Why do we care so much about faltering insurtech unicorns, given that Insurtech Gateway play in the early stages of an insurtech’s lifecycle? Because, in our experience, it is often in the early stages that it can go wrong, and it all starts with the founders.
Insurtech Gateway has seen numerous pitches from confident founders. In determining who to back, we consider the strength of a founder's will to win, their venture-building know-how, and their technical acumen. 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 is that venture metrics fail to pick up on the 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. Developing the right habits and culture early is vital and is driven by the founders.
Sounds simple? Let’s unpack this a little more.
Start-ups by definition are companies built to grow fast. Their fuel is venture capital. The universal start-up methodology prescribed to realise speed:
Burn cash rapidly to achieve high-velocity growth,
Use growth metrics to inform performance, including; monthly recurring revenue (MRR), customer acquisition cost (CAC) & lifetime value (LTV) and monthly gross churn.
Subordinate bottom-line metrics through-out the first-mover advantage phase.
The only real competitive advantage is a first-mover advantage, as everything is replicable, eventually.
As a start-up matures and growth rates slow down and the metrics that define profitability come into focus.
In sharing their Q3 2022 results, Lemonade announced that “given today’s high cost of capital, we are intentionally decelerating towards our ‘optimal cash burn’ velocity. In other words, given the high cost of gas, we’re now optimizing for miles per gallon, not miles per hour”.
This is generally the process most venture-backed start-ups, including insurtechs, follow. Insurtechs are start-ups and should adopt start-up methodologies. However, for insurtech managing general agents (MGAs) and full-stack insurtechs, loss ratio (a bottom-line metric) should be promoted from day 1 as a key performance metric.
WHY IS THE LOSS RATIO SO IMPORTANT?
Insurtech MGAs leverage the risk capital of a (re)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. The sustainability of this highly interdependent relationship is key to the success of an MGA. Loss ratio is the most informative metric for the economic health of the relationship. An MGA’s value is very little 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 the 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.
It is discipline and respect for insurance fundamentals that enables an insurance business to track and reserve for claims adequately. When 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?
We are experiencing a revolutionary period in insurance history where underwriting is set to change for the better. In 400 years not much has changed in insurance – every risk has been priced in much the same way, classifying individuals in pre-set risk cohorts like gender, location etc. However, due to rapid developments in technology and data, 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 under-performing listed insurtechs that have a history of subordinating loss ratio as a performance metric. Since IPO, Lemonade and Root are down well over 50% with loss ratios performing poorly.
WHERE COMBINED RATIO CAN BE MISLEADING
An insurtech could be acquiring customers at a LTV:CAC of 3:1. They may choose to burn a significant amount of capital – sometimes a multiple of their revenue – in sales efforts over a short period to acquire more of those valuable customers. Their loss ratio could be 60%, and yet their combined ratio for that period could read 150%, and yet in reality this would be deemed a great performance. The combined ratio’s shortcoming as an accurate performance metric in this scenario is its inability to capture the value through periods of time.
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 by Venture Capital, however, this metric may determine the path to success or failure for emerging insurtechs.
The MGAs in Insurtech Gateway’s portfolio perform substantially better than market average on loss ratio, mostly by controlling claims frequency. Controlled Growth is the mantra. If you are interested in hearing more about how we make insurtechs insurable and investable you will find our Co-Founder Stephen Brittain and CEO Richard Chattock speaking at the London Market Conference on the 21-22nd November. Or you can get in touch any time.
