Mind The (Protection) Gap
The inspiration for something new — a concept, product or strategy — can arrive at any time. It can turn up anywhere: independently, or as a result of talking to any number of people. Often, the inspiration for trying something new is the result of having a bad experience.
Take insurance, for example. Many of the startups that spearheaded the current wave of technology-driven innovation in insurance were distribution-focussed brokers or managing general agents (MGAs). The founding stories that prompted the startups include the inability to buy a landlord’s or auto insurance policy in the middle of the night, for example, which led to them bringing insurance online. Their principles were — and remain — noble and straightforward. Anyone who needs an insurance policy should be able to buy one that adequately covers their exposure at an affordable price and at a time that suits them.
These distribution-focussed startups have had a huge impact on the industry. Not necessarily in terms of premium volume — at least, not yet — but in changing the narrative around insurance innovation, causing incumbents to invest in new forms of distribution and encouraging insurance executives to think carefully about the future of the industry. However, in my opinion, where they haven’t yet had a big impact is on the ‘protection gap’ — the difference between the amount of insurance cover that is economically beneficial and what is actually purchased. Put simply, it is the protection that a customer should have, but doesn’t.
In products such as auto liability, there is next to no protection gap. Coverage is mandatory in many markets and those who do not buy it are subject to punishment, as determined by the local law. In products such as landlord’s insurance, there is a protection gap — without a law making this mandatory, not everyone buys what they need but, in developed markets, the opportunity to access these products is generally good. I believe that mature lines of business, where customers are already well-served by competitive markets with suitable products, do not need so much attention from entrepreneurs and their startups. Instead, I encourage them to roll up their sleeves and close the protection gaps in selective segments and certain areas around the world.
Where are the gaps?
Swiss Re, the largest holder of biometric risk in the world, estimated that the life insurance protection gap in 2016 was close to $25trillion in the United States alone. In the same year, the total face value of all life insurance in the US was only $21trillion. So, while the incumbents have done a great job of getting us to $21trillion, some creative approaches might be required to get us closer to $46trillion. That missing $25trillion represents coverage that people need but currently do not buy.
A similar picture emerges around catastrophic events. Total economic losses from both natural and man-made disasters were $165billion in 2018. Insurance covered only $85billion of those losses. Unfortunately, that gap is growing: economic losses grew by five per cent between 1992 and 2018, yet insured losses grew by only by 4.7 per cent.
Creating a sophisticated model to calculate the size of a protection gap is one thing, but why does a gap exist? Why don’t people buy something when they really should? Aside from that feeling of ‘it’ll never happen to me’, there are a myriad of reasons, ranging from hard, technical challenges to softer engagement-related issues. These differ in their relevance, by both product and geography, as well as the regulatory regime in place.
On the technical side, in many cases a suitable insurance product just doesn’t exist today. Sometimes that means that it hasn’t been thought of, despite all the bright minds in insurance. More likely, the lack of a product often means that it simply isn’t yet possible to suitably estimate the risk in question — either more generally or specifically — at the customer level. In certain cases, there have been advances in underwriting, but the pricing makes the product unaffordable.
With respect to engagement, insurance suffers from various issues related to perception. A recent LIMRA survey showed respondents deemed insurance too expensive (63 per cent), others claimed they have other financial priorities (61 per cent) and some believe that they already have sufficient cover (52 per cent). Furthermore, most customers estimated the price at three times the actual cost to acquire the coverage. With household budgets stretched, is it surprising that customers take the easy option and just don’t bother to buy any?
The business of distributing insurance products, especially in well-known lines of business like landlord’s and auto, is difficult. In some markets and in some product lines, brand continues to matter a lot to prospective customers. Offline, the number of agents selling insurance has declined significantly over the last few years. Online, insurance-related keywords are pricey and getting more expensive.
So, what’s exciting about insurance?
As a venture capital investor in the insurance industry, I remain convinced that there are opportunities for innovation across the insurance value chain; not just in distribution but underwriting and operations, for example, too. When it comes to distribution, there is a distinct correlation between my excitement about a new proposition and the extent of the protection gap in that space.
At Anthemis, we’re putting our money where our mouth is. A great example of this is Stable. Stable protects businesses from volatile commodity prices by insuring them against price falls or rises. Whether the business in question is a solo farmer or a multinational food processor, dealing in milk, wheat or pork, Stable can protect against the financial volatility that such companies would otherwise be exposed to. Such insurance products provide the financial stability that makes it much easier to plan major investment projects, thereby improving efficiencies and, by extension, profits. At present, the risk management strategies for such businesses range from extremely complex derivatives (out of scope for all except the largest companies), locking in prices well in advance (assuming the counterpart is even able to) or crossing your fingers and hoping for the best.
Another example is Hokodo. Hokodo offers single invoice credit insurance products to small and medium-sized businesses looking to protect against the event of default. Cashflow is the number one worry for these businesses, with late payment of invoices being one of the leading causes of small business failure across Europe. Hokodo delivers its invoice protection products through accounting services and marketplaces, among other distribution channels. Served through an application programming interface (API), the insurance is delivered at the point of need, embedded and easy to access within existing platforms and workflows.
How technology closes the gap
My enthusiasm for tackling protection gaps is driven by the optimism I have around technology and how it can materially reduce underinsurance around the world. As evidenced by the companies above, the benefits of technology are real and already underway. Technology can be, and is being, used to address protection gaps through:
■ New products: Technology is enabling the development of products that have hitherto not been possible. Insurance has become atomic, broken down to cover specific time periods or specific risks.
■ New data sources: Data science is enabling insurers to understand risk in real time and price it accordingly.
■ New methods of engagement: The existence of a risk and need to mitigate it can now be anticipated well in advance. Customers can learn about products on their terms, at their convenience.
■ New distribution: In many lines of business, insurance is gradually becoming invisible: the acquisition of cover embedded within existing transaction processes or workflows.
■ New methods for matching capital with risk: Making this process more efficient can reduce the overall cost structure, especially in insurance-linked securities and reinsurance.
As the world changes, new risks inevitably emerge and, by extension, new protection gaps emerge, too. Munich Re and Swiss Re monitor the risk landscape for new risks and have highlighted several areas to watch. These include the increasing prevalence of intangible assets, automation, social inequality and protectionism.
If you’re an entrepreneur looking for a real problem to tackle, start with the protection gap. It’s time to do more to get the right insurance products into the right hands, at the right time. There are too many people walking a tightrope without a safety net out there.
A version of this article appeared in The Insurtech Magazine.
