August 26, 2016
A New Frontier for Venture Capital
by Dax Craig
Are we in the midst of another tech bubble? No. Insurance provides a host of valid opportunities for investors.
With sales of ping pong tables declining and with first-quarter IPO numbers the lowest since 2008, many are wondering whether we are in the midst of another tech bubble and, if so, when it will burst. Despite a record amount of money flowing into venture capital, funding for startups is drying up.
Rather than believing in every single unicorn, VCs need to believe in insurance. As insurance tech investment has skyrocketed ($2.65 billion in 2015) and is expected to increase in 2016, a shift in how money is invested in Silicon Valley is beginning to take place. Investors are jumping into the insurance tech ecosystem, and, as software is increasingly pervasive in the industry, insurance startups are attacking a wide range of different pain points. Given the rapid expansion in available information, artificial intelligence and IoT technologies, innovative carriers and data-rich competitors from outside the industry may be poised to spark transformations in a number of insurance markets. From commercial auto and health aggregators to providers and solutions, the space is rapidly growing.
For starters, insurance has the two components any VC-backed startup longs for: 1) Poor customer experience issues across the board and 2) an industry that has been necessary since the 1800s. While venture capitalists and entrepreneurs have been investing and building new offerings, this seems odd to others because, from a consumer perspective, the insurance industry is highly regulated and mundane. But insurance is — and will always be — in demand because people and businesses are looking for ways to minimize risk. Let’s not forget that the industry contributes close to 8% GDP in the U.S. and employs more than 2 million people.
Insurance represents a significant part of the S&P 500 index and has seen a ton of M&A growth ($13 billion) in 2015 alone. Even though it is overlooked for a variety of reasons — regulations, low profit margins, lack of innovation, etc. — technology’s influence is providing the industry with changes that are necessary to stay afloat. Now, consumers can shop for better rates and compare prices easily, while agents and underwriters can better manage data and provide more precise quotes.
The workforce is also changing significantly, and the option for working outside of the traditional employer relationship is on the rise. Individuals need insurance and traditional models are ill-suited to accommodate, so it’s no wonder newer models are coming out of the woodwork to capitalize on this need for change. The workforce inside the industry is changing as well, with the average age of an agent at 59 and with one-fourth of the workforce expected to retire by 2018. Companies are targeting millennials in hopes of boosting numbers and more changes.
While VCs have typically avoided regulated industries, the revenue base in insurance is incredibly high, and investors are paying attention. Because of disruption, M&As, the widespread consumer dissatisfaction with dominant carriers and the Affordable Care Act’s new marketplace for individual plans, innovators are jump-starting a revolution.
The commercial lines insurance market is starting to undergo the same kind data analytics revolution that first occurred in personal auto, which caused market consolidation over the past two decades. From 1970-92, Progressive averaged a 3% annual profit margin on underwriting insurance, whereas its competitors averaged a 7% annual loss. In 1992, Progressive had $1.45 billion in premium — it now holds $16.5 billion in premium. By implementing predictive analytics, Progressive’s pricing sophistication adversely selected competitors, and the company was able to gain considerable market share. Today, the top 10 personal auto carriers represent 71% of the market. Workers’ compensation, which is often considered the leading indicator for momentum across all of commercial lines, already has companies showing signs of a market share shift.
The above graph shows several companies’ growing market share from 2009-14, with notable gains from analytically-driven companies like Berkshire Hathaway and Travelers.
Something else to keep an eye out for is the important connection between the Internet of Things (IoT) and insurance. IoT is influencing just about every industry, and it’s been predicted that, by 2020, IoT will reach a billion dollars. From driverless cars to connected homes, IoT is already hitting insurance. Liberty Mutual just acquired IoT startup Notion to help reduce water leakage and burglaries, while State Farm is already offering discounted rates to homeowners who have a Nest thermostat or smoke detector. Insurance companies are interested in these technologies because they ultimately provide better benefits to the customer.
Another reason to invest in insurance is simply that carriers themselves are investing. Insurers, who arguably have the best view of their own business and the complexities that come with it, are increasingly recognizing technology’s potential to offer real-time monitoring of vehicles, homes and all other areas of risk exposure. The main ways carriers are doing it now is by investing in emerging startups and tech giants — and even creating innovation and VC organizations internally.
From emerging tech trends to market share consolidation, insurance investment is rapidly growing. According to data from CB Insights, the first quarter of the year was the second largest ever for investment in insurance technology with more than 45 deals raising $650 million.
The industry is growing fast — with deals, acquisitions and innovations — and we can expect to see more traction in the next few years.