Tag Archives: venture capital

Is Insurtech a Game Changer? It Sure Is

Several years ago, property and casualty insurance executives were looking over their shoulders anxiously at a growing number of internet startups. Who were these scruffy people wearing black turtlenecks? Could they really “disintermediate” legacy providers that had been around for a century or more?

Since then, we’ve all evolved. By now, most brands know they have inherent strengths that are hard to dislodge. The startups have matured, too, and they clearly have something to offer the market. We’re now working with companies in both camps, helping them navigate this new normal, where collaboration, acquisition and competition are all plausible options.

Some insurers may think they’ve dodged a bullet. But insurtech’s threat is more stealthy, and no less powerful.

Insurtech: the new, new thing?

At this fall’s InsureTech Connect trade show, literally thousands of people descended on Las Vegas to show and examine the latest offerings, from core systems, predictive analytics tools and anything-as-a-service to pitches addressing distribution, pursuing unserved niche markets, offering comparative pricing and broker services and more.

In our recent report on the state of insurtech, we cautioned insurers to look beyond the many truly interesting offerings now coming to market. As impressive as these tools are, we urged decision makers to stay focused on the capabilities that make their companies unique.

See also: Has a New Insurtech Theme Emerged?  

What do insurers really do?

So, what are those capabilities? At holiday dinner tables, you may find yourself talking to a relative about what insurance is, and why it’s important. You may say something like, “We create products that help manage risk by sharing the possibility of individual loss with a larger pool of users.” This explanation held true for a long time, but,
with the rise of insurtech, it may not be the best way to look at your business.

That’s because many insurtech companies have emerged to manage the firehose of data that now shapes our world: the Internet of Things (IoT), wearable health devices, connected cars, artificial intelligence and more. Of course, there’s still a role for insurers when someone else captures and gets the insight from that data. But it’s a commodity role, driven by who is willing to write a policy to offset the risk at the lowest rate. There won’t be many winners, and the margins won’t be attractive.

Some insurers see their business as settling claims and handing out checks. But when someone else is using telematics to assess driving habits, or social media to understand lifestyle risks, who will be able to monetize this data? Increasingly, underwriting depends on getting deep into the data-driven weeds. If you’re not there, recognize that someone else will be.

The rise of outside money

There’s another factor shaping insurance today: the amount of private equity (PE) and venture capital (VC) money flooding into the industry. An industry as highly capitalized as insurance was bound to have external investors come knocking eventually. Now, they have.

To be blunt, many insurance systems are too costly and too slow. PE and VC firms have seen this, and they’ve said to themselves, “I don’t have to be perfect, and I know I can be more efficient than this. Even if I’m only a little bit better than the legacy players, I can make a very healthy profit.” It’s a form of arbitrage, and competition could soon get a lot tougher.

With the acceleration of insurtech and related technologies such as cloud and artificial intelligence, PE and VC firms have found a way in that doesn’t require them to show a century of stability. They can do very well developing an insurtech play for very specific aspects of the P&C value chain. Many traditional companies are finding themselves in a commoditized business, without the structure of a commodity manufacturer.

Finding your way to play

Some of the most exciting developments in technology are now reshaping the insurance industry. That spells new opportunities and new risks. With the rise of PE and VC funding, we now see competition emerging from companies with significant resources—and they’re privately held so they can be more patient investors.

See also: Advice for Aspiring Leaders in Insurtech  

Legacy insurance companies still have enormous advantages, and many opportunities to win. But most won’t be able to do it alone, and there are many examples of insurers that wasted time (and money) on the wrong insurtech acquisition or partnership. As the cycles of innovation and capital movement accelerate, you’ll need to be more focused than ever on the capabilities that make your company great. Insurtech is a game-changer.  Make sure you’re playing the right game.

Where Silicon Valley Is Wrong on Innovation

Silicon Valley exemplifies the saying, “The more things change, the more they stay the same.” Very little has changed over the past decade, with the Valley still mired in myth and stale stereotype. Ask any older entrepreneurs or women who have tried to get financing; they will tell you of the walls they keep hitting. Speak to VCs, and you will realize they still consider themselves kings and kingmakers.

With China’s innovation centers nipping at the Valley’s heels, and with the innovation centers that Steve Case calls “the rest” on the rise, it is time to dispel some of Silicon Valley’s myths.

Myth 1: Only the young can innovate

The words of one Silicon Valley VC will stay with me always. He said: “People under 35 are the people who make change happen, and those over 45 basically die in terms of new ideas.” VCs are still looking for the next Mark Zuckerberg.

The bias persists despite clear evidence that the stereotype is wrong. My research in 2008 documented that the average and median age of successful technology company founders in the U.S. is 40. And several subsequent studies have made the same findings. Twice as many of these founders are older than 50 as are younger than 25; twice as many are over 60 as are under 20. The older, experienced entrepreneurs have the greatest chances of success.

Don’t forget that Marc Benioff was 35 when he founded Salesforce.com; Reid Hoffman 36 when he founded LinkedIn. Steve Jobs’s most significant innovations at Apple — the iMac, iTunes, iPod, iPhone and iPad — came after he was 45. Qualcomm was founded by Irwin Jacobs when he was 52 and by Andrew Viterbi when he was 50. The greatest entrepreneur today, transforming industries including transportation, energy and space, is Elon Musk; he is 47.

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

Myth 2: Entrepreneurs are born, not made

There is a perennial debate about who can be an entrepreneur. Jason Calacanis proudly proclaimed that successful entrepreneurs come from entrepreneurial families and start off running lemonade stands as kids. Fred Wilson blogged about being shocked when a professor told him you could teach people to be entrepreneurs. “I’ve been working with entrepreneurs for almost 25 years now,” he wrote, “and it is ingrained in my mind that someone is either born an entrepreneur or is not.”

Yet my teams at Duke and Harvard had documented that the majority, 52%, of Silicon Valley entrepreneurs were the first in their immediate families to start a business. Only a quarter of the sample we surveyed had caught the entrepreneurial bug when in college. Half hadn’t even thought about entrepreneurship even then.

Mark Zuckerberg, Steve Jobs, Bill Gates, Jeff Bezos, Larry Page, Sergey Brin and Jan Koum didn’t come from entrepreneurial families. Their parents were dentists, academics, lawyers, factory workers or priests.

Anyone can be an entrepreneur, especially in this era of exponentially advancing technologies, in which a knowledge of diverse technologies is the greatest asset.

Myth 3: Higher education provides no advantage

Thiel made headlines in 2011 with his announcement that he would pay teenagers $100,000 to quit college and start businesses. He made big claims about how these dropouts would solve the problems of the world. Yet his foundation failed in that mission and quietly refocused its efforts and objectives to providing education and networking. As Wired reported, “Most (Thiel fellows) are now older than 20, and some have even graduated college. Instead of supplying bright young minds with the space and tools to think for themselves, as Thiel had originally envisioned, the fellowship ended up providing something potentially more valuable. It has given its recipients the one thing they most lacked at their tender ages: a network.”

This came as no surprise. Education and connections are essential to success. As our research at Duke and Harvard had shown, companies founded by college graduates have twice the sales and twice the employment of companies founded by others. What matters is that the entrepreneur complete a baseline of education; the field of education and ranking of the college don’t play a significant role in entrepreneurial success. Founder education reduces business-failure rates and increases profits, sales and employment.

Myth 4: Women can’t succeed in tech

Women-founded firms receive hardly any venture-capital investments, and women still face blatant discrimination in the technology field. Tech companies have promised to narrow the gap, but there has been insignificant progress.

This is despite the fact that, according to 2017 Census Bureau data, women earn more than two-thirds of all master’s degrees, three-quarters of professional degrees and 80% of doctoral degrees. Not only do girls surpass boys on reading and writing in almost every U.S. school district, they often outdo boys in math — particularly in racially diverse districts.

Earlier research by my team revealed there are also no real differences in success factors between men and women company founders: both sexes have exactly the same motivations, are of the same age when founding their startups, have similar levels of experience and equally enjoy the startup culture.

Other research has shown that women actually have the advantage: that women-led companies are more capital-efficient, and venture-backed companies run by a woman have 12% higher revenues, than others. First Round Capital found that companies in its portfolio with a woman founder performed 63% better than did companies with entirely male founding teams.

See also: Innovation — or Just Innovative Thinking?  

Myth 5: Venture capital is a prerequisite for innovation

Many would-be entrepreneurs believe they can’t start a company without VC funding. That reflected reality a few years ago, when capital costs for technology were in the millions of dollars. But it is no longer the case.

A $500 laptop has more computing power today than a Cray 2 supercomputer, costing $17.5 million, did in 1985. For storage, back then, you needed server farms and racks of hard disks, which cost hundreds of thousands of dollars and required air-conditioned data centers. Today, one can use cloud computing and cloud storage, costing practically nothing.

With the advances in robotics, artificial intelligence and 3D printing, the technologies are becoming cheaper, no longer requiring major capital outlays for their development. And if entrepreneurs develop new technologies that customers need or love, money will come to them, because venture capital always follows innovation.

Venture capital has become less relevant than ever to startup founders.

Game Theory and Insurtech

One of the hottest topics in insurance industry forums, the news and many prognosticators/speakers’ commentary is that there could be a threat to the insurance industry because of insurtech — that the insurance industry will be revolutionized and that incumbents should be in defense mode to retain their business.

That threat carries some credibility, but there is some issue with many of the forecasts out there.

I think the thought process is somewhat flawed, for two reasons:

  1. Rarely is anyone putting a time-frame on their predictions. Anyone can predict something with no time-frame and, hence, have no accountability if they are wrong. This is like the fortune teller stating, “You will die in the future.” Although that fortune is accurate, you might feel ripped off if you paid for it.
  2. The predictions seem to be coming from a vacuum and don’t include thoughts on game theory. Some predictions rarely account for or think about incumbents; the incumbent insurer advantage and reaction; and how long the insurtech investor can realistically wait for outcomes/results.

Let’s focus on No. 2.

Game Theory

Game theory is the branch of mathematics concerned with the analysis of strategies for dealing with competitive situations where the outcome of a participant’s choice of action depends critically on the actions of other participants. Game theory has been applied to war, business and biology.

But this art/science isn’t discussed when predictions about the industry are presented.

A basic thought is, if insurtech is going to threaten incumbent insurers, how do we think the incumbents will react?

Incumbent Insurer Options

Incumbents have a few options regarding insurtech:

  • Imitate — recapture market position once insurtech has revealed that an approach works. Each company can develop new technologies to improve operating efficiencies, source risk quicker, understand exposures better, etc.
  • Wait Longer– for the success of an approach to be revealed. If customers don’t react to a new technology or the advantage is not apparent in results, no resources were wasted. If you’ve read Good to Great in insurance or “Good to Great,” the book, think about the flywheel or the Walgreens example. The ability to wait is greater for incumbents in insurances, as insurance markets are not a winner-takes-all.

See also: Complexity Theory Offers Insights (Part 1)  

Incumbent Advantage

Incumbents have a huge advantage; they have customers, capital, track record for sourcing risk, systems, platforms, regulatory framework aligned, etc. Newcomers have to take riskier strategies to move into the ranks of the incumbents.

If incumbent insurers use simple game theory strategies, they have a lot of benefit.

A defensive position by incumbent insurers can affect timing, forecasted results, market share, etc., ultimately delaying insurtech investors from seeing the gains or traction they were hoping for or predicted at the time of the investment. This delay could change exit strategies for investors.

Venture Capitalist business model

Many of the funds coming into the insurtech space are from venture capital firms. An investment from a venture capitalist typically is a form of equity financing — the VC investor supplies funding in exchange for taking an equity position in the company.

According to Harvard Business Review, “Venture money is not long-term money. The idea is to invest in a company’s balance sheet and infrastructure until it reaches a sufficient size and credibility so that it can be sold to a corporation or so that the institutional public-equity markets can step in and provide liquidity. In essence, the venture capitalist buys a stake in an entrepreneur’s idea, nurtures it for a short period of time and then exits with the help of an investment banker.”

The investors in VC funds expect a return of between 25% and 35% per year over the lifetime of the investment. This is because of the nature of the risk.

For every deal that doesn’t go as planned, VC firms need those with great hockey-stick-returns to meet this expectation from investors.

Insurtech investors/Market Cap

Other questions would be around the market multiple given to an insurance company versus a technology company. Are those companies that are positioning themselves as the “future of insurance companies” taking a prudent approach in trying to unseat incumbents? Is it better to be a servicing company over a disruption startup? Given the timing and investor strategy, would insurtech companies be better off positioning themselves as technology services companies for the insurance industry versus insurance companies with great technology? At least it’s safer for the investor at the time of sale…

If an investor is looking for an exit strategy, would it prefer a multiple of earnings similar to an insurance company or a publicly traded tech company?

Capital Into Insurtech

Despite the influx of capital into insurtech recently, funding to this sector may be flattening in 2017. (There are a few articles written about this at Insurance thought Leadership and others.)

Based on funding patterns, it appears at least $2-3 billion a year is now going into “Series B” and “Series D” funding — meaning into existing companies that have been around for at least a couple of years.

Margin Compression

Who is better suited for margin compression to be removed from the system?

If you look at Uber, transportation services companies were loaded with debt (NYC medallions cost around $1 million) and insulated by a regulatory framework that supported that debt. In addition, the downward pressure on the cost of a ride to the airport was immediate and seen in real time by both the consumer and the seller. So, transportation was ripe for disruption driven by consumer demand

With insurance companies, the pressure will take time to shake out. Because the cost of goods sold (or losses) is unknown at the time of sale, the ability to decrease costs is somewhat limited to expense savings.

Again, advantage incumbent — at least until you can prove that technology works and has passed savings to the customer through enhanced loss-cost prediction and risk selection.

With incumbent insurers sitting on mountains of cash/bond portfolios as insulation to the margin compression, some companies can achieve low single digit ROEs just on their investment portfolio alone, even before underwriting results. So, who is better suited for the decrease in margin? Where should investors be putting their capital for the long term?

See also: Einstein’s Theory on Work Comp Outcomes  

Thoughts

Incumbents are going to react and defend their positions and acquire teams or technology that have proven to help (lower expenses, acquire customers, etc.). VC investors are going to push for exit strategies or sales to incumbent insurers over the next five to six years and will look for new investment opportunities.

This article isn’t intended to make incumbents feel warm and cozy about the state of the market. There definitely will be some disruptions of certain sectors of the industry. However, if you’re looking to compare the disruption of Uber to the insurance industry, I believe it will be an uphill battle to disrupt insurance in a similar fashion. (Thanks, McCann-Ferguson).

But anything is possible. Don’t get complacent and disregard the consumer.

The insurance industry is in need of a technology shakeup — and one would benefit the customer, the insurers, the insurance incumbent investors and many of the insurtech founders/VC firms.

Slump in VC Spending on Cyber?

Venture capital funding in cybersecurity is cooling. And it’s show-me time for startups battling for the dwindling pool of funds.

While the cybersecurity market is maturing, startups are still innovation drivers and venture capitalists are keen on finding the next big unicorns. Large enterprises’ tendency to juggle products from multiple vendors—despite their wishes for seamless, one-vendor-only solutions—leave the market perpetually fragmented. And the fact that cybersecurity threats are evergreen enables venture capitalists who specialize in the sector to operate with little regard for broader macroeconomic conditions.

Still, the ample opportunities afforded by the fragmented, constantly shifting market have bred too many me-too companies and fast followers, driving some venture capitalists to pause and reflect on the next phase. “It’s definitely overfunded, massively so,” Ravi Viswanathan of New Enterprise Associates told a panel at CB Insights’ Future of Fintech Conference last year.

After growing steadily since 2012, venture capital funding in cybersecurity dipped in 2016, alarming entrepreneurs. The cybersecurity market captured roughly $3.1 billion of venture funding in 2016, down from $3.8 billion a year earlier, according to research firm CB Insights.“You saw a material pause in the fourth quarter,” says Bob Ackerman, founder and managing director of Allegis Capital, which specializes in the sector. “You have too many undifferentiated companies. There’s a level of noise that develops as a result of that. … Cybersecurity is one of those areas where experience and domain knowledge matter a great deal.”

See also: Quest for Reliable Cyber Security  

The cybersecurity market will undergo a few years of retrenchment with a host of companies shutting down, VCs say.

More judicious spending

But the market is hardly mature. Money will still be spent, just more selectively. At this phase, fewer deals will be struck. But those deals will be reserved for larger companies, with proven products further along in development.

“The deal size and valuation is coming down a bit,” says Sean Cunningham, managing director of Trident Capital Cybersecurity, which raised $300 million this month for a fund to invest in cybersecurity startups. “I don’t think there’s any shortage of capital for the right type of companies. But the dollars being invested are smaller.”

Appthority is one of the companies that made Trident’s cut. Appthority, which develops mobile threat protection software for corporations, didn’t land its first paying customer until more than a year after it was founded in 2011.

Four years later, its customer renewal rate stands at 98 percent, with about 20 percent of its revenue coming from the government sector. Heartened by solid proof of growth, venture capitalists poured in another $7 million in Series B funding last July, led by Trident Capital Cybersecurity.

“You’re going to see a lot of startups out there, and good ones will rise to the top,” Cunningham says. “There’s ample supply of capital to fund them. They can get traction.”

Innovation niches

As seen in the early days of the internet, the cybersecurity market is recalibrating for a second wave of innovative technology that’s more comprehensive and cohesive. And that means more seamless products for large clients who are eager to cut down on the number of vendors.

“Companies that can stand on their own two feet, deliver value, and have deep knowledge will do fine,” Ackerman says, citing one of the companies he’s invested in, EnVeil, which uses “homomorphic encryption” to secure data in operation.

As more companies employ automation and “big data” to enhance efficiency and find new markets, data encryption products will continue to be in heavy demand.

The emergence of the industrial internet—the integration of complex machines to network sensors and software—also will breed startups eager to provide cybersecurity solutions to power and water grids, refineries and pipelines.

In May, Trident helped raise $6.6 million in Series A funding for Bayshore Networks, which develops cloud-based software that offers “visibility” into operational technology infrastructure, networks, machines and workers.

Meanwhile, the proliferation of enterprise mobile devices will continue to see vulnerabilities and pose a ripe market for startups like Appthority, Cunningham says.

Early investors haven’t gone away

That VC dollars are chasing more evolved companies doesn’t mean early-stage investing is passé, Ackerman says. “That’s where the new things get started.”

But cybersecurity, unlike more consumer-oriented technology sectors, is a competitive and difficult market, rife with startups struggling to recruit and market products.

See also: Paradigm Shift on Cyber Security  

That’s partly why Allegis funded DataTribe, a startup studio based in Fulton, Maryland. It was designed to tap into the wealth of cybersecurity-savvy technologists in the region with experience or ties to the federal government and intelligence agencies.

Ackerman also anticipates more mergers and acquisitions activity from large cybersecurity companies that may find it easier to acquire smaller niche players as they seek to add new product lines.

As venture capitalists squeeze their wallets, startups lucky enough to land Series A funding also will have to justify more vigorously their pursuit of Series B funding, Cunningham says. “And unicorns are in trouble,” he says, referring to startups valued at over $1 billion.

The Trump factor

Meanwhile, venture capitalists are hopeful that the federal government, with President Trump at the helm and promising a rollback in regulations, will cut steps in federal procurement and stay engaged in securing networks.

“We think the administration understands the value of national cybersecurity,” Cunningham says. “We’re not counting on incremental increases in spending. But we’re excited about the awareness level.”

This post originally appeared on ThirdCertainty. It was written by Roger Yu.

A Simple Model to Assess Insurtechs

“The paradox of teaching entrepreneurship is that such a formula necessarily cannot exist; because every innovation is new and unique, no authority can prescribe in concrete terms how to be innovative.”

― Peter Thiel, Zero to One

Whether we’re talking about telematics, artificial intelligence (AI), digital distribution or peer-to-peer, investing in insurance-related technology (commonly termed “insuretech” or “insurtech”) is no longer considered boring. In fact, insurtech is one of the hottest investable segments in the market. As a 20-plus-year veteran in insurance, I find it surreal that insurance has become this hip. Twenty years ago, I gulped as I sent an email to the CFO of my company, where I proposed that there was a unique opportunity in renters insurance. That particular email was ignored. Today, that idea is worth millions of dollars.

What changed?

Insurance seems to be the latest in a string of industries caught in the crosshairs on venture capital. With the success of Uber and AirBnB, VCs are now looking for the next stale industry to disrupt, and the insurance industry carries the reputation of being about as stale as they come. The VCs view the needless paperwork, cumbersome purchasing processes, dramatic claims settlement and overall old-school look and feel of the industry and think they can siphon those trillions of dollars of premium over to Silicon Valley. It seems like a reasonable thesis.

The problem is, it’s not going to happen that way. Insurance will NOT be disrupted. While insurance looks old and antiquated on the exterior, it is actually quite modern and vibrant on the interior. The insurance industry is actually the Uncle Drew of businesses; it’s just getting warmed up!

The Model

Much of the reason I think VCs are unaware of their doomed quest for insurance disruption is that they are looking at the market from a premium standpoint and envisioning being able to capture large chunks of it. $5 trillion is a lot of money. Without an appropriate model, an outsider coming into insurance can naively think they can capture even a fraction of this. But premium is strongly tied to losses. Those premium dollars are accounted for in future claims.

I once had a VC ask me what the fastest way to $100 million in revenue was. The answer is easy, “slash the premium.” I had to quickly follow up with, “and be prepared to be go insolvent, as there is no digging yourself out of that hole.” He didn’t quite get it, until I walked him through what happens to a dollar of premium as it enters the system. And it was this that became the basis of the model I use to assess new product formation and insurtech startups.

There are four basic components to my model. Regardless of new entrants, new products or new sources of capital, these four components remain everpresent in any insurance business model. Even if a disruptive force was able to penetrate the industry veil, that force would still need to reflect its value proposition within my four components.

Component 1 – EXPOSURE

This is the component that deals with insurance claims: past, present and future. Companies or products looking to capture value here must be able to reduce, prevent, quantify or economically transfer current or new risks or losses. Subcomponents in this category include expenses arising from fraud and the adjustment of claims, both of which can add substantially to overall losses.

See also: Insurance Coverage Porn  

Startups such as Nest are building products that increase home security by decreasing the likelihood of burglary (or increasing the likelihood of capturing the criminals on video) and thus reduce claims associated with burglary or theft. Part of assessing the value proposition of Nest is to first understand the magnitude of the claims associated with burglary and theft and then quantify what relief this product could provide (along with how that relief should be shared among stakeholders).

Another company that is doing some interesting things in this model component is Livegenic (disclaimer: I have become friends with the team). Livegenic allows insurers to adjust claims and capture video and imagery using the mobile phone of the insured. This reduces the expenses associated with having to send an adjuster out to each and every claim. Loss adjustment expenses can be in excess of 10% of all claims, so technology that reduces that by a few basis points can be quite valuable to an insurer’s bottom line and ultimately its prices and competitiveness.

Component 2 – DISTRIBUTION

This component focuses on the expenses associated with getting insurance product into the hands of a customer. Insurtech companies in this space are typically focused on driving down commissions. This can be done by eliminating brokers and going directly to customers. Savings can also be achieved by creating efficient marketplace portals that allow customers to easily buy coverage.

Embroker is one of many companies trying to do just that in the small commercial space by creating a fully digital business insurance experience. Companies such as Denim Labs are providing social and mobile marketing services to companies in insurance. And then there is Lemonade, which is developing AI technology that it hopes will reduce the friction of digitally purchasing (its) insurance and making the buying process “delightful.”  Peer-to-peer (P2P) insurance is a fairly new insurtech distribution model that attempts to use the strength of close ties via social methods for friends and close associates to come together to make their own insurance pools.

Distribution expenses in insurance are some of the highest in any industry. As with the risk component, reducing expenses in this component by even a few basis points is incredibly valuable.

Component 3 – CAPITAL

This component focuses on the expenses associated with providing capital or the reinsurance backstop to a risk or portfolio. For many insurers, reinsurance is the largest expense component in the P&L. Capital is such an important component to the business model that the ramifications of it almost always leak into the other components. This was one of my criticisms of  Lemonade recently. Lemonade will have a lot of difficulty executing some of the aspects of its business model simply because it cedes 100% of its business to reinsurers. So, when it comes to pricing or its general underwriting guidelines, its reinsurance expenses will overwhelm other initiatives. Lemonade can’t be the low-cost provider AND a peer-to-peer distributor because its reinsurance expenses will force it to choose one or the other. This is a nuance that many VCs will miss in their evaluation of insurtechs!

For those seeking disruption in insurance, we have historical precedent of what that might look like based on the last 20 years of alternative capital flooding into the insurance space. I will devote space to this in future articles, but, in brief, this alternative capital has made reinsurance so inexpensive that smaller reinsurers are facing an existential crisis.

Companies such as Nephila Capital and Fermat Capital are the Ubers of insurance. Their ability to connect investors closer to the insurance customer along with their ability to package and securitize tranches of risk have shrunk capital expenses tremendously. Profit margins for reinsurers are collapsing, and new business models are shrinking the insurance stack. It is even possible today to bypass BOTH veritable insurers and reinsurers and put the capital markets in closer contact with customers. (If you are a fan of Michael Lewis and insurance, you will enjoy this article, which ties nicely into this section of the article).

In the insurtech space, VCs are actually behind the game. Alternative capital has already disrupted the space, and many of the investments that VCs are making are in the other components I have highlighted. Because of the size of this component, VCs may have already missed most of the huge returns.

Component 4 – OPERATIONS

The final component is often the one overlooked. Operations includes all of the other expenses not associated with the actual risk, backing the risk or transferring the risk from customer to capital. This component includes regulatory compliance, overhead, IT operations, real estate, product development and staff, just to name a few.

It is often overlooked because it is the least connected to actually insuring a risk, but it is vitally important to the health and viability of an insurer. Mistakes here can have major ramifications. Errors in compliance can lead to regulatory problems; errors in IT infrastructure can lead to legacy issues that become very expensive to resolve. I don’t know a single mainstream insurer that does not have a legacy infrastructure that is impinging on its ability to execute its business plan. Companies such as Majesco are building cloud-based insurance platforms seeking to solve that problem.

See also: Why AI Will Transform Insurance  

It is this component of the business model that allows an insurer to be nimble, to get products to market faster, to outpace its competitors. It’s not a component that necessarily drives financial statements in the short term, but in the long run it can be the friction that grinds everything down to a halt or not.

SUMMARY

I have presented a simple model that I use when I assess not just new insurtech companies but also new insurance products coming into the market. By breaking the insurance chain into these immutable components, I can estimate what impact the solution proposed will provide. In general, the bigger the impact and the more components a solution touches the more valuable it will be.

In future articles, I will use this model to assess the insurtech landscape. I will also use this model to assess how VCs are investing their capital and whether they are scrutinizing the opportunities as well as they should, or just falling prey to the fear of missing out.

Originally published at www.insnerds.com,