In the second part of his examination into the crossover between traditional insurance and tech innovation, Jonathan Spry, CEO and co-founder of Envelop Risk, explores how insurers and innovators can work in harmony…
To date, start-ups have been the catalyst for innovation in the industry. Funded primarily by venture capital, entrepreneurs have sought to offer novel ways to underwrite and deliver insurance products.
Digital disruption and division
Insurtechs have been on a mission not only to improve existing models but also to outcompete insurers with new and inventive products. As the visionary engineer and architect Buckminster Fuller said: “You never change things by fighting the existing reality. To change something, build a new model that makes the existing model obsolete.”
Many insurtechs, particularly in the US, are, in fact, seeking to disrupt the traditional insurance ecosystem rather than partner with it. While this model of disruption has proved successful in other industries, the insurance industry has thrown up high barriers to entry via stringent regulation, onerous capital requirements and a close-knit community of insiders.
Given the fact that many insurtechs are reliant on capital from industry incumbents, attempts at widescale disruption risk biting the hand that feeds them.
At the same time, insurers need to catch up with digitally advanced competitors. In the main, this has been achieved by acquiring a start-up or attempts at in-house innovation, using a ‘corporate lab’ – although success with the latter has been limited by the lack of internal tech expertise.
Meeting of minds
Partnership could be the best path for both parties. One move in that direction is a hybrid innovation strategy, in which an alliance is executed including equity stakes, joint-venture innovation labs and the creation of advanced data platforms for analytics, built within the insurer, benefiting from knowledge transfer within the insurtech community.
In such models, a nimble technology company retains ownership of IP and benefits from a huge wealth of data accumulation while it also builds long-standing and trusted partnerships.
The formation of the insurer’s data strategy sits neatly alongside the attempts to foster innovation and can be seen as a further driver of productivity.
A robust and transparent data strategy can balance defensive approaches including cyber security with more outward-looking objectives, such as the use of predictive analytics, under the insurtech approach of augmented intelligence.
Within the world of underwriting specifically, insurtechs are already playing a role in the evolution of specialty insurance in Lloyd’s and the London market, with AI-driven algorithms now being used to select business and provide an index-based ability to passively underwrite.
Elsewhere insurtechs are using AI to pick the best business and actively beat the index, generating ‘alpha’. The use of AI is already accelerating a division between leaders and followers in specialty insurance, which will have a profound effect on the allocation and cost of risk capital and on insurance enterprises’ earnings.
Each class of business will inevitability concentrate on a smaller group of true leaders, with followers competing using lower expense bases and diversified capital, perhaps relying on earnings from comparative leadership positions elsewhere.
The role of reinsurance
Reinsurance can play more than a supporting role in the transformation of the industry, supplying not just capital but also expertise and technology-enabled products as the catalyst for innovation.
Reinsurance could also unlock insurtech sustainability ahead of a possible convergence, with the distinctions between technology-enabled insurers and insurance-focused technology companies becoming redundant.
Reinsurers occupy a unique position at the top of the risk food-chain and along with a role in allocating capital (to insurtechs that can demonstrate adequate risk-adjusted returns), reinsurers can play a role in technology diffusion.
A convergence between venture-backed technologists and publicly listed insurers is possible, but what does that mean for the thorny issue of valuations?
My view is that premium valuations are achievable and sustainable if matched by earnings momentum and clear ownership over strategic territory, particularly when allied with a deep understanding of the client and the ability to use data to better price and manage risk.
A spectrum of valuations is still likely. Strictly regulated and balance sheet heavy insurers may benefit from improved metrics if they reduce footprint and distribution costs, but that’s unlikely to receive a premium technology rating.
On the other hand, an insurtech that can demonstrate profitable underwriting growth and durability in its capacity, including some dedicated risk capital, should be able to retain premium valuation as its IP is monetised and earnings grow.
The jury on convergence may still be out, but as pioneering author William Gibson once said: “The future is already here. It’s just not evenly distributed yet.