Insurance needs Creative Destruction

Julien Brissonneau
Ledger Investing
Published in
4 min readMar 9, 2020

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Insurance has a problem.

The industry is dysfunctional and insurers are shockingly unpopular. US surveys rank insurers worse than Congress [1]. Some common criticisms are:

1) Customer service is terrible.
2) The economics don’t make sense.
3) Interfaces are outdated. Why do I need to fax documents? What’s a fax machine?

Source: Bloomberg National Poll

Insurance is similar to other services.

It is not the nature of the industry to be dysfunctional. There are external burdens preventing insurers from operating efficiently.

Debunking myth about insurance: adversity.

The insurance problem is NOT short-term adversarial relationships with clients: most businesses face just that. This pattern appears whenever you pay upfront for a service delivered or product used over time.

After you’ve paid annual tuition for college, your school has a short-term incentive to increase profits by cutting service and costs. Yet, they don’t.

After Apple sells you a phone, the company has a short term incentive to skimp on software updates and support. Yet, they don’t.

Conventional wisdom holds that companies who survive in the long term care for customers and build a good reputation, and most companies follow this advice (or attempt to).

Debunking myth about insurance: painful situations.

Similarly, the insurance problem is NOT clients interacting with insurers primarily in bad situations when dealing with a health condition or a fire at home.

Many other service providers like doctors, firefighters, and police officers are loved unlike insurers. Yet their services are most often needed in painful situations.

The burden insurance companies carry

Money.

Insurance is the most capital-intensive industry [2].

The defining and unique characteristic of insurance companies is that their products are promises. Insurers take money from insureds (premium) and money from investors (capital) to hold their promises. That is a lot of money.

This is the crucial burden of the industry: large balance sheets. For every dollar of revenue from clients, insurers must hold many dollars of assets. That can lead insurers to behave like asset managers.

Large balance sheets shift priorities.

Private companies are focused on clients because they optimize for present and future profits.

The consequence of capital-intensity is: Investment returns impact the insurer’s bottom line much more than customer experience.

The difficulty of innovation

Scale always matters.

On the other hand, startups drive innovation in most industries. New players can grow and legacy players must adapt or die. In most industries, delivering goods and services at scale is more efficient. This also holds true in the insurance industry: on a per-client basis, setting up policy management for one million clients is less costly than for 50,000 clients.

But that alone is not what prevents disruption in other industries. Here comes the second burden: economies of scale apply twice for insurers.

To Schumpeter, growth in a capitalist society happens through the introduction of innovations, which in turn create chaos and structural change in society.

New insurance products are challenged.

Capital needs for large players are lower because of the law of large numbers. Larger portfolios with more lines of business are overall more predictable. A small player with $1M in the capital may only be able to write 1,000 policies — an effective capital requirement of $1K/policy. By contrast, a big player with $1B in the capital may be able to write 5M policies — a capital requirement of $200/policy. Schumpeter’s Creative Destruction [3] cannot work without new players and new products being able to enter the game.

Securitization to fix Insurance Capital

There is a way to free insurance companies from this burden.

Today insurance capital is provided by investors using traditional instruments, typically stocks and bonds. The cost of that capital is the rate companies have to pay for the capital they use.

Ledger.

Ledger Investing is our startup, and we transform insurance promises into insurance securities. These securities are attractive to outside investors looking to gain access to pure insurance risk. They also result in a lower cost of capital for insurers. We have the expertise in insurance, capital markets, data science, software, and legal matters to help investors understand the insurance risk they’re buying. In this way, we ensure that no one is victim to information asymmetry and that everyone can share in the financial benefits.

Freed from their capital burden, insurers have room to grow and become more efficient information processing companies. This enables more capacity to provide insurance-as-a-service and win-win-win situations for investors, insurers and their clients.

Visit us at https://ledgerinvesting.com/

Sources:

  1. https://qz.com/1033336/survey-americans-hate-the-health-care-industry-even-more-than-wall-street/
  2. https://www.bcg.com/en-us/industries/insurance/how-insurers-can-build-value-transforming-capital-management.aspx
  3. https://en.wikipedia.org/wiki/Creative_destruction

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