Driven by quickly-changing technology and rising customer expectations and competition, the insurance industry is fertile ground for innovation — both from existing players as well as from new entrants. After years of low engagement, when customers purchased a policy and gave it scant notice until emergency struck, insurance touchpoints are on the rise thanks to the push for customer centricity from today’s innovative InsurTech firms.
The InsurTech space is gaining ground, boosted by global investment that reached nearly US$665 million in Q4 2018 – 78% higher than in Q4 2017.
As more and more InsurTech firms venture forth, however, an important question that arises is how many of these InsurTechs are able to sustain in the long term. Startups dazzled by short-term indicators may lose sight of long-term metrics, which could portend failure despite having a great idea or product.
Once the decision to move forward is made, it becomes essential to sustain or grow consistently. Whatever the endgame – acquisition, IPO, or running the business privately – monitoring financial health is critical.
This first of two blogs explores the cost-revenue and cash management metrics for InsurTech startups. Part 2 covers key customer-related metrics. Managing these metrics will foster sustainability while demonstrating confidence to analysts and investors.
Loss ratio – For InsurTech firms that offer end-to-end coverage, a loss ratio metric is a business performance tool. Loss ratio is the proportion of losses to gains, so the lower the ratio, the better. Loss ratio is determined by the ratio of total incurred claims’ losses plus adjustment expenses divided by the total premiums earned.
InsurTech startups are outperforming incumbents on premium growth, but falling short on loss ratios, which, despite being generally stable or improving slightly, remain unsustainable. But, with use of Technology and Data, some InsurTechs have overcome that over the period of 1-2 years.
For example, Lemonade, the American carrier that offers homeowners and renters insurance powered by artificial intelligence and behavioral economics, improved its loss ratio of 166% (Q4 2017) to 87% (Q1 2019)
The trend may be the result of optimistic initial pricing and generous discounts and offers. Therefore, startup executives should price products more realistically at the outset to maintain a healthy loss ratio and a sustainable business model.
Pricing – Low-overhead, digital-native InsurTech firms have earned a reputation for innovative business models, lean operations, and affordable policies. However, low-cost offerings often indicate short-term thinking that cannot retain customers over time. A price bump at renewal time may alienate existing customers. That is why a reasonable pricing policy focuses on top line growth while maintaining the bottom line.
When it comes to B2B offerings, transaction-based pricing, revenue sharing, subscription pricing, and gain-sharing pricing options, merit exploration. Keep in mind that while the pricing model for new customers can be changed, it may be more challenging to alter pricing for an existing customer – especially if it favors you!
Unit economics of insurance – Economics, especially unit economics, might take a back seat when measuring several ratios, but it is critical to provide a proof of concept, gain investor trust, and make early decisions – such as targeted customer segments. Increasingly, this metric is becoming a point of discussion for investors and must be kept top of mind while seeking funding. Also, as the business scales, various costs might change, and therefore, periodic calculations will be necessary.
The most effective way to measure unit economics is to start by analyzing each unit. For an insurance firm, a unit it is generally a customer, or a product or service. One method is to analyze customer segment profitability by measuring the amount of revenue the customer is generating versus the amount spent serving them. It is crucial to account for each cost and transaction that can be attributed to the customer.
Rather than working with the averages, deep dive into the specifics and estimate profitability for each customer/customer segment. Multifaceted policyholders may not fit into rigid socio-demographic-based criteria. Today, effective segmentation requires InsurTech firms to leverage data and insights to drive hyper-personalization in customer-relationship management.
As profitable customer segments are identified, efforts can be made to acquire similar customers or to eliminate those that are unprofitable. In response to market changes, it is important to track and ensure unit economics profitability at least during the business launch phase. As the company matures, corporate profitability should be the goal.
Profitability (overall) – Profitability is contingent upon elevating the top line while lowering costs. For InsurTechs, it might seem like a good idea to onboard as many customers as possible at above-market premiums. However, such a practice also increases the number of high-risk customers. Improving the bottom line through low-risk customers is a more tried and true success strategy.
A sound grasp of the costs – fixed, variable, and semi-variable – ensures an appreciation of total and unit cost evolution as the number of customers increases. Sometimes, as the number of customers scales up, fixed costs will go down, but variable or semi-variable costs might increase as the channel (firm-owned online channel or broker channels) becomes exhausted and no longer yields returns. Therefore, defensible strategies are important to ensure long-term profitability.
Cash management-related metrics
Cash is probably the least productive asset on the balance sheet. Not only does it not earn anything, it actually loses purchasing power as a result of inflation. So why do firms hold cash? Twentieth century economist John Maynard Keynes described three motives for holding cash balances.
- Transactions motive – to conduct day-to-day business of paying for purchases, labor, etc.
- Precautionary motive – to cover unexpected expenditures. If the delivery truck breaks down, it must be repaired or replaced if you want to stay in business.
- Speculative motive – unusually good opportunities occasionally arise. If the business has the money available, opportunities can be leveraged.
While cash is necessary to cover transactions, the precautionary and speculative motives can be covered with the near money (or near cash) of marketable securities. The cash management metrics outlined below are important for InsurTech firms to keep in mind.
- Working capital – Working capital is a daily necessity for any firm to make routine payments, cover unexpected costs, and purchase basic materials used in the production of goods. Working capital is a prevalent metric for the efficiency, liquidity, and overall health of a company. It reflects the results of various company activities, including revenue collection, debt management, inventory management and payments to suppliers. It covers inventory, accounts payable and receivable, cash, portions of debt due within the period of a year, and other short-term accounts.
- Liquidity – Indicates the company’s ability to meet its financial obligations in a timely manner, without affecting normal operations. Liquidity is a measure related to working capital and its financing. Liquidity and solvency are essential for insurance companies. Cash balance is a more accurate indicator of the actual liquidity of the company than well-known liquidity ratios such as current or quick ratio.
- Positive cash flow – Attention to the above-mentioned metrics at business launch and during subsequent periodic checks will help to maintain stability and sustainability. An InsurTech firm’s valuation is often determined by initial high customer acquisition costs, but because the insurance business model largely depends on policy renewals, net positive cash flows are back ended.
- Discount rate – Given the long gestation period, profit or revenue, multiple-based valuation approaches may be unsuitable even after several years of operations—it may underestimate the intrinsic value of companies that have turned profitable and are still growing at a healthy pace but incurring significant acquisition costs.
- Cash reserve – Startup cash balance is not a universally accepted or carefully defined financial concept. It mainly concerns startup expenses and startup assets.
- Startup expenses: Disbursements before launch and revenue generation. Startups often incur expenses for legal work, logo design, brochures, location site selection and improvements, and other expenses. Other expenses include rent and payroll that start before launch and continue from then on.
- Startup assets: Cash (money in the bank when the company starts), and in many cases, starting inventory. Other starting assets might be either current or long-term assets, such as equipment, office furniture, vehicles, etc.
Cash requirements estimate how much a startup needs to begin operations. In general, the cash balance on Day 1 includes investments raised or loans minus cash spent on expenses and assets.
During strategy building, if cash balance drops below zero, then the startup needs to seek additional financing or reduce expenses. Many entrepreneurs decide they want to raise more cash than initially necessary, so they have cash for contingencies.
Generally, experts recommend one should have some set amount, such as six months’ or a year’s worth of expenses, as the starting cash. That’s nice in concept, but it’s rarely practical. Moreover, it interferes with the estimates.
For a better estimate of what you need as starting cash balance, you can calculate the deficit spending you’ll probably incur during the early months of the business, after launch, and from launch until you reach a monthly break-even state in which revenues are equal to spending. Most new businesses take months and sometimes years to reach a steady-state break-even point. In theory, the maximum negative cash balance in the first six to eight months of operation is the amount needed as initial cash.
So, a seasoned entrepreneur would round that up and add more, because forecasts are never exactly right, He/she would account for 20-30% more to cover unforeseen expenses. In my experience, more start-ups fail to survive not because they did not have a good idea but because they were unable to manage cash flows properly.
InsurTech firms need to maintain a minimum cash balance to meet regulatory requirements (statutory reserves) and sustain a cushion for paying out claims depending on their past experiences.
InsurTechs offer collaborative value
While some established insurers may feel threatened by the rising number, popularity, and success of InsurTech firms, many are eager to collaborate with newcomers. For big insurers, it may be faster and more cost effective to partner with an agile InsurTech firm than to internally develop a capability. However, it is essential for incumbent insurers to team with the right partner to ensure sustainable and productive collaboration.
To facilitate successful collaborative partnerships, Capgemini has developed a ScaleUp Qualification program that measures InsurTech capabilities along four broad pillars: People, Finance, Business, and Technology. With a particular focus on finance, the model looks at quantitative metrics such as year-over-year growth, income and revenue value, available cash flow, while assessing factors such as how recent the funding is, and the geographic spread and credibility of investors.
I encourage you to reach out to me on social media to learn about InsurTechs or other financial services trends.
The author would like to thank Aditya Jain, Shreshtha Bansal, and Tamara Berry for their contributions to this article.
 FinTech Global, “Global InsurTech funding tops $3bn in 2018”, FinTech Global Database, January 23, 2019, https://fintech.global/global-insurtech-funding-tops-3bn-in-2018
 Nearly There, “Why Lemonade’s steadily improving loss ratio is important”, John Peters, May 6, 2019, https://www.lemonade.com/blog/nearly-there/
 Insurance Innovation Reporter, “Putting the Insurance Back in InsurTech: Three Mistakes Startups Make,” Rick McCathron, February 21, 2018, https://iireporter.com/putting-the-insurance-back-in-insurtech-three-mistakes-startups-make/
 The Intelligent Economist, “Liquidity Preference Theory,” https://www.intelligenteconomist.com/liquidity-preference-theory/, Accessed July 2019
 Business Start-up Guide: Bplans, “Estimating realistic start-up costs,” Tim Berry, https://articles.bplans.com/estimating-realistic-start-up-costs, Accessed July 2019
 Capgemini, “FinTech Co-Innovation with Capgemini’s ScaleUp Qualification,” Elias Ghanem, https://www.capgemini.com/service/fintech-innovation-and-engagement/