I’ve never been a big fan of the term “disruption.” I believe that a majority of insurance startups are partnering with incumbents to enable industry transformation and are catalysts for change, to be sure. But few are truly turning the industry on its head.
For instance, Lemonade is a startup that, since its inception, has positioned itself as a disruptor. The slogan is still, “Forget Everything You Know About Insurance.” The constant marketing drumbeat from the company has emphasized its different approach and has focused on appealing to millennials. And, with the recent spectacular IPO, Lemonade has the attention of the insurance world. I believe Lemonade has been very good for the industry (and it has certainly been good for the founders). But I think that Tesla has the potential to be even more of a disruptor in the long run.
This might seem an odd assertion, given that Tesla has heretofore only dipped its toe in the insurance waters, and Lemonade is four years old and on a roll. At this stage, Tesla is only a year into the California auto market as a broker backed by State National (a Markel company), with mixed results. But what has caught my attention is Elon Musk’s callout to insurance actuaries – inviting them to join Tesla to create a “revolutionary” insurance company. You don’t go on a hiring spree of actuaries if you plan to be just a distribution player. Now, on the surface, it might seem strange that insurance would be of interest to Elon Musk. To illustrate, let’s play the Sesame Street game, “Which one of these things is not like the other?”
Space exploration…Autonomous vehicles…Hyperloop travel…Battery Gigafactory…Insurance.
The answer is obvious – does insurance really have the potential to transform the world like these other ventures? Maybe not, but insurance is undoubtedly an enabler of these revolutionary advances and an essential foundation of the economy. And there is actually great potential to “revolutionize” insurance and make a lot of money in the process.
Back to the Lemonade/Tesla discussion. Starting an insurance carrier is a long play. Lemonade, with all its success, is only a small blip in the industry financial picture. Renters and pet insurance are nice businesses, but they will always be secondary lines. Lemonade has also entered homeowners, so there is much more potential there. But now they have to contend with the likes of Hippo, not just the State Farms and Allstates of the world. At SMA, we consider insurers with premiums of over $5 billion to be Tier 1. Lemonade may become a Tier 1 insurer someday, but likely not for years.
On the other hand, let’s consider Tesla’s prospects. Tesla is not the first auto insurance company to enter insurance and try bundling. Others have taken this approach, and, especially those in the autonomous vehicle game, have announced plans for insurance. Most still partner with an insurance company as underwriter. This has been Tesla’s initial approach, as well. Now, with stated plans to build an insurance company, the calculus changes.
Imagine yourself as a brilliant young actuary – wouldn’t it be cool to sign on with visionary Elon Musk and help rethink insurance? For that matter, it won’t stop at actuaries – other industry professionals are sure to be recruited for this venture. Underwriters (if Musk has them), adjusters, loss control engineers and others will probably join. Now, that is no guarantee of success … and the same long play dynamics will apply to Tesla as Lemonade. However, Tesla has some unique advantages. First, it has a well-respected, established brand. Secondly, it has the underlying assets that will be insured – the electric/autonomous vehicles. Third, it has the track record and energy of Musk and his enterprise.
Of course, this is all speculation – Tesla may not go full bore into insurance, and, if it does, it may not succeed for various reasons. But I, for one, would not bet against Elon Musk.
Postscript: This blog sets up a discussion about two prominent players. There are certainly others that could be big disruptors for insurance. Three companies come to mind and have been the subject of prior SMA discussions: Root, Hippo and Munich Re. Root has shown the most impressive growth among the full-stack insurer entrants and has significant future potential as it moves into other lines and other states. Hippo has built an impressive ecosystem and a unique approach for homeowners insurance. And SMA is on record as saying that Munich Re may be the ultimate disruptor as it explores new business models, new products and broadly invests in insurtech.
Since the first “Five Dispatches from InsurTech Survival Island,” I’ve been partnering with Adrian Jones and in recent months with Sri, to analyze quarterly statutory statements of the most relevant U.S. P&C full-stack insurtech carriers. The principal goal has been to influence the dialog, debate and deliberations in the insurtech space debate, and to promote a fact-based perspective for the discussion. Even as we continue to write about the future of insurance, about a year ago, I declared my love for “old insurance KPIs” in this widely read article. While futurologists distanced from assessing P&L statements might disagree, many readers have liked the usage and explanation of insurance KPIs (key performance indicators) in the context of innovation. We are pleased to see more industry experts and authors join us in crunching numbers, assessing issues and taking a fact-based view on insurance innovation. We were especially pleased to see even some executives of insurtech startups talk about core KPIs in the context of their innovative business models. So, we entered 2020 with a belief we had accomplished our mission to spark a P&L, fact-based dialog in the insurance innovation space.
Surprisingly, neither Q3 ‘19 nor Q4 ’19 financials got any attention from analysts, and some friends pinged us suggesting we continue the series for the foreseeable future. We hear you loud and clear, and we will continue to publish these digests based on assessing the fundamentals of the insurtech players in the context of the broader insurance industry. We are back!
Our journey continues here today with an analysis of the insurtech trio’s financial performances and to share our humble assessment of the competitive posture and advantage for these three innovative startups.
Let’s start as we typically do, with a look at the core financials. Frequent readers might recall our snapshot view that lists the core financial metrics for the three players. As you read this summary, we would like to remind you that we do not comment on the cost side of the equation and that we suggest our readers not believe in the cost side because of the “goals seek triumph” issue I discussed in this article from last year.
“To each his own.” This phrase probably sums up best how we view the distinction between Lemonade, Root and Metromile. We see the three players take three different paths to customer relevance and financial performance:
Metromile: An auto insurer with modest growth that has only partially closed the profitability gap with the market (73% loss ratio vs 64% market average). This, to us, does not seem the story you would expect from a startup in the growth phase.
Lemonade: A home insurance company that has improved the technical sustainability of its business, partially closing the profitability gap with the market (66% vs 58% for the market) and showing a promising trajectory. However, it has sacrificed along this journey the expectations many had for this “market disruptor.” The $480 million of funding has created a book of business that still accounts for just 0.1% for the U.S. homeowners insurance market. The $115 million in revenue is a far cry from the “massive disruption effect” that was expected during the debut.
Root: An auto insurer that continues its journey of exponential growth (the portfolio is three times bigger at the end of 2019 than it was at the end of 2018) but is paying in claims the same amount collected as premium. The company appears to be using the $350 million Series E funding from DST Global and Coatue in August 2019 to cover expenses. This company, too, accounts for less than 0.2% of the auto insurance market.
Metromile’s loss ratio has been stable in the lower 70s for all of 2019. The company started selling its claims tools to other insurers, but the performances on its own book do not tell a great story for this new business. More broadly, the usage of telematics data on claim processing has shown potential to reduce the loss ratio at an international level. If an insurer has to choose a provider for telematics-based claims, it makes more sense to use one that has achieved results. A carrier would probably feel more comfortable using something like the G-evolution services that have already provided competitive advantages on Groupama Italy’s auto portfolio.
Root ended 2019 with a 100% loss ratio, paying out in claims effectively an amount equivalent to the premiums received. While Q4 ’19 saw a loss ratio at 93% compared with 113% in the prior quarter, and 91% in the second quarter, the technical profitability has not yet shown a consistent improvement. It is interesting to see how the loss ratios are fairly consistent in the core lines of business: auto liability and auto physical damage. In 2018, auto liability showed a loss ratio not too far from the market average, but physical damage showed a terrible loss ratio, above 120%. The folks at Root are smart, and we believe they are deliberately underpricing the risks to attract customers. Theoretically, telematics could allow them to improve their loss ratio through behavioral change, and the use of data in claims processing could let them anticipate the FNOL and enhance the effectiveness of the claim handling processes. It seems they have still ignored this potential, instead focusing only on a few weeks of monitoring, but these strategic options seem achievable.
Lemonade has been on a trajectory of improving loss ratios over the last few quarters. From a loss-ratio of 88% in Q4 ‘18 to a loss-ratio of 61% in Q4 ‘19, loss-ratios have always improved. Lemonade celebrated the use of advanced, AI-powered fraud detection in ensuring “bad risks”are caught, assessed and filtered out. Looking to the slowdown of their growth, an increase in pricing seems to be the main driver of this technical profitability recovery.
In the last article, we highlighted the “pricing war.” So, let’s take a closer look at the top line generated by these different approaches to reach a sustainable loss ratio:
Root’s quarter-over-quarter growth rate appears to have “settled” at around 20%, which is lower than past performances. Looking back over a two-year horizon, 2019’s quarter-over-quarter growth rate seems rather sedate compared with 2018. However, in absolute numbers, in the latest quarters the company has increased written premium by $20 million (from $99 million to $119 million) and $24 million (from $119 million to $144 million). These represent their third and second best quarterly increases, after the $38 million increase achieved in Q1 ’19 (from $51 million to $89 million). With Root now available to more than 65% of the U.S. driving population (‘18 new states contributed 29% of the ‘19 growth, and ‘19 states for a further 17%), it remains to be seen how the company can continue to capture customers switching for cheaper prices. Root has also started to cross sell the customer base with renter insurance.
Lemonade’s growth has slowed: After healthy growth quarter over quarter from Q1 ‘19 through Q3 ‘19, we saw a reversal in Q4 ‘19. The 13% reduction in Q4 ‘19 was worse than the 10% reduction between Q4 ‘18 and Q3 ‘18. One year ago, Lemonade said, we “messed up an entire quarter” because premium growth turned negative, when in fact the company generated its best quarterly loss ratio ever (and it has happened again!).
Metromile underwritten premiums grew only by $3 million in Q3 ‘19 (compared with Q2 ‘19), and in Q4 ’19 the company had, in absolute numbers, its worst quarter since Q3 ’18. This to us is a clear sign that the company’s product likely attracts only users who drive infrequently or never drive.
We are also not able to compare their real costs. As we discussed earlier, the companies are not reporting all of their costs in the yellow book any more, and therefore true cost positions cannot be judged. As an example, Metromile’s stated underwriting expenses in the fourth quarter of the year went down, similar to movement we saw in the fourth quarter of 2017.
Our humble opinion
Let’s be frank. From these figures only Root is showing the trajectory expected for a startup in the growth phase. Even with gaps on the technical sustainability of its portfolio, the company has a profitability improvement opportunity driven by better usage of telematics data. If the team builds mastery in usage of telematics data for behavior change and claims management, this venture could find the “root” for sustainable growth. With this focus and strategy, the company really wouldn’t need to invent anything fundamentally different. There are best practices on behavior change and claims management the company can emulate from players like Allstate (U.S.) and Discovery Insure (South Africa) and UnipolSai and Groupama (Italy) respectively.
Continuing on the telematics topic, Metromile’s equity story seem less exciting. Customer appeal toward pay-per-use continues to be limited at best. Uncertainty of a fluctuating premium over the period of coverage is a barrier for adoption. This model is attracting only customers who drive infrequently and focus on saving on their insurance premium costs.
The long tail of excitement with the disruption buzzword continues to characterize Lemonade’s march in this trio. The charity giveback – which has fascinated many commentators over the past years and which I described in detail in one past article with Steve Anderson – accounted for 1.3% of the 2018 premiums last year and 1.8% of the 2017 premiums; i.e., a pretty inexpensive public relations and marketing tool. On a different note, plans to cross-sell and offer pet insurance appear to be well thought out and fit with the equity story for a startup at their stage. Finally, the expansion into the German market generating appears to be another checkmark on the “to do list” of the “perfect startup.” Net-net, Lemonade’s story appears to excite industry commentators more than it excites customers!
(I’ve already earned the title of “cynic” from the Lemonade founder for a similar statement a year ago.)
What paths will each of these insurtechs take now, and how will they get there? Will COVID-19 change everything?
Another question on everyone’s mind is probably this: What will be the impact of the temporary lockdowns? As we look ahead into expected results from Q1-2020, we expect to see COVID-19 play out in a few different ways:
We expect Metromile to be the most affected because its product is based on a “per mile” computation basis. Analysts are already reporting, that mid-March to the end of the April, “miles driven” were reduced by 50%. With millions of U.S. residents spending a couple of months in lockdown, we expect the Metromile top line will shrink in Q1 ’20. The company has already laid off employees, including the entire marketing team.
Root has announced a “stay at home” bonus similar to many other auto insurance carriers. Root’s incentives are based on a measured 20% or more reduction in driving in April and May. With the lockdown, the company’s try-before-you-buy approach probably takes more time to be completed, so their growth will be affected.
We do not currently expect any change in the coverage needs or customer behavior for the core products that Lemonade provides. We do, however, expect that macroeconomic issues like increasing unemployment, underemployment and reduction in disposable incomes will lead on one side to some customers seeking lower prices through competitive shopping but, on the other hand, customers who have never considered or bought renters insurance policies possibly continuing to ignore the need and shun the product. Industry watchers will recall Lemonade’s claim on effectively attracting first-time buyers of rental insurance. We expect this claim to be tested.
From a broader P&L perspective, we also expect to see Q1 ’20 investment income to be depressed.
Looking ahead to the rest of the year from my exile in a downtown Atlanta hotel, I have already articulated my thoughts about futurologists who are designing a future based on their own self-image over the past few weeks. (Note: There have been tons of articles and webinars claiming that “nothing will be as before” and announcing the triumph of both digital distribution channels and pay-per-use telematics.) I am skeptical about any long-term structural changes brought about by a few weeks of lockdown. Sri, on the other hand, believes that, while the “target state” of consumer behavior and expectations may not be known for a while, the COVID-19 crisis will cause at least some segments of consumers to fundamentally rethink their risk management and insurance solution needs. He also expects changes in sectors like commercial real estate to push commercial insurance companies to rethink products, pricing and positioning in the commercial sector.
As we sign off this quarterly dispatch, many U.S. states are reopening their economies. We hope to be back soon to discuss insurance innovation on the stage of a big conference and to never have to comment again on the impact of a lockdown!
Whether you’re browsing an article about the latest trends in insurtech or listening to a panel of insurance industry disrupters discussing customer acquisition strategies, it’s hard to avoid references about emerging technologies such as machine learning, artificial intelligence, chatbots and data analytics. But, have these digital advancements truly transformed the experience for customers shopping for insurance? Are insurers, agencies and consumers benefiting from such enhancements in technology?
Arguably, the answer is yes. The insurance buying experience has evolved dramatically in the last decade, and insurers, their agents and consumers have all benefited. However, when we examine the underlying products and the various touchpoints throughout the customer journey, we can see there are significant opportunities for improvement.
Insurance Shopping: Consumer shopping patterns and expectations have changed in all industries, and insurance is no exception. The enormous dollars spent by top insurers are pushing more consumers to start their shopping process in a digital format, where speed and accuracy are paramount in keeping customers engaged. Consumers have become accustomed to choosing from multiple product options and to one-click shopping, but replicating an Amazon experience in the insurance industry is extremely challenging.
For one thing, insurance products are highly complex and regulated, and premiums can change based on a multitude of variables that are not immediately transparent to consumers. Variables such as: age, coverage limits, credit, driving history, prior claims or age of home can dramatically affect eligibility or policy premium. And while these factors are key data points for underwriting, verification of these inputs often leads to lengthy question sets and inaccuracies in pricing at point of sale and beyond. Then there are the costs associated with verifying reports such as credit, MVR, CLUE and prior carrier through third party vendors, which add friction and cost in the shopping process.
These are among the challenges that a few digitally focused, independent insurance agencies such as Gabi Insurance are aiming to overcome. Such digital platforms can simplify the quote process while representing both traditional carriers and newer entrants to the market like Clearcover. Digital agencies stay engaged with the customer throughout the life of the policy and may help reduce the cost of third-party reports, which are currently passed on to consumers.
Beyond the Quote: While the point-of-sale experience is critical in effective customer acquisition, the entire customer journey — meaning all the touchpoints along the way — help maintain customer loyalty. Digital distribution channels that leverage emerging technologies can track customer interaction and use the data to identify improvement opportunities up- or downstream. While some insurers have made significant improvements in their frontline underwriting and product design, most still rely on products that were designed for traditional distribution channels (brick and mortar) and require some level of post-sale verification of policy attributes. As a result, customer experience can quickly shift from digital to paper-intensive, snail mail and the requirements can vary based on the type of products purchased. Consumers may be required to send proof of discounts, photos or evidence of insurance that were unverified at the time of the quote.
In such cases, digital agencies like Gabi may be better equipped to quickly engage customers via text, chat or email and expedite requirements on behalf of their insurance partners while contributing to higher net promoter scores (NPS) and improved overall retention.
Ultimately, to create an optimal insurance shopping experience that’s more aligned with customer expectations, insurers need to invest in revamping their products and processes for digital distribution channels. That’s easier said than done, as bringing products to market takes multiple years to deploy and millions of dollars in investment. Large, established insurers may require additional investment in core technologies, rebranding and potentially cultural and ideological transformation, while new insurers such as Clearcover, Hippo and Lemonade are not encumbered by legacy systems.
Adopting the entire digital transformation ecosystem is difficult and costly for insurers and involves multiple departments within an organization, which often have competing objectives and operate in silos. Insurers may have much to gain from partnering with digital agencies as their distribution models provide growth opportunities and turnkey access to customers who are less likely to buy from brick and mortar agencies. Further, insurers can gain valuable insight into customer demographics and behavior that are unique to online shoppers and use this information in future product development and process improvement strategies.
We have previously evaluated and discussed the financial performance and operating results of the insurtech trio Lemonade, Root and Metromile. Based on the analysis of the last available data, we think that:
There is a pricing war
The trio is missing an edge and story with respect to gaining a sustainable competitive advantage
At first glance, it appears that all three firms are focusing heavily on containing and improving their loss ratios. Metromile and Lemonade continue to have a relatively stable loss ratio, while Root has drastically improved compared with the prior quarter. At 91%, Root delivered a better result compared with the 105% in Q1-19 but still has some distance to go before getting closer to Lemonade or Metromile in terms of quality performance.
Note: The expenses ratios are not significant because part of the expenses are paid by the parent companies and not reported on the Yellow Books.
There is a pricing war
We believe the insurtech trio is facing a pricing war. We find three data points in support of this view:
Viewed through the lens of growth rate, after a robust Q1-19 for all three players, Q2-19 presents a different story. We find the most interesting perspective by looking at the performance over the last year and half. Clearly, the premium evolution of Metromile is the less exciting story, as I previously wrote. The pay per mile doesn’t seem particularly effective in attracting customers. The “pay per mile” model introduces an element of uncertainty for segments of customers who want to save money and know what insurance coverage will cost them. The only comfortable customers are those who almost never use a car. (We will cover the customer experience and expectations for usage-based insurance in future articles.)
Lemonade has shown consistent growth in the last two quarters and appears to be on target to meet the $100 million annual revenue target. This revenue target is a far cry from the “massive disruption effect” that was expected during its debut. The revenue curve is not yet showing the vaunted hockey stick.
Root is the only of these three players with exponential growth in revenue. However, something happened in the second quarter, and growth slowed significantly as the loss ratio improved. As mentioned in our last article, insurtech D2C seems to be a “price game.”
Let’s go back to look at the top-line numbers. Root and Lemonade registered a net increase in direct premium written compared with Q1-19. Metromile, on the other hand, registered a marginally lower DPW than in Q1-19.
Having looked at the top line, let’s switch our attention to the loss ratios. For an insurance carrier, the loss ratio is really the litmus test that assesses the strength and quality of the top-line numbers. Loss ratio is a fundamental insurance number, and the fact that all three players have improved this crucial metric is a sign of increased maturity for the “not so” fast-growing trio.
All three improved compared with the prior quarter. This bodes well for the trio. Of the three, Root continues to have the highest loss ratio at 91%, suggesting that between new sales and renewal it is still under-pricing risks.
The Q2-19 loss ratios are significantly better than what the three firms exhibited in Q2 of 2018, when Lemonade had a loss ratio of 120%, Metromile was at 95% and Root at 112%. The loss ratios are still far higher than the respective market segments.
Missing an edge and story with respect to gaining a sustainable competitive advantage
In our last article talking about insurtech direct-to-consumer (DTC) as a “price game,” we highlighted how the companies have not been able to make customers fall in love with anything other than “saving money.”
We would like to share some thoughts on the business models of these three full-stack carriers, investigating where and how their approaches might both enable and impede them in terms of gaining a sustainable competitive advantage. What might be the proverbial sling that the “insurtech Davids” can use against the entrenched Goliaths of State Farm, Geico, Progressive, Allstate, et al? Let’s explore.
If we consider the economics of an insurer, there are three areas where you can obtain a competitive advantage that can allow financing this kind of “pricing war”:
The loss ratio
The administrative expenses
Investment income even in the current market conditions characterized by low interest rates represents the main source of profit for U.S. P&C insurers. A recent report by Credit Suisse has pointed out how, “over the last five years, approximately 90% of the industry’s profits have been generated from the investment income (float) component of the income statement.” In 2018, U.S. P&C insurers generated $53 billion net investment income, which accounts for 8.6% on the premium written. Well, all three insurtech carriers were far from this investment performance in the same period.
Probably, hidden in the parent companies income statements, there is some additional investment income obtained investing the cash received by their investors.
However – as of today – the return obtained investing the floating is clearly a competitive disadvantage for the insurtech players.
As explained in a previous article, the loss ratio is the key measure of the technical profitability of an insurance business . The U.S. P&C market showed $366 billion net losses incurred, which means almost 61% loss ratio (net of loss adjustment expenses). Can any insurtech element allow Metromile, Root or Lemonade to have a competitive advantage on the loss ratio?
Metromile and Root are telematics-based auto insurers. Matteo is a fan of the usage of telematics data on the auto business and an evangelist of these approaches through his IoT Insurance Observatory, an international think tank that has aggregated almost 60 Insurers, reinsurers and tech players between North America and Europe.
Based on the Observatory research, four value creation levers have been the most relevant in telematics success stories:
The telematics approach has demonstrated around the world a consistent ability to self-select risks. Simply said, bad drivers don’t want to be monitored;
Some players such as UnipolSai and Groupama have achieved material results by improving claims management through telematics data;
Some other players have been able to change drivers’ behaviors, e.g., the South African Discovery and the American Allstate;
Many players have been able to charge fees to customers for telematics-based services, providing a revenue stream.
Metromile and Root are mainly using telematics for pricing purposes. Root is currently using a try-before-you-buy approach that allows potential customers to generate a driving score in a couple of weeks and obtain a tailored quotation. If consumers buy the policy proposed by Root, they will not be monitored anymore. This usage of a driving score at the underwriting stage could represent a way to price better the risk (if the price is settled at the right level), but the absence of further telematics data doesn’t allow Root to extract any value from the value creation levers above mentioned.
By contrast, the Metromile pay-per-mile approach is constantly monitoring the driver for the duration of the policy, which is the necessary foundation for those telematics value creation levers. As of today, the only area where Metromile seems to exploit the value of telematics data is claims management. The biggest limit for Metromile seems to be the nature of the pay-per-mile business, which has found only a limited market fit (niche nature of the mileage-based approach).
So, we think that both the players are still far from telematics best practices, currently represented by a few incumbents. However, the evolution of their telematics approaches can generate some competitive advantages against many incumbents that are less advanced.
About the possible capability of Lemonade to generate a better loss ratio than other renter insurers, the game is around its famous focus on behavioral economics and the attempt to influence behaviors with the iconic giveback. Everyone (among insurance executives) remembers Lemonade for the fixed percentage of premium it charges — the iconic slice of pizza — while all the rest is used to ensure the company will always pay claims; whatever is left goes to charities. As of today, nothing in the loss ratio shows benefits from this approach. Would you avoid submitting a claim or resisting the urge to file an inflated claim (an unfortunate reality in our industry) because “whatever is left goes to charities.” We find it hard to believe that the fundamental economic incentives will move from individual gain to community gain. Ancient Latins were saying homo homini lupus. (Man is wolf to man.)
Moreover, a recent comment by Lemonade CEO Dan Schrieber suggests that “AI may have played a role in higher loss ratios.” The increase of straight-through processing combined with a vast reduction or elimination of legacy checks and balances can increase the risk of fraud. Sri and his team at Camino Ventures, an AI/ML fintech, believe that this is a natural phenomenon with respect to AI/ML adoption. Ilich Martinez, co-founder and CEO at Camino Ventures, says, “Companies need to take a holistic view of AI/ML integration into business processes and business rules. Piecemeal or spotty inclusion of advanced AI/ML capabilities can be akin to installing a Tesla induction motor on a gas guzzler. It simply does not work.”
Sri expects to see a spurt in fraudulent claims in certain domains where autonomous claims management is introduced or expanded. As bad actors try to game the system, it is imperative that insurance companies expand the fraud detection models and be willing to enter a phase of continuous and strenuous test-and-learns. Eventually, usage of AI/ML can be crucial to achieving better administrative cost positions, but the path to that destination will not likely be a straight line.
The U.S. P&C markets showed costs that represent 37% of the written premiums on 2018 (of which 10% was loss adjustment expenses). Unfortunately, we are not able to see any more the real costs of Root and Lemonade; part of the costs are on the income statement of their parent companies, and we can only enjoy the results of their goal-seek. Efficiency – if it will ever be achieved by these insurtech startups — can be a way to compete and to sustain a pricing war, but the scale matters.
We ask whether the AI-driven approach of a player such as Lemonade will become a key competitive advantage against the current established incumbents. Can an early, extensive and immersive adoption of AI/ML provide insurtechs a competitive edge? Will incumbent leaders be fast followers or late adopters in a domain as critical as AI/ML?
We are already seeing the incumbents make early and deliberate moves to gain an AI/ML capability advantage. From domains like telematics to computer-vision-enabled image processing for claims, we see the Goliaths not waiting to be left behind. They are quickly moving from a “test and learn” approach to wide-scale adoption of numerous AI/ML capabilities and are finding early success. This adoption is accelerated by nimble, agile fintech and insurtech enablers like Camino Ventures that help industry leaders quickly move from opportunity to outcomes. Given these market conditions, we believe that advanced AI/ML capabilities would give insurtech an edge only against incumbents that are less focused, capable or invested in integrating insurtech solutions into their value chain.
We believe the current business models are not yet showing any clear competitive advantages that can make the pricing war sustainable for the three full-stack insurtech carriers. However, they have a lot of cash combined with highly talented teams that can experiment and find new ways to build moats and forts to gain competitive advantages.
The three P&C venture-backed U.S. insurtech start-ups — Lemonade, Metromile and Root — finished 2018 with pretty good results. Quarterly growth was the slowest ever, but all three paid out in claims less than they collected in premium. All three start-up carriers have more work to do to achieve sustainable financials.
A year ago, when I started with my friend Adrian a public conversation about insurtech statutory results, the picture was ugly — loss ratios well over 100%, an aggressive focus on price and promotional messages on company blogs that dismissed traditional measures of success in insurance.
Since the first post titled “5 Dispatches From Insurtech Island,” the conversation has shifted dramatically. Fast forward a year, and one founder said he “messed up an entire quarter” because premium growth turned negative, when in fact the company generated its best quarterly loss ratio ever. In the months since, several start-ups have hired top underwriting talent from their traditional competitors, showing that they increasingly recognize the value of traditional insurance skills.
Skeptics point out that a quarter doesn’t mean much, that there’s a long way to go before reaching sustainability and that each additional point of loss gets harder to take out. True, but the increased focus this year on reducing losses and increasing prices is making a difference.
Here are the quarterly results:
I think – as already mentioned in the previous articles – these companies have strong management teams who could ultimately create valuable businesses. This will take several years, but all three companies are well-funded, even if the combination of statutory capital injections and operating losses consumes tens of millions in capital each year. (The Uber/Lyft model of growing rapidly while also incurring large losses is doubly penalized in insurance because carriers have to maintain statutory capital that increases with premium.)
Here is a year-over-year comparison.
The three companies have sold in the last 12 months between $40 million and $110 million, less than some of the early 2017 enthusiastic forecasts that Lemonade (for example) would hit $90 million of premiums by the end of 2017. In auto, I pointed out at my IoT Insurance Observatory plenary sessions that the pay-as-you-drive telematics approach seems to attract only the niche of customers that rarely use cars – maybe a growing niche, but not a billion-dollar business (in premium at least).
Loss ratios have all been below 100%, which is a great improvement from the 2017 performances. The quarterly dynamics show a positive trend, but these loss ratio levels are far from the U.S. market average for home insurance (Lemonade) and auto insurance (Root and Metromile).
While loss ratio is a fundamental insurance number – claims divided by premiums — I’ve been asked how to normalize/adjust the loss ratio of a fast-growing insurtech company.
Imagine a fast-growing insurer with the following annual figures:
Premiums written: $10 million
Premiums earned: $6 million
Claims paid: $2 million
Losses incurred but unpaid: $5 million
Any of the following numbers might be called a “loss ratio”:
Claims paid divided by premiums written: 20%
Claims paid divided by premiums earned: 33%
Claims paid and losses incurred divided by premiums written: 70%
Claims paid and losses incurred divided by premiums earned: 117%
The least attractive is the right one.
Claims paid and losses incurred divided by premiums earned is the loss ratio, for a fast-growing start-up as for a large incumbent.
The others are only “exotic loss ratios.”
I’ve heard people say that accounting rules cause the loss ratio to be overstated based on the following unlucky scenario:
There is a book of business done by a one-year homeowner’s policy sold for $730. This policy will earn $2 of premium each day. If a $100 claim (net of the deductible) is received on that first day, the loss ratio is 5,000%. That’s how it works, but is it overstated? Well, as long as premium is being earned, more claims could arrive and the loss ratio could go even higher still.
Obviously, you expect the following 364 days to be less unlucky for this portfolio. But I don’t think there is any need to adjust that loss ratio…only to know that is not (statistically) relevant.
The analyzed start-ups have portfolios of more than 100,000 policies, so the bad luck can’t be accountable for eventual unfavorable loss ratios.
It could be that some approaches are specially targeted for fraud, and it only takes a few fraudsters to cause big problems in the loss ratio on a small book, as the above illustration shows. Some start-ups have advertised how quickly they pay claims, sometimes not even having a human review them, which invites unsavory people to pay a small amount to start a policy then “lose” a valuable item. Early on, when less premium has been earned, this fraud has a particularly great impact on the loss ratio. Over time, in a bigger and more balanced book, fraud gets tempered by the law of large numbers.
Additionally, some start-ups have offered large new-business discounts. If they can retain customers, reducing the premium leakage, their second-year loss ratios should be more reasonable, but the overall loss ratio will be elevated for however long they are acquiring customers with aggressive discounts.
I would love to discuss also the other lines of the income statements, but unfortunately they are not meaningful or comparable any more, because companies now move expenses among their entities not represented in the yellow books. The cost amounts represented in the yellow books are only a part of the real costs necessary to run the insurance business.
The statutory information I’m commenting on is reported only for insurance companies, not agencies, brokers or service companies. The term “insurance company” or “insurer” has a very specific meaning: “the person who undertakes to indemnify another by insurance.” Within an insurance holding company, it is typical to have an insurer and an affiliated agency, and sometimes other affiliates such as claims administrator. The insurer pays the agency to produce policies. This may feel like moving money from one pocket to another, but there would be reasons for it — which I won’t get into now.
The point for commentators and investors is to beware of this: If an insurer (for whom the public receives financial data) pays an affiliate 25% of its premiums to provide certain services, then the insurer’s expenses (which are reported in the yellow book) are set at (or close to) 25% of their premiums, regardless of what they actually are.
Major investors are typically privy to large amounts of information and can disentangle the back-and-forth between the insurer, agency and holding company. For smaller investors, or those who simply pick up a statutory filing, it is easy to be misled.
At the beginning of 2018, Lemonade was no longer consolidating its parent and affiliate expenses into Lemonade Insurance Co., its statutory entity. Lemonade’s CEO commented that this change was at the request of its home state regulator. Root followed suit in October 2018, so the 4Q18 expense ratio is moved to 28% from the 70% in the 3Q18. So the “new” expense ratios (and therefore combined ratios) are artificial and not comparable with the previous ones or with competitors’.
While regulators may have reasons for their actions, it is better for students of insurance innovation to know the full, real financials, so as to determine if the start-ups are ever able to “walk the talk” of better expense efficiency from “being built on a digital substrate.” Unfortunately, bloggers are not the main audience of statutory filings. Nonetheless, innovation cheerleaders, investors and journalists …please pay attention to these accounting differences before commenting the performances.
Since the beginning of the quarterly discussion of U.S.-based insurtech carriers’ financials based on their public filings, many have responded that these players needed to be evaluated on other metrics, too. I agree, so let’s look at one of those measures and talk about some questions to determine whether the measure really stacks up.
Misleading vanity metrics
The insurance value chain is complex and difficult to compare across models. This can lead to comparisons between very different companies. Take these two hypothetical companies:
Company A — flashy Start-up Insurance Co. uses outsourced call centers, bots, incessant Instagram ads, comparison rater websites, third-party claims administrators and a slick app. It sells one line of insurance, only personal, with low limits, and has no complicated old claims (yet). If your house burns down, you open an app and wait. The company has a low expense ratio, high acquisition costs and a high loss ratio.
Company B — old Traditional Insurance Co. uses a mix of direct sales, captive agents and independent agents. Claims are handled mostly by agents and in-house staff. If your house burns down, your agent turns up with a reservation for a nearby hotel, billed directly to the insurer. The company sells 12 lines of insurance, including small commercial, and a wide range of products within each line, with bundling encouraged. The company has a high expense ratio, high acquisition costs, strong customer loyalty and losses less than the industry average.
A “vanity measure” could easily make one of these companies look better than the other.
The start-up, for example, may claim performance several times better than the incumbent on a “policy per human” KPI, considering in the count of “humans” agents and brokers. Why does a policy-per-human number matter at all? And why is more policies per human better than fewer?
Company A and Company B are two different business models, with two opposite approaches about humans — neither of which is necessarily better. Steve Anderson and I wrote a heartfelt defense of the model based on agents, brokers and other distribution partners a few months ago.
To measure efficiency, I prefer to use the two traditional components of the expense ratio:
General operating expense ratio = general operating expenses ÷ earned premiums
Acquisition ratio = total acquisition expenses divided by the earned premiums (for high growth companies, it’s acceptable to do the division by written premium). This metric includes advertising, other marketing expenses, commissions and other distribution expenses. However, this number (like CAC) can be difficult to compare – for example, are fixed marketing expenses included or excluded? And the economics of customer loyalty are different between direct (where initial CAC is high but renewal is low) and agent sales (where initial CAC is lower and variable but renewal commissions are significant).
I love numbers and – as shared in an interview with Carrier Management – the absence of quantitative elements in self-promoting website articles, conference keynotes, whitepapers and social media exchanges have been one of the reasons for starting the publication of articles about the full stack U.S. insurtech start-ups.
Although I’m sometimes described as “critic” or “cynic” about insurtech companies, I’m only critical of the misuse of numbers and am a big fan of those who get the old school insurance KPI right. I’d love to see innovation succeed in the insurance sector, and I wish all the best to these three players and their investors.