January 12th, 2010

(Re)Insurance Innovation: Committing to the Leading Edge: Part II: The Challenge of Innovation

Posted at 12:00 PM ET

mckeown_christopher_bioChris McKeown, CEO of Global Analytical and Specialty Practices

Innovation can be a source of competitive advantage. A (re)insurer — or service provider (e.g., a reinsurance intermediary) — devises a solution to a particular challenge that the industry faces. It results in improved risk or capital management, for example, leading to enhanced margins, the optimization of capital deployment or expense management. Since the innovator — or early adopter of a service provider’s new idea — has access first, it realizes the benefit ahead of competitors that wait for the trend to crystallize.

We saw this dynamic at work with property catastrophe models in the 1990s. At first, adoption was slow, with cedents earlier in the cycle gaining an edge. Hesitation naturally arose as the industry considered a shift from traditional rule-of-thumb risk assessment to the complex calculations of probability and severity served up by a computer. Wide acceptance of modeling only began to grow after major natural catastrophe losses in the early part of the decade, when the existing mode of doing business revealed itself to be painfully insufficient.

Of course, catastrophe models are now ubiquitous. This is because, over time, the good ideas begin to be absorbed. They become more common. When this happens, the advantage dissipates, and adoption starts to become the price of admission to the marketplace. With each subsequent adopter of an innovative solution, the solution itself becomes less “new” until, eventually, it is a de facto operating standard.

The evolution of catastrophe models follows this dynamic. Once leading edge, the concept is now de rigueur. Yet, within the catastrophe model segment, innovation continues — from improvements to the models by their developers to the creation of extended capabilities, such as Guy Carpenter’s i-aXs platform. Those amongst the first to embrace the innovation are still at the leading edge of that technology today through their continued endeavors.

The innovation cycle is continuous. As techniques and solutions are introduced and absorbed, the next generation is already being planned and developed. Thus, it’s incumbent upon (re)insurers to decide what positions they will take regarding the leading edge. To be an early adopter entails a continual commitment to spotting, developing and implementing new ideas. It’s not something that can be done once and forgotten.

Alternatives to staying at the front of the industry do exist: there are several points at which a company can enter the innovation cycle. Some may opt to watch the experiences of competitors on the “bleeding edge,” only adopting the innovations that are most likely to gain traction, while others may wait for commoditization or get on board when market conditions leave them no choice. The costs — financially and in terms of other company resources - may be higher at the tip of the spear, but the returns tend to be far greater. Ultimately, a company needs to make a deliberate decision on where in the lifecycle to adopt emerging solutions; an ad hoc approach can be disruptive, expensive and unproductive.

For innovators and early adopters, the challenge is to identify the likely game-changers and integrate them into their operations smoothly and quickly. Doing so can lead to new business opportunities, improved margins and growth in shareholder value. It takes dedication, though. A company has to accept a higher resource commitment and a bit of uncertainty. The rewards, meanwhile, tend to justify the internal angst.

Click here to read Part I: Overview >>

Click here to read all Guy Carpenter articles about (re)insurance innovation >>

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