Insurance experts put premium on start-ups reaching the big time

Lemonade, the SoftBank-backed home insurance start-up, got its long awaited IPO away last week and enjoyed a big initial price jump. The shares more than doubled to $69 on the first day of trading, valuing the company at $3.8bn.

Lemonade is one of the big hopes of the emerging “insurtech” sector, with investors betting that its combination of slick technology and new ideas about how to sell insurance will bring in ranks of new customers.

The industry is “ripe for disruption”, said Hugh Tallents of consultancy cg42. “The top four property & casualty [insurance] carriers in the US were established in and around the great depression and their product offering hasn’t changed a whole lot since then.”

According to research firm CB Insights, insurtech companies have raised a total of $17bn from investors since the start of 2016.

Column chart of Quarterly funding for insurtech companies showing Investors bet on insurtechs

UK-based Octopus Ventures is one of those that has invested. “You see many very valuable, very large, very established companies which generally haven’t seen the challenge . . . that we have seen in other sectors,” said Malcolm Ferguson, a partner at Octopus.

He added: “When we see . . . someone that’s not been displaced for a very long time and has a very powerful business model but customers are unhappy, we know there’s something there that could be interesting for us.”

Lemonade is aiming to shake up home insurance with promises to use artificial intelligence to settle claims quickly and a business model designed to ensure that charities receive some of the benefit when payouts to customers are low.

“A lot of what we are trying to do is capture consumers young,” said chief executive Daniel Schreiber.

The company has already expanded from renters insurance into cover for homeowners, and is now eyeing other markets such as pet insurance.

The model has pulled in a swath of VCs as well as SoftBank, while other more traditional investors such as fund manager Baillie Gifford bought in at the IPO.

But for all that enthusiasm, five-year-old Lemonade is still lossmaking and has only a small share of its core markets.

Last year, it generated $116m in premiums, mostly on insurance for home renters and homeowners in the US. The US renters insurance market is worth about $5bn a year according to research firm CB Insights, while the homeowners insurance market is worth about $74bn.

Bar chart of Lemonade is attracting more customers showing Reaching out
Line chart of Growth in Lemonade's quarterly customer numbers showing Less fizzy

“I just don’t see that Lemonade has had a significant impact on the industry, let alone transformed it in any meaningful way,” said Chris Sandilands at consultancy Oxbow in a recent blog post.

Lemonade is not the only insurance start-up that has yet to win the sort of market share that start-ups elsewhere have managed. Root, for example, is one of the biggest insurtechs to target the $250bn US motor insurance market. It generated premiums of $187m in the first half of last year. That is an annualised rate of $374m, but it suggests a market share of just 0.1 per cent.

“I am concerned there isn’t anyone in home or motor doing enough to properly disrupt the marketplace,” said Steven Mendel, chief executive of pet insurance specialist Bought By Many. While there are some interesting ideas such as pay-by-mile car insurance, he added: “I am nervous that this does not become big scale disruption, it just becomes a side event.”

Potential disrupters face an array of challenges, from hefty regulation to finding the capital needed to ensure that claims can be met. But one of the biggest hurdles, say industry experts, is the need to find customers and convince them to put their faith in a new brand.

“The cost of entry in this market is extremely high. It’s a bit of an advertising arms race,” said Mr Tallents. “The big four insurance companies in the US spend north of $2bn on marketing each year . . . it’s incredibly difficult to break in.”

Some insurtechs have dropped the idea of going direct to consumers entirely and are instead working with more established brands to sell their services. One of them is Trov, which was set up in 2012 with the idea of selling insurance for individual items such as cameras.

Trov started out targeting consumers directly, but found that the costs were too high. So over the past year it has changed tack, signing partnerships with Lloyds Bank in the UK and Suncorp in Australia instead. “Our decision was an economic decision” said Scott Walchek, Trov chief executive. “The proposition was appealing to consumers but the economics weren’t sustainable.”

He believes there is plenty of scope for partnerships between established brands and start-ups. “Consumer brands have found ways to capture millions of customers but their margins are pressed. Now they have to increase wallet share by offering new products and services,” he said.

But some in the industry think that direct to consumer insurtechs such as Lemonade and Root can still make it into the big time.

“It is a matter of time,” said Mr Ferguson. “These businesses take ten or 20 years to become really disruptive . . . In ten years, I don’t see how the old school players can compete with those that are more efficient and can lower claims.”