While insurtech, start-up funding and data and technology developments are important to all of us, we also need to understand how the major insurers make money, what their needs are from technology and how they address the challenge of change.
William Hawkins, Director of Research for Europe at investment bank KBW, joins Matthew to share insights from his team's research into the mainstream world of insurance.
With incumbent insurers spending an annual IT budget of $200 billion how much is earmarked for innovation, and how should a technology company attract insurers as clients?
Talking points include:
- The basics of how insurers make money
- Why incumbent insurers struggle to innovate
- What senior executives think about insurtech
- MGAs and new distribution models
- Which emerging technologies could become the norm
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Continuing Professional Development - Learning Objectives
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The Learning Objectives for this podcast are:
- Realise what is holding some incumbents back from innovating
- Understand what the linear adaptation model is and how to break free of it
- Discern some technologies that are receiving investment in the insurance industry
Let us know you have listened to this podcast and if your organisation is a member of InsTech London you will receive a quarterly summary of the CPD hours you have earned.
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How insurers think: the equity analyst’s view - Episode 147 highlights
Matthew: For those who aren’t familiar with KBW, can you tell us a bit about the company?
William: KBW is an investment bank - specifically, a financial services boutique. I run the equity research department for Europe. It’s a team of 20 analysts covering quoted banks, insurance and diversified financials. This includes companies as big as Allianz and as small as the Just Group.
I need to emphasise that because I am a regulated equity analyst and not permitted to provide retail investment advice the purpose of this podcast is only to discuss my personal opinion about industry trends. It should not be taken as advice on any specific investments.
Matthew: How do insurance companies fundamentally make money these days?
William: There are two parts of the insurance market: non-life and life. A non-life insurance company receives a premium and pays out a claim after an event occurs. The company invests the premium, hoping to make an incremental return from its investment portfolio. The aim is to either increase profit or subsidise the premium charged. A life insurer is similar to a non-life company, but it sits in the spectrum between assets and wealth management. These days, a lot of life products are sold in parallel to mutual funds or even bank accounts (1). What normally defines a life product is that it's associated with a long-term investment return that is offering stability for the policyholder.
Matthew: What do incumbents think of innovation and insurtechs - are they starting to take notice?
William: KBW believes that insurtech and fintech are both a big deal for the established financial services sector - particularly for the incumbent insurers. The insurance value chain is evolving, but it is doing this very slowly. Companies are trapped in what we call a linear adaptation model. It is hard to adjust quickly. Insurers want to be bold but can’t take innovation too far as they need to pay their dividends. The other challenge is that what traditional insurers view as their strengths may become their weaknesses. For example, their claims databases - they have spent 150 years building them up, but a lot of these may become redundant as the nature of risks underwritten changes.
Matthew: Have you seen companies start to be able to break out of this linear adaptation model?
William: For the early part of the 2010s through to 2018, there was a polarised response from the incumbent insurers to insurtech. Today all insurance companies know this is one of the biggest trends that they’re contending with. They all have a strategy for innovation, so now it's more about the execution phase. The most successful companies are operating a bit of a siloed approach between evolution of the existing business model and thinking disruptively.
Matthew: What is your view on the new digitally enabled MGA, with new distribution models and as a means for finding insurance solutions for new lines of business?
William: MGAs can be the most efficient structure for discovering new lines of business or new routes to old lines of business (2). The theme of the digital MGA has emerged partly because of a few reinsurance companies that have been thinking creatively. Conceptually, an MGA isn’t complicated to them, so they can use it to find new revenue sources. This means that they end up using quite an old form of financial technology to accelerate the introduction of new lines of business.
Matthew: There is still a lot of money being spent on technology. Is this being used for new technology and driving things forward, or just fixing old issues?
William: On average, about 70% of the profits of an insurance company are administration expenses. Most of the incumbent companies that I cover want to grow their earnings per share by around 5% a year, sometimes a bit more, sometimes a bit less. There's a massive technology efficiency opportunity, but it is very hard to enact change.
Within the 70%, approximately half of it is specifically IT costs. Insurers now spend $200 billion annually on IT. Based on my conversations with companies, that budget is split in half between keeping the machine alive and investing in change. A lot of that change is just incremental essential upgrades. So, there is only a small amount left for investing in more fundamental changes.
$26 billion has been raised in the insurtech market since 2012, with over a quarter of this raised last year alone. On the one hand, insurtech is still a marginal cost relative to the incumbent insurance industry. But insurtech growth is compounding - when thinking about tech spending in big companies it's important to consider that insurtech investment is now 10 times bigger than any individual company spends on IT.
Matthew: In the future, what do you think the norm will be for technology within insurance?
William: When thinking about how insurtech is changing the world of insurance, I consider three main areas: risk management, business management and then customer engagement. Specific themes for the future include changes to transport and logistics. For example, 40% of an average non-life company’s premiums are in motor, and in 15 years the motor market is going to look very different. Embedded finance and sensor technology are also going to be game changers.
Matthew: Are people in insurance companies able to access some of the research KBW is putting out?
William: I’m highly regulated so I’m restricted in who I share my research information with, but building a network is important. Anyone that wants to learn more should approach me via InsTech London. I'd be delighted to start an informal conversation.
InsTech London - Editor's Notes
1) Download our Insurance: to Embed, or not to Embed report, featuring use cases and profiles of more than 50 companies from across the globe who are embedding insurance products.
2) Read Matthew Grant's article, MGAs: the fast track to insurance innovation?