Underwriting Takeaways for Insurtechs

A detailed, not overly complementary, and sometimes amusing analysis by Inside P&C called “Root IPO in full: InsurTech and The Big Lie” (paywall), based on Root’s S-1, highlights potential flaws in its disruptive business model and notes why the business model may not be all that different from incumbents.  More importantly, the analysis includes important lessons for Insurtech MGAs and insurers.  

Regardless of whether Root will turn out to be a good investment or whether they will ultimately be successful in disrupting the insurance business, the analysis raises important questions.  How hard is it to disrupt the sleepy insurance business?  Can scaling a money losing insurance underwriting business model end up being a successful company and a good investment?  Can Insurtechs grow fast enough outpace bad underwriting?  Does underwriting matter, anyways?

Underwriting is not static, and there is not just one right way to underwrite any particular segment of customers.  The age of Insurtech is not the first time that newly formed insurers and MGAs have changed the insurance industry’s approach to underwriting difficult risks.  Two examples are:

Hartford Steam Boiler (HSB, see here, here):  HSB was formed in 1866.  The company focused on industrial safety, specifically on preventing boiler explosions, and used insurance as an incentive for customers to practice good risk management.  As HSB shows, tying insurance to strong risk management practices is not a new concept, and HSB is continues to be a successful specialty insurer with strong risk management 150+ years later as part of Munich Re.

Executive Risk (ER, here, here):  ER was formed in 1986 as both an MGA & insurer, and commenced operations in 1987 with an alternative and disciplined approach to underwriting Directors & Officers (D&O) insurance.  After a successful IPO, the startup was acquired by Chubb.

Startup insurers & MGAs can drive change in the insurance business, but successful risk taking requires disciplined underwriting.  Because insurance is a competitive industry and is based on assuming risk, traditional insurance industry underwriting practices might be helpful to underwriting-driven Insurtechs.  Best underwriting practices might include:

  • Discipline:  Profitable underwriting is hard and takes discipline
  • Declinations:  Underwriters do not write all risks presented – through pricing and risk selection, declinations are a part of successful underwriting
  • Segmentation:  Segmentation, often through specialization and expertise, leads to larger underwriting profits
  • Retention:  Retaining the better risks is critical to long term underwriting success
  • Capital:  A strong balance sheets is essential to assuming risk, and can be a competitive advantage
  • Reserving:  Inadequate reserving may enhance short term returns, but will lead to a weak balance sheet

Buffett has his own view of underwriting success here.

Insurtech management teams are typically well versed in the essentials to startup success:  get traction quickly, grow topline very fast, reduce burn to get to breakeven, raise capital through multiple rounds at increasing valuations, exit, etc.  Insurers & MGAs have an additional challenge.  Insurers take risk, and successful underwriting will ultimately determine the success of the insurer or the MGA.

Innovate Insurance – Innovation & Entrepreneurship in Insurance

Also, see the related Specialty Insurance Blog – News & Commentary on Specialty Insurance – with an Emphasis on Professional Liability Insurance

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