Come Out and Play
What’s so hard about building a sandbox? After all, what do you need other than some planks and sand?
Well, if the sandbox in question happens to be an insurtech regulatory sandbox, the process can be difficult indeed.
A regulatory sandbox is a method to give flexibility to companies to develop a product and to determine whether the product has any market legs, says Patrick McPharlin, director of Michigan’s Department of Insurance and Financial Services and head of the National Association of Insurance Commissioners’ Innovation and Technology Task Force. For example, sandboxes might tackle such issues as how coverage reduction/cancellation notices would apply to on-demand insurance.
But there’s not a single one in the United States. In fact, across the country, there’s not even agreement as to what an insurtech sandbox looks like. The issue is critical because Insurtech has become a more important part of the insurance landscape, and with the potential to touch virtually every nook and cranny of the business, it will only become more important.
“Our definition of insurtech is technology-fueled innovation anywhere within the insurance ecosystem,” says Jennifer Urso, vice president of market intelligence and insights at The Council. “Our stance on this is the innovation and evolution that technology is bringing to the table is helping the industry align with consumer expectations and preferences that have been shaped by other industries.”
The American Insurance Association has drafted a proposal calling on the NAIC and state legislatures to actively encourage the pilot-testing and implementation of innovative new insurance technologies, products and services. The AIA is asking the NAIC to consider authorizing insurance regulators to grant targeted relief giving state regulators broad discretion to attach consumer protections and other conditions to any grant of relief and to adopt clear protections for trade secrets while including measures to maintain a level playing field.
But Jillian Froment, director of the Ohio Department of Insurance, says she isn’t sure how a sandbox would differ from Ohio’s approach of actively encouraging innovation. She says Ohio already promotes Insurtech innovation without having to construct a regulatory sandbox.
McPharlin takes a similar stance in Michigan. “We’ve had a handful of people come and talk to us, those who have real questions about a product they wanted to innovate. We were able to tell them there was no problem.” They hadn’t asked before, he says, because they thought they’d be turned down.
But because these conversations are happening in some states, that doesn’t mean they’re happening in all. “At this point, this is a state-by-state approach,” says John Fielding, general counsel for The Council.
“There’s no uniformity in the way states are coming at this.”
While this reflects how insurance is regulated in the U.S., some say such an approach might hinder sandbox progress.
Doing Our Own Thing
While the United States continues its individualized approach to sandboxes, several jurisdictions outside the United States have created them with shared characteristics. According to the AIA, those in the United Kingdom, Australia and elsewhere all provide a supervised process for experimentation with insurance innovation. And under some circumstances, they offer relaxed legal and regulatory requirements that otherwise might be hurdles to forward motion.
Some observers fear the United States will fall behind its competitors if regulation does not catch up with digital reality. “We currently see on the global level competition for investment and talent,” says Vladimir Gololobov, The Council’s international director. “It’s all about pairing innovation with insurance services, an opportunity for countries to claim their leadership in the financial segment they want.”
Things have gone “a lot farther overseas than here in the U.S.,” says Mike O’Malley, senior vice president for public policy at AIA. He notes the United Kingdom established its sandboxes in 2016 and has already had more than 150 applications. “They’ve been very active,” O’Malley says.
And despite the experimentation happening in some states, some sandbox proponents believe the state-based insurance regulatory system doesn’t give room for enough meaningful innovation to allow the United States to follow international competitors’ lead in creating sandboxes. One main roadblock “is that basically you can’t have a national sandbox,” says Vikram Sidhu, a partner at law firm Clyde &Co. in New York. “Any sandbox that is created would have to be in a state. But states don’t have meaningful flexibility in being able to give exemptions to startups from the various insurance laws that exist.”
The fragmented nature of U.S. insurance regulation is an impediment to creating sandboxes, Gololobov says.
“Regulators historically are worried about their turf,” he says. “Fragmented regulatory structure takes away from the whole idea of insurtech globally, which is all about scale and breaking down barriers.”
However, some regulators say it’s easier for innovators to deal with a single state than to try coordinating efforts nationally. McPharlin says it’s easier to innovate on a one-state basis because innovators and state regulator scan meet one-on-one and get to know each other. “With a federal agency, I’m not sure you’re going to get that same level of personal service,” he says. “I think the state format is an advantage. We’re talking about having some sort of coordination among the states. We’re not at any decision yet.”
Regulators Not So Tech Savvy
Ultimately, lack of knowledge and budgets slow insurtech progress.
Regulators willingly embrace technology to enhance their own operations, according to the Deloitte Center for Financial Services. But the regulators remain guarded about how carriers employ new technology.
“In a time of rapidly increasing technology adoption, a growing number of regulators are likely to use the latest technology to enable the kind of deep, broad, and real-time oversight of the insurance market that could not have been dreamt of even a decade or two ago,” says the 2017 Insurance Regulator Technology Adoption Survey. However despite those predictions, the survey found regulators are implementing new technologies in their departments mainly to automate manual processes and replace or integrate legacy systems. The fact that 69% of them cited legacy systems as a driver could indicate they still need to modernize current systems before considering more advanced technology. Not surprisingly, nearly three quarters of the respondents cited budgetary constraints as the main roadblock to adopting technology.
“Generally speaking, everybody sees technology will change the interaction between the regulators and the industry,” says Rich Godfrey, principal and U.S. insurance advisory leader at Deloitte & Touche.
But the survey also found regulators “seem unlikely to give insurers the benefit of the doubt regarding new technology uses, so insurers would need to display greater transparency in their relationships with bold customers and regulators.”
Nearly half the respondents said new technologies create more need for regulatory oversight. Among the chief concerns are data security and fair market conduct. Regulators also seemed somewhat cool to the idea of insurtech sandboxes.
“While most agree engaging with different stakeholders—insurtech start- ups, insurers, consumer-protection groups, and other regulators—to pursue innovation would be a positive step, more than four in 10 only somewhat agree,” the survey says. “So if sandboxes are to be a useful tool, state insurance regulatory leaders may need to educate their colleagues on their potential.”
Many regulators say they have nothing against innovation, provided it affords consumers adequate protection. In fact, over the past few years, regulators have begun to agree a regulatory sandbox is an important and effective tool, says Andy Mais of Deloitte’s Center for Financial Services.
“It’s important to allow testing of innovative ideas but in a supervised environment,” O’Malley says. “For example, you don’t want someone to sell policies in a sandbox who can’t cover claims.”
“We also want to make sure that we don’t inadvertently create an unlevel playing field,” says Dave Snyder, vice president at the Property Casualty Insurers Association of America.
“Most commissioners are very positive on innovation,” McPharlin says.“ But if someone comes in and wants to be free of paying taxes during the development process, no legislature will allow that.” He also raises concerns about consumer protections regarding personal data. “Who owns information and profits from it?” he asks.
“It’s about trying to support industry and their use of innovation while balancing that with consumer protection,” says Ohio’s Froment. “That’s not easy, but it’s not impossible.”
Sandbox proponents have an educational job ahead of them, Fielding says. “It’s a quickly evolving area. It’s a big task for insurance regulators to getup to speed on the constant change and regulate it very quickly. Education and understanding are the biggest parts.”
“The general feeling on the part of state regulators is they will not fall behind the curve,” Mais says. “I think there is openness despite what some regard as a fragmented system.”
And regulators have a stake in encouraging innovation, notes Scott Sinder, The Council’s chief legal officer and a partner at Steptoe & Johnson.“ The big threat to state regulation is, if they’re not able to keep up with the innovators, then as an innovator, you say, ‘Maybe I need to rethink this,’ and come up with something that allows the transfer of risk but is not an insurance product.”
That insurance is governed by decades-old regulatory approaches is another obstacle. “When I talk to regulators, they think they’re doing a lot,” Sidhu says. “They are really trying, but our system of insurance laws and regulations grew up over 150 years. It’s trying to address issues that arose a long time ago, but how we do business has changed dramatically. The issues arising from the 19th- or 20th-century approach to regulating the insurance business clash with the 21st-century ways of doing the business and are only going to get bigger.”
We’re Not Going Backward
One factor that could give the U.S. some breathing room in the race for Insurtech expansion is the size of the nation’s insurance market. “When you’re comparing us to other countries, we have by far the largest insurance market in the world,” PCI’s Snyder says. “We’re going about this in a careful way, and we’re convinced that in the end we’ll be up to the challenges as we have been in the past.”
“You can prove a concept in Hong Kong, you can go to Australia and develop an interesting product—but America is still the largest insurance market,” Sidhu says. “Insurtech will still come to these shores.”
While the U.S. is still the leader in technology, O’Malley says, the country needs to take action to remain ahead. “I worry if we in the U.S. don’t get on the sandbox bandwagon soon, we are going to fall behind,” he says. But he adds that AIA “is very confident we’ll get to the point where we have sandboxes in the U.S.”
In fact, legislation that would create insurance-specific sandboxes has been introduced in Hawaii and Illinois, while less-targeted but applicable bills have been introduced in Arizona and Massachusetts. “We’re not going backward,” Fielding says. “You’re going to see more and more talk at the state level and more and more talk at the NAIC. I think it will move from education to actually doing something. The market’s just going there. They’re going to have to figure it out.”
Hofmann is a contributing firstname.lastname@example.org
Hawaii Commissioner Says We Will Innovate
Ito, who has testified before state legislative committees in favor of bills that would create a sandbox, says realizing the sandbox concept would bring economic benefits to the state.
“It could create growth in our tech sector by attracting innovators to work with insurance companies in Hawaii,” Ito says, “as well as encourage insurers outside of the state to use Hawaii’s sandbox to test innovations for use in the United States or Asia.”
He says technological advancements in mobile platforms, artificial intelligence, data collection, storage and the “continuing transformation in our economy are factors that attracted our interest in creating a sandbox in Hawaii to encourage innovation in the insurance sector. Hawaii’s unique location could result in the state becoming an insurtech center that facilitates collaboration between tech innovators, insurers and even other insurtech countries that are already fostering innovation.”
Ito points out that Hawaii has built a reputation as an insurance regulatory innovator. “Back in 1986, Hawaii was one of the first states to adopt captive laws, resulting in the state’s becoming one of the premier captive domiciles in the world,” he says. If the current legislation becomes law, “Hawaii would be the first state to pass a law specifically dedicated to creating an insurtech environment.”
Not surprisingly, Ito does not share the concern of some sandbox supporters that state-based regulation stifles innovation such as sandboxes. “The state-based system does encourage innovation,” he says.
He says states will either pass insurtech laws or will work within their own frameworks and provide flexibility by granting exceptions. He believes the insurance and technology sectors will work together to create efficiencies and new products, underwriting processes, and sales and payment methods. The blending of insurance, technology and other sectors will also occur.
“Insurtech or regulatory flexibility will be the rule and adopted in many states rather than the exception,” Ito says.
Carrier legacy systems, he says, need to be replaced. “Attracting tech companies to work with insurers in not only upgrading existing systems but implementing entirely new processes is an example of the talent and technology that could bolster the insurance sector,” Ito says.
“There is an infinite number of possibilities, which could benefit consumers by creating more choices and improving efficiencies in the insurance area,” Ito says. “They are already evident in other sectors of the economy. The U.S. is a technology leader and has the largest insurance market in the world. Changes are constantly happening in both worlds. It’s exciting times in the insurance and technology areas.”