Tag Archives: unicorn

The Unicorn Hiding in Plain Sight

Attend any insurance-focused conference, and you will undoubtedly hear about the high volume of angel and venture capital currently chasing the next unicorn in insurance – the industry equivalent of Facebook or Amazon. In the search for value, investors are first asking questions about how long it will take for innovation to transform the industry’s business model or who will be the major disrupters. Is it the new approach to distribution that will render the current ecosystem extinct? Is it a different approach to underwriting courtesy of new advancements in data and analytics? These are legitimate questions – but what if we are looking in all the wrong places? What if the next Uber of insurance has already arrived?

An important component of the value chain in consumer-facing markets is access to the customer. Creating a user-friendly application drives user engagement, and therefore retention. The critical difference in the insurance industry, however, is the lack of engagement. Insurers are challenged with a product that does not lend itself to a frequent interaction with clients. There are typically only two points of contact: sale and claim payment. Though both present opportunities to build customer relationships, this number is orders of magnitude lower than for consumer technology applications. This means insurers need a better solution to work around the value chain to gain control of the customer, one that involves driving down costs. Herein lies an unexpected solution – alternative capital.

Alternative capital refers to pools of capital available for the transfer of risk from an insurer to the capital markets, typically in the form of insurance-linked securities (ILS) or special purpose vehicles (SPVs). The impact of alternative (or third party) capital is well understood in the reinsurance world today as global risks have been packaged, turned into portfolios and offered to the very largest providers of capital in the world as an alternative, risk-bearing asset class. The size of the market has grown considerably in recent years, with alternative capacity reaching $86 billion, or 14% of global reinsurance capital, as of the first quarter end of 2017, according to Aon.

Alternative capital represents 14% of global reinsurance capital

The question, though, that investors should be asking is: Who has access to the cheapest capital? The answer to this question, the authors believe, will yield important insights as capital efficiency enables players in this space to get closer to the clients and, more specifically, the source of risk. After providing appropriate scale for disruption in the industry, along with an important framework to understand industry cost of capital, we consider evidence from the banking sector and anecdotal data from current trends in the market to argue that the Uber of insurance is already here.

See also: Preparing for Future Disruption…  

Disruption at Scale

In an era of rampant overcapacity, it is sometimes easy to forget the historical significance of access to risk-based capital. The explosion of new technology applications to challenge the gatekeepers in the industry, funded by a dramatic rise in venture capital for Insurtech startups, has taken a lot of interest among industry participants. Insurance and reinsurance applicants are still, though, fundamentally sending submissions and applications to be accepted as insureds and cedants. There is an offer of risk transfer for premium. Unless platforms that control the customer also start retaining the risk with an equal to or lower cost of capital, the incumbents are still likely to control the system. Until this happens, those who build the best capital platform can offer the best products to attract customers, with the lowest-cost capital translating to lower prices for consumers – a reality supported by the scale of alternative capital disruption.

Alternative capital currently on risk in 2016 dwarfs VC funding in Insurtech

While the scale of insurtech investment itself is enough to make serious people sit up and take notice, it is the speed, velocity, sources and efficiency of capital that will drive the future direction of the industry. To assess the long-term impact to the industry of these dueling solutions to disruption, an understanding of the drivers of industry cost of capital is required.

Insurance Company Cost of Capital

While ILS as a practice is nearly 20 years old, we are still in the first inning of how this once-niche part of the global reinsurance and risk transfer market will expand its influence. The current problem the industry is facing is that it does not do a good job of differentiating capital sources with specific levels of risk. Investors looking for a 5% or 7% or 11% return all fund risk whether at the 1-in-50 return period or 1-in-250 return period. This capital inefficiency not only lowers margins but also increases the cost of capital and perpetuates a system that hinders new product development at the expense of the end consumer. The use of third party capital gives underwriters the ability to cede remote, capital-intensive risk off their books and onto a lower-cost balance sheet. This matching of different types of risk with different pools of capital produces a leaner, more customer-focused, lower-priced risk transfer market, ultimately benefitting the end consumer from cheaper reinsurance products.

The industry also cares about returns. Meeting analyst expectations has become increasingly difficult as pricing and investment yields have declined. Because insurance companies operate in a market that is becoming more commoditized, insurers and reinsurers need to either find another way to increase returns or figure out a way to lower their cost of capital. Alternative capital providers have a fundamental advantage in this respect, as “…pension fund investors are able to accept lower returns for taking Florida hurricane risk than rated reinsurers, for whom the business has a high cost of capital.” Similarly, the opportunity cost of capital for a typical venture capital fund (17% before management fees and carried interest) outstrips the hurdle rate for pension fund investors who turn to catastrophe risk as a diversifying source of return.

Similarities to the Banking Sector

The importance of cost of capital in determining winners and losers in capital-intensive industries can be clearly seen in the banking sector. When banks accessed lower-cost capital through capital market participants, their balance sheets were essentially disintermediated as they no longer had to finance the bank’s capital charges. By going straight from the issuer to capital and removing the need to finance these expensive capital costs, the aggregate cost of the system (value chain) was reduced. This benefitted consumers and drove retention in the same way we normally associate technology disintermediating distribution in other industries to drive down costs.

Just as loan securitization transformed the banking industry, so, too, can risk securitization change the economics and value proposition of insurance for the end consumer. Capital disintermediation offers new operating models that connect the structurers of risk with the pricers of risk, until disrupters prove they can do this better. Because insurance underwriters and mortgage loan originators retain differing levels of risk ceded to the capital markets, gaining access to the most efficient forms of financing is an increasingly important battleground for players in the insurance space. When investors no longer tolerate capital inefficiency and increasing returns proves challenging, value chain disruption is a real threat because the lack of client proximity and customer engagement provides no competitive moat. A comparison between the recent growth in U.S. P&C industry direct written premiums and growth in U.S. P&C industry surpluses shows just why capital efficiency is so important.

Renewed focus on capital efficiency as industry surpluses overtake industry premiums

Industry surpluses have increased at a rate more than double that of industry premiums ($418 billion increase vs. $200 billion increase) since 2002. The surplus growth relative to premiums highlights the steep drop in capital leverage from 1.4 in 2002 to 0.8 in 2016. As insurers sit on larger stockpiles of capital, they are relying less on underwriting leverage to juice up returns to meet their cost of capital. Hence, pricing power and cost controls have taken on increased importance.

The Current Fall-out

The growth of alternative capital has fostered innovation, both directly and indirectly, among industry participants across the value chain. Under the weight of efficient capital, industry players can take a step beyond leveraging insurtech to create value within the system – they can collapse it. In fact, we are seeing this happen right now. ILS funds such as Nephila are bypassing the entire value chain by targeting primary risk directly. Nephila’s Velocity Risk Underwriters insurance platform enables the ILS manager to source risk directly from the ultimate buyer of insurance. From consumer to agent to the Nephila plumbing system, homeowners’ risk in Florida can be funded directly by a pension fund in another part of the world.

See also: Innovation: ‘Where Do We Start?’  

Innovation is a healthy response, and this evolution of the reinsurance business model, while producing losers, will produce a leaner, more customer-focused, lower-priced risk transfer market in the end, ultimately benefitting everyone. The opportunity set for alternative capital to benefit the industry is not just limited to retrocession and access to efficient capital. Leveraging third party capital to provide better products and services to clients allows insurance companies to not only expand their current product offerings but also extend the value proposition beyond price alone, with different capital sources offering different structural product designs, terms, durations and levels of collaterization.

Consider solar. The insurtech solution to creating a product that will provide protection for this emerging risk might include distribution and analytics. In contrast, partnering with third party capital providers can allow an insurance company to create a product with unique features such as parametric triggers that could solve a problem the traditional reinsurance industry, with its complicated and long casualty forms, has long struggled with. In doing so, third party capital can help grow the market for insurance in a way that insurtech has not yet achieved.

Conclusion

Two of the most common counterarguments for alternative capital’s Uber-like impact on the industry are that it remains largely untested capital in the face of a significant event and that we’ve hit a ceiling on the limit of third party capital in the traditional reinsurance market.

On the first point, as of this writing, it is still too early to assess how existing and new potential third party capital investors will respond to hurricanes Harvey and Irma in coming renewals. However, the combination of the ILS market’s established track record, experience paying claims and fund managers staffed by people who have long experience as reinsurers provides support that investor interest post-event will remain strong.

As for the second, in a static world, that claim may be true. But we believe there is plenty of room to grow in this market from both a supply and demand perspective. On the supply side, ILS accounts for only 0.6% of the global alternative investments market, with ample room to increase assets under management, according to the latest survey on alternative assets from Willis Towers Watson. On the demand side, around 70% of global natural catastrophe losses remain uninsured, and these risks are only growing. Insurers will require protection against aggregation and accumulation risk, and increasingly see the natural home for the tail risk in the capital markets and ILS.

We have witnessed alternative capital’s ability to attract risk to capital and lower aggregate cost of the entire value chain. Many in the industry are monitoring how insurtech will sustainably attract risk and attract customers over the long term. In the meantime, the companies that have used their time wisely in the soft market by increasing capital efficiency to source, return and attract new forms of capital the quickest will be well-positioned in the space and can happily partner with great distribution partners of their choice. Even so, the players with the lowest cost of capital can accept risk more quickly and easily and can develop products more cheaply and with unique technological features for consumers.

Insurtech will still play a pivotal role in shaping the future of the industry. Most of the participants in the insurtech space are in the early stages of capital formation. As investment scales and business models mature, insurtech should help leverage the proliferation of new sources of information and data pools to advance the securitization of different types of risk. Access to enhanced analytics helps make the underwriting and funding of more intangible risks, such as reputation and contingent business interruption, more sustainable, thereby increasing the participation of third party capital in lines of business outside property catastrophe.

In the mid-1990s, far less than 1% of global reinsurance capacity was alternative capital; by 2016, its influence had grown to nearly 15%. Here is our question for the next industry conference: What will alternative capital look like in 2030?

Why to Boost Visas for Foreign Entrepreneurs

Immigration has become a toxic subject. In the U.S., President Trump is trying to ban or block the entry of refugees and of people from Mexico and parts of the Middle East. Other nations, from the U.K., France and Germany to Australia and Thailand, face political pressure to curb numbers of incomers.

Anger at the erosion of national competitiveness is the root of the rage in the U.S., in my view. Increasing financial inequity, changing racial and ethnic demographics and a widening knowledge gap between technology haves and have-nots are other factors. Immigrants and global trade have become the scapegoats.

Blaming foreigners is not new; it happens when people feel disenfranchised. Throughout U.S. history, each wave of immigrants has forced preceding generations to compete. Newcomers often achieve great success, and face resentment. Chinese engineers helped to build U.S. railways in the nineteenth century, but faced riots and even massacres because they were hired on cheap wages preferentially over whites. The Italian immigrants who came after them were blamed for everything from domestic radicalism to organized crime. Then it was the Poles, the Japanese and the Germans who faced abuse.

The U.S. has gained tremendously from foreign-born inventors. From Alexander Graham Bell, the Scot who invented the telephone, and Nikola Tesla, the Serbian who invented the laser and radio remote control, to Albert Einstein and the wave of scientists fleeing Nazi Germany, immigrants have made the U.S. the world’s leader in technology. Indian and Chinese entrepreneurs fueled the dot-com boom in the late 1990s. A South African, Elon Musk, founded Tesla Motors and the aerospace firm SpaceX.

But in the past decade, skilled immigration has stalled. Flaws in the U.S. visa system make it hard for well-educated and experienced immigrants to stay. Rather than set up companies and create employment in the U.S., foreign-born scientists and engineers have been returning home, taking their ideas and inventions with them. As a result, innovation has become global and the technology playing field has leveled across the world (see go.nature.com/2kmqmjq).

Now, as dark clouds of nativism swirl around Capitol Hill, the country’s leaders face an important choice. They can play the populism card, close the doors and watch U.S. global competitiveness fall — or they can welcome the world’s best and brightest to boost innovation and create jobs. Technology will advance with or without the U.S. The nation needs to decide whether it wants the innovators on its side. Other countries seeking to limit immigration should ask themselves the same question.

Global innovation

Today, internet companies in China, such as Alibaba, Baidu and Tencent, are among the most innovative and valuable in the world. Facebook has mimicked features of their products; Apple has been accused of copying Chinese innovations in the iPhone 7; and search engine Baidu’s artificial-intelligence system is more advanced than Siri. Chinese scientists will soon lead the pack on applying CRISPR–Cas9 gene-editing technology (see, for instance, Nature 539, 479; 2016). India has sent an orbiter to Mars and launched a record-breaking 104 satellites from a single rocket. Its new platform for digital currencies, India Stack, may allow its financial system to leapfrog that of the West. Chilean scientists have built cheap technologies that sanitize water by temporarily changing it into a plasma phase. South Korea has built autonomous cars that it aims to have on its roads before the Pyeongchang Winter Olympic Games in 2018.

See also: Why Trump’s Travel Ban Hurts Innovation  

One measure of globalization is the number of “unicorns,” technology startup firms valued at $1 billion or more. As recently as 2000, nearly all of these were in the U.S.; other countries could only dream of creating a Google, Amazon or Facebook. By February 2017, of the 213 unicorns in the world, China had given birth to 55 and India 10. The U.S. is home to only 110 (Global Entrepreneurship); half of those have at least one immigrant founder. The U.S. share of unicorns is shrinking, and Silicon Valley is facing unprecedented competition.

Gone are the days when, owing to the high costs of the core technologies, U.S. and European research labs held a monopoly on large-scale innovations. Whereas early generations of supercomputers cost tens of millions of dollars, today’s smartphones, which outperform them, cost as little as $30. Sensors, artificial intelligence, robotics, genomics and 3D-printing technologies are globally available and inexpensive. Anyone, anywhere, can use these to build world-changing products. Government-built walls of visas and travel restrictions are no barriers to innovation, only to economic growth.

Brain drain

The contributions of immigrants to tech companies are well-documented. In 1999, regional economist AnnaLee Saxenian at the University of California, Berkeley, found that Chinese and Indian executives were at the helm of 24% of the businesses started in Silicon Valley between 1980 and 1998. That proportion doubled the following decade. My research team worked with her to show that between 1995 and 2005, foreign-born innovators founded 52% of technology companies in Silicon Valley and 25% nationwide. We also showed that immigrants generated $52 billion in revenue and employed 450,000 workers in 2005. They filed the majority of patents at technology companies such as Qualcomm (72%) and Cisco (60%), and more than 40% of U.S. government-filed international patent applications had foreign authors.

Then things changed. A backlog of applications built up for employment-based visas that allow permanent residency (green cards). With sociologist Guillermina Jasso of New York University, we analyzed this backlog. As of Oct.1, 2006, there were almost half a million applicants (more than one million when family members were included). Because only about 120,000 visas are available each year, getting a green card can take a decade. We forecast that this wait would increasingly frustrate highly skilled workers, leading to a reverse brain drain.

Indeed, by 2012, my team found that immigrant entrepreneurship had stalled. The proportion of companies founded by immigrants fell nationwide to 24% and in Silicon Valley to 44%. We believe from anecdotal evidence that highly skilled workers are returning to their home countries in even larger numbers today.

Canadian-born chemist Michelle Zatlyn co-founded the US Internet company CloudFlare.

These are the people who set up the unicorns in countries such as China and India. Each of those companies has one or more U.S. returnees in senior leadership positions, and restrictive U.S. immigration policies put them there.

Two decades ago, it was the norm for students who came to the U.S. from China and India to want to stay. No longer. On graduating from engineering courses, most overseas students say that they will work for a short time to gain experience, then return home. Human-resource directors of companies in India and China tell me that they are flooded with CVs from students from U.S. universities. Working for an exciting start-up such as Baidu or Alibaba is more enticing than being locked into a menial U.S. position for a decade awaiting your green card.

When I visit technology centers in China and India, and increasingly in places such as Mexico City or Santiago in Chile, I see a beehive of startup activity. As well as social-media and Internet applications, overseas entrepreneurs are designing wearable medical devices, robots, drone-based delivery systems, microsatellites and agricultural-automation systems. They are building self-driving cars, solar technologies and 3D-printing systems to solve global problems.

See also: Is U.S. Losing the War for Talent?  

Meanwhile, the U.S. visa backlog is climbing. I estimate that there are more than 1.5 million skilled workers in immigration limbo in the U.S. today. Each one is a lost opportunity and a waste of talent.

Everyone loses. The precarious position of foreign-national staff leaves them open to mistreatment by their employers. Rules prevent employees from changing jobs while waiting for their green cards — even to other jobs in the same company. H-1B visas for temporary stays allow employers to replace U.S. workers with people who are paid less than they should be, given their skills. This is one of Silicon Valley’s darkest secrets — and it is why tech companies lobby for more H-1B visas rather than more green cards. Skilled people become frustrated as their careers stagnate. The jobs that would have been created in startups go overseas.

Unless it changes its immigration outlook, the U.S. will forgo economic benefits and jobs in a misguided effort to protect both. It will have to watch as the rest of the world leaps ahead. It doesn’t have to be this way.

Embrace outsiders

The U.S. needs to expand the number of permanent-resident visas and clear the backlog. These people are already working in the country legally and have the experience and skills needed. Retaining them will boost the economy. Accelerated granting of permanent residency could be contingent on buying a house, making investments or starting companies that create jobs. Imagine the benefits of 10,000 new technology startups.

“The U.S. needs to decide whether it wants the innovators on its side.”

We need to make it easy for entrepreneurs abroad to bring startup firms to the U.S. One solution is to provide a “startup visa” as a path to permanent residency. This would perhaps be valid for five years, with an upgrade to permanent residency dependent on the firm’s employment of U.S. workers. The Kauffman Foundation in Kansas City, MO, has estimated that such a visa would create 1.6 million jobs within 10 years and boost the U.S. economy by $224 billion a year.

See also: What Trump Means for Best Practices

The solution to the mistreatment of foreign workers is easy: untether the H-1B visa from the employer. Let people change jobs, and let the market decide what their salaries should be. This would remove the financial incentives for companies to replace Americans with cheaper foreign workers and would encourage them to hire the best talent.

By becoming the best place in the world for entrepreneurs to study and work in, the U.S. could again be in the driving seat of technology innovation. Then we can share the resulting prosperity in a more equitable way to mitigate the anger of the electorate.

Venture Capital and Tech Start-ups

Unicorns – to some they are just mythical creatures of lore. To today’s tech world, a unicorn is a pre-IPO tech start-up with a billion-dollar market value. These are the companies driving innovation, technology and disruption in every corner of every business, and their impact is truly being felt across the insurance industry.

The number of unicorns is as elusive as the creatures themselves, as the herd is growing rapidly.

“Fortune counts more than 80 unicorns today, but more appear with each passing week. Some even received their horns, so to speak, as the magazine went to press. And they’re getting bigger — there are now at least eight ‘decacorns,’ unicorns valued at $10 billion or more. So much for being mythical.” — Fortune

Recognizing the powerful sway that unicorns have over new technologies, business models and more, insurers are now getting into the unicorn game themselves. They are identifying technology start-ups that can transform insurance and are becoming venture capitalists to tap into this great potential for creating the next generation of insurance.

Different models and approaches are being used to identify, assess and influence these companies’ offerings. By understanding the benefits of outside-in thinking, insurers are finding ways to leverage these innovations. Some insurers are partnering with leading technology firms. Some of the large insurers are setting up their own venture capital firms. Still others are creating consortia to fund new start-ups to help accelerate innovation.

Insurers and Unicorns

The following are a few examples of new partnerships in 2015; the trend is continuing;

AXA– In February 2015, AXA announced the launch of AXA Strategic Ventures, a €200M fund to boost technology start-ups focused on customer acquisition, climate change, travel insurance and more. The goal is to advance AXA’s digital and customer strategy by connecting with new technologies, new solutions,and new ways of thinking. The company anticipates the fund will complement AXA’s major operating investments, across all entities, into research and digital developments that will help transform how customers experience AXA.

XL Insurance – On April 1, 2015, XL Insurance announced the formation of a venture capital fund, XL Innovate, to support insurance technology start-ups, with a focus on developing new capabilities in the insurance sector. XL indicated that this effort would extend its capabilities in existing markets and give it new opportunities to address some of the most pressing and complex risk problems in the global economy. In addition, XL sees it as a critical element to driving focus on innovation forward while securing relevance in the future.

Global Insurance Accelerator – In February 2015, a group of seven Iowa-based insurers announced the formation and launch of the Global Insurance Accelerator (GIA), an insurance accelerator for start-ups. The start-ups receive $40,000 in seed money from the pool to create a minimum viable product to present to the Global Insurance Symposium. The insurers involved believe that the accelerator program will bring potential innovation and technology insights to the insurance industry.

The Future

Innovation, technology and the need to be future-ready are fueling today’s unicorns and their capital supporters rapidly expanding the herd. In turn, these new business models and market leaders are spawning challenges and opportunities for all companies.

Today’s forward-thinking insurance companies are running their businesses while simultaneously creating their futures as Next-Gen insurers. It’s critical to recognize the power and benefits of innovation and the role that unicorns play in planning for tomorrow.

This is a decisive time as Next-Gen insurers emerge along with their unicorns to disrupt and redefine insurance and competitive advantage. What is your company’s approach to leverage and experiment with emerging technologies, start-ups and unicorns to fuel the potential and enable future market leadership?