Technology, Risk and Insurance

1
Technology, Risk and Insurance

• Technology means more than computers, and
  biotechnology is making a big impact on
  insurance, and so are other kinds of technologies

2
Major developments

• On the computer front This is a well talked
  about area but all aspects of risk management are
  never explicitly explored
• Biotechnology Genetic engineering can
  potentially transform life/health business
• Applied mathematics of securitization
  repackaging risks
• Note These developments bring their own problems
  with them

3
Computer revolution

• Tofflers view of three revolutions
• Agriculture Development led to settlement and
  tremendous growth of stationary population
• Industrial Revolution Industrial development
  transformed civilization
• Electronic technologies Computing and
  telecommunication will have profound social and
  political implications

4
Insurance and technology

• Changes in corporate strategy
• Services strategy which allows decision making to
  move closer to customers
• from head office to field office
• from centralized to decentralized (autonomy)
• Already it has transformed the reinsurance
  business around the world
• Capital is very mobile via technology

5
Distribution channels

• Internet as a distribution channel
• For many companies, it is becoming another
  distribution channel
• Banks are offering financial services via
  internet
• They already had great success with telephone
  banking and the ATM
• Increases efficiency and reduces cost of
  providing service (customers benefit)

6
Insurance Applications

• Four areas
• general communications
• product pricing
• agent support
• direct sales

7
General communication

• coordinated program or campaign to build
  awareness and build image with consumers
• insurance businesses already have them in
  newspaper, radio and TV advertisements
• internet will provide another channel, and in
  time, the biggest channel of communication
• Why?

8
General communication

• The Internet is a great medium for providing much
  more product detail and more current product
  detail than is typically available, and you can
  provide it much more cost effectively.
• In that regard, its a good medium for making
  major announcements and getting the word out on
  new developments, whether it be to your
  employees, to consumers, or to your agents

9
General communication

• A number of companies are using the Internet as
  the primary distribution channel for shareholder
  informationitems that companies are required to
  make available by law and the type of thing that
  companies spend a great deal of money printing
  and distributing.
• They put it up on the Web.
• It can be downloaded and printed out on demand

10
General communication

• 1. Many are using the Internet as a tool to
  direct consumers to local offices and to local
  agents.
• 2. Others are using it to collect customer
  feedback and distribute customer satisfaction
  surveys and other types of feedback devices.
• 3. The most fundamental use of the Web now and
  what most people are using it for is as a
  stepping stone.
• 4. Using it as an electronic form

11
Pricing

• Agent function
• Doing needs analysis and price quotes, providing
  product detail and carrier detail and taking the
  application is easily accessible to a
  well-thought-out Web site, and it typically
  ensures a degree of consistency and accuracy that
  you dont always get through the agent channel

12
Pricing

• Result
• Days of most agencies are numbered
• Bread and butter functions can easily be tackled
  by the internet
• How do we know?
• Look at banking
• ATM has revolutionized banking as we know it
• Most teller functions can be handled by ATMs

13
Pricing

• Front and back end efficiencies
• Offering eletronic form with built in help
  wizards
• an agent or a consumer can fill them out, and
  those data will be transmitted to all the
  necessary users of the data, the pyramid company,
  directly into the carriers underwriting system

14
Pricing

• Using the electronic decision maker
• Before an application is submitted
  electronically, its going to go through a screen
  that contains the basic underwriting criteria,
  and its going to make an immediate determination
  whether or not that applicant meets the basic
  criteria for the product. If the answer is no,
  the agent knows about it immediately and can
  direct the applicant to a more appropriate product

15
Pricing

• The problem with the current system
• when a large percentage of these applications
  come in, theres a great deal of work done on
  them only to find out that the product wasnt
  sold properly to begin with, that the applicant
  really doesnt qualify for the product that he or
  she is applying for, and theres a great deal of
  cost involved in that

16
Agent Support

• provide product details and updates
• Announce when a new product comes out, or
  announce a change in an existing product to the
  field personnel.
• Typically it costs a great deal of money and
  takes a great deal of time. Even then, the agents
  often dont get it and dont use it.
• When you make a change to product information on
  the Internet, it is available worldwide in
  seconds.

17
Agent Support

• Real saving
• When a company spends money for new forms,
  typically for many months after the new forms
  have gone out, applications still come in on the
  old forms. The Internet really solves all that.
  Its a good way to provide financial planning or
  sales tools to your agents. Needs-analysis
  worksheets, state planning worksheets,
  telemarketing scripts, and telemarketing letters
  can all be put out there and downloaded and used
  by your agents very easily!

18
Agent Support

• Real time distribution
• Most agents have the ability to provide price
  quotes now, but the distribution of that
  information is fairly awkward. Usually it
  involves creating diskettes at the home office,
  trying to get them out to people in the field.
• The Internet provides an easily accessible,
  centralized place for storing all that
  information, and it ensures integrity of the data

19
Direct marketing

• What will the consumer get?
• Consumers are going to have direct access to
  information that, in the past, has been available
  only through the agents.
• Theyll be able to go online and assess their own
  needs using basically the same tools that agents
  use now. Theyll be able to get price quotes
  across hundreds of carriers where they can
  actually get an unbiased view of the marketplace
  without any pressure

20
Risks from technology

• Type of risk low risk high cost events
• Electronic fraud
• credit card problems
• with electronic fund transfer, bank robber need
  not enter a bank to rob money
• Laws currently cover paper based documentation
• With electronic means, plagiarism can be more
  widespread

21
The Y2K problem

• A problem that arises for computer dates that do
  not start with 19xx
• What is the problem? If the date does not have
  four digits for the year, at the turn of the
  century, they will all go back to the beginning
  of time
• How widespread is the problem?

22
Y2K

• A banking pass in the Netherlands has an
  expiration date of four years. My brand new bank
  pass shows an expiration date of '00'. After
  filling up my car at the gasoline station their
  computer find out that my pass expired. Although
  2000 - 1997 3 but 00 - 97 -97

23
Y2K

• Card expiration date of VISA card is still MM/YY,
  although Visa has threatened to impose fines of
  160,000/month on any of its merchants that fail
  to make their credit-card Y2K compliant

24
Y2K

• Set PC date on 2358 1999, switch PC off , wait
  five minutes, set PC on, check date...result Jan
  4 1980! In case date is OK create a file and
  check the creation data. Investigation via
  Internet indicates that 75 of the PC will fail
• Try to set the date manually. Type DATE at the
  DOS prompt and enter 01/01/00. What did you get
  as a response?

25
Y2K

• In 1992 Mary Bandar of Winona was invited to join
  kindergarten because she was born in '88, in fact
  she was 104
• Last year a 106 year old woman in Sweden received
  letter for the first grade (born in 1890),
  Needless to say, Mary Bandar didn't have to buy
  crayons and a backpack

26
Y2K

• For Marks Spencer, the nightmare began with a
  tin of corn beef, rejected on the ground that it
  was 96 years out of date
• Marks Spencers are auditing their 700
  suppliers for compliance

27
Y2K

• New Year's Eve 31/12/1996 saw a software failure
  at the New Zealand Aluminum Smelter shutting down
  controlling computers without warning. Caused by
  a programming error that couldn't handle 1996
  being a leap year, temperature control in the
  melters failed causing extensive damage.
  Replacing them will cost in excess of NZ
  1,000,000.

28
Y2K

• Two hours later, the problem was duplicated in
  Tasmania as Australia entered the new year. Both
  smelters used the same software
• The global Positioning System week number
  rollover at midnight of 1999-08-21 setting this
  number back to 1980-01-05 This system is on board
  of satellites and can not be corrected

29
Y2K

• Lufthansa recently announced they will be
  grounding their flights for a 24 hour period on
  19991231-20000101. Apparently they are not
  concerned as much with the electronics on their
  aircraft as they are with the various national
  air traffic control systems and the tremendous
  risk of legal exposure.
• Other airlines are avoiding flight time

30
Why Y2K problem?

• Lack Of Widely Accepted Date Standards
• Nobody has a standard representation of dates
  that has been internationally accepted and
  implemented. For example, to an American, 1/4/96
  means January 4th, 1996. To an Englishman, 1/4/96
  means the first of April, 1996 - more
  colloquially known as "April Fools' Day".

31
Why Y2K problem?

• Attempts have been made since the mid 1970s to
  set such standards, and even as recently as the
  late 1980's the ISO-8601 standard advocated the
  yyyymmdd format for date storage. But the use of
  these standards was never internationally
  mandated and they never achieved critical mass in
  commercial acceptance. Many IT shops have never
  even heard of them.

32
Why Y2K problem?

• Computing Resource Restraints
• Main memory, disk space and even punched card
  space was at a premium in the early days of
  computing. Whatever could be squeezed to save
  space and money was squeezed to save space and
  money. In the early days of computing, it made
  sense NOT to include any extra digits for years.
  In In the early days of computing, it made sense
  NOT to include any extra digits for years.

33
Why Y2K problem?

• User Demand
• Computers are designed to make life easier for
  users and to relate to users in a manner
  consistent with their known world.
• Nobody wants to key in the century when he or she
  is not used to having to do it in other
  circumstances (for example, when writing checks).

34
Why Y2K problem?

• 4. Applications Have Lasted Longer Than Expected
• When designing a new application, a typical
  justification for using a date algorithm which
  would fail when processing dates outside the
  20th Century was that the application wouldn't
  last outside that era anyway. The older style
  applications have been required to soldier on
  while their much vaunted younger replacements
  have fallen by the wayside.

35
Why Y2K problem?

• 5. Backwards Compatibility
• As the reservoir of established applications
  grows ever larger so each and every new
  application written is expected to maintain some
  form of compatibility with previous systems. If
  Windows had not been able to run DOS
  applications, Microsoft would have been dead in
  the water when their GUI was launched. Windows95
  is faced with the burden of supporting DOS,
  3.1.etc...

36
Why Y2K problem?

• Code Re-Use
• It has always made sound economic sense not to
  redevelop the wheel. Virtually all new
  applications have algorithms and even code
  incorporated from previous systems. This speeds
  up development and results (usually) in more
  reliable systems. The re-use of algorithms which
  have a hidden date processing fault is one reason
  why the year 2000 problem is so huge

37
Why Y2K problem?

• New complications with PC revolution
• With the PC revolution, development and control
  of many applications has typically passed out of
  the control of the IT professionals into the
  hands of the end users. So changing the core
  corporation data means immense inconvenience and
  cost to all those end users

38
Costs and Benefits

• Clearly, it will cost to fix the problem
• How much?
• There are benefits to be considered the
  additional cost that companies would have had to
  bear if they had used YYYY instead of YY (this is
  the concept of opportunity cost)
• Which is larger?

39
Costs of Y2K

• Direct cost The cost of fixing all the source
  codes
• Gartner Group estimates that there are 225
  billions of lines of code to be fixed
• 1996 cost is around 1.10 per line
• Total bill 250 billion
• More recent estimates of cost per line has gone up

40
Costs of Y2K

• Some estimates put cost per line to be 3-5
• If so, the cost can be as high as 6 billion
• Is this correct?
• The problem is routine fixing of lines
• It can be easily handled off shore e.g., in
  India or in the Philippines
• Then, the cost can be lowered dramatically

41
Costs of Y2K

• Many programs with problem are mainframe programs
• They can easily be phased out
• Half the programs are not worth saving
• This can reduce the cost by more than half
• There will be cosmetic problems that are easily
  fixed by off-the-shelf program
• Thus, cost can be much lower

42
Benefits of Y2K

• In the late 50's and early 60's, when many of
  today's general accounting and core business
  systems were designed and programmed, a major
  constraint was the number of characters which
  could be recorded on an 80-column punched card.
  This physical limitation led us to record dates
  with only 2 digits representing the year to save
  precious space. This limitation was eliminated by
  disk storage when it became widely available in
  the early 60's.

43
Saving so far...

• Disk storage devices greatly enhanced the
  usefulness of computers because of their ability
  to access data randomly, but this new type of
  storage was very expensive.
• In 1996, as we upgrade and/or replace systems to
  accommodate the millennium change, the lease
  price of mainframe hard disk storage is under 10
  cents per megabyte (MB) per month.

44
Saving so far...

• But in 1963, 1 MB of mainframe storage cost about
  175 a month to lease (that's about 10,600 per
  year per MB in 1995 dollars or nearly 1 million
  percent more than the 1996 cost). So, to save
  money we continued to use 2-digit year fields.
  And economic reasons were why we continued this
  space saving practice.

45
Saving so far...

• By 1972 the price of mainframe storage was down
  to 36 per MB per month, but that's still over
  1,600 per year per MB in 1995 dollars (or nearly
  150,000 percent more than current cost)!
• By 1983 the price was just under 22 per year per
  MB in 1995 dollars (but still 2000 more than the
  1996 cost). So just how much have we saved our
  organizations over the years?

46
Saving so far...

• Depending on the industry and application, about
  3 to 6 of the data stored in organizational
  databases is dates. Using 4-digit, rather than
  2-digit year fields would have required 33 more
  storage for dates (MMDDYYYY versus MMDDYY). Using
  the lower 3 figure for date density, we
  conservatively estimate that 1 more disk storage
  would have been required through the years if we
  had stored all 4 digits of the year field.

47
Saving so far...

• One percent doesn't seem to be very much until
  you consider several important factors the large
  volumes of data stored by organizations, the
  historically high cost of storage, and the rate
  of inflation. So for every gigabyte (GB) of
  organizational data stored, a 1 savings
  represents 10 MB. Designing systems to save 1 of
  storage costs since 1963 has saved between 1.2
  and 2 million per GB (in 1995 dollars) depending
  on how quickly storage equipment was upgraded.

48
Saving so far...

• Then, there's the cost of capital, as well as the
  opportunity cost had those precious dollars been
  spent on storage rather than invested in other
  ventures. Using only a 10 internal rate of
  return (IRR) on capital, 16 to 24 million (in
  1995 dollars) has been saved per GB of total
  storage in the 30 years from 1963 through 1992.
  This is a more realistic indication of the
  economic benefits of our date storage decisions.

49
Saving so far...

• In light of these savings, the 10 to 50 million
  estimated cost organizations may incur to correct
  the "millennium bug" pales in terms of benefits
  accrued. One organization, currently storing 12
  terrabytes of mainframe data and about 700 GB 15
  years ago, estimates that if their average
  storage over the 30 years from 1963 through 1992
  were only 10 GB, they saved over 100 million in
  1995 dollars. They estimate that their actual
  savings may be 5 to 10 times that size!

50
Insurance and Y2K

• Is there insurance available to resolve the Y2K
  problem?
• Some.
• AIG recently announced the availability of
  "Millennium Insurance," which it describes as "a
  policy that provides business interruption and
  legal liability coverage in the event that 'Year
  2000' information technology system
  solution/conversion efforts by the insured or a
  third party fail.

51
Insurance and Y2K

• The Millennium Insurance policy is comprised of
  three coverages direct business interruption,
  contingent business interruption and third-party
  liability.
• The direct business interruption coverage covers
  loss of profits for business interruption
  resulting from unsuccessful conversion by the
  insured of its own systems.

52
Insurance and Y2K

• The contingent business interruption coverage
  covers loss of profits and extra expense for
  business interruption of the insured due to an
  unsuccessful or incompatible conversion by a
  third party that results in the failure or
  interruption of a third-party system or data
  transmission capability. The third party
  liability coverage includes errors and omissions
  (EO) and directors and officers (DO) insurance
  and covers an insured's legal liability resulting
  from its own or a third party's conversion
  efforts.

53
Liability problems for internet

• If I post an anonymous message against you on the
  usenet, who is liable?
• Technology can create problems with privacy
  rights
• credit card information, telephone records,
  medical records, educational records, insurance
  records, police records can be cross referenced
  and build profiles of people

54
Biotechnology

• Pharmaceutical advance
• drugs old method-mostly biological
• new synthetic-example-plasma-it requires
  matching by blood types, in future, it will not
• Medical advances
• use of mechanical heart, liver
• use of potato for skin

55
Genetic research

• Human genome project There are 100,000 genes and
  3 billion pairs of ATCG DNA codes
• Genome needed two ingredients gene mapping
  technology and advances in computer technology
• Cure for potential diseases that arise out of
  faulty genes

56
Potential candidates

• Most genetically linked diseases
• Downs syndrome
• Alzheimers disease
• muscular dystrophy
• genetically linked cancer (breast)
• cure for baldness
• screening fertilized eggs

57
Potential problems

• Identifying problem gene does not mean
  identifying cure
• so far, 4,000 dieases have been linked to
  specific sites on specific chromosomes
• Potential to identify disease long before it
  manifests itself
• Identified genetic risk factor may lead to loss
  of health insurance, workers compensation or
  life insurance

58
Examples

• California man was denied health insurance when
  he changed job because he had the gene for
  neurofibromatosis
• Missouri woman had a blood test showing that her
  unborn child may have abnormally formed spinal
  cord
• Texas woman denied life and disability insurance
  because her mother might have died due to
  Hintingtons disease

59
The issue

• Rights of insurance company versus the rights of
  the individual
• Insurer use genetic information to underwrite
  risk for a homogeneous group
• Discrimination when it is not justified by facts
• Justification insurance companys
  view-statistical justification

60
Ultimate implication

• Insurance is only available for individuals who
  are free from genetic diseases
• Each group with sufficiently identifiable genetic
  disease potential can be insured
• Many types of discriminations are not allowed by
  law based on skin color
• Can an employer make hiring or insurance
  decisions based on genetic tests for cancer?

61
Hazards of technology

• Industrial waste is a hazard to humans
• cyanide is a poison used in many chemical
  processes
• radioactive material is a by-product of nuclear
  energy
• many industrial by-products are known carcinogens
• some harmful effects are known later DDT

62
Example

• Environmental cleanup in the US would cost
  500b-1trillion
• Surplus in property casualty in the US is 200b
• If insurance industry cannot offer insurance for
  the general market, government will have to
  step in and eventually the taxpayers will foot
  the bill

63
Technological advances in the financial markets

• Financial and risk management are converging
• Insurer can hedge risks of interest sensitive
  assets and liabilities with currency futures and
  other derivatives
• Securitization derivative financial instrument,
  act-of-God bonds, Catastrophic Re Options...

64
Potential problems

• Many in the corporations do not understand the
  new instruments
• Hence, they do not understand the potential abuse
• Barings problem one persons misuse brought down
  a company
• If some complex derivatives are intentionally or
  deliberately mispriced, it could be a potential
  problem