Tag Archives: insurance model

FinTech: Epicenter of Disruption (Part 3)

This is the third in a four-part series. The first article is here. The second is here.

Typically, disruption hits a tipping point at which just less than
50% of the incumbent revenue is lost in about a five-year timeframe. Recent disruptions that provide valuable insight include streaming video’s impact on the video rental market. When broadband in the home reached ubiquity and video compression technology matured, low-cost streaming devices were developed and, within four years, the video rental business was completely transformed. The same pattern can be seen in the Internet-direct insurance model for car insurance. At present, 50% of the revenue from the traditional agent-based distribution model has been moved to direct insurance providers.

Revenue at risk will exceed 20% by 2020

According to our survey, the vast majority (83%) of respondents from traditional financial institutions (FIs) believe that part of their business is at risk of being lost to standalone FinTech companies; that figure reaches 95% in the case of banks. In addition, incumbents believe 23% of their business could be at risk because of the further development of FinTech, though FinTech companies anticipate they may be able to acquire 33% of the incumbents’ business. In this regard, the banking and payments industries are feeling more pressure from FinTech companies. Fund transfer and payments industry respondents believe they could lose as much as 28% of their market share, while bankers estimate that banks are likely to lose 24%.

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A rebalancing of power

FinTech companies are not just bringing concrete solutions
to a morphing consumer base, they are also empowering customers by providing new services that can be delivered with the use of technological applications. The rise of “digital finance” allows consumers to connect to information anywhere at any time, and digital services can address their needs in a more convenient way than traditional nine-to-five financial advisers can.

According to our survey, two-thirds (67%) of the companies ranked pressure on margins as the top FinTech-related threat. One of the key ways FinTechs support the margin pressure point through innovation is step function improvements in operating costs. For instance, the movement to cloud-based platforms not only decreases up-front costs but also reduces continuing infrastructure costs. This may stem from two main scenarios. First, standalone FinTech companies might snatch business opportunities from incumbents, such as when business-to-consumer (B2C) FinTech companies sell their products and services directly to customers and position themselves as more dynamic and agile alternatives to traditional players. Secondly, business-to-business (B2B) FinTech companies might empower specific incumbents through strategic partnerships with the intent to provide better services.

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FinTech, a source of opportunities

FinTech also offers myriad possibilities for the financial services (FS) industry. B2B FinTech companies create real opportunities for incumbents to improve their traditional offerings. For example, white label robo-advisers can improve the customer experience of an independent financial adviser by providing software that helps clients better navigate the investment world. In the insurance industry, a telematics technology provider can help insurers track risks and driving habits and can provide additional services such as pay-as-you-go solutions.

Partnerships with FinTech companies could increase the efficiency of incumbent businesses. Indeed, a large majority of respondents (73%) rated cost reduction as the main opportunity related to the rise of FinTech. In this regard, incumbents could simplify and rationalize their core processes, services and products and, consequently, reduce inefficiencies in their operations.

But FinTech is not just about cutting costs. Incumbents partnering with FinTech companies could deliver a differentiated offering, improve customer retention and bring in additional revenues. In this regard, 74% of fund transfer and payment institutions consider additional revenues to be an opportunity coming from FinTech. This is already true in the payments industry, where FinTech generates additional revenues through faster and easier payments and digital wallet transactions.

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This post was co-written by: John Shipman, Dean Nicolacakis, Manoj Kashyap and Steve Davies.

Is P2P a Realistic Alternative?

At American Family Ventures, we believe “Insurance 2.0.” will be, in part, shaped by structural innovation. The traditional insurance structure of centralized risk-pooling has been around for a long time. Unsurprisingly, it is also subject to heavy regulation. As a result, many entrepreneurs are using new approaches to lower regulatory burdens or unlock value through decentralization.

Two of the approaches we’re excited to watch develop are peer-to-peer (P2P) and private-investor-backed insurance.

Peer-to-Peer Insurance

P2P insurance isn’t a new concept. Mutual insurance companies effectively use a peer-to-peer model today. However, there appear to be a number of emerging approaches altering the dynamics of the risk/insured pool and creating new benefits for policyholders, carriers and investors.

For context, we see P2P as a set of techniques allowing insureds to self-organize, self-administer and pool their capital in a way that protects all the pool members from loss, all while ensuring any capital in the pool not reserved to pay claims (less any fees owed to a facilitator or administrator) is returned directly to the pool members. Of course, there is a great deal of nuance to making that work.

See Also: P2P Start-Ups From Around the World

Here’s a simplified diagram of a P2P insurance model:

We’ve identified a few reasons to think that, by redefining the traditional insurance structure, P2P models can offer unique benefits.

For one, the P2P system could mitigate elements of conflict in traditional, centralized insurance models. Because insurers (for the most part) get to keep the premiums they don’t pay out in claims, occasionally the incentives of policyholders and carriers fall out of alignment. Conversely, in a pure P2P model, because the premiums not needed for claims are refunded to the policyholders, in theory, any conflict with a carrier is diminished.

While that logic is clear, it likely oversimplifies the issue. The insurance system, while not without its flaws, has functioned for some time and has regulations and processes in place to mitigate adversarial circumstances. In addition, if conflict exists in the insurer/insured relationship, it likely remains present in the P2P model but shifts from customer/carrier to peer/peer. In essence, because any pool member’s payout is a function of the claims paid out to others in the pool, members now have personal disincentives to pay claims, similar to carriers in the traditional model. That said, the carrier/customer relationship isn’t perfect, and new variations of P2P could help advance it.

Secondly, P2P organizing models might leverage large networks like Facebook and LinkedIn more effectively than traditional insurance. The nature of self-selection logically fits the use of a social or professional network — it’s easier to imagine a group of Facebook friends deciding to form an “insurance group” than it is to imagine that same group recommending all of their friends purchase individual policies from a large provider. In effect, large networks power the formation of smaller networks.

In addition to organizing benefits, integration with large, network-based platforms can create efficiencies in administration and retention. Increased frequency of engagement as well as preexisting communication and payment infrastructure could power usability advantages, stronger net promoter scores and better retention rates.

Finally, P2P models, by enabling modifications to the size and composition of risk pools, could create differentiated pricing strategies. P2P models are often associated with self-organization, but they don’t necessarily require it. So, if P2P facilitators become involved in pool selection and can use existing or new underwriting criteria to influence or control pool composition, they could construct pools that offer each member the highest possible returns after claims (or, effectively, the lowest possible cost of insurance). In other words, P2P facilitators might algorithmically generate smaller baskets of varying risk profiles, shifting members, when necessary, to intentionally spread expected claims across numerous pools, thereby creating consistently lower average claims volumes per pool (and, consequently, better payouts for members).

Private-Investor-Backed Insurance

Private-investor-backed insurance allows third-party investment capital to pay or backstop claims expenses in exchange for investment return. For example, a private investor, in theory, could agree to receive premium payments from a basket of insureds in exchange for the obligation to pay claims when they arise. In this model, the private investor (or group of private investors) essentially steps into the financial shoes of the insurer, accepting a stream of certain cash flows in exchange for an uncertain future liability (which could exceed those cash flows). The facilitator of such a marketplace would likely take some fees in exchange for customer acquisition, administration, securing reinsurance and performing the functions of an insurer other than providing risk capital.

See Also: Insurance 2.0: How Distribution Evolves

There are a handful of benefits we think the private-investor-backed model offers participants in the insurance relationship.

First, if certain types of insurance risk can be effectively securitized, those securities would (theoretically) offer professional or retail investors diversification through an instrument that is not highly correlated with the general market (low beta). Some investors already have exposure to insurance through reinsurance contracts and catastrophe bonds, but securitized insurance could offer broader access to more familiar risks with different payoff profiles.

Secondly, similar to what Lending Club and Prosper were able to accomplish in personal and small business lending, a private-investor-backed insurance model might offer price-competitive options to customers who have difficulty securing traditional insurance. For example, today, customers who are unable to secure insurance from conventional insurers (standard market) use excess and surplus (E&S) markets to address their insurance needs. If private investors are willing to take on these E&S risks—whether due to the presence of unique underwriting criteria or higher risk appetites—they could create new competitive dynamics in the E&S market and ultimately improve options for buyers.

As a side note, we often hear people combining the notions of P2P and private-investor-backed insurance. In our minds, they are related and can work together but are separate concepts. Private investor backing is not a prerequisite to building a P2P model — a pure P2P model could employ a variety of strategies to guarantee liquidity and solvency. For example, P2P insurers could leverage reinsurance to cover large or aggregate claims beyond the pool balance, eliminating the need for private investment capital. The P2P insurers might also use traditional fronting arrangements to ensure solvency. By comparison, a pure private-investor-backed model doesn’t need P2P features to function. Instead, it might offer investors financial products that look similar to reinsurance contracts without making any changes to risk pooling or centralization of control.

Additional Considerations and Questions

There are various other structural approaches that might be used to create acquisition cost and pricing advantages or lower barriers to entry for start-ups. Often, these are not necessarily new structural ideas but are rather applications of existing legal strategies employed in surplus or specialty lines insurance to broader, bigger lines.

The successful execution of the P2P model relies on a number of assumptions we’re sure someone will figure out, but we don’t fully understand them just yet. For example, will pools self-select, or will they need to be automatically or algorithmically selected? If self-selected, will most pools (financially) perform as expected, or will there be a small subset of high-performance pools (created by information asymmetry) that generate an inverse adverse selection issue for the P2P business, thereby creating disincentives for participation by the majority of potential buyers? Will pools self-administer and self-police to influence lower losses and guarantee payment of claims, or will some centralized entity still need to exist to ensure member compliance? Will there be regulatory hurdles to overcome if small pools are constructed to reduce claims costs? Finally, how will pool facilitators/administrators/members handle float management — will the capital in the pools sit in cash, or will those assets be actively managed until need for claims? If actively managed, by whom?

The issues we’re interested to see addressed in private-investor-backed insurance are also numerous. Can insurance be a desirable or profitable asset class for private investors? Apart from catastrophe bonds, we haven’t seen much securitization of insurance. Which insurance products or coverages might one securitize best? In other words, which magnitudes and patterns of risk exposures will private investors accept, which existing or new data will they demand as third-party underwriters and what terms will be up for negotiation? Can facilitators find a way to make long-tail risk compatible with liquidity expectations for the asset class?

At the end of the day, we’re looking forward to finding out how companies are able to use structural innovation to create unique and differentiated value for customers.

Digital Insurance, Anyone?

The digital banking conversation is alive and kicking within the FinTech world, focused on discussing the merits, definitions and initiatives around what it means for a bank to become digital across its entire technology and business stacks. I have yet to find the same level of discourse and vibrancy within the insurance world.

Spurred by Yan Ranchere’s latest blog post, I am adding my own thoughts to the insurance narrative or, dare I coin it, the “digital insurance” narrative.

First, let’s frame the discussion by attempting to define the evolution of the insurance model from old to current and future or digital:

Old Insurance Model:  This model is mostly paper-based with an application collected from the customer by the agent and sent to the carrier. The agent quote is not binding and may indeed change once the carrier has reviewed the application. I would qualify this model as carrier-centric. The carrier does all the heavy lifting with data verification and underwriting, with little stimuli from external data feeds in real time; the agent merely serves as a conduit.  As result, underwriting and closing a policy may take several days or even several weeks.

Claims management and customer service are cumbersome. Arguably, this delivers poor service in today’s age of instantaneous expectations. Not only can the old model be considered carrier-centric, I would also venture it is product-centric (in the same way that the old banking model is product-centric). The implications from a technology point of view are the same as in the banking world: a thin front end, shaky middleware and a back end that is silo-driven and that makes it difficult to optimize underwriting or claims.

Current Insurance Model:  The current model optimized the old model and made the transition from carrier-centric to agent-centric, which means that things are less paper-based and more electronic and that there is more process pushed onto the agent to be closer to the customer. In this model, the agent is empowered to issue policies under certain limits and risk frameworks—the carrier is not the gating factor and central node anymore.

Instead of batch-processing policies at the carrier level, the system has moved to exception processing at the carrier level (when concerned with nonstandard data and policies), thereby leveraging the agent. The result is faster quotes and policies signed more quickly, with the time going from days and weeks to hours or just a day. Customer service will go the same route. Claims management will still remain the central concern of the carrier, though.

Digital Insurance Model:  This is the way of the future. It is neither carrier- nor agent-centric, and it certainly is not product-centric any more. This model is truly customer- and data-centric—very similar to what we witness in digital banking. The carrier reaches out to the customer in an omni-channel way. Third-party data sources are readily available, and the technology to process and digest the data is extremely effective and delivers fast and furiously. Machine learning allows for near-instantaneous underwriting at a carrier or agent level, any time, anywhere. The customer can now get a policy in minutes.

Processes after policy-signing follow a similar transformative route. The technology implications are material: new core systems of record, less silo effect, more integration, massive investments in data warehouses and in products and services that act as layers of connection between data repository centers, core systems, claims management platforms, underwriting platforms and omni-channel platforms.

Picture the carrier effectively plugged in to the external world via data sources, plugged in to the customer in myriad ways that were not possible in the past and plugged in to third-party providers, all of this in real (or near-real) time. That means no more of the old linear prosecution of the main insurance processes: customer acquisition, underwriting, claims management. Furthermore, with a fast-changing world and more complex customer needs, delivering a product is not the winning formula any more. Understanding the customer via data in a contextual manner is.

To be fair, insurance carriers have nearly completed massive upgrades to their database architecture and can claim the latest in data warehouse technology. Some carriers have gone the path of renovating their channels and going all-out digital. Others are refining the ways they engage new customers. Most are thinking of going mobile. Still, much remains to be done. These are exciting times.

Boiling down what a digital insurance model means, we can easily see the similarities with digital banking; digital insurance must be transparent, fast, ubiquitous and data-focused, and there must be an understanding that the customer is key and is not a product.

Once you digest this new model, it is easier to sift through the key trends that are reshaping and will reshape the industry. I am listing a few that we followed at R66.  By no means is this an exhaustive list, nor is it ordered by priority, impact or size of opportunity:

1) Distribution channel disruption: There are three sub trends here—a) the consolidation of brokers and agents, b) channels going all-out-digital and disrupting the brick and mortar and c) carriers continuing to go direct and competing with brokers.

2) Insuring the sharing/renting economy: Think about Uber, Airbnb and the many other start-ups that are building the sharing economy. All of them need to or already are creating different types of coverage through their ecosystems. Carriers that focus on the specific risks, navigate the use cases, gather the right data and are forward-thinking will win big. James River is an insurance carrier that comes to mind in this space.

3) Connected data analysis: I do not use the term “big data” any more. Real-time connected data analysis is the right focus. Think of the integration of a series of hardware devices, or think of n+1 data sources. These are powerful, mind-blowing and will affect the trifecta of insurance profits: underwriting, claims management and customer acquisition.

4) Technology stack upgrades:  This means middleware to complement data warehouse investments, new systems of record, software platforms for underwriting (or claims management) and API galore. It’s the same story with banking; there is just a different insurance flavor.

5) Technology externalities: GPS, telematics, AI, machine learning, drones, IoT, wearables, smart sensors, visualization and next-generation risk analysis tools—you name it, these will help insurance companies get better at what they do, if they adopt and understand.

6) Mobile delivery:  How could I not list mobile delivery? Whether it is to improve customer acquisition; policies or claims management; or customer service, we are going mobile, baby.

7) A la carte coverage: Younger generations are approaching ownership in different ways. As a result, a one-size-fits-all insurance policy will not work any more. We are already witnessing a la carte insurance based on car usage, homes or commercial real estate connected via sensors or IoT.

8) Speciality insurance products:  We live in a digital world, baby, which means cyber security, fraud and identity theft.

It should be noted that the above describes changes in the P&C industry and that the terms “carriers” and “reinsurers” can be used interchangeably. Furthermore, I have not focused on health insurance—I know next to nothing in that field.

Any insurance expert is welcome to reach out and educate me. Anyone as clueless as I am is welcome to add their thoughts, too!

This article first appeared on Pascal Bouvier’s blog, here.