Where is all the innovation in insurance? Let the capital flow

Published on
November 19, 2015
Toby Coppel
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Where is all the innovation in insurance? Let the capital flow

A giant and heavily regulated industry which many would argue has lost sight of its customers should be ripe for attack. After all, entrepreneurs are tackling some of the toughest challenges in sectors like healthcare, transportation and financial services, using software to radically transform the product offering. Yet insurance has been overlooked, protected by large capital requirements and regulatory complexity.

No more. We're engaging with a new generation of insurance companies, founded by entrepreneurs who want to take on this $3.5 trillion industry.

Insurance companies' biggest oversight is simple: they have not been serving their customers. Actually, they rarely interact with their customers, since the vast majority of their business comes through brokers. Brokers are treated as their customers, and collect $45 billion of fees every year from insurers globally. It should come as no surprise that the web and mobile customer experience for consumer and SME insurance is shocking, since the DNA of most insurance companies is heavily B2B. They don't know how to relate to end-consumers. (In this post, I am primarily referring to consumers and SMEs, rather than large corporate customers that continue to be served well by insurers.)

There are a few notable exceptions, such as GEICO and Progressive in the US and Admiral in the UK, that have demonstrated the economic benefits of going direct, eliminating broker commissions and building a more engaged customer relationship. And some insurance companies are slowly waking up to the need to develop consumer DNA, and to rebuild their internal systems to support a direct model. But most of this is invisible to their end-customers and has little positive impact near-term. The banks are a few years ahead on re-designing legacy infrastructure to support a new customer paradigm; we are sceptical that their transformation will be fast enough, which suggests that insurers too will struggle to compete with focused new entrants.

The broken customer value proposition

Most consumers view insurance as a tax on their income and do not look forward to the annual communication from their broker/insurance company containing the renewal premium. To begin with, it has often increased, inexplicably, from the prior year, even in the absence of any claim. Second, consumers also don't believe their insurance company will fully pay out, even when they have a legitimate claim. As a result, end-customers have limited brand loyalty to their insurer, especially for property & casualty and for health insurance. Third, the customer experience is consistently poor. One notable exception is claims handling, although that has less value since claims may only occur every 5 years or so.

All this leads to a situation where consumers churn frequently and shop around heavily based on price. They know that insurers quote lower prices for new customers, and then hike prices in year 2 - new customers are basically subsidized by those who don't churn - which in turn creates a vicious cycle, incentivizing customers to switch constantly. There remains some loyalty in life insurance, but only because it is so painful to get through the upfront paperwork and medical exam that most consumers cannot be bothered to switch.

Finally, not only is the overall customer proposition weak, but the insurance industry is one of the biggest laggards in developing even minimally acceptable online and mobile customer experiences.

These factors create opportunities for startups at various parts of the insurance value chain, across property & casualty, health, and life insurance:

The next generation broker

Brokers can and do play an important role in ensuring that a customer understands the nuances of the product and that it matches their needs. However, brokers must adapt as software encroaches on their world. In wealth management, the role of the broker is being disrupted by new robo-advisor services such as Wealthfront and Betterment, and brokers such as Charles Schwab are reacting by offering their own automated investing products (for free in Schwab's case) and investing in more powerful tools to improve the advice they provide. In real estate, Compass's software enables brokers to reduce the time spent in the office on paperwork and admin, freeing them to get out and market properties. Compass has attracted many top-producing brokers from other firms because of the boost to income that can result from operating on their platform.

In insurance, the first internet product innovation came with the price comparison sites with their lead-gen models - services like Moneysupermarket in the UK, and Check24 in Germany (an investment Simon worked with pre-Mosaic). More recently, tech-powered next-gen brokers have emerged, including Knip and GetSafe in Europe, and Policy Genius, Coverhound and TheZebra in the US. But the state of insurers' APIs (or lack thereof) makes it difficult for brokers to offer a comprehensive and seamless customer experience for finding and purchasing the right policy, so customers often have to make at least one phone call to complete the process - not ideal at all.

Innovating on insurance structure

There is plenty of (re-)insurance capital interested in supporting new insurance products and models; the problem is connecting it to the entrepreneurs that are doing the innovating. Founders of insurance startups discover that even if they have end-customer demand for their product, finding a licensed insurance company to underwrite policies is not straightforward. The world of underwriting has become homogenized in recent years, with standardization of ratings tables and very little creativity allowed by corporate guidelines. This was one of the the key issues highlighted at a "Future of Insurance" roundtable hosted recently by Mosaic. One entrepreneur complained underwriters are "box tickers called Derek, who probably still live with their Mum, sitting in regional offices across Europe, without any ability or license to price a risk outside their nice square box". And the insurance market and its capital that funds traditional underwriters does not have a good mechanism to bypass them and more directly fund innovators.

Founders such as Steven Mendel at BoughtbyMany are trying to tackle this challenge by moving up the value chain and taking more of an active role in underwriting, in close collaboration with several insurance partners. BoughtbyMany is going after white space, assembling groups of people with very specific insurance needs (e.g. users of quad-bikes or owners of classic cars) who cannot easily find (affordable) insurance as individuals - BoughtbyMany can negotiate discounts by aggregating them into larger groups. However, even with the scale of these groups of customers, insurance capital was not easily flowing into the groups, and BoughtbyMany recently acquired a traditional insurance broker that came with a set of underwriter relationships, so they could underwrite these policies themselves.

For founders who want to have complete control over their product, pricing, go-to-market and target customer profile, which is typically true with the most ambitious founders we know, then they need to become a "full-stack" insurance company, with their own underwriting capability. They may choose to outsource claims management or medical assessments, but without being able to issue their own paper, they will always be beholden to one or more underwriters. The regulatory capital requirements to become an underwriter actually start quite low at approximately $5 million in Europe or the US, and once an insurance business is up and running, the cash flow characteristics can be attractive, as Warren Buffett has demonstrated with his 50 year track record in insurance. Startups may be able to fund marketing from their float, but they will need to increase their capital base if they grow their book very fast.

Venture capital investors have different return profiles from insurers/reinsurers and to date have shown limited appetite for a blended VC/reinsurance return on their capital. This may be a mistake given the overall returns available to innovators in this space. Oscar has raised over $370 million of smart venture capital in the health insurance business, a large portion of which has been invested as regulatory capital to support underwriting their health insurance policies. Some entrepreneurs are looking at structures in which they finance their operating business with VC money and their captive underwriting vehicle with reinsurance capital, which may get around this issue. And startups such as Uvamo are exploring using a P2P marketplace to provide underwriting capital.

The mutual insurance model

The Hand in Hand Fire & Life Insurance Society was one of the oldest British insurance companies, founded in 1696 right after the Great Fire of London. It was the first mutual model of insurance which was owned and run for the benefit of its members - they were one of the first peer-to-peer finance startups. Members would pay their premia into a single pool and claims would be paid out. At year-end, if there was money left in the pool, members would receive a dividend. Guevara is a new Mosaic-backed team that is building a similar peer-to-peer model (albeit 300 years later), with aproduct that enables small groups of people with common relationships to form and be incentivized to keep claims low. We are excited about the potential of a peer-to-peer model in insurance that can fuel low-cost customer acquisition, motivate members to minimise losses, and enjoy low churn, with any benefits realised in the form of lower premia in future years.

New risk pools

Technology also enables insurance opportunities in new areas. Cyber-security is one of the fastest growing new areas within insurance. In the same way that Zenefits monetises its software through selling insurance policies, we think that cyber-security software startups may use an insurance product to underpin their business model. We also believe that on-demand insurance enabled by smartphones will be important - rather than annual coverage, Uber drivers may be offered buy coverage by the hour (e.g.Cuvva), Airbnb hosts by the night or Taskrabbits by the day, and in emerging markets this may become the standard for how insurance is sold. Existing actuarial models and claims data are not easily applied to new risk pools, and therefore startups have an opportunity to address these under-served markets.

Robo-advisor powered life insurance

Old fashioned life insurance as a protection product is in decline. At today's mortality rates, consumers see limited value in paying 40 years worth of premia without seeing a pot of money build up over time. Consumers prefer to see life insurance as a long-term savings product that can support them and their families after retirement or death, which may make sense once the tax benefits of a pension or 401k have been maximised. Robo-advisor platforms (such as Wealthfront) are best positioned to provide this type of "life insurance", rather than the current crop of confusing and expensive products from large insurers such as Allianz, Aviva, or AXA, with embedded and hidden costs of 300-600bps compared to 20bps for Wealthfront.

As you can tell, we think the insurance industry is ripe for founders to tackle head-on. For consumers, it's clear there is an unmet need: if only there was a value proposition where a customer could pay a premium that reflects their true risk profile and, in the event of a claim, take out their "insurance claim card" and pay for all reasonable expenses with it. There are many opportunities resulting from this, none of which are straightforward, but the prizes will be large. Insurance capital will need to flow to these entrepreneurs to underwrite risk, in partnership with venture capital to fund operations. If you are working on an ambitious startup in this area, we would love to hear from you.