The class of 2020: how insurance start-ups can thrive now
In a changing market, start-ups and “reloaders” can thrive with a clear purpose, the right talent and better tech and data capabilities.
Like the “classes” of 2002 and 2005, 2020 insurance start-ups have benefited from an attractive rating environment and strong private equity (PE) funding.
New risks, low-interest rates, de-globalization, and freedom from legacy tech constraints are what make the latest crop of start-ups different.
A clear purpose, strong digital capabilities, and the right approach to ESG are necessary for the class of 2020 to navigate an evolving landscape.
2020 was a year like no other, but it proved to be a good one for insurance start-ups. Planes were grounded, office buildings closed, and financial markets were down precipitously in the immediate aftermath of the pandemic. However, despite these adverse conditions, there was a strong “class of 2020” of start-ups, particularly in specialty insurance and reinsurance. There was also significant “re-loading” by relatively new companies that seized the opportunity to build on their initial capital base and scale-up their businesses.
This level of start-up activity has not been seen since the early noughties when the “class of 2002” and “class of 2005” were created in response to major losses in the insurance and reinsurance markets. This article will explore the similarities and differences between the class of 2020 and previous classes of start-ups. The business environment in which this new generation is operating has changed markedly, thanks to rapid social, environmental, political, legal, medical and technological shifts. The members of the class of 2020 will need to address a more holistic set of business requirements if they are to thrive.
The class of 2020’s resemblance to the classes of 2002 and 2005
The biggest driver for last year’s crop of start-ups has been the attractive rating environment. While the classes of 2002 and 2005 had similar conditions, multiple events – rather than single large events – created the current rating cycle. The market in 2002 was shaped by the impact of the 9/11 attacks, whilst the market in 2005 was a result of large catastrophic loss events, most notably Hurricanes Katrina, Rita and Wilma. In contrast, the current hard market cycle has resulted from multiple large losses, such as Hurricanes Harvey, Irma and Maria and Typhoon Hagibis, and the wildfires in California and Australia, to name only a few.
The attractive rating environment created ideal conditions for the creation of new, agile companies with simple business models that are led by charismatic “market makers.” New companies that have clean balance sheets and no legacy claims are in a particularly good position to take advantage of the hard market. Such new platforms offer attractive alternatives for top underwriting talent, where they can focus on assessing risk opportunities without the distraction of legacy management commitments.
Much like previous generations, 2020’s start-ups and reloaders saw renewed interest from PE investors and sovereign wealth funds attracted by the superior returns the specialty and reinsurance market offer compared to other sectors. To date, more than $11.2 billion of new capital has been raised in the specialty insurance and reinsurance market, of which PE contributed $7 billion.
Similar to the classes of 2002 and 2005, today’s new companies have set up on company platforms in the US, Bermuda and UK and/or at Lloyd’s. The latter group takes advantage of the license network and credit rating provided by the market. In some cases, legal entities have been set up within the EU to access European markets. These companies have moved swiftly to get their trading platforms set up and approved by relevant regulators in order to start trading.
What’s different about 2020
There are also some key differences this time around that have changed the client and business landscape for new carriers and significantly influenced their strategic focus and operating models.
The main economic difference is the ongoing low interest rate environment, which means that investment capital continues to be cheap and abundant. The current trajectory in the insurance pricing cycle makes the industry market an attractive target for investment capital relative to other sectors. On the flip side, low interest rates have also cut into insurers’ investment income.
In 2002 and 2005, carriers could count on investment returns of 5-7% on top of any underwriting profit. Such returns are no longer realistic, although investment income became increasingly important through the soft market cycle of the recent past. Interest rates do not look likely to increase substantially any time soon, despite recent concerns around inflation. The class of 2020 will have to manage the underwriting cycle profitably because it cannot rely on investment returns.
The customer risk landscape has changed. Clients have new risks (e.g., cyber threats, pandemics) that must be addressed, and globalization has heightened supply chain risks. Clients are also having to adapt to environmental changes and the increased frequency of property catastrophic activity in the last few years. Shareholders are demanding increased focus on sustainability from the companies in which they are invested. Customer purchasing behaviors have also changed to align to more integrated risks strategies within corporations and the rise of super captives. Customers will increasingly expect to trade with insurance markets on a digital basis with real-time risk data as a hygiene factor – not a differentiator.
This landscape has been further impacted by increasingly globalized tax and accounting rules, such as IFRS 17 and BEPS, and political changes, such as Brexit. The new start-ups will need to address these changing customer requirements whilst keeping their models agile to respond to changing tax and regulatory requirements.
Changes in social attitudes mean that customers, shareholders, and employees want to engage with companies that demonstrate clear purpose and commit to delivering social value. More consumers want to do business with companies that embrace diversity and inclusion and support environmental sustainability, as well as providing economic value. It will not be enough for the next wave of companies to simply deliver an investment return; they will need to attract diverse talent and help drive client sustainability.
If an insurance company is made up of three key assets (capital, talent and data), then there is an “arms race” for the last two asset classes. Technological advances in recent years have led insurers to develop data and technology strategies to differentiate from the competition. Clients will expect to engage digitally and in real-time.
The new focus on ESG will require companies to access the data to support ESG objectives and measure progress against ESG targets. Incumbent players have typically focusing the majority of their governance on capital and talent, and are only now giving data the focus that it merits. New start-ups can embed a proper data strategy from the outset and avoid the legacy management issues of incumbents. It speaks volumes that 50% of the staff of a typical FinTech company are data scientists or data analysts. Tomorrow’s winners will need to attract the right data talent and embed a digital culture to differentiate in this market.
Four keys to success for start-ups and reloaders
EY teams have supported a number of the new start-ups to get established and to develop their operations. As these companies now look to scale their businesses, they will need to embed a number of key principles if they are to have the potentially disruptive impact on the market they are targeting.
1. Establish and embed a clear purpose
Companies are now operating in a business environment that expects companies to deliver more than just financial value. Thus, all types of companies, including start-ups, will need to communicate clearly how they deliver sustainable environmental and social value, if they are to attract the clients and talent to grow their businesses.
The bedrock of this approach is to establish a clear purpose and make sure it is embedded as the DNA of the company and is clearly communicated to customers, intermediaries and investors. Start -ups will need to enforce this purpose, and set of values, as the business grows and takes on more talent in multiple locations. Retaining this purpose-led approach will be a key challenge as these new start-ups scale and grow.
2. Embrace environmental, social and governance (ESG)
A clear ESG policy and framework is typically rooted in company purpose. ESG policies will speak to the values of the business and may be used as a differentiator. In fact, one recent start-up is looking to establish itself as a pure ESG carrier as their core proposition.
Having a clear ESG policy establishes a company’s position on environmental matters, which is increasingly important to clients, employees and shareholders looking to support sustainability. From a societal perspective, companies will not be able to attract the talent they need, notably for technology and data capabilities, unless they embrace diverse talent and build inclusive work environments. Key market initiatives in this space, such as the Net Zero Alliance and the Lloyd’s ESG report, are already underway. An ESG policy needs to clearly set out and embed a company’s philosophy on these important themes.
3. Think and act digital
The members of the class of 2020 have the opportunity to develop clear differentiation from incumbents by developing agile, digital operations from the outset to avoid the legacy issue faced by incumbents. Already, we are seeing innovative new start-ups develop intelligent, algorithm-based platforms to create lean and efficient follow-line businesses. These models are not easy to create, which acts as a barrier to entry to potential competitors.
Merely by creating agile, cloud-based, data-driven and technology-led models, the next wave of companies can scale, transform and grow more effectively and efficiently than incumbents. A digital model will enable new companies to address the rapidly changing client risk environment by supporting real-time risk understanding and insights into the impact on pricing. By embracing digital trading, the class of 2020 will be able to engage seamlessly with clients, brokers and market platforms.
4. Focus on the core
New start-ups have the opportunity to design and build their operating models so that they focus exclusively on what is core to the business. A number of the new players have evaluated the end-to-end value chain to identify core vs. non-core processes. They have looked to outsource non-core processes, where there is no competitive advantage to be gained by undertaking the process in-house and suppliers can perform the work more effectively and efficiently.
Financial reporting, tax reporting and actuarial quantitative reporting templates (QRTs) are examples of processes that today’s start-ups are likely to outsource. Not only does this approach keep the operating model simpler and free up management bandwidth, it also supports greater scalability and agility as the business grows. Ongoing global regulatory and tax changes are also more likely to be addressed by a global specialty outsourcer than in-house teams.
A dynamic future happening now
EY teams have supported a number of the new start-ups in this rapidly changing marketplace by leveraging our own NextWave strategy (pdf). This approach looks to help companies meet the demands of the future business environment by delivering not only financial success, but also by creating long-term value for clients, employees and society as a whole.
The development of a strong insurance start-up class reflects the huge upside opportunity in the specialty and reinsurance market. It also speaks to the current dynamism of this market. Never before has the world needed a high-functioning specialty and reinsurance market as much as it does now – and rarely before have there been as many promising start-ups.