Given a terrible customer service track record and bloated infrastructure, the global insurance industry stands poised to be disrupted. Nimble, tech-driven firms are challenging the status quo, using behavioral economics and technologies like IoT and cloud to target inefficiencies in the insurance value chain ranging from customer acquisition to back-office processing.
In the fourth installment of PitchBook’s Fintech Analyst Report series, our emerging-tech analysts dive into the consequent segmentation of insurance, exploring how the industry’s value chain is being disrupted. Key points of discussion include:
- The burgeoning variety of niche products
- How conglomerates—especially in developing markets—are leveraging synergies to appeal to emerging masses of middle-class consumers
- Peer-to-peer insurers returning the industry to its roots
The report also profiles companies in each nascent insurance sector, drawing on the PitchBook Platform to lay out key data points on investment in the space.
Global Insurance Industry – Overview
The analog business processes still prevalent in the insurance sector suggests roots in antiquity. The fundamental function of insurance as the pooling and sharing of risk dates back to the ancient world. Maritime societies from the Greeks, to the medieval Genoese, to British merchants all employed schemes to pool resources in financing risky trading voyages. The Romans formed funeral societies to pay for and conduct funeral rites for members from shared contributions. Sir Edmund Halley (of comet fame) compiled an early actuarial table of death rates in order to establish a fund for widows and orphans of Scottish clergy.
The industry began to take its modern form in 19th century Britain and America when large corporations emerged to insure against various forms of catastrophe, while government regulations popped up to both encourage the purchase of insurance policies and to prevent insurers from operating unscrupulously. Insurance operates assymetrically, with customers paying relatively small monthly premiums and insurers on the hook for large but irregular payouts. This creates the opportunity for unscrupulous businesses to promise terms that they can’t ultimately uphold. Insurers might be tempted to try and pull off cash-flow underwriting by selling insurance below cost and gambling that they will make up the difference with risky and/or speculative investments. The tactic drives sales in the short term, but becomes unsustainable when claims can no longer be paid out to policyholders and the insured are no longer covered against catastrophe.
Governments in many cases incentivize participation in insurance as well as other retirement benefit and pension schema such as 401ks in the US. Life insurance is used as a form of tax arbitrage in many jurisdictions in order to provide a defined benefit for survivors while making contributions tax deductible. Individuals choose to purchase insurance (or are compelled to by the government) due to natural risk aversion. Consumers pay more than statistically necessary in premiums, hedging against extreme tail risks while ensuring a profit for the insurer after deducting administrative costs. The price of premiums includes the not just the actuarial expected loss, but also the cost of running a business and the cost of capital, i.e. firms need to generate a return for investors.
In the US, private health insurance emerged first during the early 20th century as a way for hospitals to finance emerging pharmaceutical research and improved education by getting groups of people to pay in advance for medical care on a monthly basis through their employer. During the World War II-era economy, wages were fixed so employers began enticing workers with more generous health benefits.
In the high-tax postwar era, contributions became tax-deductible, further incentivizing employee plans. This system created a private system with a high degree of price opacity since patients would rarely see their full bill.
Fast forward to present day, insurance premiums alone make up 7% of US GDP. Sir Halley’s previously mentioned Scottish Widows fund grew into a corporation acquired by Lloyds Group for £7 billion in 1999. While insurance doesn’t always merit inclusion into the buzzy fintech vertical, the stubbornly analog nature of the industry makes it extremely exciting for venture capital investors. Globally, the insurance industry covers all manner of risks from life, disability, healthcare, fire, burglary, collision, and professional and business insurance including cybersecurity and medical torts. Government programs like Medicare and more recently The Affordable Care Act have added a further degree of complexity in the US due to the layering of public and private primary and secondary coverage.
Insurance also covers to a large degree the risks assumed by the financial and shadow banking sector, e.g. AIG’s role in the financial crisis and wealth management products in China. Insurers are incentivized to specialize in niche risks in order to find pockets of mispricing. Insurers typically hedge some of their own exposure via reinsurers which lend capital to rapidly growing direct insurers. Reinsurers have played a key role in technology transfer to developing markets. Local governments are often wary of foreign entities yet local operators need foreign seed capital and expertise. Thus it makes sense to partner with foreign reinsurers who have the expertise and access to technology as well as the balance sheets to de-risk partner firms. The growth of emerging markets over the last several decades with billions of new middle class consumers around the world have played a prevalent role in insurance sector growth strategies.
While insurance largely remains an extremely analog industry, technology has begun to play a crucial and increasing role, impacting all facets of the insurance business. Improved data, often from connected devices, improves the pricing of risk. Thus, when companies know more about their customers, they are able to partner with insurers or insurance products directly to better serve consumers, building ecosystems around loyalty and trust. This puts pressure on incumbent insurers to improve their customer service both via online user experience, and by increased alignment of consumer interests. This comes both from the incorporation of new tools and data to calculate risk, but also a fundamental shift in business models within the insurance ecosystem.
Disrupting the insurance value chain
Historically, the insurance value chain has been linked, with each company offering multiple lines of insurance and managing that business line from customer acquisition and marketing to underwriting and back office as well as other intermediate and related processes. The horizontally and vertically integrated insurance model will begin to be disrupted along both planes. The integration of digital-only players into the insurance ecosystem will only further vertically segment the entire insurance value chain. This segmentation will only align the interests of companies and consumers as players focus on the niche where they hold maximum comparative advantage without depending on cannibalizing other parts of the value chain to extract profits.
We’ve identified several major trends for disruption across the value chain. The first trend is the integration of alternative data sets into more accurate pricing models. These include data from wearables and other IoT devices to track health information, to GPS and other sensors to track driving habits, to social media data. The increase in data utilization has facilitated alignment in stakeholder interests from across the insurance value chain such as removing the financial incentive to delay or deny legitimate claims. Companies have increased information on consumers throughout the marketing, sales and customer service processes. Players that leverage this information in novel ways will be able to generate sizable comparative advantage.