“Neo Banks” vs “Neo Insurers”
Which model is the better bet?
The latest in a series of headline-grabbing funding rounds, German “Neo Bank” N26 recently announced it had raised $300 million financing, at a reported valuation of $2.7 billion. Meanwhile its UK-based competitor Revolut is rumored to be raising $500m from investors including Softbank, and just in late 2018, Monzo (another UK-based player in that space) announced a raise in excess of $100m.
In their current incarnation, all three startups are just four years old, and yet each of them is valued in the billions. Going from Zero to Unicorn in such a short matter of time is a highly impressive achievement by any standard. Thus, they seem to have confounded critics who doubted the sustainability of the Neo Bank model.
Meanwhile, a new breed of “Neo” is rapidly emerging, this time in insurance. These “Neo Insurers” are younger and thus still receive less public attention than their counterparts in banking, but if I am reading the signs correctly, this may be about to change.
So what exactly is a Neo Insurer?
I define Neo Insurers as companies that offer fully-digitized insurance products to consumers or businesses, exclusively through digital channels, with end-to-end digital service delivery. Typically, this includes:
- Quoting, binding and issuing of policies
- Documentation and proof of insurance
- Electronic billing and payment
- Real-time policy management through a mobile app, this includes adjusting coverage of existing policies, buying additional policies, changing address or payment details, etc.
A Neo Insurer may or may not take insurance risks on its own books. Large reinsurers such as Munich Re make their balance sheet available to those Neo Insurers that don’t take risk.
From a consumer perspective, Neo Insurers replace broker appointments, letters, phone calls and paper-based files with an insurance experience that is entirely app-based.
As a VC who focuses on both FinTech and InsurTech investments, one question has been on my mind for a while: Which model is the better bet? Neo Insurers or Neo Banks?
From an investment perspective, I look for startups that:
- solve a meaningful problem for a large number of people/ clients
- get paid well for doing so, and
- are able to scale customer acquisition and operations cost-effectively
Based on this “hunting pattern”, the following framework helped me to structure my analysis.
Neo Banks vs Neo Insurers: Framework for comparison
Value proposition: To what degree does the product solve customer problems better than existing offers (ie. those by industry incumbents)?
Disruptive potential: Will the new players rewrite the rules of the industry?
Addressable market: How large is the potential customer base for which the value proposition is meaningful?
Customer acquisition: How much does it cost to acquire a paying user? How scalable are the acquisition channels?
Monetization: How much revenue per user is generated? How high are gross margins on these revenues?
Regulatory overheads: How burdensome are compliance and risk management requirements?
Analyzing the two models through the lense of this framework leads me to believe that one of them may indeed be a better bet. Now, let me walk you through my thought process:
Nicer and cheaper vs Fundamentally different
Neo banks offer a superior UX/ UI, relative to the mobile banking offers of most incumbents. They tend to be cheaper when it comes to FX services or card payments abroad. Through their app, they also offer products such as loans and savings accounts, mostly through specialized partners.
While this is certainly a valid value proposition (and their fast-growing user numbers are testament to that), it is not entirely unique. Quite a few direct banks have caught up with Neo Banks when it comes to their mobile banking experience, and they offer similar pricing for their card products.
Account aggregation and payment apps such as Bankin’ in France, or Yolt and Money Dashboard in the UK, offer a similar experience to Neo Banks — but without the need to open a new account. Traditional banks have started offering mobile account aggregation as well, working with technology providers such as figo, Tink and Linxo.
In comparison, Neo Insurers’ value proposition seems more fundamental.
For the first time in the insurance industry, they offer a suite of fully-digitized products and enable their customers to manage all their insurance-related needs through one mobile app: No more annoying letters in the mailbox, awkward broker visits, and being stuck in call center “hotlines”. This is a big step ahead, compared to the offers of insurance incumbents (including Direct Insurers) and so called “digital brokers” (that have to rely on the paper-based processes of their insurance partners in the back-end).
Run for the money vs Transforming the industry
The disruptive potential of Neo Banks has been the topic of many debates over the last few years. The consensus that has emerged is that Neo Banks are giving traditional retail banks a run for their money, but they are not fundamentally rewriting the rules of retail banking.
With regard to Neo Insurers, that debate still has to unfold. It is conventional wisdom that superior data analytics will be the key to successful transformation in the insurance industry, and it is exactly here where Neo Insurers have their biggest advantage. They are acquiring more data about their customers and at dramatically faster rates than traditional insurers, given their multitude of digital touchpoints. This will enable machine learning-based underwriting of insurance risks — indeed a fundamental competitive advantage.
Users vs Customers
Typical banking customers open their primary bank account at the same bank that their parents are customers with, or keep using the one their parents opened for them. Rarely would they switch that account to another bank. While switching primary accounts has become easier than it used to be, it is still perceived as a “hassle”, and there needs to be a very strong motivation for doing so.
Such a motivation typically would be a move abroad. Though expatriates and foreign students are by definition a rather transient demographic.
The majority of accounts opened with Neo Banks are not primary accounts. They are opened by persons who, due to their lifestyle or consumption patterns, benefit from an additional account and card (on top of their primary ones).
Most customers of Neo Insurers are first-time or early insurance buyers, typically aged between 20 and 35 years. They are digital natives who, for the first time in their lives, need to buy insurance protection for themselves.
At their age they rely less on their parents relationships than first-time banking customers. Naturally, they would search for and buy their insurance policies digitally. A fully-digitized product and service offer intrinsically appeals to them, and the Neo Insurer will likely become and remain their primary insurance provider.
Creating Awareness vs “Harvesting” Intent
If you recently used public transport or an airport in Germany, you will likely have seen the large billboards of Berlin-based Neo Bank N26. If you live in the UK and have not stayed under a rock, you probably will have noticed the brand advertising of the likes of Revolut, Monzo, Monese, etc.. And if you are following news media, chances are you have read a story on how a new breed of innovative banking startups is disrupting the dusty old incumbents in the high street.
PR, brand and word-of-mouth campaigns (online and offline) have become the bedrock of user acquisition for Neo Banks. This is not surprising, given that the number of people actively searching for a new bank account is limited.
However, these acquisition channels come with a set of challenges. Attribution is difficult, it is hard to tell when they reach their saturation point and their overall effectiveness is hard to predict.
Neo Insurers can use more direct acquisition hooks. Young people understand that certain inflection points in life (such as moving out from their parents home, starting an employment, etc.) have implications on their insurance needs.
This creates clear intent to buy, and this intent will manifest itself online. Of course, Neo Insurers are not the only ones trying to “harvest” that buying intent online — competition is strong. However, with a superior product that is precisely targeted at a certain customer segment, some have achieved customer acquisition costs that are substantially lower compared to other market players.
Over time, Neo Insurers also will have to invest into building trusted brands. These brand-building efforts will tend to be more targeted towards preference (as opposed to general awareness), given they can build on existing buying intent.
Activity-based revenues vs Recurring revenues
Neo Banks typically do not charge for basic banking services, and their revenues are mainly coming from card payment fees, so called interchange fees. These fees are paid by merchants and in the EU are capped at 0.2% for debit cards, and 0.3% for credit cards.
An emerging revenue source for Neo Banks is based on referring their users to other financial services providers, eg. for consumer loans, savings products, and even insurances.
For both revenue streams to become meaningful, Neo Banks will depend on continuously activating and engaging their user base.
This will work much better for primary account holders (ie. those users whose salaries are paid into that account) than for other users. Currently it is estimated that c. 25% of accounts at Neo Banks are primary accounts.
In the case of Neo Insurers, monetization works more directly. Customers buy a policy and pay an insurance premium at regular intervals. If they don’t cancel the policy, it will renew. Therefore, insurance premiums represent predictable recurring revenue.
Given that the insurance needs of a typical consumer increase during their late 20s and early 30s (starting a family, buying a car, renting or buying a home, etc.), Neo Insurers have a clear opportunity for revenue expansion with each individual customer. To capture this opportunity over time, they will need to manage their customer touchpoints very well and ensure a high level of customer satisfaction.
Moving money vs Processing claims
While monetization and customer acquisition cost are very important drivers of any business model, one should not overlook the business overhead that is created by regulatory requirements.
Neo Banks in principle are subject to the same requirements regarding compliance (eg. AML, KYC) and risk management as incumbent banks. Therefore they need to maintain an extensive infrastructure to satisfy these requirements. This may be one of the reasons why some Neo Banks employ close to 1,000 staff, but still seem to be challenged by security issues and potential violations of AML regulation (according to media reports).
The regulatory overhead for Neo Insurers largely depends on their licensing. However, even with their own insurer license, it would not be as burdensome. They are not as often a target of money-laundering activities or hacker attacks. After all, Neo Insurers are not in the business of moving people’s money, they “only” hold policy data and process claims.
As you may surely have noticed, Neo Insurers came out on top for each of the criteria I analyzed. In some cases, their advantage is obvious, while in others the picture may be more nuanced.
Neo Banks have grown strongly and raised huge funding rounds over the last few years. Neo Insurers are still at an earlier stage — but over time may have an even more transformative impact on their industry.
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As a specialized FinTech and InsurTech VC, I am more than happy to discuss this analysis and have my perspective challenged. I look forward to your responses!