Game Theory and Insurtech:

One of the hottest topics in Insurance industry forums, news, and many prognosticators/speakers commentary – is that most are predicting the threat to the Insurance industry due to Insurtech.   That the insurance industry will be revolutionized and incumbents should be in defense mode to retain their business.

While there is credibility to the thought that technology will impact Insurance industry, there is some issue with many forecasts out there.

I think this thought process or credibility to the predictions is somewhat flawed; for two reasons:

  1. Rarely is anyone putting a time-frame on their predictions. Hence anyone can predict something with no time-frame and hence no accountability for being wrong.  This is like the fortune teller stating “You will die in the future”.  Although accurate, you might feel ripped off if you paid for this fortune.
  2. These predictions seem to be coming from the perspective of a vacuum and don’t include thoughts on Game Theory and Insurtech.
    1. Some predictions rarely account or think about Incumbents, the incumbent insurer advantage & reaction, and how long the Insurtech investor can realistically wait for outcomes/results.

Let’s focus on #2.

Game Theory

Game Theory is the branch of mathematics concerned with the analysis of strategies for dealing with competitive situations where the outcome of a participant’s choice of action depends critically on the actions of other participants. Game theory has been applied to contexts in war, business, and biology.

This art/science is something that isn’t discussed when predictions about the industry are presented.

A basic thought is if Insurtech is going to “threaten” incumbent insurers, a simple question would be “How do we think the incumbents will react?”

Incumbent Insurer Options

Incumbents have a few options regarding Insurtech, the biggest advantage is the ability to wait.

  • Imitate – to recapture market position once Insurtech has revealed approach works. Each company can develop new technologies to improve operating efficiencies, source risk quicker, understand exposures better, etc.
  • Wait Longer– incumbents have the ability to wait longer to see if anything comes from it. The success of the approach will be revealed.   If customers don’t react to the new technology or the advantage is not apparent in results, no resources were wasted.    If you’ve read Good to Great in Insurance or Good to Great the book, think about the Flywheel and/or Walgreens/ example.
    • More advantageous for incumbents, as insurance markets are not a winner take all market

Incumbent Advantage

Incumbents have a huge advantage – they have customers, capital, track record for sourcing risk, systems, platforms, regulatory framework aligned, etc.  Newcomers have to take riskier strategies to move into the ranks of the incumbents.

If incumbent insurers utilize simple game theory strategies, they have a lot to benefit.

A defensive position by incumbent insurers can impact timing, forecasted results, market share, etc. ultimately delaying Insurtech investors from seeing the gains or traction they were hoping for or predicted at time of investment.   This could change exit strategies for investors.

Venture Capitalist business model

Many of the funds coming into the Insurtech space are from VC Firms.   A venture capitalist is a person who invests in a business venture, providing capital for either start-up or expansion.

An investment from a venture capitalist can be in many forms but typically is a form of equity financing – the VC investor supplies funding in exchange for taking an equity position in the company.

According to Harvard Business review,

“Venture money is not long-term money. The idea is to invest in a company’s balance sheet and infrastructure until it reaches a sufficient size and credibility so that it can be sold to a corporation or so that the institutional public-equity markets can step in and provide liquidity. In essence, the venture capitalist buys a stake in an entrepreneur’s idea, nurtures it for a short period of time, and then exits with the help of an investment banker.”

The investors in VC funds expect a return of between 25% and 35% per year over the lifetime of the investment.  This is due to the nature of the risk associated.

For every deal that doesn’t go as planned, VC firms need those with great Hockey stick returns to meet this expectation from investors.

Insurtech investors/Market Cap

Other questions would be around the market multiple given to an insurance company vs. a technology company.  Are those companies positioning themselves as the “future insurance companies” taking a prudent approach trying to unseat incumbents?   Is it better to be a servicing company over disruption startup?

Giving the timing and investor strategy, would these insurtech companies be better off positioning themselves as technology services companies for the insurance industry vs.  Insurance companies with great technology?  At least it’s safer for the investor at time of sale…

If an investor is looking for an exit strategy, would they prefer a multiple of earnings similar to an insurance company or that of the publicly traded Tech companies?

Capital into Insurtech

The largest influx of capital into Insurtech recently.  The investments have grown, however recently seen reports that funds to this sector may be flattening in 2017.

There are a few articles written about this at Insurance thought Leadership, and others.

Not to dispute the data, just putting size and scale around the reported investments into this space.

“According to the latest data from Venture Scanner, overall InsurTech venture funding grew at an annual clip of 31% from 2011 to 2017.

This investment growth is taking place across the globe. Leading sectors include insurance comparison marketplaces (280 startups), insurance infrastructure/backend (222 startups), automobile insurance (114 startups), health and travel insurance (108 startups), insurance data and intelligence (100 startups).

Based on funding patterns, it appears at least $2 to $3 billion a year is now going into “Series B” and “Series D” funding, meaning into existing companies that have been around for at least a couple of years.”

Margin compression:

Who is better suited for margin compression to be removed from the system?

To use the Uber disruption example/comparison:  please review the case studies but Transportation services companies were loaded with debt (NYC medallions alleged to be $1m) and insulated by a regulatory framework that supported that debt.  Making it ripe for consumer demand driven disruption.  Also, the downward pressure on the cost of a ride to the airport was immediate and seen real time by both the consumer (price) and seller (margin/cost to get to and from airport).

In regards to Insurance companies the downward pressure on the cost of a premiums/rates vs. %/$ of premium for loss costs will take time to shakeout.  Since the cost of goods sold (or losses) is unknown at the time of sale, the ability to decrease costs is somewhat limited to expense savings.

Again advantage incumbent, until you can prove technology has eliminated the need for the LOLN and passed savings onto the customer through enhanced loss cost prediction/risk selection.

With the incumbent insurers sitting on mountains of cash/bond portfolios as insulation to the margin compression, some companies can achieve low single digit ROE’s just on their investment portfolio along before UW results….who is better suited for the decrease in margin?

Where would investors long term be putting there capital?


Incumbents are going to react and defend their positions, make acquisitions of teams or technology that have proven to help (lower expenses, acquire customers, etc.), and VC investors are going to push for exit strategies or sales to incumbent insurers over time.

Based upon the timing about growth in the investment in Insurtech, the growth of 31% annually.  We could expect to see VC firms (over the next 5-6 years) looking for the exit strategy and execution, new investment opportunities, etc.

This isn’t a piece to make incumbents feel warm and cozy about the state of the market, there definitely will be some disruptions of certain sectors of the industry.  However, if your looking to compare the disruption of Uber (consumer driven deregulation of the livery business) to the insurance industry, I believe it will be an uphill battle to disrupt insurance is similar fashion (Thanks -McCann-Ferguson) but anything is possible.

Don’t get complacent and disregard the consumer.

Also, I’d recommend you don’t feel bad for the VC firms, they will do quite well with many of these investments.   The insurance industry is in need of these technology shake up and will benefit the customer, the insurers, the insurance incumbent investors, and many of the insurtech founders/VC firms.

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Arnold Smith

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