Technology stocks in general have declined substantially on Wall Street in the past year, but for insurtech stocks, the decline has been a bloodbath. Lemonade, the best-known Israeli example, fell by no less than 78% over the past year to a current market cap of $2.3 billion, lower than at the end of its first of trading day in July 2020.
Hippo, founded by Israeli entrepreneurs in California, has also crashed 77% since entering the New York Stock Exchange through a SPAC merger last year. Its current market cap stands at $1.5 billion, which compares with $ 5 billion at the time of the merger.
But Israeli entrepreneurs are not alone in their troubles. US-based insurtech company Root, which specializes in car insurance and went public in 2020, lost 88% within a year. Metromile, another American car insurer that went public via a SPAC merger a year ago, lost 87%, and in November was acquired by Lemonade.
Oscar Heath (founded by Joshua Kushner, brother of Jared Kushner, US President Donald Trump’s son-in-law), wants to change the US health insurance sector, but since its IPO last March, its share price has collapsed by 79%. Gil Arazi, co-founder of fintech and insurtech investment fund FinTLV Venture Capital, sums it up best: “Right now, there probably aren’t many insurtech company executives in the world sleeping well at night.”
The insurance industry awaits disruption
It really wasn’t meant to happen this way. In a world accustomed to stories about startups successfully disrupting entire industries, as Amazon did to malls (and a few other industries) and Netflix to cable companies (and video stores before that), the insurance industry seemed ripe for disruption.
The insurance industry is huge, with $700 billion a year in premiums in the US alone. Even a specific focus on the US auto insurance sector has enough meat to sink your teeth into, with $260 billion in annual premiums.
And yet, the insurance industry is dominated by very old, outdated companies founded decades ago. State Farm, for example, the US largest insurer, was established nearly 100 years ago. With its antiquated, hard-to-update computer systems, superfluous personnel, and outdated work methods, insurance seemed like the ultimate industry ready for change. “Relative to its size and value, the insurance sector hasn’t yet been significantly disrupted by technology,” says Itay Rand, a partner at investment fund 10D, which invests in insurtech.
Enter Lemonade, Hippo, Root and Oscar Health, promising to disrupt insurance, aided by modern technology and an updated business model. Technology was supposed to help them recruit customers cheaply and quickly, and make better decisions about which customers to insure, and how to price policies properly.
Lemonade was established in 2015 to be a fully digital insurance company, with no agents or physical distribution channels, a concept then in its infancy. Lemonade customers can buy an insurance policy within minutes by interacting with a bot called Maya. Pricing is based on artificial intelligence and machine learning, and at least a third of customer claims are handled automatically, without human contact.
Assisted by behavioral experts like Prof. Dan Ariely, Lemonade has formulated a mechanism through which it allocates 25% of income on premiums paid by policyholders to day-to-day company operations, and the rest to payments on claims. Any money left over that has not been paid out in claims, is donated to the nonprofit organization of the policyholder’s choice, thus reducing the motivation to defraud the company, at least in theory.
Like Lemonade, Oscar Health is based on a sophisticated app that promises to centralize all policyholder health needs in one place, including scheduling appointments with medical specialists, and remote consultations with doctors. It even tracks the policyholder’s daily walking patterns, with the possibility of earning up to $100 a year if step goals are met.
Both Root and Metromile emphasize that their car insurance policy pricing is based on the driver’s actual behavior. Root, for example, monitors new customers’ mobile phones for 2-4 weeks before setting the policy price. Drivers who travel less will probably be involved in fewer road accidents, and can therefore be offered a cheaper policy. Hippo, for its part, provides homeowner policyholders with smoke detectors and water leak sensors. This helps the homeowner, but at the end of the day, should also reduce Hippo’s property damage payouts.
It all sounds great on paper, but so far hasn’t really helped insurtech companies capture a significant share of their niche markets. While Lemonade accounts for about 5% of the US home renters insurance market, this is a relatively small market amounting to only $4 billion in annual premiums.
Beyond the disappointing market share taken thus far, the insurtech companies need to be concerned that investors no longer believe in their ability to disrupt this giant industry and become giants worth tens of billions as they dreamt of doing. Their current low market cap says it all.
The exit was important in building the company
To a large extent, the companies have only themselves to blame for the current situation. Disruptive companies like Uber in the travel sector, or Airbnb in tourism, waited 10 and 12 years, respectively, before going public. In the insurtech arena, by contrast, Lemonade went public after only five years, and Hippo at six. Both took advantage of the period during the Covid-19 pandemic when the market was hot, before it cooled. Hippo and Metromile entered the stock market through SPAC mergers, which wasn’t helpful to them.
One entrepreneur familiar with the sector claims that the desire for an exit is what brought the companies down. “There was a kind of mad rush for a public offering. The feeling is that, for some of the companies, it was more important to make an exit than to build a company for the long-term.
“All the insurtech companies went public before they could predict their growth well enough, and that’s really suicidal. You have to know with a high degree of certainty what your top and bottom lines will be at least three quarters ahead, without revising or missing forecasts. Otherwise, you’re liable to get into a tailspin on the capital market.”
The beginning for some of the companies, like Lemonade, was actually very promising, when the Israeli company’s market cap soared to about $10 billion. At that time, valuations for insurtech companies were determined by generous multipliers, particularly on revenue, that were more like those granted in the super-profitable software sector than in the insurance sector.
The leap was based on a good deal of hype, influenced by the pandemic, and also on very strong top line growth figures presented by the companies. Lemonade’s customer base, for example, grew at a furious rate of 294% in 2018 and by another 108% in 2019.
But after that rapid growth period, perhaps naturally, the growth rate for Lemonade’s customer base slowed to 55% in 2020, and is expected to be 44% in the coming year. As top-line figures ceased to be impressive, investors began to look more at midline items relating to efficiency, where the technology should have had an impact.
When promising technology becomes a disadvantage
But, so far, the technologies haven’t proven themselves, at least not in a way that can be quantified clearly in numbers. That was exactly the point made in a study by investment bank Jefferies, published last November. The study addresses, for example, Root’s driver monitoring technology. This technology was supposed to provide Root with a competitive advantage in the underwriting process, where the insurance company decides whom (or whom not) to insure, and of course, at what price.
In practice, Root’s loss ratio, [the ratio between the insurance company’s expenses on claims and the premiums paid by policyholders], is actually higher than the industry average, indicating lower insurance efficiency. In the third quarter of 2021, the average loss ratio on car insurance for US companies was 72.1%. At Root, it was 91.3% in the third quarter, meaning that for every $100 Root charged in premiums, it paid $91 in claims to policyholders, compared with $72 in the industry as a whole.
Jefferies also reported an overall problem with Lemonade’s use of artificial intelligence (AI) in the underwriting process. “The company [Lemonade – O.D.] often points to the benefits of its artificial intelligence over traditional insurers. Again, we do not believe that the information available to public investors can prove or disprove this. But if that is the case, we would expect Lemonade’s AI advantage to be reflected in a lower claims frequency rate,” it states.
Even if the new insurtech companies have a technological advantage, it pales in relation to their much more significant disadvantage – their limited size. Hippo, for example, suffers from a particularly high loss ratio, which jumped to 161% in the second quarter of last year. The reason was a large concentration of Hippo policyholders in Texas who suffered from extreme weather conditions, resulting in a massive amount of property damage claims.
For the big insurance companies, with policyholders distributed throughout the US, the effect on the loss ratio was much smaller. And when it comes to such storm conditions, discussing the benefits of installing sensors in the home is pointless.
Under certain conditions, technology can also be a disadvantage for the insurance sector. For example, customer acquisition through digital channels is by its nature more attractive to young new drivers, but these drivers are also more prone to having accidents, and to filing insurance claims.
As a result, Root has abandoned its sole reliance on digital channels, and is now trying to expand into additional customer acquisition channels. Lemonade, which entered the car insurance market this year, devoutly maintains its adherence to digital only.
The momentum may yet shift
It’s too early, of course, to eulogize the insurtech companies, with the exception of Metromile, which has already been acquired in a $500 million share transaction by Lemonade. Artificial intelligence and machine learning are a function of the database size available for analysis, and therefore, as the companies grow, these should improve significantly. This underlies Lemonade’s acquisition of Metromile, which has accumulated over a decade of data on 400 million driver journeys, monitored by a special device placed in the policyholder’s vehicle. Such information should help Lemonade calibrate its car insurance underwriting algorithm.
Hippo has in recent months added a number of experienced insurance executives from giants like AIG and Chubb, to help the company improve its underwriting process. In addition, Hippo announced it had added five more data sources to its underwriting process in the third quarter of last year, and starting in the fourth quarter was adding 50 new weight variables to its customer analysis.
At the end of September, Hippo a respectable $850 million in cash, meaning it has significant breathing room to improve its models, and try moving towards profitability, something none of the insurtech companies have yet achieved.
“The capital market dumped all the companies together,” says Arazi, “but at some point, the momentum will shift, and some companies, not all of them, will come back up. Those that can maintain exponential growth, have a good business model, and know how to be profitable – they’ll go up dramatically. Those companies that don’t will be acquired and become the digital divisions of the veteran insurance companies.”
There is another possibility as well. It may be that the today’s insurtech companies are the first generation of attempts to disrupt the insurance industry, paving the way for successors who will succeed where they have failed. The next insurtech generation may succeed in capturing a larger market share through a more significant change in the industry’s current value chain.
In the private market, quite a few insurtech start-ups are warming up on the starting line, such as the Israel-based Next Insurance, which last year raised $4 billion from private investors. Next wants to disrupt the small business insurance sector, which is relatively less competitive but with a higher level of underwriting complexity, which may make its technology more impactful.
“To some extent, the disruption in the insurance industry has not yet begun,” Rand says. “Some of the existing insurtech companies have created shiny exteriors and branding, together with good applications and excellent service that reimburses policyholders quickly, but that doesn’t yet amount to a real paradigm shift.
“A paradigm shift in the insurance sector could be, for example, offering a unified insurance product that would cover all aspects of life. So, we wouldn’t have to buy life insurance, car insurance, and home insurance separately. It could be insurance that would automatically be assigned to a policy, without having to provide details. There are many possibilities.”