The Next Billion-Dollar Insurer

By Jay Farber for Techcrunch.com

Venture capital-backed insurance success stories have risen at a regular drumbeat over the last few years: 2011 brought the billion-dollar Esurance acquisition, 2012 brought the wildly successful Guidewire IPO, 2013 brought the large Climate Corporation acquisition and 2014-2015 brought Zenefits to prominence.

Each of these companies pulls a piece of the insurance industry kicking and screaming into a more modern age.

This year, many more of these companies are poised to succeed. Insurance carriers have moved from resisting online and direct insurance sales to partnering with and investing in companies like CoverHound, Metromile and PolicyGenius. Complex data analytics tools like Hadoop and Spark now enable the use of more sophisticated datasets in real-time underwriting.

Perhaps most importantly, consumers are increasingly open to interacting with financial institutions online. The Federal Reserve reports that more than half of us use mobile banking, and a recent EY study suggests up to 30 percent of us will use modern fintech services this year.

There has never been a better time for talented entrepreneurs to build companies that change the insurance industry. We can anticipate the emergence of three types of companies effecting this change:

• new insurance carriers innovating on the full stack
• brokers reshaping insurance sales
• managing general agents offloading risk but advancing product and distribution

Full-stack innovation

Oscar’s customer-driven health insurance in New York and Lemonade’s upcoming launch as the first U.S. carrier to offer peer-to-peer policies suggest one path: starting a brand new insurance carrier.

Starting a carrier presents a significant capital challenge, however. Witness the $70 million Oscar raised before launching, and Lemonade’s recent $13 million seed round. In both cases, a significant portion of that capital sits idle on the balance sheet as statutory reserves, mandated by each state individually.

New carriers are also subject to the whims of regulators in each state in which they are active. These regulators review every product, mandate detailed premium rate filings and conduct thorough audits each year.

Still, starting a carrier is the only way to have full freedom to design new products and processes without relying on external parties to validate and integrate.

For new insurance carriers, success starts with offering a vastly improved customer experience — today’s carriers know a positive claims experience creates a far more loyal customer. Low-single-digit conversion rates among carriers selling direct online suggest there’s opportunity to vastly improve the conversion funnel, as well.

Distribution machines

Operating as an insurance broker instead of a carrier frees a startup from the capital and regulatory responsibilities; getting set up involves a much simpler broker license process. While brokers don’t touch the insurance product itself, they have the ability to reshape the way insurance is sold.

Being a broker also provides fantastic unit economics. Commissions average 10-20 percent of premiums for the length of the policy, and usually avoid price compression.

Outsized success as a broker comes from securing priority access to customers when they’re looking to buy. Most insurance today is bought in time-sensitive situations, such as closing on a new house or hiring a first employee for a small business. This means consumers often start and finish their search with the first broker they encounter.

HR managers logging into Zenefits daily know where to go first to set up benefits, workers’ comp and other insurance, just as online travel sites present the option of travel insurance to every customer checking out. Matic’s tool for lenders and Sure selling episodic insurance at point of use are early examples of expanding this opportunity.

The challenges for brokers are persuading the right carriers to appoint them to sell their policies, and influencing carriers to prioritize the building of any needed integrations.

Brokers also can’t control the entire user experience, as the final underwriting steps and claims processes usually involve dealing with carrier legacy systems.

The best of both worlds?

For many entrepreneurs, the best option is to establish a special type of broker called a Managing General Agent (MGA). MGAs have the same regulatory light-touch as any other broker, but control much more of the value chain and usually find a single carrier to hold the risk. They have full flexibility to both develop an innovative product and craft unique distribution channels. Think the Climate Corporation’s crop insurance priced using advanced weather analytics, or Metromile’s pay-per-mile car insurance.

Historically, MGAs have often struggled to maintain good relationships with their back-end carrier. Unexpectedly high losses, even in a single year, can cause the carrier to shut down a promising program. If the MGA is too small to have a material impact on the carrier, the carrier may decide to simply end the relationship in favor of focusing on its core business. Even if the relationship remains solid, insurers require oversight of many business processes and can restrict the ability of the startup to act flexibly in the market.

Entrepreneurs running MGAs can work around this by partnering with reinsurers instead. Reinsurers are far more nimble, have experience building underwriting models for new or complex product types and are over-supplied with capital right now.

The reinsurer and MGA can then offload the regulatory burden of holding the paper to an entity called a fronting carrier, which gets paid to issue the policy officially but passes all its risk on to the reinsurer. WebBank, a small bank in Utah, achieves one of the highest return-on-equity metrics of any bank by providing an analogous service for marketplace lenders.

Insurance carriers are notorious for having inflexible and complex policies, caused in part by the legacy technology they typically use for policy management. Why has Metromile had no sizeable competition offering car insurance priced on a per-mile basis, even years after its initial launch? It’s a cost-prohibitive, multi-year effort for existing carriers to create a competing product — meaning most MGAs will have years to build their businesses before facing direct competition from incumbents.

Look for more startups to simplify and customize coverage to better fit customer needs in this model.

What’s next

I am convinced that a new breed of entrepreneurs who build teams with superb product sense, industry expertise and marketing acumen will drive significant change in insurance over the next decade. A trillion-dollar premium prize awaits those that can find success.

I can’t wait.