There has been keen interest in Insurtech investments in recent times, specifically on the rise and fall of Insurtech IPO’s in the US that since going public have performed below expectations and lost a news-worthy amount of shareholder value. The industry wants to understand exactly what went wrong with companies such as Metromile and Root, and this was a key theme of discussion at the annual Australian Insurtech LIVE conference held in Sydney this month.
Firstly, why do we care so much about faltering insurtech unicorns, given that we play in the early stages of an insurtech’s lifecycle?
Put simply, from our experience it is often at the early stages where it can go wrong, and it starts with the founders.
We’ve seen our share of pitches from confident founders. In determining who to back, we consider the strength of a founders will to win, their venture building know-how, and their technical acumen, to name a few. We also consider the founders’ discipline and willingness to respect insurance fundamentals. It takes discipline to forego; the forbidden fruit, the allure of top line metrics, to respect insurance fundamentals and temper growth by promoting risk metrics.
The primary reason behind the faltering post-IPO performances – venture metrics fail to pick up on an Insurtech nuance; a metric specific to the insurance industry that no other start-up sector needs to consider – loss ratio.
The act of prioritising performance metrics and consequently optimising operations to drive results, produces habits and culture. From our experience, setting the habits and culture right early is key, and this is driven by the founders.
Sounds simple? Let’s unpack this a little more.
Insurtech start-ups – almost by definition – are venture backed. The method of most venture backed start-ups is:
- Use external (venture) capital to scale as quickly as possible.
- Burn cash at a rapid rate to achieve high velocity growth, whilst managing monthly recurring revenue (MRR), customer acquisition cost (CAC) & lifetime value (LTV), monthly gross churn; all of which are growth metrics.
- The objective for Series A to Series D+ capital rounds is to burn for high velocity growth rates with little concern for the bottom line.
- The only real competitive advantage is a first mover advantage, as everything is replicable, eventually. Thus, make hay while the sun shines is the mantra.
Eventually, as a start-up matures and growth rates begin to hit the single digits, the metrics that define profitability are brought further into focus.
This is generally the process most venture backed start-ups, including insurtechs try to follow. However due to being in the insurance industry, loss ratio is a metric that should not be ignored, regardless of the stage of growth.
Why is the loss ratio so important?
Insurtechs who deploy a Managing General Agent (MGA) model generally leverage the risk capital of an insurer. Whilst the loss ratio – in these circumstances – does not appear on the MGA’s P&L directly, it does sit on their risk capital provider’s P&L, and the sustainability of this relationship is key to the success of the insurtech. It is critical for the immediate term sustainability of an insurtech to manage their risk capital providers’ P&L and thus the loss ratio. An MGA is nothing without risk capital.
Full-stack insurtechs – those who carry risk capital on their own balance sheet- will be directly impacted by loss ratio and thus equally as concerned by loss ratio as a metric.
Loss Ratio is a sound proxy for performance of key functions within an insurtech, including underwriting and portfolio monitoring. Anyone can offer an insurance policy to a poor risk. But who can find the better performing risks, acquire, and retain them? Poor loss ratios ultimately indicate poor insurance fundamentals and investors and the broader market are beginning to understand this.
To dive slightly deeper for a moment, a sharp-eyed reader would have seen reference to ‘under-reserving’ in Lemonade’s Q4 Shareholder Letter. Lemonade’s Q4 loss ratio was 96%, up from 77% in the prior quarter, bucking an otherwise favourable trendline in recent times. The letter stated “a meaningful driver of this sequential increase is an unfavourable prior period development due to a handful of older large losses for which we under-reserved”.
It is discipline and respect for insurance fundamentals that enables an insurance business to track and reserve for claims adequately. For every part that an insurtech seeks to pursue high velocity growth at the expense of a balanced combined ratio, the sensitivity of claims reserving and other key insurance fundamentals increases exponentially.
How is this helpful in the current climate?
The truth is that we are experiencing a revolutionary period in insurance history where underwriting is set to change for the better. In the past 400 years not much has changed in insurance – every risk has been priced in much the same way. For example, life insurance once cost the same for a certain age with little regard to the insured’s health profile other than asking if they are a smoker. However, due to rapid developments in technology and data, the industry is moving away from classifying individuals in pre-set risk cohorts like gender, location etc. Insurance products are being personalised to better reflect the individual and their psychographic motivations alongside their demographic profile. This results in loss ratio performance proving to be a far more accurate metric that can give insight into how successful an insurtech may be.
This is further evidenced by the current low performing insurtech IPOs who have had a history of placing less importance on loss ratio. Lemonade had loss ratios starting at 166% and now averages roughly 72%. Similar public insurtechs like Root and Metromile track closely.
The industry standard for an acceptable loss ratio is 40% – 60% depending on the product line.
To accurately assess an insurtech’s performance while they’re in the high velocity growth stage it is important to focus on metrics outside of the combined ratio. For example: An insurtech could be acquiring customers at a LTV:CAC of 3:1. They may choose to burn $xm (x could be revenue multiplied by 2) in sales in one year to acquire more of these valuable customers. Their Loss Ratio could be 60%, and their combined ratio could be 120%, and yet this would be deemed by investors and insurtechs themselves as a great performance. Whilst ever the loss ratio is in check, the insurtech can choose proactively to pull the marketing / CAC expense in, to balance bottom line metrics.
To summarise
Insurtechs are unique in the context of the broader start-up ecosystem. Venture capitalists and founders need to manage insurance metrics (including frequency and average cost per claim) in addition to more widely used venture metrics focused on growth, to ensure success from market launch to IPO and beyond. Loss ratio is a metric that can be overlooked in the industry, however this metric may be the one thing that determines the path to success or failure for emerging insurtechs.
The Insurtech Gateway portfolio MGAs perform substantially better than market average on loss ratio, mostly by controlling claims frequency. Controlled Growth is the mantra. We make insurtechs insurable and investable.
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If you have founded a pre-seed or seed insurtech and are looking for support and funding – or maybe you just have an idea that you would like to chat through – we have the experience and the tools to help you get to market faster. Check out our incubator and venture fund or get in touch.
References: Lemonade Loss Ratio Statistics | Loss Ratio Resource