#16 - Insurtech, here's your cheat sheet to avoid eliminatory marks

"You amuse me with your start-ups... You make it sound like they do everything really well… except make a profit! You know, insurance is like school: there are eliminatory marks. You can get ‘A’ in UX, but if you get a ‘D’ in technical profitability, you're out 🚽”.

Thus speaks my mentor, Gilles B.! Basically, he's not wrong (otherwise he wouldn't be my mentor 😎). Even if eliminatory marks may also punish incumbents.

The question remains an interesting one: what are the basics that new entrants to the insurance industry have to deal with and that put them at risk of an eliminatory rating?

Which licence, full-stack insurer or broker?

In the mid-2010s, launching an insurtech under a full-stack insurer's licence rather than as a broker was a real issue. Alan in France or Oscar and Lemonade in the US were leading the way. How does being an insurer change the game?

Being a broker or MGA means that you have to devote time negotiating insurance conditions and essential elements of the user experience with the risk carrier. For an insurtech like Alan, there is a real challenge in mastering the full value chain for a line of business with a high frequency of customer contact (and claims). Therefore, dependence on suppliers in that regards is viewed as a blocker. At the time, there was no internal debate, especially as the regulatory capital requirement for medical expenses is lower than for other lines of business. I still believe it was the right thing to do.

At a time when the supply of capital was abundant, and the idea attractive to VCs, it was feasible. The current context is completely different, especially as the solvency rules for insurers mean that the need for equity increases with revenue.

In terms of both ROE and EBITDA, the brokerage industry has not waited for the emergence of insurtech to demonstrate a performance that is often superior to that of insurers.

To B2C or to B2B, that is the question

There's another basic question: should you sell directly to customers or via intermediaries? The subject of CAC in B2C has been raised many times, so I won't go into detail: these acquisition costs need to be amortized over the life of the contract, hence the importance of retention and the famous CAC / LTV ratio.

Quite a few insurtech have started out on the premise that brokers are useless, as all they do is add to the cost of the insurance tariff and cause insurtech to lose ultimate control of the customer. I tend to subscribe to this approach for simple insurance products where the need for advice is not substantial enough to necessarily be delivered face-to-face… provided comprehensive advice is effectively delivered online.

The fact is, if acquisition costs are high, it's because the market is highly competitive, so B2C traction can't be envisaged as on a Netflix-style platform.

Hence the 'pivot' of many B2C insurtech towards B2B, i.e. to work with 'traditional' brokers to generate traffic. When the insurtech is already a broker, this means becoming a wholesale broker. It's quite a big deal: building up a network of contributors who not only sign up on the platform but also bring in a substantial / quality / continuous flow of business, building their loyalty with commissions that are likely to increase prices, providing them with a high-performance sales and support platform... It's a paradigm shift, and - above all - traditional players have been doing it very well for decades.

Yes, Bon Scott is right: "It's a long way to the top if you wanna rock'n'roll".

Managing growth and bottom line

Start-ups are all about strong growth. As an insurer, uncontrolled growth means losses of the same order.

This reminds me of Alan's first individual health insurance product, which showed strong growth and a very high loss ratio. In fact, a single poorly calibrated in-patient coverage made psychiatrists very effective prescribers for our product 😬. You learn as you go.

In this example, we are talking about adverse selection, but the subject would be the same with an under-priced product.

So I cough when I sometimes hear funds recommending insurtech to boost their growth at the expense of the bottom line, even if it means correcting afterwards: just because it works (?) for Tech platforms doesn't mean it should be applied to insurtech. Abruptly adjusting rates of an insurance portfolio is immediately reflected in the churn, especially in an industry where sustained losses will inevitably be scrutinized by the regulator.

It may seem counter-intuitive, but exponential growth is not necessarily an insurtech's natural ally.

Time, an ally of the insurer... and the broker

Problems faced by some notorious insurtech showed that technical profitability goes with risk selection, churn and renewal campaigns. When this is executed well, profitability improves over time.

What is true for a full-stack insurer is just as true for a (neo-)broker. I've heard insurtech start-ups say that the problem of technical profitability doesn't have a direct impact on them as an intermediary: in reality, when an insurer decides to recover with double-digit rate increases, it's in the broker's interest to have a plan B. Therefore it's ultimately the broker's problem.

As soon as an insurtech reaches a minimum size, they have to technically steer their portfolio the same way an insurer would. The broker has a sharper eye for his own business than an insurer who is likely to analyse all his small providers as a single cohort. On the day of the renewal negotiations, this will come into play.

Insurance is a ‘stock’ business, not a ‘flow’ business

A new entrant should keep this axiom in mind: incumbents take their profits from a portfolio that has been streamlined over time. This also applies to brokers, with a portfolio that generates recurring revenue to ensure their economic stability.

For these players with chubby books of business, taking on new business that is loss-making or has an exaggerated acquisition cost will easily pay for itself. "If, in addition, it can p*ss off a new entrant, we won't be shy!” That's the kind of music I used to hear when Alan was rubbing shoulders with the market leaders.

This is the structural equation for new entrants: acquire market share at a high price and take time to turn it around, without a profitable book of business to offset a flow of potentially loss-making new business. This requires significant equity in order to sustain these losses over time, and therefore shareholders with deep pockets. A complicated equation in current times.

Product-market fit: what next?

It's not enough to have a good product - you have to sell it to the right target group. The European insurance market is worth Trillions of euros; any start-up might consider it can easily break into the market, given the sheer size of it. The reality is more complex. The existing players know where their growth potential and their sources of profit lie. They are sure of their positions and know how to defend them.

For a new entrant, the challenge is to identify a segment that is not a primary target for incumbents. These are often profitable secondary segments for incumbents, which they use to offset losses sustained by priority segments where competition is fierce. As long as a new entrant knows how to reach these underserved market segments and offer them a true value proposition, they will build their growth base.

There are quite a few examples of success of this kind, in insurance and elsewhere. The challenge lies in the next stage: moving from a niche to become a mainstream player, in head-on competition with incumbents. Same applies when a start-up has to move from its domestic market to become international.

Unless the niche turns out to be deep-rooted, the search for critical mass (and the quest for brand awareness required to access mass markets) will sooner or later force the new entrant to move out of its initial position.

To do this, over and above choosing the territory to conquer, a startup has to be clear about their key assets and how to leverage them to extend their footprint. A typical example is Amazon, which has grown from an online bookseller into the eCommerce giant we know today.

Fraud, or "policyholders aren't necessarily cool"

Insurtech stand out for the user experience they deliver. But the more the customer experience is digitalized and simplified, the greater is the risk of fraud.

"Since we are cool with our users, they'll be cool with us and they'll commit less fraud". Alan's statement startled me. Then, it was a bit of a rude awakening. You learn as you go.

If at least 10% of insurance customers admit to having already defrauded their insurer, that's enough for a minority of uncool policyholders to cause significant damage.

The challenge for pure players is to find effective safeguards without compromising the experience for all users. Some players like Lemonade are working on it but, beyond technology, public acceptance is not necessarily a given.

Claims & policy admin and the "make or buy" option

In their quest to control the user experience, insurtech often aspire to manage claims and support policyholders internally. This is what I experienced with Alan and observed with many of Wakam's business partners. This preference for 'make' runs counter to the 'buy' approach adopted by many incumbents, who outsource all or part of their administration to specialized operators.

Starting from scratch (or almost), start-ups who manage their own operations assume that their management costs are higher than those of traditional players who benefit from a long learning curve or from TPAs who bring economies of scale to the table.

The challenge for these insurtech is to dedicate a high amount of resources to building an admin platform that achieves a level of productivity at least equal to that of the traditional players, while providing a far superior UX. Given the effort at stake, owning the admin capability should be of strategic importance for the investment to be justified.

Another, almost more important, issue when internalizing management is the ability to make the best claims management decisions without the benefit of experience. This has a direct impact on the UX and technical profitability of the portfolio.

On the other side, the dilemna for insurtech that decide to rely on an outsourcer, is to obtain from their supplier a customized service aligned with a premium UX promise, while the outsourcer will not be prepared to go to the wall for reduced volumes.

In short, this issue, which rarely comes under the spotlight, is one of the most complex for an insurtech, once it has passed the launch phase.

... But how do you avoid an eliminatory mark?

You might think, "to avoid falling into these ruts, all an insurtech has to do is steer their insurance P&L, as any insurer or broker would do".

In my view, it's a bit more subtle. By definition, an insurtech builds its trajectory as it goes along and adjusts it in an uncertain environment. So it's primarily through a trial-and-error approach that the subjects I've mentioned will be brought under control, with the appropriate set of KPIs to measure success.

It is up to these insurtech to determine the execution framework and the KPIs that go with it, so that the short-term iterations remain aligned with the medium-to-long-term target.

I have my own ideas on how to go about this, but that's where I'm going to stop: I've already said quite enough 😬. Fell free to reach out if you have some matters to discuss!