Dissecting InsurTech — Part 1: Where is the Value?
The number of technology ventures in the insurance industry has been growing at an unparalleled speed in the last couple of months. Like with FinTech before, the InsurTech landscape is constantly expanding, and it’s hard to keep track of every new development. On the other hand, so far we haven’t seen a lot of high valuations (and even fewer large exits) of InsurTech startups (of course also due to the young maturity of this vertical). I have followed the industry closely for a couple of months now, and as a venture capitalist, I find myself asking: “Where should my attention be? Where to look for potential investments?” Of course from a VC perspective, this translates to the question: Where is the potential to create massive (enterprise) value?
I took this question as the underlying to dissect the insurance industry and then identify sub-categories that I think have the potential to create highly valuable technology companies. The result is a value-driven analysis of the InsurTech vertical that may not only serve as a framework for investors, but for anyone who wants to understand and navigate this industry. I divided the analysis into two parts:
- In part 1, I dissect the insurance industry into sub-categories and identify the ones that yield strong potential for value creation (step 1 and 2)
- In part 2, I discuss which other prerequisites need to be met in order to build a highly valuable tech company (step 3), and which of the previously identified sub-categories finally seem most attractive from this angle
With that said, here we go:
Step 1: Who is the customer?
There are two possible customer groups for InsurTech companies. Either they cater to policyholders, which can either be private persons or companies (”B2C” businesses). Examples are insurance wallets like Knip or new insurance carriers like Lemonade. The other group builds products for insurance companies or other companies in the insurance industry, e.g. brokers (“B2B” businesses), for example Snapsheet, which improves the claims handling process. These businesses are “enablers” in the way that they allow insurance companies to improve their business. Of course there are also companies that cater to both customer groups, e.g. Gewerbeversicherung24, who have a B2C comparison website, as well as a tool for brokers.
Step 2: How to create value for each customer group?
B2C:
Given that today insurance is often such a bad experience and customer satisfaction is low, I believe that for B2C InsurTech startups, the largest potential for value creation lies in the relationship with the customer and the ability to create a positive experience. There are basically two main touch points that an insurance business has with its customer: a) the purchase, i.e. the entire consulting, sales and sign-up/subscription process. This touch point always exists. And b) the claims and reimbursement process if and when the customer has suffered a loss. This doesn’t necessarily come into play and ideally won’t. Of course, both touch points can be broken down further: the purchase includes comparison of different products, consulting, and the sign-up process. The claims and reimbursement process includes notification of loss, damage assessment, claims processing, and the actual reimbursement, either through a service or cash.
The customer experience will improve most, if many of these interactions are rethought, supported by technology, and — very importantly — unified by a single point of contact (i.e. company). Looking at the insurance industry today, there are four different business models that cover the customer interaction to different extents:
Digital comparison and brokerage are a good start to increase transparency and efficiency in the subscription process. But the real potential lies in unifying the customer experience of purchasing insurance and claims handling, combined with the possibility to develop and underwrite own products (red boxes). Some examples for new insurance products are on-demand insurance, parametric/index insurance, or insurance policies for new threats like cyber security or social media. These products can be offered both by Managing General Agents (MGAs), as well as fully licensed carriers. The difference between the two is that an MGA doesn’t carry the risk of loss itself, but “outsources” it to an external carrier. The advantage is that an MGA license is much easier to obtain than a carrier license. However, from a customer’s point of view, it shouldn’t make a big difference whether he obtains the policy from an MGA or a carrier.
B2B:
B2B companies in this context are companies that sell their product or service to insurance companies (or other companies in the insurance industry, however I’ll focus on insurers since they make up for the largest part of the industry). So how can value for insurance companies be created? One of the most important KPIs for insurance companies is the Combined Ratio (CR):
Combined Ratio = (Claims Costs + Operating Costs) / Premiums
Insurance is a mature sector with large behemoth companies — and like in every mature industry, the players are optimizing the performance of their existing business by increasing revenues and cutting costs. Therefore, when catering to insurances, we can take the CR as a high-level framework, as it includes all important performance levers of an insurance company. Value will be created through those measures (or companies) that can significantly improve (i.e. reduce) the CR.
Because the equation as it is shown above is very high-level, I broke down each of its components further. We can then identify InsurTech fields that address each of the components in the equation (see (2)):
Claims costs for an insurance companies are usually something in the area 60% of premium volume. Any measure to reduce claims costs is of massive value for an insurance company. This can be through reducing rightful claims (e.g. through loss prevention measures or optimizing the risk pool), or by reducing fraudulent claims through better analytics.
Operating costs amount to about 20% of premiums. The largest cost drivers in operating costs are claims management, IT infrastructure, sales support and policy servicing (see “Successfully reducing insurance operating costs”, McKinsey 2014, p. 6). Each of these areas are tackled by InsurTech companies that use a wide range of new technologies, for example increasing efficiency in claims management through image recognition technology.
The third lever is increasing premiums — either by increasing premiums for existing products or creating new products. Premiums for existing businesses can be increased by improving risk modeling and underwriting, e.g. through new data sources, e.g. from IoT devices or through stronger customization of insurance products. New insurance products are being created by a number of InsurTech startups, e.g. offering on-demand insurance (Trov).
And then of course, there are certain technologies that have an especially high potential to create value in InsurTech. Two that come to mind are IoT and Blockchain. Both can be leveraged in a number of ways, for example IoT can enable loss prevention through alerts, improve risk modeling by collecting additional behavioral data, and improve claims management by providing information, for example on an accident. Blockchain can be used to automate processes (for example claims payouts), and reduce fraud through proof of ownership, among others. I don’t want to cover the technology angle more in depth at this point, as this deserves an analysis on its own.
So let’s recap part 1: We started by dividing InsurTech companies into B2C and B2B businesses. This makes sense, because value is created for both customer groups in very different ways. For B2C customers it’s mostly through improving and unifying customer experience, while for B2B customers it is primarily about improving their existing business. For each of the groups we then used a framework to identify sub-categories within the InsurTech vertical that have the potential for high value creation.
In part 2, we will continue to examine these categories whether it seems likely that valuable technology businesses can be built in these areas. Stay tuned!
