It is probably a bit presumptuous to liken the insurtech startup movement to Hamlet’s famous “To be or not to be” soliloquy. It is, after all, a well-known and historical Shakespearean reference. However, the similarity is in the questions asked, and such a question has probably been asked prior to many defining moments. And just as Hamlet pondered many questions, there are many questions that revolve around the state of the insurtech movement. At this juncture, some five years into this movement, the one question that has most likely gone by the board is – Is it real? You can debate whether we are at the beginning of the insurtech cycle or at the end. However, there are several strong points in favor of the fact that it is real.
SMA has been following the insurtech startup trends since 2013. Currently, we track approximately 1,200 insurtechs. It is definitely a fluid number. Some startups go out of business, and others come in to fill the void at a regular pace. In the 2013-2015 timeframe, the insurtech startup landscape was a tsunami of activity – it was difficult to get one’s arms around what was happening. In the latter half of 2017, some strong realities emerged. SMA’s recently released research findings have revealed several major insurtech trends or themes that are specific to insurance and have meaningful implications for the industry. In response to the “is this real” question, three of the 10 themes anchor the insurtech movement firmly in reality.
Insurtech has spread to all tiers and lines of business – Originally, most of the activity was in personal lines and health. Now, of the P&C contingent, which SMA data indicates is 39% of all the activity, a little over half is personal lines; 35% is commercial lines; 13% is workers’ comp. Historically, technology providers have targeted particular tiers for their sales efforts. The startup community targets insurance business problems without a specific tier focus. What this means is that insurers of all sizes are able to adopt insurtech-provided technology. SMA partnering data shows that there are insurtechs with customers ranging from top 10 insurers down to single-state insurers. The bottom line: The fact that insurtech is not focused on the top echelon of global players but rather on business problems across the insurance ecosystem lends itself to the “it’s real” theme.
Live implementations are increasing – Not surprisingly, in the beginning of the startup movement, most of the activity was around fundraising and proofs of concept. In 2017, and continuing at an accelerating pace in 2018, insurer “go lives” are happening. Some insurtechs have 10, 12 or more insurer logos on their websites. These are not investor listings; they are the names of insurers that are rolling out capabilities in the marketplace. In particular, drone usage, smart home/connected property and connected vehicle initiatives are common and growing. The “it’s real” indicator is that insurers are not going to roll out technology that affects their customers just for the fun of it – customers are not guinea pigs. Insurers are seeing the value in insurtech offerings and are executing.
Insurtechs are partnering – While there is nothing wrong with a technology provider staying in their space, a long-standing trend within the insurance industry has been partnering for greater value. This has not escaped the attention of a number of insurtechs. For example, Bold Penguin and Ask Kodiak have partnered, as have Elafris and Hippo and Betterview and Understory. Mature technology providers also see the value of startup partnering; for example, Willis Towers Watson and Roost, Verisk Analytics and Driveway. Majesco partners with a network of insurtechs. The “it’s real” factor is that insurtechs are not simply attempting to see what they can do just for today – but, rather, what they can do for the long haul, to become strategic contributors within the insurers they work with.
While there are still questions about the insurtech movement, one of them should not be – Is it real? Business value is being generated by many startups – and no insurer is going to walk away from that. New channels and service opportunities are emerging that are generating interest and execution. New products are sprouting up at a regular pace. Not every startup and every idea is going to be a winner, but many will be. And some already are. Bottom line? Both Hamlet and Shakespeare would be proud of the insurance industry for seeing the possibilities and not just the questions.
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.
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.
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.
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?
Employers looking to dial up the correct mix of benefits to retain valued employees are increasingly including identity theft protection services as a perk.
Research firm Willis Towers Watson predicts identity theft protection, offered by 35% of employers in 2015, could double to nearly 70% by 2018, making it the fastest-growing type of employee benefit over the next couple of years.
ThirdCertainty recently sat down with Joel Ray, the CEO of New Benefits, a Dallas-based employee benefits solutions provider, to discuss the drivers — and the arc — of this trend. The following text has been edited for clarity and length:
3C: Identity theft has become part of the lexicon of the world we now live in.
Ray: With all the hacking of corporations, health plans and government, there is a myriad of ways people can get their identities stolen and misused, whether it’s medical fraud, tax return fraud, stealing a Social Security number or a credit card information scam.
To me, not protecting yourself with an identity theft protection service is commensurate with not locking your door and setting an alarm when leaving home or not buying life insurance to protect your family. It just makes all the sense in the world, when you have the ability and a product is available to address identity theft, to include this as an employee benefit.
3C: So how do employers view this?
Ray: Employers were the first ones decades ago to offer health insurance to their employees, and early adopters have added other types of benefits over the years. The idea, of course, is to attract and retain good people . … Research shows an employee’s financial health is every bit as important as physical and mental health. If anything goes wrong (financially), they are not going to be a productive worker. Meanwhile, identity theft happens every two seconds in the U.S. to quite a large number of Americans. So, identity theft protection is something that, in today’s digital world, makes perfect sense to provide employees, either on an employer-paid or payroll deduction basis.
3C: How much of a challenge is public awareness?
Ray: The hard part is the education. Yet the almost daily reports about breach events have gotten employers more interested. We’ve had many (benefits) brokers representing our products say that, for the first time, employers are asking for identity theft protection.
It really is the brokers in today’s world who act as consultants regarding the latest and greatest new products. And, typically, identity theft is toward the top of the list — if not at the top of the list.
Ray: Identity theft protection is like any other benefit. Basically, anything you can do to provide financial security to your employee is a good thing. It’s a primary reason employers provide 401Ks. A lot of voluntary benefits, like cancer disability, critical illness and dental, charge a lot more for family coverage. This one charges a little bit more, but you get financial security and protection, not only for the employee but for the entire family, as well. It’s a very inexpensive benefit relative to the protection it offers, and I think it will become a staple of the industry in the very near future. The early adopters who provide this benefit to their clients now are going to have market advantage over those who wait.
3C: Sort of like supplying peace of mind as a benefit?
Ray: Yes. For example, employees buy life insurance for peace of mind so the family is protected in case of an untimely death. With identity theft protection, employees and their families are protected from something that happens every day from thieves who always seem to be one step ahead and out of reach from the law. If you’re an employer, wouldn’t you rather offer your employees a benefit that will meaningfully protect them from financial harm versus other benefits that, based on the historical record, may not add any real value?
Insurance Europe’s International Insurance Conference touched on some critical friction points between government and industry. Capital standards, consumer protection and climate risk resilience have grabbed the headlines, but important new ground was trodden when industry leaders began adding a new policy challenge to the industry’s agenda: the intersection of insurance and technology.
Axa’s Cecile Wendling summed up the challenge when she asked how we are going to regulate this new world of a fully digitized insurance market. But it was XL’s Mike McGavick who put it in context — as only CEOs can do — by suggesting insurers could be “the next taxi cab industry” if they don’t get their regulatory issues right.
These are fundamental questions that deserve greater attention in the growing dialogue around technology and insurance. Tomorrow’s insurance buyers — more tech-savvy, empowered and diverse than today’s — are already demanding an insurance market that reflects the full potential inherent in technology-enabled disruption; the question is whether the industry and its regulators are prepared to meet that demand. Early signs suggest no.
According to a BCG study, insurers rank near the bottom of online customer satisfaction, a reflection of how little the industry has invested in digitizing its approach to engaging customers. Similarly, a recent J.D. Power survey captured consumers’ frustrations with insurers’ web-based services, the most basic of all digital engagement platforms.
However, despite this track record, one soon-to-be-dominant demographic still trusts the sector to get it right: millennials. Consumers in the 18-35 cohort actually trust the insurance sector 16% more than the public at-large does. This “trust premium” is at risk, though, if insurers are unwilling or unable to make the transition to a tech-enabled market.
In fact, two Willis Towers Watson surveys illustrate just how comfortable millennials are with where the market is going — even if so many of us are still just starting the journey to get there. First, millennials prefer usage-based insurance to coverage based on conventional determinants (such as age and gender) 19% more than the general public. And second, millennials are nearly 60% more likely than anyone older to change their driving behavior to obtain cheaper car insurance. To exceed these expectations, insurers are going to need to fundamentally alter their approach to sales, underwriting, policy administration and claims (another speaker at the Insurance Europe conference provocatively suggested many of these functions will actually merge, as technology allows the consumer to become her own underwriter); regulators — particularly those fixated on rate and form approval — will need to fundamentally reassess their approach to consumer protection.
This tension was evident during a spirited afternoon panel that pitted consumers’ expectations of executing a transaction in less than four clicks against the traditional insurance view that its products are so complex and important that enhanced levels of consumer protection are needed.
These are real issues, but posed this way, they offer a false choice. It can’t be EITHER a digitally enabled seamless customer experience OR a regulatory paradigm that maintains the trust so fundamental to the insurance promise. It must be both. To get there will require leadership — and a constructive dialogue on these challenging topics in Dublin was a good start.
A session at RIMS 2016 illustrated how to methodically examine and review the right activities in claims audits to improve the bottom line.
Speakers in this session were:
Jenny Novoa, senior director of risk management, Gap
Joe Picone, claim consulting practice leader, Willis Towers Watson
They explained that, in a claims management context, an audit assesses compliance with the carrier and industry best practices and special handling instructions. A “typical” claim audit determines if the TPA/carrier’s performance is meeting its obligations in the service agreement. It also determines adequacy of reserves, benchmarks the TPA/carrier and adjuster performance, measures against best practices, provides constructive observations and recommends and identifies areas for improvement.
A group came together from some major companies including Gap, Foot Locker, Saks/Lord & Taylor, Corvel and Willis Towers Watson to study the claim auditing process. This study explored different areas of the process and was conducted over the course of about a year.
The mission of the study was to determine several things, including:
Does the claim audit fairly measure the outcome of the claim?
Is there’s a better way to audit the claim?
How is “outcome” defined?
What factors are important in defining claims outcome?
Does a best practice score really equate to a good outcome?
The study group came up with categories of what matters most in the claims process, including: quality of the adjuster, overall health of employee and quality of medical care. They looked at various audit criteria for retail business with the basis for “outcome” being days out of work. They also had a set of specific audit rules.
The group used a large sample of questions by category and compared the Best Practice Audit (BPA) with the Outcomes-Based Audit (OBA). Results were very different.
A few observations from the study:
BPA audit scores did not identify any of the 28 claims with poor outcomes.
OBA identified just 10 of the 28 claims with poor outcomes.
The average OBA audit score was 91, and the average BPA score was 97.
The OBA overall audit score is much more in line with the overall outcome of the universe of claims audited.
The team proved that audits must be designed to really affect not just the performance of the adjuster but all elements of the claims process.
Review your questions. For example — each question should be individually reviewed with regression analysis to determine correlation levels. Questions that have no correlation should be eliminated and those that do show correlation added.
Know that BPA can score 100, but the claim can still have a bad outcome.
OBA is a better predictor of outcomes than BPA.
The group determined the correlation between a best-practice compliance audit score and outcome may be lost if the wrong activities are audited. Critical activities that are never audited may cause poor outcomes in a claim. Again, only when you methodically examine and review the right activities do you improve the bottom line.