“Insurance is the next FinTech,” is a buzz phrase that has spread through VC circles over the last 12 months. And indeed, insurance technology startups raised over $2.6 billion in 2015. Among the notable recipients were Oscar, Zenefits, Clover, PolicyGenius (portfolio company of ours) and Lemonade.
Certainly the insurance space feels a lot like financial services did five to 10 years ago, when startups — including LendingClub (founded 2006), Betterment (2008), Square (2009) and many others — began changing the day-to-day business of finance. The FinTech comparison isn’t completely accurate, but there are some key parallels in terms of the opportunity:
- Sheer size. The U.S. insurance industry in 2014 wrote new policies worth $1.1 trillion in net premiums and employed 2.5 million.
- Opaque fees. Almost every area of insurance has complex fee structures that are difficult for consumer to understand.
- Lack of loyalty. Clients don’t love their existing insurance options; even the top insurance companies have low Net Promoter Score (NPS) ratings compared to other industries.
Many VCs believe Insurance Tech has, like FinTech, the potential to shape the future of a huge industry and they are investing seriously and developing their portfolio companies. But despite a dramatic upswing in funding, Insurance startup investing is dwarfed by current FinTech investment (see chart) but growing quickly.
Why has Insurance Tech been slower out of the gate?
Creating a new insurance company is really, really hard. Getting licenses in all 50 states (or even just for New York, Texas and California) is a slow and costly process. Purchasing a shell company with existing licenses is faster but even more expensive — about $2 million, plus $5 million to $10 million in required regulatory capital. Though some have done it (Oscar, Clover and Lemonade) this level of capital is prohibitive for most entrepreneurs.
The industry also still generally believes that insurance is “sold and not bought.” As a result, insurance agents still dominate new policy sales.
Carriers want to take more control of sales for several reasons: The commission structure Agents require make the process expensive an misalign incentives between the carrier and the end client. Agents tend to own their clients. And this aging workforce isn’t replacing itself. Carriers know they have to find better ways of selling policies directly to consumers. Until very recently it’s been clunky to buy insurance online. At the carriers, paper forms remain the norm and it’s hard to find a consumer who uses their insurer’s online portal routinely, let alone enjoys the experience.
Insurances’ inherent leverage makes carriers and regulators skittish of product innovation or changes to underwriting. Leverage is typically associated with banking and debt but insurance is arguably the most levered product in the market. In almost any insurance contract, the premium a customer pays is many times smaller than the payout. If the underwriting wrong, carrier loses would dwarf revenue. This has led to conservative regulators and incumbent carriers and innovative products subject to lengthy reviews and skepticism.
So most Insurance Tech startups need to partner with existing insurance companies. Insurance executives, broadly speaking, are keenly interested in new models, and many feel the need to innovate urgently. Given the industry’s stiff regulation, long sales cycles, and levered nature, they are inherently conservative. A minimally viable product simply will not fly in the insurance space.
The state of insurance innovation today
The good news is that the industry doesn’t have its head in the sand. It is embracing innovation, actively seeking new ideas, and big insurers are investing directly in startups (AXA through ASV, Mass Mutual through MassMutual Ventures, Transamerica through TransAmerica Ventures, AmericanFamily through American Family Ventures, Prudential through Gibraltar Ventures, and more). Executive understand that the industry is becoming more transparent about fees, digitally enabled, and more focused on the policyholder over the agent.
That said, there’s lots of room for insurance innovation. How fast it can and will happen, however, will vary a lot by market segment. Property and casualty (P&C) has, for instance, moved faster than life/annuity. Health may move the fastest, spurred on by regulatory change.
There will be multiple winners with multiple exit opportunities. Each major segment has room for at least a big winner (like a whole new carrier) and many smaller niche winners (companies providing services to carriers). Given how much capital insurers have and the industry’s history of mergers and acquisitions, insurers are likely to acquire start-ups.
Coming up next: Distribution Disruption…