InsurTech: Great expectations, record funding and the ‘Valley of Death’
Investment in tech firms is on the rise, for those able to articulate their value. But is venture capitalist interest in this sector creating a sliding scale?
As the re/insurance industry’s embrace of new technologies continues apace, it’s amusing to recall a time when the term “InsurTech” was new. These days, it has become a staple of the insurance-business vernacular worldwide and has become synonymous with re/insurer innovation and the acceleration of processes. Once relegated to the tech-geek sidelines, InsurTech is now on the lips of re/insurance leaders at every level.
ACORD, the global standards-setting body for the insurance and related financial services industries, has steadily tracked more than 1,600 InsurTech investment activities since 2011. Its analysts have observed steady growth in the past three years across three key metrics: deal flow (15.5% three-year CAGR), average deal size (30.9%), and total value of investments (53.6%).
Given the number of mega-funding deals executed in recent months, it is also worth recalling that 2020 did not start out well for InsurTech investment. Economic uncertainty wrought by the global pandemic helped deliver the lowest quarter of global InsurTech funding since Q2 of 2018: in 2020’s first quarter, $912 million was invested (about half of the investment seen in the prior quarter), hampering the momentum that had been building throughout 2019.
Q2, however, saw that level of investment ignite again with Lemonade’s IPO and InsurTechs Hippo and Buckle’s acquisitions of Spinnaker and Gateway, respectively. Further major investment rounds for Pie Insurance and States Title showed the InsurTech investment market was ready to rebound. In Q3, things not only bounced back but accelerated, with an unprecedented level of global funding going to InsurTech businesses both in dollar amount and transaction volume. InsurTech companies globally raised $2.5bn across 104 deals.
By year’s end, global InsurTech investment had reached an all-time high of $7.1bn, among 377 deals — the highest in any prior year. Q4 saw $2.1bn raised across 103 deals. “Later-stage” companies, including Hippo, Unqork, Waterdrop, Oscar Health, Bind Benefits and Newfront Insurance — each received in excess of the $100-million-dollar “mega-round” funding mark, Willis Towers Watson notes in its Quarterly InsurTech Briefing for Q4 2020 – representing six mega-rounds for that quarter alone.
While fundraising for tech firms has reached new heights, however, a “funding gap” could threaten midsize players – relatively well-known but not particularly well-established InsurTech firms. With global markets preparing for one of the largest forecasted recessions in a generation, investors’ appetite to support either well-established InsurTechs or brand-new ones full of promise (and in some cases, no small degree of hype) is greater than mid-tier firms who still have things to prove. For those midsized companies, the heat is on.
“There are quite simply too many mid-tier companies in the mix who caught the wave of irrational exuberance to land a few customers and are now struggling to hit the inflection point to become truly sustainable players,” says Seth Rachlin, Executive Vice President and Global Insurance Industry Leader at Capgemini and Lecturer in Public Policy at the University of Chicago. “InsurTech is no longer a new thing, and we are seeing a growing maturity in terms of investor expectations and market understanding.”
High-quality companies that have met or exceeded their promised metrics are succeeding in B and C rounds, Rachlin points out. He notes that Capgemini’s venture fund recently invested in a B-round of funding with “a terrific InsurTech. We worked with another venture capitalist fund to perform due diligence for another successful B-round, and are now partnering with that firm as it continues to win market.
“I would view what’s going on now as the separation of the wheat from the chaff,” he adds. “Great companies get funded. Others may not.”
The Funding Games
Henri Winand, co-founder and CEO of AkinovA, an independent, regulated electronic marketplace for transferring and trading insurance risk, explains that when it comes to InsurTech investment, it’s helpful to understand the “tiers” of financial backers – and how those sources change as the firm grows.
“Pre-seed, seed and early stage InsurTechs that may have very promising ideas but don't yet have a proven track record and that can be a challenge: the industry will be very reluctant to deploy any sort of capital to them and to those who have been there for about a year or two who are unable to articulate their potential,” he notes.
“It's different for different stages of the company,” says Winand. Brand-new firms can often start out with the founders putting up their own money or getting backed by family members or other contacts. North of that is “angels,” those investors who are knowledgeable in the space “who have enough capital to go and roll it and see whether or not it's going to yield anything.” Those backers typically place small bets – $10K, $50K, maybe $100K at most.
The seed-investor venture capitalists, he continues, will play the numbers game: “They'll typically bet between $50K and $250K and they'll have a lot of those types of investments with focus on team experience and determination to succeed, and scale of the total addressable market too, of course. And they know that most of them are going to disappear.”
The ones that survive and thrive, however, often see interest from corporate and growth investors. “Once you're north of $1m to $2m in annual recurring revenue rates, you have a world of new investors coming in. Then you have a ton of capital that's available, depending on your prospective rapid growth.” The reputational equity of the firm’s management also plays a vital role at this stage.
Those InsurTechs with the best ideas but the inability to prove their ability to plot a path to profitability, however, fall in the middle – a slot Winand refers to as the “Valley of Death.”
“That's where there are very few people who are able to articulate why the vision of what they possess is so transformational, because they're not quite there on the revenue. That's the challenge.”
Additionally, the larger the fund, the less inclined the investor will be to invest in smaller tickets since the due diligence needed to be done – and the likely return on their investment – simply isn’t worth it.
“Let's assume you have an investment fund and you have $5 million to deploy,” says Winand. “You would be quite happy to deploy that in small tickets of $50K to $100K. Why? Because you need to have portfolio diversification and you try to get no more than 2% to 5% exposure to any business you invest in, especially if you need capital to follow-on for later rounds. You could do a number of small tickets. So now you could do basically early stage investments, but you’re certainly not going to make large-stage plays because you only have $5 million.”
Large investment funds, however, aren’t interested in wasting time on InsurTechs that aren’t already proving themselves; they’re looking for healthy yields on major-league investments. “So suddenly as there's more capital in the system, then the gravity pulls to the larger play,” Winand adds.
Late-stage deals are indeed taking all of the oxygen in InsurTech, says Steve Bernardez, Partner at Avanta Ventures, the venture capital arm of CSAA Insurance Group. He sees more evidence of slowing seed-stage InsurTech deal counts relative to early stage or late-stage deal numbers.
According to Pitchbook, seed-stage deal counts dropped from a high of 179 in 2018 to 116 in 2020, he points out. Early stage (A and B rounds) deal count has grown modestly from 181 in 2018 to 189 in 2020; late-stage deal counts, meanwhile, have jumped from 55 to 94 over the same period.
There are three key reasons for this, Bernardez explains.
First, across the general venture landscape, there is a greater supply of capital allocated to lower-risk late-stage and growth equity fund strategies than before, creating a flight to quality late-stage deals. Non-traditional VCs such as corporate venture groups, private equity firms, and hedge funds are increasingly deploying capital to the venture asset class, primarily at later stages.
Second, he says, “the pandemic increased the friction of developing relationships with early stage entrepreneurs and diligencing their products, markets, and business models. It’s easier to diligence a later-stage deal that has historic financials, products already in market, and established distribution channels.”
Last, exit opportunities for late-stage InsurTechs have never been better with the advent of the special-purpose acquisition company (SPAC) phenomenon, says Bernardez: “Investors want to invest in potential SPAC targets before those reverse mergers are completed. Lemonade and Root’s IPOs and Hippo’s and Metromile’s SPACs should draw even more attention to late-stage InsurTechs, at least until the IPO window closes.”
Which begs the question, what criteria do investors look for when placing their InsurTech bets?
Non-industry investors, including venture capital and private equity, continue to be the biggest contributors to the smaller funding rounds for InsurTechs, according to WTW, while re/insurers were responsible for most of the larger investments in 2020. So what are they looking for?
Winand believes the aforementioned reputational equity of an InsurTech’s leadership team is a key factor for investors.
“If you are someone who is saying, ‘I'm going to do all this stuff,’ but people don't believe that you can achieve that with the capabilities or the talent you've got around you, you won't make it. If they don't believe you can do that, then you’re toast. It's as simple as that.
“First and foremost, funds always invest into the management team,” he adds. “And so to survive in that space, you get the best people you can't quite afford. And that's the way you survive it. Then you relentlessly have to push as hard as you can on delivery, get the best talent through the front door, and provide a framework. And then, of course, engage.”
Bernardez says that irrespective of stage, investor dollars will flow to those who can execute on the promise of their differentiated innovation, be it product or business model: “The proof is in the pudding. Assessing execution at the seed stage might include metrics around market opportunity, product market fit, initial customer uptake, and regulatory approval.”
ACORD has identified which InsurTech initiatives have gained the most traction and delivered the most impact for the industry, and we have found that they tend to exhibit certain common traits. While an idea that is truly unique and innovative is able to gain investors’ initial attention, these criteria are necessary for success over the long term.
“Insurance stakeholders are a varied and unique group, each with its own legacy context. Long-term viability for InsurTech requires compatibility and ease of integration with existing capabilities, systems, and processes. Successful solutions are easily deployable across diverse stakeholders, with varying requirements,” says ACORD CEO Bill Pieroni.
Further, successful InsurTech solutions must be readily testable, lend themselves to piloting, and have a convincingly demonstrated effect, Pieroni says: “Key decision-makers will insist on confirming the solution’s value before committing to it, which will require compelling evidence that its deployment is proven to drive positive results.”
Finally, successful InsurTech ventures “leverage the ever-growing interconnectivity of the insurance ecosystem,” he adds. “They are typically solutions that enable industry ‘co-opetition’ and are able to secure authoritative early adopters. Positive network effects increase the value of these solutions and drive adoption across trading partners.”
Rachlin’s assessment is more succinct. “Only two things matter: addressable market and a firm’s ability to execute to capture it within a reasonable investment horizon,” he says. “Though InsurTech has certainly changed the pace of innovation within insurance, the industry still moves at a comparatively glacial pace. Investors are looking for companies that can overcome inertia and achieve non-linear growth in an industry where decisions typically take many months if not years.”
“Ecosystem” has become the buzzword and distribution is the focus, he adds: “The COVID crisis has accelerated the need for digital transformation of customer acquisition in all channels – direct, agent, and alternative. Firms that come with unique approaches to connecting customers with insurers will be darling of investors in the months ahead.”
“The only reason a startup shuts down is lack of funding,” says Bernardez. “It’s the reasons they can’t inspire enough investor confidence to continue to secure funding that are interesting.”
There are almost infinite reasons that an InsurTech can fail to raise more capital, he adds, including poor customer acquisition, products failing to meet customer needs, regulatory issues, and excessive loss ratios. “Sometimes exogenous factors decimate your market overnight. A Singaporean insurance and financial product comparison site shut down this January, citing inability to raise funds due to the global coronavirus crisis after raising a total of $97M since 2015, including $17M in 2020. Demand for their financial products, including travel insurance, had weakened sufficiently to drive a shutdown decision.”
Where two roads meet
Michael Wasyl, Managing Partner at InsurTech DeerCreek – a corporate innovation and growth strategy company focused on bridging the gap between emerging technology and enterprises within the Banking, Financial Services and Insurance (BFSI) sector, says investors are attracted to InsurTechs that provide “an unfair advantage in winning distribution, a technological advantage. AI companies that can streamline the process. A lot of investors are looking strictly through that lens.
“Insurance is inherently a digital product now,” he adds. “User experience is top priority. Thinking about the customer has gotten away from [insurance companies].”
However, insurance remains an industry that venture capitalists view as a stable business worth investing in. “The VC community sees a tremendous opportunity in an under-insured market,” says Wasyl, who adds that one of biggest hurdles traditional insurers face is that “they have had a lot of trouble becoming technology companies.
“It’s not like big insurers don’t want to collaborate, they just don’t know how,” Wasyl notes. Insurers, he adds, need to invest more in incubation labs – 54% are currently already doing so, he notes – “and bring in big hitters. They play reaction games, and that’s not a good model.”
Underwriting technology innovation “still seems to be in the early innings,” adds Bernardez. “AI in underwriting still seems nascent and behind in usage relative to other industries. New data sources such as telematics are enabling better underwriting. Startups enabling easier data acquisition and better analysis will benefit.”
Wasyl says he would encourage CEOs to look at their incubator and ask, ‘are we building enough?’ “There’s no excuse not to get ahead of it; they have the money. They won’t cannibalize their own business; they’re afraid of that, but that won’t happen. They might upset the apple cart with their broker partners, but not at the expense of their shareholders.
“At the end of the day, people are going to follow the path of less friction,” adds Wasyl. “Trim the intermediaries and create a clearer path. Digital distribution – that’s who’s going to win.”
As they seek to deliver on their promise, up-and-coming InsurTechs would be wise to heed the wisdom of the authors of Willis Tower’s Watson’s latest Quarterly InsurTech Briefing: “We are already seeing a number of companies delivering on their business promises before being burdened with unsustainable valuations. A useful reminder to InsurTechs is to fall in love with the problem you are trying to solve for others, not the technology you have built for yourselves.”