We’re about five years into the insurtech boom, but we’re also in the middle of a pandemic. Excitement around emerging technology and startup innovation has taken a backseat as the insurance industry shifted its focus to COVID-19.
Yet startups have not failed as quickly as the industry might have predicted. It’s possible that some startups will begin to outrun their funding and close their doors in the next year or two. But for the time being, the insurtech market and funding remain relatively stable. What’s driving this?
COVID-19 and Insurtech Partnerships
The pandemic has altered insurers’ approach to insurtech investment. Insurers appear to be focused on tactical initiatives that can produce more immediate results. This contrasts with the R&D that was more prominent pre-pandemic.
Yet it turns out that startup activity and the global pandemic are not necessarily mutually exclusive. Insurer priorities most notably changed focus to cloud computing and digital strategy — with digital covering both external channels and internal workflows. Cloud and digital are two areas in which almost every insurtech excels and have led to additional opportunities in many cases. Insurers expect that these areas will continue to be prioritized even when the pandemic is over.
Lemonade’s IPO and What It Means for Insurtech
Lemonade’s IPO cemented one of the most notable insurtech players as a certified unicorn. IPOs validate the potential returns of insurtech and will help attract more investment dollars into the space, whether from venture capitalists or insurer investment arms. Few other startups have gained the investment attention that Lemonade has, but others — like life insurance startup Ethos or property insurer Hippo — have received funding over $100 million. Each of these startups’ successes helps attract dollars for the rest of the insurtech ecosystem.
Many insurtechs, especially startup MGAs, are exploring new revenue streams. For some, this means selling a wider variety of coverages directly online or embedding at different points of sale. Some MGAS are also moving to become full-stack carriers, like Buckle and Clearcover. Still other startup carriers, like Slice, Trov and Metromile, have gotten into the software business and are licensing their platforms out to other insurers.
Platform and analytics players are also finding success proving value to insurers in the current environment. Atidot, for example, partnered with Pacific Life to analyze product and pricing changes to help optimize market penetration for the insurer. In addition, Principal is licensing Human API’s medical records platform to circumvent paramedical exams for disability insurance during the pandemic.
Many startups have interesting ideas but haven’t thought through long-term financial or regulatory hurdles. The goal of many startups is to validate a business model first, then work out the details later. It’s possible that some startups will start to outrun their funding and eventually close their doors. But it will be interesting to see how insurtech evolves in a post-pandemic world, especially as new realities cause insurers to rethink processes that were manually intensive. For startups that can show value to insurers, this new normal may be an opportunity.
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!
The insurance industry has undergone a transformation over the past five years. Once manual and paper-based, insurance professionals now recognize the overwhelmingly positive impact technology has had on efficiency and customer relationships.
We can expect the acceleration of tech-enabled customer experiences that promote dynamic customer interactions and empower the insurance industry to deliver tailored solutions and products to meet customers’ personal risk advisory needs. Here are a few of the innovations we will see take off in 2020.
Pay-as-you-go car insurance. This unique approach to car insurance is especially appealing for urban consumers who own a car but rarely drive it. Rather than forcing occasional drivers to spend money on the same caliber of coverage as someone who drives every day, on-demand insurance means car owners can activate coverage only when they need it or pay per mile. The program requires a significant investment in technology that provides direct, self-service options for consumers, but we’ve already seen Liberty Mutual and Metromile offer this flexibility. We can expect many of the larger brands to begin offering similar options.
Self-service capabilities. Sometimes it’s just not feasible to call an agent when a need or question arises. Modern consumers increasingly want the convenience of DIY options to allow them to secure coverage or access information on their own schedule. To meet that demand, we’ll see self-service portals offer a wider range of features, including risk rating, on-demand premium quotes, home inventory solutions and claims processing. There’s also a growing demand for virtual adjuster technology and drone/satellite integration that help speed claims processes. Many agencies aren’t aware that their carrier partners even offer these tools, so be sure to ask.
Smart home claim avoidance/prevention tech. You’re probably already familiar with tools that track driving habits and offer discounts on auto insurance. A similar tech is emerging to help homeowners head off costly insurance claims on some of the most common mishaps. For example, a large portion of claims are related to water damage, such as a pipe bursting or an old water heater that fails. By implementing smart home sensors, automated controls and other Internet of Things devices, insurers can help homeowners mitigate the damage. For example, a sensor installed on a water heater can help monitor its structural integrity and remaining useful life, giving homeowners a heads up if it looks like a leak is imminent. In addition to offering premium discounts for participating in such a program, carriers might also provide incentives for replacing risky appliances ahead of time to avoid the risk of claim. Other solutions might involve installing a flood sensor or automated water control valve, which would send a mobile notification if a pipe bursts while no one is home, or even automatically shut off the water to prevent major damage. Some carriers already offer smart home kits for free to avoid these types of claims, and, while some homeowners might be a little concerned about privacy issues at first, I expect we’ll see this become table stakes soon.
Deeper data insights to drive business growth. With threats of a potential economic slowdown beginning to percolate, we’re starting to see signs of a hardening of the market in commercial lines. In many cases, premiums are rising, and business customers are looking at all options to save money and reduce costs. Agencies need quantifiable data and insights from smart analytics to help commercial customers strike the right balance of risk, coverage and cost.
That means the demand for industry-wide data analysis will grow substantially, as agents and carriers need measurable and accurate insight into what’s going on across industries — what customers in similar business sectors are buying, what the risks are and what are any potential gaps in coverage. Combined with their experience and knowledge, comprehensive industry analysis tools will enable agents to see the big picture and give business customers data-backed recommendations to ensure they receive just-right coverage.
In the coming year and well beyond, consumers will increasingly demand greater transparency, a higher level of service, and on-demand solutions from their insurance carriers and agents. This means adopting innovative technology will become a norm rather than a novelty as the industry digitizes to provide a more modern experience.
The good news: A wide array of insurtech solutions are now available, providing accessible and affordable tools for even the smallest independent agencies. Adopting insurtech solutions can not only improve agency efficiency, allowing agents to spend more time with customers, but also help agencies spot opportunities for growth. This powerful combination can deliver substantial ROI for investment and position your agency as a modern, tech-savvy partner for both consumer and commercial customers.
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.