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
Recent History
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.
Customer Acquisition
At the top of the value chain, firms are optimizing customer acquisition through more data-driven digital strategies. Firms assess key data points such as big-ticket purchases, e.g. a home or car, and target offerings to customer needs in light of these events. Comparison platforms have emerged for consumers to compare quotes across dozens of providers without filling out multiple forms. Acquiring customers is highly competitive with brand-awareness highly important when the time investment to fill out forms made it difficult to compare directly on price. US-based insurance firms spent $6 billion on advertising last year, according to McKinsey.
Increasingly, as consumers can more easily compare more insurers, firms will need to invest more in technology, both in demand generation and marketing analytics technology but also in accurately pricing risk. Insurers will be well-off to focus on the latter as customer acquisition becomes increasingly commoditized and frictionless.
Pricing Risk
This continued segmentation will force insurers to focus on their core competency of pricing risk. Insurers can more accurately price risk through a number of technology-driven channels. Most of this strategy revolves on the increased use of data and algorithms. This can take the form of analyzing social media accounts to assess propensity for risk-taking and thus risk as a driver, homeowner or potential patient. Additionally, insurers may make use of data around utilization such as whether or not the insured is filling prescriptions. For segments with fewer data points around behavior such as auto or dental insurance where claims and or office visits are relatively infrequent, IoT-connected devices are filling the gaps. For instance, GPS-connected telematics systems can track driver behavior, while connected toothbrushes can monitor and approximate frequency of brushing approximating oral hygiene.
Claims Management
Further up the value chain, insurers are seeing substantial savings through claims management and administration tasks becoming automated with software. Insurance remains one of the last industries where your provider is likely to send you a paper fax. Armies of back-office clerks stand to benefit from increasingly digitized workflows, and more efficient claims processing aims to improve customer experience. All aspects of running an insurance practice can be improved with technologies such as cloud and mobile streamlining processes. Many large insurers have processes spread across multiple locations and departments. Streamlining on both these fronts can increase speed as well as optimize utilization.
Reinsurance
At the top of the value chain, reinsurers have been a crucial catalyst for implementing technology throughout the insurance sector. Reinsurers provide policies for insurance companies in order to de-risk their balance sheets. In general, the insurance industry growth remains heavily tied to GDP. Thus, the low-growth environment in developed markets in recent years has pushed many companies to strategically seek out inorganic growth. Due to the heavily regulated nature of the industry that can crowd out foreign incumbents, in many cases reinsurers have helped foster insurance companies in developing markets, arming them with capital and expertise. This often takes the form of best practices regarding technology as the reinsurance sector has been a major catalyst for technological proliferation in the developing world.
Market Applications & Segments
Property And Casualty
The business of insuring items such as homes and cars known as property and casualty insurance (P&C) remains strongly linked to GDP. Individual purchases of cars and homes as well as the value of these items is highly contingent on general economic output. Thus, P&C offers limited opportunities for organic growth. In part due to the low-growth environment in the developed world, companies in the P&C ecosystem have begun to drive innovation and gain scale by improving upon customer incentive alignment and expanding into new business lines.
Since P&C deals with the risk of incurring loss of physical property, this type of insurance is less regulated than types of insurance dealing with human lives and health. The relative lack of regulation in the P&C space has made the market highly competitive and lower margin due to increased commoditization. This does not lend itself to strong customer service, as it makes insurers overly sensitive to fraudulent claims. We’ve seen a number of exciting business models spring up addressing some of these market dynamics within P&C. One exciting development is the proliferation of peer-to-peer insurance business models. Users are grouped into affinity groups around shared values or commonalities. Customers then receive year-end bonuses contingent on the group hitting certain metrics, e.g. a low number of claims, making them less likely to commit fraud. These companies also cut costs by operating exclusively online. Integrating technology such as chatbots and AI further cuts costs and allows customers to avoid waiting in phone queues to speak to a representative in a call center. Companies like Lemonade have employed behavioral scientists to engineer the claims process to minimize fraudulent claims. One example was the reduction in fraud realized when the customer signs terms and conditions on the first webpage of the claims process rather than after filling out details online.
Since P&C tends to be relatively less regulated, this segment stands most ready to gain scale globally as business models can be quickly duplicated across borders. For example electronic device-insurer Trov launched in Australia last year, quickly expanded to the UK, and will launch for US consumers in 2017. This is possible since the market for insuring cell phones, laptops and photography equipment is naturally less regulated than insuring against death or illness. The need for incumbent P&C insurers to find inorganic growth made the space privy to the largest insurance M&A deal this year as electronics extended warranty provider SquareTrade was acquired by AllState for $1.43 billion in January 2017.
In developing economies with less mature insurance sectors, a number of P&C insurers have emerged around leveraging superior customer insights to provide bundled services. Another causal factor is the trend towards centralization of services on a single platform in the Asian market, a la WeChat. This trend runs opposite to the segmentation in North America and Europe. Chinese fintech conglomerates like Ant Financial and Zhong Anh have made it their business model to cover individuals across a range of financial services including insurance. This allows them to incorporate data that their competitors do not have access to. These conglomerates also look to combine traditional banking services into insurance business lines.
Auto
One segment of P&C that warrants a standalone section is the auto insurance sector. Historically, auto insurance that protected drivers from catastrophic losses incurred by accidents had few data points from which to price policies. The integration of additional data into auto insurance stands to revolutionize the way auto insurance is priced. Globally there are around 1.2 billion vehicles on the road, with this number expected to grow to 2 billion by 2035. Auto seems to mark a sweet spot for the aggregation of ever-larger datasets into improving coverage as globally accidents cost $518 billion per year.
Traditional insurers have incorporated “telematics” into traditional policies for years. Accident, claims or ticket data offers a tiny sample size from which to price driver risk. The customer brings home a device that they leave in their vehicle for several weeks and records their driving data. A new breed of tech companies have cropped up to offer continuous real-time data to insurers and even more efficient pricing data. This sort of data offers increased opportunity for customer engagement via behavioral feedback, and, like other IoT-influenced verticals, allows for gamification.
Cars will only continue to become more connected. Regulations going into effects this year in the EU require all new vehicles to be equipped with an “eCall” system that automatically alerts an operator in case of emergency. Insurers will continue to push to use this data to more accurately price risk. However, the industry faces an inevitable turning point. Once cars ultimately become driverless, it remains a question as to how accident risk will be priced, and who will assume liability. It’s likely that OEMs will begin coverage themselves, as this both properly aligns incentives and allows for another stream of revenue.
The most prominent company, Metromile, offers by-the-mile insurance to consumers as well as policies approved for Uber drivers. On-demand workers like Uber drivers make up one new class of risk that traditional players have been slow to address. Traditionally, the ridesharing company covers liability when a passenger is in the vehicle, while the driver’s personal insurance covers use when off the clock. However, neither includes coverage for the significant periods between trips. As the sharing and on-demand economy continues to grow, further niche areas will continue to crop up where startups may be uniquely positioned to price and broker risk.
Health And Life
More than any other subsector, health insurance is driven by regulation. In the US, insurance was traditionally sold via employers. This opacity in health insurance delivery has enabled prices to creep up to 18% of GDP in 2015. There is ample opportunity to capture some of this spend. Enterprise businesses in the health insurance space have seen success under a SaaS model. In one prominent example, embattled insurance broker Zenefits gives away free HR software in order to generate revenue from insurance sales. Many players, like in other sectors, act technically as brokers rather than direct insurers. Much of this stems from the analog nature of the insurance brokerage status quo, which in many cases is made up of broadly dispersed Main Street offices.
Only since the advent of the ACA did a significant market open up for direct-to-consumer offerings. The largest and most famous, Oscar, targets millennials purchasing insurance online. The second largest, Clover, offers supplemental Medicare Advantage plans, a profitable niche providing secondary coverage for older Americans eligible for Medicare. Health insurance often lacks the same scale as P&C due to heavy regulations in each jurisdiction. For example, Oscar was forced to roll out on a state-by-state basis with reports of wide disparities in profitability.
A number of companies have also emerged to attack the delivery of healthcare and thus lower costs. Mobile diagnosis platforms have emerged to help treat specific conditions that can easily be treated without in-person visits. These platforms will help reduce the inefficiencies and high frictions that lead to $2.9 trillion being spent annually on US healthcare, as well as reduce other headaches for patients in scheduling and taking the time to make it into a medical office.
Emerging Markets
Much of the problems addressed by insuretech companies are related to solving the glaring inefficiences of the outdated insurance delivery business model. A number of startups are acting as comparison platforms to better drive lead generation for insurance firms. Oftentimes investment in these companies is a macro play on specific regions. One example, Mumbai-based PolicyBazaar, has raised $77.9 million in private capital from a number of prominent investors including Singaporean SWF Temasek Holdings, Tiger Global and Intel Capital.
Investors wager that overall growth in emerging markets will drive and increase in online insurance in general. In China, the lack of an established insurance industry and in the growing middle class has enabled young platforms to rapidly gain scale. Companies like Ant Financial, Zhong An and Lu.com have offered a number of insurance offerings in comparison to the tendency of Western companies to focus on niche offerings. These firms may demonstrate a model for the future of insurance in the West. Each of these companies leverage a broad base of customer data from other types of financial services, trade finance or ecommerce, and are thus able to compete by bundling services.
Private Investment and Corporate M&A
In comparison to other subsectors of fintech which saw a pronounced drop-off in investor interest and investment in 2016, insurance tech companies saw a plateau from 2015’s blockbuster numbers. Last year saw $1.4 billion in VC deal value, across 74 deals. This was a slight decline from the $1.5 billion and 90 deals in 2015. The larger average deal size indicates a substantial maturing of the industry even from 2014 when a similar number of deals (69) accounted for just $514 million. Each of the last two years saw figures get a boost from single mega-deals. Zenefits raised a $512.6 million Series C in May 2015 led by asset manager Fidelity Investments. The company has struggled since, facing regulatory scrutiny for hiring unlicensed insurance brokers to sell its suite of HR products as well as HR issues of its own. In 2016 Oscar raised a $400 million round to offer direct-to-consumer health insurance in New York, California, Texas and (at the time) New Jersey.
Read the full report here.
