insureds a better, fairer claims experience?
In 1990s Australia, the financial services sector (including many general insurers) underwent a significant movement away from mutual structures. Money was returned to owners; shares were issued; much capital was raised.
What we don’t know, because the data was not collected, is whether policyholders benefited from that development. If mutuals had been seen historically as a desirable legal structure for delivering general insurance, were appropriate steps taken to protect the insureds' interests in this new structure where they no longer owned the company?
A new starting point
If society recognises the importance of certainty for consumers, we must have a new starting point for consideration and determination of all the relevant issues. The fundamental question must be "what is in the best interest of the policyholder; how can society and the law achieve the optimum outcome every time?"
Consumers expect claims to be paid promptly and in full. Closing the expectation gap has long been recognised as perhaps the most important intended outcome of compulsory pre-contract notices, compliance legislation, voluntary codes, IDR and EDR.
For most consumers, a rejected claim or seriously reduced payment can destroy a lifetime of material achievements, be it a destroyed house, a serious legal liability, a catastrophic injury or illness. Having paid for insurance, often over decades, there is an unsurprising expectation that, if a claim does occur, the insurer "will do the right thing".
And much of the time, that is what happens. But, for those occasions where it does not go smoothly from the beginning, uncertainty, anxiety and fear can compound the stress which is invariably caused by the insured event.
It’s bad enough to suffer the consequences of the insurance peril. That’s the risk against which the insurance is taken out. But does any insured have at mind’s centre, the risk their insurer will run for cover at the time of the claim? Or, perhaps that is precisely what many do have at mind’s centre.
So what can be done to reduce this second risk to the point of eliminating it. Compulsory classes like CTP and workers’ compensation have largely achieved that, driven by the social imperative that created them in the first place. Other compulsory classes have since been created with similar intent.
Consumer friendly interpretation provisions, firstly enunciated in the courts and more recently in the ADR terms of reference have closed the gap. Government intervention for risks like flood and terrorism have also helped.
What is now largely absent from policy selection and claims transactions for consumers is personal advice. Most consumer policies are arranged without the benefit of advice from an insurance expert; they are purchased direct from an insurer or its agent.
Many consumers see the selection process as a grudge purchase, an unwelcome intrusion on their time and basically an assessment of who has the lowest price.
Insurance policies and terminology are complex. Financial literacy has not worked in this space. There seems to be little interest or skill for a careful time-consuming examination of "which policy and terms are best for me".
Who’s best placed to assess the risk?
Historically, the law of disclosure proceeded from the correct assumption an insurer was at the mercy of an insured who knew all there was to know about the risk being presented while the underwriter knew little or nothing.
As the law developed, disclosure became an unfair, often draconian excuse for rejecting claims. The history was well researched and reported on the ALRC in the lead up to the Insurance Contracts Act, which provided much needed law reform and fairness for insureds.
In the subsequent 40 years, more reforms have been enacted in the Insurance Contracts Act. In addition, and perhaps of greater relevance, the pendulum has swung dramatically.
An outbreak of publicly available, computer searchable and easily digestible information enables insurers to learn much about many risks such as household policies. They may be better placed than the insured in many respects, including, for example, when determining appropriate replacement costs.
Indeed, the construct and content of most consumer policies authored by insurers appropriately demonstrates their familiarity with what consumers need. And as AI, data gathering and smart hyper-fast analysis grows apace, this function may be removed from insurers and brokers entirely by law and/or market disruption. Should we explore what’s necessary for that to happen?
A compulsory core for each consumer policy – this seems sensible and growing in attraction.
No contracting out? Add-ons permitted? All risks covered? A government pool for risks that are too costly or said to be uninsurable?
This discussion can now occur in a far more constructive environment. We have found a way to insure terrorism and flood. Whether some major event is or is not insurable is really not the point. Australian social values generally support the restitution of injury and damage. The only question is the mechanism for doing so.
AI and the information age
In 1766, Lord Mansfield delivered his landmark judgement in Carter v Boehm, determining that insurance policies were contracts requiring the parties to act towards one another in accordance with the duty of utmost good faith. Central to his formulation of utmost good faith was the concept of disclosure, particularly by the insured.
Lord Mansfield described insurance as a “contract upon speculation”.
Although the non-disclosure aspect of the duty of utmost good faith has now been separated and exists independently within Australian statute, the spirit of Lord Mansfield's formulation has endured the passage of time.
However, one wonders whether he would have reasoned differently had he known what the future would hold – insurtech, AI, robotics and the 'internet of things'.
Technological advancement has given rise to the information age, where data is king and connections are everywhere.
More than ever, underwriters are intimately familiar with their customers' particular circumstances and able to manage risk with heightened sensitivity and precision. Globally, technological progress is driving insurers toward improvements in underwriting decision-making, product pricing, and, eventually, policyholder experience.
The speed and ease with which information can be digested will continue to fuel the development of new insurtech products focused on 'event-based', 'real-time' and 'just-in-time' offerings. Insurers will be able to quickly grasp the full spectrum of a risk at any point in time, including risks arising from an insured's changing patterns of behaviour, together with the probability and severity of potential events. Equipped with that information, insurers will be able to make 'real-time' underwriting decisions and pricing adjustments that reflect the fluidity of risk.
It seems inevitable there will come a time where it is no longer correct to say, as Lord Mansfield did, that the facts which inform an insurer's risk “lie most commonly in the knowledge of the insured only”.
And it may not just be insurance carriers who are well-placed to benefit from advancements in AI. Customers may also be better off through introducing machine learning into insurance distribution, enjoying unprecedented access to immediate, personalised advice about their insurance needs and options.
The full disclosure obligation could be replaced by a secure, comprehensive information portal which is the only source of information for insurers to rely upon, including all matters relevant to moral risk. An application for insurance could be an automatic authorisation for insurers to access the information efficiently and with minimal cost and delay.
AI is now used to a degree by insurers to resolve less-complex claims and answer simple questions and it will continue to play an increasingly important role in claims handling.
Does law/regulation achieve its objectives?
This question has much broader application than consumer insurance. However, for the best part of 50 years we have been introducing legislation and regulation often to plug holes in the dyke and sometimes to effect significant reform.
How effective has all this change been? Who benefited and who paid? Was it cost effective? In hindsight were there better ways to solve the relevant problem?
The Insurance Council of Australia established a taskforce to advise on improving the effectiveness of disclosure documents. What was the evidence of the effectiveness of the then existing disclosure regime? In short, there was none.
And how do we test the success of all the other laws and regulations that are supposed to improve the lot of consumers of insurance services and products? We know regulation and compliance costs are significant and presumably impact on the price of insurance products. Hardly good for consumers unless there are demonstrable benefits that clearly outweigh the addition to the price.
Consumers need/want outcomes, not expertise. For most, understanding insurance in its detail is simply unattractive partially because it is too difficult, too uncertain.
The big challenge for this change of era is to close the expectation gap.
To be more certain that law and regulation is beneficial for consumers, why not a compulsory and robust testing regime to measure the success of all such laws on the basis of what they were intended to achieve. A regime which requires objectives to be clear, precise and measurable.
Otherwise, we will continue with costly punts that hold lots of hope and little promise. Going forward, we need to be much better than that.
What’s legal v what’s right
Concern has been growing about the practice of a legal sign off replacing proper behaviour, especially where the doctrine of utmost good faith has a role to play.
The financial services royal commission report has turned on the spotlight. Unfortunately, immediate regulatory reaction suggests a residue of thinking that more law is the answer to everything.
The royal commissioner has suggested a formula for proper behaviour. It is to be assessed through the prism of “community standards and expectations”.
The Australian Financial Complaints Authority is working on a definition of fairness and a tool for its application. Perhaps the essence of fairness isn’t found in the place rules are made. Perhaps it is more about decisions of the conscience and the exercise of individual discretion.
May be the issue needs less input from regulators, bureaucrats and lawyers and more contribution from behavioural scientists, psychologists and ethicists.
This is one area where a change of era looms large. Are we seeing an emerging new era where law has a lesser role to play? Or is this a relegation of law to a more appropriate role?
Law reform is always playing catch up. But correct behaviour needs to be applied and adjusted in real time and for a plethora of individual and different circumstances. Correct behaviour will be delivered by genuine professionalism, honesty and a sense of fiduciary obligation to customers, or not at all.
A change of era: the internals
I challenge you and AILA to think well outside the historical and current square; to be willing to consider that the answers of today don’t mostly reside (indeed may not principally reside) within the knowledge and expertise of traditional experts in insurance and the law.
In 2019, we are increasingly looking for faster, cheaper solutions, via social media and the web and what goes with them. We are deliberately spending less time in physical community and conversation. It is often discouraged. It is seen as costly, slow and less desirable than applying AI.
At the same time, we have identified at the top of our challenges, a loss of trust with consumers and the need to replace strict application of the law and regulation with a human application of fairness.
Perhaps our new brains will be better able to deal with these issues and the many more not yet identified. Perhaps we will have new skills to replace those that may disappear.
Take confidence from others. From Albert Einstein: “Imagination is more important than knowledge. Knowledge is limited. Imagination encircles the world.”
From Senator Robert Kennedy: “Some men see things as they are and say why. I dream things that never were and say why not.”