A Cynic’s Guide To Fintech
Dan Davies

Good Ideas Are Not Enough

Two Cautionary Principles for Financial Technology Startups

Dan Davies put together a brilliant roundup of the clever business models that financial technology startups are pitching to their investors — and why most of them are deeply flawed. Some of them apply much more broadly than to just the financial services industry. Number three, for example — “Hoping that a load of people who actively mistrust each other will trust you instead” — is a decent description of the business-to-business marketplaces that Ariba was trying to build when I worked there back at the beginning of the millennium.

I’d like to add two more general principles that apply to technology companies that are trying to serve the financial services industry — mainly learned during my years working at an insurance software company before going to law school.

1. Don’t Overestimate the Rate of Adoption

Do you want to know what the biggest driver of technology projects at P&C insurance companies is today? The Internet. Twenty years after the Netscape IPO, most U.S. insurance companies are trying to figure out how to market to, sell to, and service consumers over the Internet. (European companies are further ahead, but still face plenty of challenges.) Allstate, one of the two largest U.S. personal lines carriers, does offer online quotes (if you’re willing to wade through a long and complicated process that I abandoned)—but also tries to actively discourage people from buying insurance online.

There are reasons for this state of affairs. Several large insurers sell primarily through independent or captive agents and don’t want to upset their most important channel. Insurance policies are considerably more complicated to configure and price than, say, computers, so you can’t just buy an off-the-rack product configurator and stick it on the Internet. Insurers have huge amounts of rating and validation logic accumulated in mainframe back-end systems that can’t easily be exposed on the Internet. And so on. Today, the industry is trying to move as fast as it can to the Internet. But the bottom line is that if you had launched a startup in 2000 to enable online sales by big insurance companies, you would have gone out of business long ago.

2. Consumers Matter. But Businesses Matter More.

Of course consumer preferences matter. The driving force behind technology advances in the retail financial services industry is consumer demand. If ordinary people didn’t want to be able to deposit checks using their phones (in my opinion, the most important technology innovation in personal financial services since the ATM), then no one would bother making it possible.

But if you’re a technology company, chances are that you don’t sell to consumers — you sell to service providers (banks, insurance companies, brokerage firms, etc.). Your revenues depend on the preferences of those service providers, which are influenced in turn by their end customers. And remember, in most cases they know a lot more about those end customers than you do.

You may have some bright idea about how you can transform some financial services business, but most likely someone in the industry has already thought about it. Charles Schwab was a broker before it was a discount broker, and it was a discount broker before it was an online broker. Online banking is a great thing — and it’s completely dominated by traditional banks.

One of the biggest technology-driven disruptions in the insurance industry has been the rise of aggregators — websites that allow you to compare quotes from dozens of insurers. This trend is furthest along in the United Kingdom and certain other advanced European markets, but Google is trying to do the same thing in the United States. Even then, to create an aggregator, you need products , and that means you have to convince insurers to participate. You might go further and try to source the insurance in some kind of “peer-to-peer” model, but unless the people taking the risk have their own underwriters, you then become the underwriter — and that’s not something you want to take on unless you really know what you’re doing. That need to bring the incumbents along is why Apple can start Apple Pay (or the iTunes Store, for that matter) and you can’t.

Still, there are lots and lots of things that are broken in the technology infrastructure of the financial services industry, and lots of problems that need to be solved. It would be great if some smart software entrepreneurs could tackle those problems. But few of them are going to radically upend the industry. Banks and insurance companies have been around longer than written constitutions and driving on the right side of the road. They’ll be around for a few more decades.

James Kwak is, among other things, an associate professor at the University of Connecticut School of Law. Find more at Twitter, Medium, The Baseline Scenario,The Atlantic, or jameskwak.net.