Tag Archives: investment income

5 Challenges Facing Startups (Part 5)

The insurance industry is a $4.6 trillion market worldwide that lags when it comes to digitization and providing consumers with a great experience and service. We are looking at the five main challenges that startups face. We have covered Challenge No. 1 here, Challenge No. 2 here, Challenge No. 3 here, and Challenge No. 4 here. In this article, we will look at Challenge No. 5.

Challenge No. 5: Tuning the economics to achieve profits will require time and capital

We expect that the time to profitability will be 10 to 15 years. And many startups will never reach that point as there are two competing challenges: growing revenue and generating profits. Furthermore, flaws in the underlying economic models cannot be pivoted away from as easily as with other digital startups. After all, there is no such thing as a beta insurance policy, and it is more difficult to find additional or new revenue streams in insurance.

See also: Shark Tank Secrets for Startup Success  

Insurance is, at the end of the day, a high-volume business with challenging economics. Margins are small, especially on new sales. Typically, customer prices and broker commissions have been falling, with the advent of online insurance. And, with a raft of competitive startups, the long-term trend can only continue. In addition, maintaining a healthy underwriting margin is challenging, with premiums changing due to claims rates and industry competition and capacity.

Startups must deal with dynamic pricing and claims forecasting, coupled with upfront acquisition costs that are paid back over a long time and with a complex operational structure, given the need for multiple partners and service providers.

Insurance is such that claims because of unforeseen events, fraud and mispricing can potentially have a major detrimental impact, especially with fast scaling of customers and growing revenue. Companies require robust systems and experience and large insurance portfolios to manage and the capital and time to get right.

Insurance is different than many industries, where you can achieve a positive gross margin with increased sales and expect that to continue because of improvements in production and scale economies. 

The cost of acquiring an insurance customer is relatively high given that insurance is a low-turnover product. After all, you don’t buy more insurance than you need just because you see a good advertising campaign or you are targeted on social media. This means that the relationship between marketing and sales is different than in other consumer products, and it can result in a longer conversion funnel.

Typically, the time between when a person first gets attention and the purchase could be three to 12 months or longer. In addition, retaining a customer is crucial for the profitability of the business, and digital solutions make it easier to switch.

Regulations may constrain pricing options and in some cases raise hurdles to dynamic pricing. Regulatory and consumer legislation can also affect the scope for upselling of ancillary products and cross selling of other insurance and products.

Traditional retail car insurance targeted a 60% to 80% claim ratio (as proportion of premiums) and 40% to 25% operating and acquisition cost levels, compensating with additional investment income to target an overall profit of 8% to 15%. The insurers were helped in improving profitability by a large and static pool of customers who rarely switched carriers and required minimal administration support.

With the emergence of direct telephone insurers in the 1980s and 1990s and online insurers in the 2000s, premiums fell 15% to 30%. The new models could bring operating and acquisition costs down to 15% to 20%, with loss ratios still in the 60% to 90% range. The challenge was that initial acquisition costs for new customers could be at least 20% to 30% of premiums, and the rate at which existing customers switched to new carriers each year rose from the historic rate of 5% to 10% to a churn rate of 20% to 40%.

Can new digital startups create as much as 30% savings for consumers, which normally is considered sufficient to encourage switching? And will savings on claims be sufficient to support this sort of cost cut? Can the startups build an efficient operating platform to reduce costs to around 5% to 10% of the premiums and still improve services?


Working on building the team, data analytics, pricing engines, processes and systems to ensure in-depth control on not only revenue generation but profitability will be critical. Just as a low-cost airline has to have in-house expertise in capacity utilization and pricing, this ability to both generate revenue and profit must eventually be a core function of most digital insurance startups. This will be an important differentiator for successful startups.

Providing new services and rewards for certain behaviors will be critical to avoid competition on price only.

See also: Should Incumbents Ally With Startups?  

In addition, further reducing claims frequency and costs by enhanced data analysis and focus on prevention will be one of the success factors.

Customer service and retention will become even more important to recoup upfront acquisition costs. Best that this focus is embedded in the business model!

Having a low-maintenance cost platform covering the complete value chain is an important factor. The platform needs to be robust and agile enough to provide the relevant information and easily adjustable for dynamic pricing, marketing and services. Although there are many off-the-shelf solutions, will these be sufficient?

We are curious about your perspective.

The Truth on Workers’ Comp Premiums

As employers try to limit their workers’ compensation premiums, my suspicion is that many do not realize that insurers have traditionally relied on investment income to, in effect, subsidize underwriting costs, and that the subsidy is going away. Insurers are relying on “safer” Treasury bonds and are not realizing the returns they received before the Great Recession.

Sure, employers feel workers’ comp insurers are too profitable. In fact, the combined ratio — insurers’ total costs for covering work-related incidents, divided by total premiums — was 106 in 2013, according to the National Council on Compensation Insurance. That means that, for every $100 that insurers received in premiums, they paid $106.

Insurers need to shrink the combined ratio to be profitable and need to make up for the diminishing investment income, so premiums have been going up for the past three years. Experts expect this to continue.

So, to control premiums, employers must improve the experience modifier that is used to calculate their rates. Employers need to address the direct and indirect costs of work-related injuries, illnesses and diseases, investing in workplace safety and return-to-work and other initiatives. Insurers must use predictive modeling to produce more sensitive risk measurements. (Here is a blog post that goes into detail.)

The good news is that workers’ compensation claim costs are not out of control as they were in the past. Those of us who are old enough to remember the late 1980s and early 1990s remember just how bad it was. Liberty Mutual, often considered the largest workers’ compensation carrier in the nation, quit offering coverage in its home state of Massachusetts in the early 1990s because costs were spiraling out of control. Today, overall costs are going up but more slowly because the frequency of claims has been declining for 20 years.

There are many possible reasons for why frequency has declined.

Some point to reforms reducing claims eligibility for workers’ compensation. But, if this were a large factor, I think we would be seeing more work-related claims in the tort system.

Others cite changes in workplace exposure. Some point to the shift in the kind of work Americans are doing. For example, high-risk jobs in manufacturing have been exported in recent years. And while some manufacturing jobs are returning to the U.S. because of lower energy costs here, more work is being automated, making it less risky. Meanwhile, still-high unemployment rates mean there is less risk exposure.

I believe the No. 1 reason why frequency has declined is workplace safety. While I cannot prove this on a quantitative basis, I make my observations based on 25 years of observing workers’ compensation. Back in the early 1990s, employers were discovering how much they could lower their premiums through safety. When I was the lead reporter for BNA’s Reporters’ Compensation Report in the mid-1990s to the year 2000, I spent a lot of time writing about employers that were discovering strategies to contain workers’ compensation. Many of these approaches are now used widely.

There still remain, however, many employers who need to get religion.

While medical-cost inflation for workers’ compensation remains a concern, it is not in the double-digits as it was 20 years ago; it has been about 3% annually in recent years. Workers’ compensation insurers still pay more for procedures than health care insurers. Medicare will not pay for opiates dispensed by doctors, but workers’ compensation will in many states. The $1 billion question is how Obamacare will affect workers’ compensation claim costs. Some worry that claims that previously would have been handled under healthcare insurance will be shifted to workers’ comp, but I doubt it because workers’ comp is just too complicated. (It could turn out that Obamacare will be more complicated than workers’ compensation, but a worker still needs to prove work-relatedness for a claim.)

As a whole, indemnity claim costs have been relatively flat in recent years. In states where the maximum weekly benefit that workers can receive is relatively low, such as Virginia, indemnity costs are naturally lower than in other jurisdictions, such as the District of Columbia, where the maximum weekly benefit is much higher.

Reducing the amount of time workers are on workers’ compensation through quality medical care and return-to-work programs has also helped curtail the financial burden of claims. But, again, more employers still need to get religion, and for reasons that go beyond reducing the time that employees are on workers’ compensation. It is also true that return to work is challenging in the current economy, as there are fewer jobs available.

Besides national economic factors, employer premiums are affected by the workers’ compensation conditions in individual states. California’s combined ratio has been in the triple-digits, so employers are seeing bigger premium increases than in other states.

Meanwhile, there is always the political wildcard in workers’ compensation that can favor the interests of insurers, employers, organized labor, plaintiffs’ attorneys and others, depending on who is in power.

Employers often feel too busy to be politically involved in the workers’ compensation system but can be a critical voice for change. Employers that want to make a difference should look into joining UWC in Washington, D.C., and the Workers’ Compensation Research Institute. I have worked with both of these groups in various capacities and believe they are worth the investment. (By the way, neither organization knows I am recommending them.)

Making the case for investing in workers’ compensation is a challenge. But because insurers can no longer use investment income to soften the blow of rising workers’ compensation costs, employer investment in curtailing claim costs is more important than ever.