Is insurance too complex to disrupt?

by Laura Cain on July 11, 2016

Investors are bullish on insurance. After witnessing the disruption of banking, revolutionizing the insurance industry appears both lucrative and attainable. There are a multitude of parallels between banking and insurance; they are massive consolidated industries that have failed to innovate since the 80s. Incumbents are shackled to outdated IT systems which cannot support functions that have become expected by consumers, such as online applications, instantaneous decisioning, and singular account management.

However, insurance is in many ways a completely different beast than lending – and arguably much more difficult to disrupt. Beyond state-by-state regulation and large capital requirements, the dynamics behind consumer purchasing behavior provides significant challenges.

Insurance is sold not bought. When weighed against other financial priorities, consumers will often forgo insurance to address immediate needs. Additionally, when hedging against potential losses, consumers express a resistance to testing new carriers and products, as doing so introduces new risks. Insurance products are therefore extremely sticky, and consumers extremely brand sensitive. In sectors with long term products, in which a consumer plans to receive benefits decades out (life), or sectors with mandated insurance, in which markets are saturated (auto), attracting and acquiring high-value consumers will be both difficult and expensive for new entrants.

Consumers with the most incentive to switch insurance carriers are often high cost customers. Individuals with pre-existing health conditions are most likely to search for new insurance products, and drivers with poor driving records are likely to search for auto insurance carriers which heavily weigh other underwriting criteria. Cherry picking the best consumers will be extremely difficult, as bad risks are the most likely to shop for new insurance and both customers and incumbent insurance carriers have an information advantage.

The potential losses of bad insurance policies also far exceed those of loans. While reinsurance is a potential option, securing deals in a cyclical market may prove problematic. An insurer with bad timing could experience catastrophic losses and be unable to recover. For example, a homeowners insurance company that has not sold enough policies to be sufficiently diversified could be wiped out if a natural disaster hits within the first years of operation.

With these points in mind, we remain cautiously optimistic regarding the insurance sector. We believe there are numerous opportunities to innovate within the insurance sector, albeit certain sectors will be easier to disrupt.

Among P&C, life, and health insurance, we believe P&C insurance will be most easily disrupted. Policies are of lower value and have shorter durations, requiring the insurance carrier to take on less risk. Additionally, there are numerous data sources that are underutilized in the underwriting process. Unlike life and health insurance, improvements can be made with minimal action taken by the customer.

In the P&C insurance sector, we have seen several recurring themes. Summarized below are the areas we find most intriguing for investment.

Insurance Comparison Aggregators

Auto insurance has paved the way in moving the insurance application process online. Naturally, comparison sites have popped up in the space. Serving as a lead generation platform, insurance aggregators generate revenue when a customer purchases a policy.

However, with huge marketing budgets, insurers have incentive to heavily spend on direct marketing. Progressive, State Farm, Esurance, Allstate, and Nationwide provide car insurance comparison tools which directly compete with and startups such as Coverhound. By circumventing agents and brokers, the margin on each policy skyrockets – providing incentive for the insurer to digitize the sales process.  Given the strength of market leader auto insurance brands, it is both reasonable and beneficial for carriers to provide comparison tools and own the entire sales process.

We believe however, that customers value and trust unbiased third party sources, and that new startups in the space have the potential to gain significant traction. Given current market dynamics, to remain competitive in the long term insurance aggregators will need to develop their revenue models so that they are less dependent insurance carriers.

Insurance Comparison Sites:

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P2P P&C Insurance

P2P insurance is essentially reciprocal insurance. Those seeking insurance form small groups online, and claims are paid out by the group. While cutting out agents and digitizing the application, underwriting, and servicing has the potential to reduce the insurance carrier’s load factor significantly, reciprocal insurance has proved to be a difficult model to maintain.

Only a few auto insurers operate under a reciprocal insurance model, including AAA, USAA, and Farmers insurance. The model restricted the ability of companies to raise additional funds and secure reinsurance contracts. Diversifying groups and maintaining incentives for good behavior will be key for insurance startups in the space. We believe P2P insurance will be successful in the microinsurance space, but will be confined to low-premium policies.

P2P Insurance:

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P&C Connected Devices

Connected devices have the potential to revolutionize risk management within the insurance sector. Beyond detecting losses (such as a car crash), sensors can be used to prevent losses (such as alerting drivers regarding weather conditions in the location of a parked car).

However, adoption of standalone hardware solutions has been slow. Without proper incentives, customers have shown a resistance to sharing behavioral data (driving history) and to purchasing preventative solutions (sensors to measure pressure in water pipes).

Although the applications are somewhat limited, utilizing mobile device sensors shows great potential given the penetration of smartphones in the US. We believe products with a short lifespans will lead IoT’s disruption of the insurance space. While house gas pipes are almost never replaced, stoves and heating systems are replaced with higher frequency, making them more attractive entry points to install sensors.

Connected Devices:

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