Viewpoint: Insurtech 2023 – sunshine after the showers?

Public insurtechs have significantly underperformed the market, which has led to a slowdown of the acquisition market. However, there is hope the insurtech sector may bounce back and be an attractive market with large growth upside.

Indeed, IA Capital Group’s managing partner Andy Lerner recently stated: “The drastic underperformance of the public insurtech stocks has resulted in the current venture capital opportunity to invest in top-tier private insurtechs at attractive valuations.”

In this paper we look at the recent underperformance and examine the opportunity to access a market with an enormous amount of potential upside at a discounted price.

The tech sector underperformed throughout 2022, with values of the FAANGs – Meta (formerly known as Facebook), Amazon, Apple, Netflix and Alphabet (the parent of Google) – down 45 percent for the year.

The story can be attributed in part to rising interest rates, heightened geopolitical risk, recession fears and, of course, unexpected monetary policy actions. These headwinds, coupled with the failures of several crypto businesses/exchanges and the liquidation of several SPACs in late 2022, also cast a shadow on the tech sector at large.

While the public markets regained some ground in the second quarter of 2023, those businesses whose current valuation is largely a derivative of future growth remain in jeopardy given the fact that 500 basis points of Fed rate hikes are now fully baked into the net present value modelling of that growth. The 10 rate hikes between March 2022 and May 2023 have adversely affected tech sector valuations.

Tight public financing conditions and a very limited appetite for new listings or follow-ons have dramatically impacted funding for high-growth expense plans. As a result, many tech firms have paused hiring and have subsequently announced large layoffs.

In a brief episode this March, all tech suffered from the Silvergate, Silicon Valley Bank and Signature Bank failures, and to a lesser degree, First Republic in May, but that has settled down as the Federal Deposit Insurance Corporation resolved them, which calmed the markets.

Forward interest rate expectations mellowed in Q2 2023, and larger tech names have partially come back. Big insurtech names have seen a similar story with Guidewire and Verisk up 10 percent and 28 percent respectively for the year to date (compared to a 14 percent rise for the S&P 500).

Clearly, public investor sentiment has made its way into the private markets as well. Still reeling from the fallout of the most prominent stakeholders to the start-up world (regardless of industry vertical), private companies have pivoted quickly to focus on profitable growth, rather than seeking growth at all costs and hoping that profit margins will come in due time.

While the insurtech market is still in its early days – representing a small subset of the broader fintech segment – only a few insurtech investors avoided placing capital into prevalent high cash burn models, and they generally outperformed accordingly in 2022 and 2023.

Private insurtech deal activity picked up some pace in Q1 2023 driven mainly by M&A (the majority by strategic investors), including Vista's $2.6bn acquisition of Duck Creek and LexisNexis Risk Solutions acquiring Human API. In addition to the private insurtech M&A activity, insurtech companies also made their own acquisitions such as Insurify acquiring, Cover Genius buying Clyde and Verisk Analytics acquiring Mavera.

Also, on 21 June, Embedded Insurance offered to acquire Root for $19.34 per share, representing a significant premium to the company’s closing price of $6.02 on 20 June. Although Root turned down the offer, a takeover price of more than 3x the undisturbed stock price is an encouraging signal for the future of the balance sheet insurtechs.

Insurtech financing volume continues to show weakness compared to previous years, as seen by the 55 percent decline versus Q1 2022 as financing volume in the first three months of 2023 totalled $1.2bn across 53 capital raises. A lot can be said about the dip in activity – some suggest that large rounds printed at markedly high valuations in previous years are not in the forecast for this year or maybe next.

However, smaller rounds with more realistic uses of proceeds are intentionally in vogue, and founders appear to realise that it’s all about executing with all existing capital on hand.

While overall venture capital activity in Q1 2023 was muted, strategic investors stepped up with participation across nearly 60 percent of the insurtech funding rounds. In particular, MS&AD, Scor Ventures and Axa Ventures all made two or more investments in insurtech during Q1.

Across the insurtech value chain, pricing, valuations and modelling the exit value varies significantly. Insurtechs that provide services to insurers trade more on their growth prospects and gross profit margins and have diverged from the balance sheet companies over the last two years. Software-as-a-service businesses have been attractive to investors considering the sticky nature of their revenue stream and inherent ability to scale across the market. These business models offer exposure to tech sector growth upside without direct exposure to insurance risk.

Less successfully, insurtech start-ups with balance sheets focused on personal lines tend to trade like personal lines insurers, although with lower book value multiples reflecting their lower returns on equity at the current stage of their development. Many are struggling to find either scale or gross profitability. As a group, they are far off their 52-week highs. We do not expect to see any new e-tailers launch soon.

The value in any new venture can typically be realised in one of two exits, an IPO or in a business combination (sale or merger). The IPO window was closed for nearly all industries until recently, but it appears incumbent carriers and platforms need to lead the way to reopening later this year. Anecdotally, some insurtechs are rolling into strategics at good values, but in private-to-private deals with little data available. Stonybrook understands that some investors are finding significant opportunity for new investments at currently attractive valuations.

The insurance business has been laying down generations of legacy processes for almost seven centuries. We are confident that there are a great many entrepreneurs with new, accretive projects that will improve all of our businesses through better-informed decision-making and more efficient processing and execution. Stonybrook stands ready to assist insurers, investors and entrepreneurs in making these connections.