Insurance Industry for InsurTech Noobs

So you developed the newest insurance innovation that is going to revolutionize the industry -congratulations!  But we also have a couple of questions:

• What sector of the industry? Property & Casualty? Life? Health? Title?
• Where in the revenue cycle is your innovation going to make the biggest difference? Distribution? Underwriting? Claims?  What about Finance or Reinsurance?
• Will your innovation be regulated and if so by what jurisdictions? Just the state you’re doing business in? All 50 states? The Feds?  How long does it take to obtain those licenses and permits?

If you think these sound like arbitrary questions of an ancient industry that is resistant to change and ripe for innovation, you wouldn’t be too far off.  But knowing why the questions are being asked in the first place and the appropriate answers to each will allow you to refine and target your innovation to not only have the greatest impact on the industry, but also a higher likelihood that your investor pitch will land on receptive ears.

A Deloitte study on InsurTech recently found that traditional insurance companies are avoiding startups that don’t understand their industry and that “InsurTechs need to refine their pitches to align to real-world challenges for insurers, while demonstrating both industry and technical expertise…  [and know] ahead of time where legal and compliance issues might arise.”

To that end this article and the articles that follow on this blog are intended to provide InsurTech startups with a primer on how the insurance industry really works (that way you won’t sound like a total noob when you are walking the floor of InsurTech Connect).  We then will be following up in the coming weeks and months with other articles on:

• How to figure out where your company fits into the insurance industry and what that means from a regulatory perspective;
• Analysis of some of the largest hurdles InsurTechs need to overcome to be attractive to investors, both from a regulatory and financial standpoint;
• Managing the initial capital raising process;
• Interviews with some of the major players in this space, including regulators, investors and successful startups; and
• Our thoughts on the biggest trends impacting InsurTech in 2019.

We will also be posting a roundup of various InsurTech related news every Friday to ensure that you don’t miss anything happening in the industry.

But before we get into all of that, let’s start with the basics.

What is Insurance?

If you google the official definition of insurance, you will likely come up with something like this:

“‘Insurance’ means any agreement to pay a sum of money, provide services or any other thing of value on the happening of a particular event or contingency or to provide indemnity for loss in respect to a specified subject by specified perils in return for a consideration. In any contract of insurance, an insured shall have an interest which is subject to a risk of loss through destruction or impairment of that interest, which risk is assumed by the insurer and such assumption shall be part of a general scheme to distribute losses among a large group of persons bearing similar risks in return for a ratable contribution or other consideration.” Conn. Gen. Stat. §38a-1(10).

If your eyes glazed over before the third line we don’t blame you.  This business loves to be very specific about everything, which often leads to a lot of mind numbing legalese (just take a look at any of your insurance polices if you dare).

But all insurance truly is, at its heart, an insurance company making a promise to a bunch of people (who each pay the insurance company) that if something unexpectedly bad happens to any one of them the insurance company will pay (either directly or by paying for services, such as in health insurance) a larger amount of money than what was paid to them in the first place.  The insurance company in turn is making a very calculated bet that it will collect enough money from enough people that it will have enough money to pay out claims when they occur and that it is statistically highly unlikely that it will have more claims for payments than money in its reserves.

However, because no one wants their insurance company to be insolvent when they file a claim, the states heavily regulate the industry to ensure that insurance companies are not only open and transparent with consumers during the sales process, but that they also maintain very healthy levels of capital, surplus and reserves so that insurance company insolvencies are not common occurrences.  This public policy driven regulation, which often unintentionally serves as roadblocks to innovation, is where many Insurtechs get tripped up early in their development, especially those startups coming from an agile software development background where iterative and fast moving changes are second nature.  Unfortunately, filing new policy forms, obtaining different licenses or rolling out new claims handling processes all take longer than most InsurTechs expect and often requires that InsurTechs have talent with prior industry specific experience within their ranks.  Furthermore, these regulations vary not only from state to state, but also based on the type of insurance coverage.

The Four Major Types of Risks that Insurance Covers

The insurance industry generally can be broken down in four main sectors based on the type of risks or unexpected events covered:

• Property & Casualty: Think of your car insurance, home insurance, etc.  Something breaks or gets lost and the insurance company pays you money to repair or replace it.
• Life: Think of life insurance and annuities as basically two sides of the same coin.  Life insurance protects your family and loved ones from running out of money if you die too soon, annuities protect you from running out of money if you do not die soon enough.
• Health: Not just major medical insurance (the type of coverage required by Affordable Health Care Obamacare), but also vision, dental and limited benefit policies as well.
• Title: The odd duck of the insurance industry.  Basically guarantees that the piece of property you end up buying after your InsurTech is bought by Amazon is actually owned by the person selling it to you.

Generally, insurance companies that cover one type of risk (such as property & casualty) do not cover any other type of risk (like life or health).  While this is largely due to restrictions imposed by state regulators, it would also be unfeasible from an efficiency standpoint as the major cost and profit drivers for each segment are significantly different.  For example, profitability for most traditional life insurers is driven by figuring out the likelihood of whether you will die during the term of the policy.  In contrast, the profitability of many health insurers is directly correlated to how well it can reduce the cost of healthcare being provided to its insureds.  Obviously, it would be difficult for a company to be focused on both things at once.

Key Revenue and Cost Drivers for Every Insurance Company

Despite these differences, the game for nearly all insurance companies is:

• getting more people to buy and renew insurance policies so that the likelihood of the unexpected happening to any given person decreases to statistically predictable levels, (e.g. “Distribution”);
• figuring out better ways of predicting when, how often and to what degree unexpected things will occur or figuring out how to accurately price coverage for new lines of business (who thought drone insurance would be a thing two years ago); (e.g. “Underwriting”);
• decreasing the costs associated with paying for services associated with the unexpected, including decreasing the frequency of unexpected events (e.g. “Claims”); and
• managing their finances better so that the money they do have to pay for unexpected events grows as quickly as possible while still being safe and secure (because you wouldn’t want your insurer to bet all of its money its holding to pay your claims on a complex commodity hedge involving brick, wood, wool, wheat and ore). (e.g. “Finances and Reinsurance”).

If you can figure out how to help insurance companies: (i) increase Sales, (ii) develop more accurate Underwriting for existing or new lines of business, (iii) reduce the cost and/or frequency of Claims or (iv) get better returns from their Finances you will have the insurance industry beating down your door — although to be honest they will more likely politely knock and take about twice as long to come to a decision about investing in your company as you will want.  Remember this is an industry based on careful and measured evaluation of risk, and no matter how amazing your InsurTech company is, it still represents risk to an industry which traditionally only devotes its resources to the most financially secure investments.  Your job is to convince the industry and interested investors that the bigger risk is not investing in your innovation and being left behind.

Next week we will look at how to determine where your InsurTech innovation fits into the insurance industry and what that means in terms of the dreaded regulation (where many great InsurTech ideas go to die).

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