Insurers seemingly don’t attract the adulation they deserve from investors. Despite a core subset of insurers delivering strong operational results, share-to-price performance has largely lagged other financial companies. The KBW Nasdaq Insurance Index (KIX), which reflects performance of US carriers, has trailed performance of the Financial Select Sector SPDR Fund (XLF), which tracks financial-services companies, though many insurers have long track records of attractive operating results.
A reason often cited is that institutional investors are wary of insurers’ sensitivity to low interest rates, their regulatory complexity and risks in long-tail products such as annuities, long-term care and commercial P&C liabilities. Consequently, many investors minimize allocation to insurance equities. Successful narratives enticing insurance-sector investors tend to involve companies with capital-light products such as small commercial P&C with strong top-line growth, better-than-average underwriting margins and ROE exceeding cost of capital.
About new-age insurtechs, investors are generally more bullish and readily factor multiple years of growth in valuations. These companies score by targeting large underserved markets and their ability to scale into new markets. An analysis of 2,000+ global insurtechs from life, P&C and health insurance found that during 2010-20, about one-third secured funding and a handful established strategic partnerships with incumbents. Insurtech funding peaked in 2020 with €6 billion in deals.
Insurtechs and established carriers have different success yardsticks. The 12 insurers in the Fortune-100 are on average 125 years old, with low revenue growth, good profitability and typically trade on multiples of earnings forecasted for the next 12 months. On the other hand, successful insurtechs are characterized by impressive growth rates, negative net income, obviating the use of similar valuation approaches. Nor can IPOs of software companies be a reference. Instead, the approach has been to combine traditional insurer metrics, with those of consumer businesses. Looking at the kind of growth insurtechs like Lemonade and Root saw before going public and how they have performed since, helps investors spot similar patterns.
High multiples in case of Lemonade were attributed to a large target market, with focus and innovation centered on customer experience, enabling it to grow with a millennial customer segment covering their other insurance needs, maximizing lifetime value. Another insurtech with an IPO, Root has focused on innovation around its underwriting model, more specifically to auto insurance.
An insurer’s Loss Ratio (LR) is a leading indicator of ability to underwrite risk: more claims imply a higher ratio. An LR under 30% is what underwriters prefer, but the average is between 30-60%. Lemonade and Root, as do many insurtechs, started with a poor LR, as newer technologies and business models needed time to demonstrate their effect on underwriting risk.
Scale advantage has been eluding insurers, particularly P&C insurance. US life insurers with more than $1.5 billion premium in 2019 had a 30% lower cost ratio than players below $0.5 billion. Across developed markets, large players achieve operating costs that are one-third that of smaller players. While scale advantages are visible across all core functions, they are most obvious in support functions such as finance, legal and compliance, and audit.
In P&C, total operating costs have not always declined with size. However, there are exceptions. In non-motor retail, larger players achieve near 40% lower cost ratios in claims. Similarly, larger P&C direct players achieve claims-handling costs around 24% below smaller players. Largest commercial lines carriers achieve total cost ratios 25% lower than of smallest players.
Public company multiples are useful in setting valuations, for fundraising by founders in similar lines and innovation. Insurtech valuations underscore that markets are buying into first movers’ revenue growth stories, not so much on long-term profitability plans. Insurtech valuations will remain creative with considerations ranging from market size to regulation. As more upstarts float businesses, the valuation playbook will keep getting refined.
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