Disruption risk in the insurance industry
By: David J. Gimpelevich
Tags: Insuretech, Disruption, Corporate Innovation, Insurance, Venture Capital

Co-authored with Joe Agiato, CEO of PIUS Limited, http://piusre.com/the-pius-team/.

The business landscape is littered with formerly invincible companies that have fallen prey to digital disruption. Enterprises such as Sears, Blockbuster, and Kodak that were once the pillars of the global industry are now tombstones in the graveyard of corporate demise, driven to extinction by innovation in technology and business models by VC-funded startups. Entire industries, as diverse as stock brokerage and newspapers, have been driven to the edge of ruin because of their inability to effectively adapt to the new landscape.

Consumer lines of the insurance industry are no exception, with commodity products such as homeowners and auto businesses falling prey to new, internet-driven business models, as demonstrated by the acquisition of Esurance by Allstate. Commercial lines have so far been spared from the carnage, but that is no reason for complacency. If recent history is at all a guide, proactive planning for disruption is the key to survival for incumbents. In this article, we examine the levels of disruptive threat to the major segments of the business and recommend strategies for mitigating innovation-driven risks.

To date, the primary targets for disruptive innovation have been in the areas of distribution, policy creation, underwriting and claims management, but new business models are emerging using automation, advanced analytics, connected devices, and machine learning to build holistic policies for consumers that can be switched on and off on-demand. An emerging peer-to-peer (P2P) business model stands poised to transform the personal and small business lines. AI-driven innovation is already setting its sights on some of the higher margin products. New business models are enabled by reams of high-quality, IoT-collected data. Processed by AI-enabled algorithms, it obviates the need for underwriters’ judgment. Even now, you can get MetroMile and pay your auto insurance premiums as you go.

Property & Casualty

Funding in the billions of dollars has been flowing into startups directly attacking the business models of a number of segments of the P&C space. Companies like Metromile, Root, and Censio, for instance, are changing the way consumer auto policies are underwritten, priced, and sold, while Lemonade and Trov are doing the same for the home and renters segment. There are startup entries into the travel risk, cyber liability, and general commercial lines. An entirely new segment of on-demand insurance has recently emerged, driven by new entrants such as Slice, Risk, and Cuvva.

To date, the market share captured by all new entrants has been relatively minor. The sheer scale of the leading multiline P&C carriers offers them a level of security, inasmuch as they are in the position to acquire the more promising new startups — albeit at a healthy premium. While there have been platform entrants expressly seeking to displace incumbents — startups such as Clover, Ladder, and Oscar — their combined scale and funding are still not large. Having said that, we have seen the scale achievable by a successful digitally driven startup — witness Amazon and Netflix for example — so P&C incumbents would do well to keep a wary eye on developments. Insurers with large personal line operations should probably feel the most threatened at this juncture because digital disruptors have repeatedly demonstrated their ability to capture large market shares in consumer segments.

Specialty P&C and Liability

The relatively small P&C and liability segments such as MedMal have not yet been frontally attacked, possibly because the market sizes have so far failed to generate venture capital excitement. However, as the InsureTech category becomes more crowded, more and more sectors are likely to be targeted by well-capitalized new entrants.

Specialty insurers generally lack the resources of the larger P&C incumbents, which give the latter the ability to strategically acquire disruptive innovators. This makes specialty insurers considerably more vulnerable. In fact, it would not be surprising if startup-led disruption transformed their business landscape into a much less friendly place within the next half-decade.

Life

Life companies face an uncertain outlook with regard to imminent disruption. On one hand, they often command significant resources and a high degree of customer lockup through existing policies, which supports the argument that they have a level of insulation from disruption in the short term. On the other hand, given that their primary business is consumer-oriented, they are directly in the crosshairs of digital disruptors skilled in rapidly making large inroads into consumer segments.

As the Electronic Health Records marketplace becomes more concentrated, it may well become feasible to price policies based on access to aggregated health data. Patient privacy concerns will no doubt remain present, but permission can often be elicited with promises of discounts. Combined with social media data from the likes of Google and Facebook, insurers would then be able to price risk with the inclusion of actual propensities to engage in risky behavior. If the insurance companies start investing in these types of data aggregators, they will have much better data to make decisions.

As it happens, a number of new entrants into the Life space have been attacking the dominant business model, with well-capitalized startups such as Ladder, Halo, and Ethos beginning to take some market share. On balance, it would appear that Life insurers are on notice for imminent disruption and should be especially proactive in implementing defensive innovation, as well as taking steps to participate in the innovation cycle on the theory that if they cannot beat them they should join them.

Health

Health insurance, integrated as it is, so closely into the entirety of the national healthcare system, is a very capacious topic that is beyond the scope of this article. It should be noted, however, that while funding has been flowing to new entrants such as Oscar and Devoted who are seeking explicitly to disrupt the space, the sheer ponderousness of this segment militates against disruption. As of today, the largest threat to the Health business appears to be large employers’ desire to form self-insurance consortia. If this trend accelerates, the industry stands to lose many of its most profitable customers. How long before an app is developed that will, with permission, access your electronic health record and quote a premium?

Reinsurance

Small and midsized reinsurers have been under pressure for some time, with consolidation and market exists being driven by falling margins and a string of losses, exacerbated by the entry of a number of new startups, such as Aeolus, CATCo, Fermat, Nephila, Securis, and Stone Ridge, offering less versatile product but with better pricing supported by leaner cost structures.

The Big 5 Re companies have not only survived the shakeout but have been pioneers in InsureTech venture investment, seeking to forestall disruption by being at the table when it threatens. Their example illustrates the best practice approach to disruptive innovation: anticipate, allocate investment, and actively adopt emerging innovation. In effect, the most innovative reinsurers have become disruptors in their own right, leaving them in the best competitive position of the industry today.

Brokerage and Distribution

The brokerage business is probably most immediately and existentially threatened by digital disruption. Disintermediation has been gathering momentum across industries touched by startup innovators. Stockbrokers are almost non-existent now, and investment advisors are highly threatened. Retail real estate agents’ fees are rapidly approaching zero, and appraisers are preparing to join buggy whip makers in the halls of obsolescence. Car dealers are also going by the wayside because startups like Carvana will let you buy your car online and deliver it to your house, while the Teslas of the world are migrating to direct sales. Malls are also disappearing because Amazon and online stores are putting them on their heels and slashing brick and mortar profitability. In banking, Capital One, Ally, and Grasshopper operate with virtually no branches.

Startups like Hippo, Lemonade, Next, Goji, and Wrisk are not the sole threat to the brokerage business. Thanks to new digital technologies, carriers are finding it ever easier to reach their customers directly. Personal line brokers are probably the first in line for obsolescence, but commercial line agents are also in danger? At risk? (You just used “threat” a couple of sentences ago) threatened. In fact, those brokers who think that it will never happen in the commercial lines space are in for a rude awakening. The personal attention of the broker will be more than offset by the big data — and better data — of the data aggregators and AI learning algorithms.

Technologies enabling instant underwriting and custom policy pricing are already taking much of the value-add of brokers to the end consumer. While for some time now brokers have been casting themselves as risk management consultants, this by itself will not save them from the ever-falling pricing that may well put an end to commissions as a form of distribution compensation.

Survival Strategies

While disruption looms, incumbents have a few arrows in their quiver to help them remain relevant and thrive in today’s changing landscape. Broadly, the most promising strategies based on the experience in other industries can be outlined as Embracing Innovation, Seat at the Table, and Business Reinvention.

Embracing Innovation is a strategy to actively seek out innovations that streamline operations and grow revenues and profitability and aggressively drive internal adoption. Most companies have established innovation executive roles and/or innovation committees. Results vary, but well-implemented innovation programs do pay dividends such as survival and lasting competitive advantage. The key to the success of such programs is a well-managed combination of top-down mandates and bottom-up initiatives that ensure both buy-in and resources necessary to drive adoption. A key part of this approach is a strategic M&A program to acquire startups pursuing promising disruptive business models, as a way of future-proofing the core business. It appears that some brokers feel that if they can control their client relationships, they can own the distribution chain. We do not believe that will continue: personal relationships will give way to more efficient pricing with better data.

The Seat at the Table strategy is fundamentally a set of programs to engage with and invest in tomorrow’s disrupters. Becoming early alliance partners and investors for startups gives insurers a unique early view of the emerging changes to the industry. Many companies have already created corporate venture capital initiatives, with various levels of effectiveness. Their task is to adopt best practices of CVC formation and management in order to maximize both strategic and financial returns. Companies that are too small to create private CVC initiatives at meaningful scales should consider forming investment consortia with their channel and alliance partners, and even with competitors, because a shared early view is better than none at all. A word of caution: investing in third-party funds as limited partners may provide financial returns, but not a meaningful seat at the table because of the insulation created by the presence of fund managers.

While carriers can compete by anticipating and adopting innovation, brokers have no such luxury. Their very business model is under existential threat. To survive as enterprises, they need to Reinvent their Businesses entirely. Their competitive advantage lies in their relationships with and knowledge of the customer. To capitalize on this strategic asset, they must aggressively seek out new business lines that serve these customers, by partnering with and investing in innovative startups on one hand and launching risk carry businesses on the other.

In Conclusion

The insurance industry is increasingly a target for digital disruption, but incumbents still have an opportunity to retain relevance and thrive in the rapidly changing business environment.