Launched amid grand Wall Street hoopla with expectation they were the next Google, Tesla or Uber, tech companies that promised to disrupt the stodgy insurance industry have instead struggled to find footing -- and some are even fighting for survival.
Perhaps the most notable cases are those of Lemonade and Root, two insurtechs that were founded in early 2015 and went public in 2020. The stocks of both companies are off more than 90 percent from their IPO prices, and profitability seems to be years away. Root, in fact, just laid off 330 people, 20% of its workforce, raising chatter about its long-term prospects.
Insurtech Advisors analyst Kaenan Hertz told S&P Global Market Intelligence that Root, which lost more than a half-billion dollars in 2021, still has not “tamed the economics of insurance.”
“More importantly, they haven't figured out how to appropriately underwrite and price the risk,” he said.
That’s pretty much the ballgame when it comes to selling insurance. The concept of spreading risk and writing insurance contracts hasn’t changed much since the notion was first introduced in 18th century B.C., with the Code of Hammurabi. The key is you have to be able to have enough customers to absorb the impact of losses, cover expenses, and be bringing in enough in premium revenue to earn a profit.
Insurtechs are winning on some of those counts — by growing their user base and revenue. But their losses and expenses are increasing by just as much, keeping them in the red.
“There’s still a real opportunity for insurtechs,” said Robert Tomilson, a partner at the law firm Clark Hill and chair of the firm’s insurtech practice. “They have made their mark in distribution, in sales, but the real challenge new products, offering a different experience, remains.”
A perfect opportunity for disruption
If ever there is an industry ripe for disruption, it is insurance. As one insurance advisor recently told The Business of Business: “Insurance companies are slow, unresponsive, and unimaginative. They're all the same, and they are difficult to deal with. They are not friendly, and they just don’t care.”
With a reputation like that, it’s no wonder entrepreneurs enthusiastically entered the market using technology and telematics data to revolutionize the way insurance is priced, bought, and sold; pitching to the generation of consumers who transact nearly everything over their phone or desktop computer with easy-to-use apps that promise quick delivery with no human salesperson or overseer.
“Our long-standing two-pronged strategy has been to win with technology and to grow with our customers,” Lemonade co-CEO Daniel Schreiber, told investors in a conference call last week where he discussed the rent and home insurance company’s record $241 million net loss for 2021.
“That is to build a digital native company on the premise that an insurance company, built on a technological foundation, will be able to service customers and quantify risk with a degree of precision and level of automation unavailable to incumbents,” he added. “And secondly, to engage customers when they’re young, delight them with a cocktail of values and fabulous experience, and then grow with them by offering them all the upgrades and coverages that they will naturally grow into as they go through predictable lifecycle events.”
Broad appeal in the marketplace
That’s essentially the mantra of all the budding insurtechs. And market research back them up. Surveys show people want new and innovative ways to purchase insurance and would happily shun the traditional giant insurance companies.
According to a new survey from Breeze, a disability insurtech, 55% of American consumers would be interested in buying an insurance product from Amazon over traditional insurance carriers. About 66% would consider buying auto insurance from an automobile manufacturer such as Tesla, Ford, or Honda; 61% would purchase renters and homeowners policies from a real estate company such as Zillow or Trulia, and 59% would think about buying health or life insurance from a pharmacy such as CVS or Walgreens.
Largely because of research like that, investment into insurtechs exploded. Recent data from CB Insights showed that global insurtech funding was at $10.5 billion through Q3 2021, which was 48% greater than 2020's year-end total.
Data from Thinknum, The Business of Business's parent company, shows that both companies have grown over the past year in terms of number of App Store ratings (a proxy for downloads) and Twitter followings.
But more than a half-decade after entering the market, investors, many of which had notions of 10 times earnings returns or better, are still waiting. What is keeping insurtechs from taking off? Analysts and investment specialists generally boil it down to three factors: unreal expectations (see: “Hype), heavy regulation, and the unique nature of the products themselves.
Many of the insurtech entrepreneurs migrated from fintech, which isn’t nearly as regulated as insurance, and perhaps thought the dynamics were similar.
“Insurance is a unique product,” said Clark Hill’s Tomilson. “It’s heavily regulated. The pricing is regulated, and how you sell it is regulated. Almost every aspect of the production and distribution chain is regulated.”
Pain points for Lemonade and Root
Insurtechs are good at one thing: acquiring customers. Lemonade says it has more than 1 million customers and grew its customer base by more than 55% last year. More than 75% of its customers are under the age of 35. It also offers a broad suite of coverage, including home, life, liability, renters, and with its recently announced acquisition of Metromile, also auto. That should help spread risk and balance loss ratios, analysts say.
But there is a high cost of accumulating customers. Lemonade’s operating expenses ballooned 100% last year. And it reported an unsustainable 96% loss ratio (how much it paid out versus how much it took in) for the fourth quarter of 2021, up from 74% in the previous quarter. Lemonade’s Schreiber said the company miscalculated its necessary reserves for losses.
“We have a strong record of cautious reserving, but reserving is an imprecise science,” he said. “And so adverse developments do happen every now and then.”
Adverse selection definitely seems to be a problem for these insurtechs and perhaps explains why the traditional insurers don’t seem to be losing customers to the insurgents.
“The competition is unlikely to lose significant share to Lemonade from accounts they prefer to keep,” said Mathew Queen, CEO of a captive insurance company writing on Seeking Alpha. “The lack of institutional response from the legacy carriers suggests that the accounts won by Lemonade are the accounts the legacy carriers prefer not to insure.”
Root’s results show similar pain points. Its loss ratio of 91% in the final three months of 2021 was far off from its goal of 65%, and also an increase from 82% in the fourth quarter of 2020. The onset of the pandemic was a good time for auto insurers. With so many fewer vehicles on the road, established auto insurers earned billions of dollars in windfall profits that year.
Given its losses and mounting expenses, Root reported a $92 million operating loss for the quarter and a $485 million operating loss for the year despite growth in premiums.
Root’s problems are magnified, analysts say, because it only sells one product: auto insurance, relieving consumers of the ability to bundle homeowners, rental, life, pet and other policies under one roof.
“The company is valued at an all-time low mostly because a company with no profitability is expected to show high growth,” said a report by Moonshot Equity Analysis. “But Root has exhibited unimpressive growth, high loss ratios, and stressed fundamentals.”
Both Lemonade and Root also been adding headcount steadily, at least until recently for Root, which started sinking weeks before the layoffs, according to data Thinknum has collected from LinkedIn.
Ironically, the insurtechs may be making good on their original promise of improved customer experience, easier billing, and better claims handling. But in the end, it’s still insurance. The products don’t vary that much from company to company, the prices are regulated by governments, and advertising the benefits of how user friendly you are may not be as be as major a factor in purchase decisions as one might think.
“The very fact that the largest incumbent insurance companies continue to advertise in the same ways as they did 30 years ago, suggests that they continue to believe that the only differentiator in insurance is price,” said Tomilson. “Insurtechs will hopefully prove them wrong.”