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.
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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.
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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.