Disrupting Insurance: The Playbook
I’ve tried to convince a dozen promising founders to disrupt the insurance industry the past year. The reaction, not surprisingly, is a blank stare at best, disgust at worst. But there’s never been a better time to disrupt this arcane (and large) industry … which means plenty of money to be made by startups.
First, why should you even listen to me? Before venture capital, I spent 18 years on Wall Street analyzing public equity markets, including the insurance sector from 2006, expanding into all financials in 2011. Some may see those ten years as my lost decade, but I’ve infiltrated the citadel and found their weakest points.
Crash Course on the Industry:
Insurance might be boring, but there’s a lot of money in it (why else would Buffett buy Geico and Gen Re?). It’s one of the few businesses where you get paid first, before your goods and services are delivered. Positive cashcycle means you can self-fund your growth, if and only if you’ve priced your risks appropriately. The industry is split between life insurance (annuities, savings-related products, former pension plan transfers), and property casualty (P&C for short, your traditional home, auto, boats, RVs, renters, accident). Health insurance is usually covered by the healthcare analyst due to its strong economic link to hospitals and pharmaceuticals.
The property casualty portion alone is $617 billion in TAM (total addressable market) today. That should be enough to get any big VC’s attention.
And VCs have been investing in insurtech:
… but I believe this investment curve will become more vertical. Keep reading.
The P&C segment has seen a lot more disruption than the life insurance segment because the tail of the business is much shorter (auto policies are usually 6 months, versus life insurance policy of ~20 years), hence the insurer can take on more smaller bets and iterate quickly (sounds a lot more like a startup now, huh?). The second reason is that life insurance premiums are actually shrinking at a ~2% pace in developed markets (but growing at emerging markets due to rise in income levels). My hypothesis is that as birth rates decline in developed markets, there is less need for vanilla life insurance policies. My insurance agent friends are always asking “who’s having a baby soon?” That’s the life event that opens the door for these agents.
Perfect timing for disruption:
Without further ado, here is a list of the thermal exhaust ports of the death star and why the timing of attack is nigh. Insurance is a sector where:
(1) Data accuracy and analysis can mean the difference between zero cost of goods sold (no car crash), or multiples of revenue (totaled car). It’s a power-law distribution just like early stage venture … but flipped to the loss side (at best you gain the premium paid, but at worst the loss is theoretically uncapped, if you didn’t buy reinsurance to offload the tail risk). Instead of buying a call option, you’ve sold a put option struck at the price of the deductible. On average, cost of goods sold (called claims ratio) for property casualty insurance ranges between 65-95% of premiums, thus this part is a big profit driver.
(2) Speed of customer service has allowed high-end insurance companies to charge 2x that of low-cost insurers … and the high-end customers happily pay the premium. Technology can improve on that speed even further. Claims handling and admin costs (called expense ratio) range between 10–35% of premiums, thus the second big profit driver. The sum of claims ratio and expense ratio is called combined ratio.
(3) Distribution has averaged 10–15% of premiums. Many startups in other sectors have figured out virality and network effects bringing down customer acquisition cost to zero.
(4) Reinsurers getting onboard. One of the biggest hurdles used to be access to balance sheet in order to underwrite more or bigger risks. And as every great entrepreneur knows: if you can’t build it, borrow it. MGA stands for managing general agent (aka managing general underwriter, MGU), is a type of wholesale broker, acts as an insurance agent or broker for the insurer, the intermediary between carriers and agents, while having no contact with the insured … translation: you the startup can borrow a balance sheet now without having to hire your own actuaries. This is huge! Metromile working with a MGA in 2013 was a game changer, but the industry has caught up fast: Munich Re Digital Partners is partnering with 20(!).
(5) Traditional customer retention tools no longer working. One of the ways legacy insurers retained customers is through bundling, remember those commercials about getting your home and auto insurance from the same company for a 10% discount? The theory was the more products a customer had with the insurer, the stickier that customer will be. Banks used the same scheme. However, given how quickly driving trends have changed, how readily available data and processing power are, that 10%, or even 20% discount, is no longer enough to retain customers. Why am I salivating at the prospects of stealing a long-time customer? Because in the insurance business, due to adverse selection, the profits and return-on-equity are made on the long-time customers, losses average the most for the first-year customers. Topdanmark is one of the most tech-savvy P&C insurers I’ve come across globally, with consistently some of the lowest combined ratios in the industry. Even they, given their headstart in technology, noted customer retention as the biggest entry barrier.
The entry barriers are lowered. We, the disruptors, have a shot at getting their most profitable customers. The sheer speed of market evolution compounds the data advantage and quick decision making of startups over big companies.
(6) Major platform and cultural shifts — autonomous driving, real-time biometric health tracking, tiny homes — none of these existed a decade ago, which means that there are now new customers that are not being served by the traditional insurance products. Supply to this new demand. Not every customer-focused startup succeeded, but every startup that succeeded was maniacally focused on its customers.
Top startups and disruptors to watch:
(a) Real-time, as-need, pay-as-you-use:
Trōv — global on-demand, real-time, as-needed coverage. Consumers can insure single items such as cameras and digital devices, activate and terminate at any time over a mobile app.
SnapSheet — white-label mobile photo app for auto claims, eliminates the need for assessors (historically cost insurers $250 per visit), shortens claims processing turnaround time from one week to one minute.
ZenDrive — mobile telematics, raised $57 million over 4 rounds. Investors include XL Innovate and BMW i Ventures.
Cambridge Mobile Telematics — software called DriveWell, touted as a complete telematics and behavioral analytics solution to improve safety.
Root Insurance —try-before-you-buy approach to pay-as-you-drive auto insurance
(b) Property/Homeowners Insurance:
Hover — used for property claims, creates fully measured, customizable 3D models of any home. Investors include GV and Home Depot.
Flyreel — using AI to analyze property claims, still seed stage, raised $5.9 million over 3 rounds, Gradient Ventures.
Hippo — UX matters, especially when it comes to consumer and SMBs. Hippo pre-fills homeowners insurance applications via tax and county records, aerial and satellite imagery, inspection reports, and listing information
NearMap —vertical coverage of >71% of the US population. Leveraging big advances in image classification for insurance underwriting and claims processing: in 2015, a deep neural network outperformed humans in the ImageNet Challenge for the first time.
(c) Fraud detection:
Shift Technology — aggregates claims data to build AI models for insurance fraud detection. Very rapid growth, signed first customer in 2015, 70 customers in 2018. Leveraging advancements in ML, Shift’s software called FORCE has a 75% hit rate, and fewer false positives than other solutions.
(d) SMB focus:
SafetyCulture — workplace inspections done via their iAuditor app.
Pie Insurance — direct to consumer (SMB owners) worker’s comp
Next Insurance — is taking a chapter out of the Square’s segmentation playbook, tailoring insurance to each specific profession (restaurant vs caterer, engineer vs architect, real estate agent vs property manager).
(e) Underserved Niche:
Bought by Many — niche products that legacy insurers often avoid, such as travel insurance for those with preexisting medical conditions. Munich Re is an investor.
REIN — backed by Liberty Mutual, offers customized coverage for the new drone market.
Tesla — No list of disruptors is complete without Elon. Tesla announced last week that it will be offering insurance to Tesla owners in California. Unclear if Tesla is retaining the risk inhouse.