Ripe for Disruption: Our Thesis on the Insurance Tech Space

medieval vehicle-only underwriting in motor leads to good customers subsidizing the bad

Motor continues to be a third-party distribution business with 95% of new car premiums distributed by third parties, primarily in two categories. Firstly, OEM brokers (e.g., Maruti), which dominate the new car market (0–4 years of age), and individual agents, which dominate the subsequent one (4–8 years). These third parties don’t provide PII (personally identifiable information) of vehicle owners to insurance companies for fear of disintermediation at the next renewal, and as a result, 95% of new car underwriting is vehicle-only underwriting – i.e., any two vehicle owners buying the same vehicle in a given city will be asked to pay the exact same premiums. This also means that there is no underwriting based on customer-specific factors like vehicle usage, driving behavior, demographics, CIBIL score, etc. It’s tribal knowledge in the industry that certain customer segments are good customers and display a materially lower claim ratio. Two concrete examples include prime CIBIL score (750+) and middle-aged (35 to 50 years) customers, among many. This has led to the problem of good customers subsidizing the bad.

Two InsureTech companies have emerged to solve the above issue with two very different approaches: Acko and GoDigit. While the former tries to solve the problem by going direct-to-consumer (D2C) and getting access to PII, the latter works with the traditional third-party channels but economically incentivizes them to pass on good customer cohorts, leading to a win-win for both. That said, the problem still persists and is large enough. A similar problem also exists in retail health. In terms of investable opportunity for us, we believe there is an opportunity for another D2C insurer to exist besides Acko. The key question to address, however, is charting out an economically viable direct go-to-market (GTM) strategy.

insurance carries a massive trust deficit among SMBs due to the perception of complex policies and deliberate claim rejections by insurers

We spoke to a double-digit number of SMB owners across business models (i.e., manufacturers, traders, retailers, service providers), revenue scale (<10 Cr, 10–250 Cr, >250 Cr), and industries (battery storage, alcohol manufacturing, auto OEM, steel fabricator, food processor, etc.) about insurance products such as fire, marine, liability, health, and engineering. The pain is extremely clear, consistent, and severe in the middle segment (10–250 Cr revenue), while not as severe in the other two. The <10 Cr segment didn’t feel the need for insurance, while the >250 Cr segment argued that they are already well served by institutional brokers (e.g. Marsh). The two did not have a stated need, though we suspect there might be latent demand.

We also learned that there are two markets for insurance within SMBs: compliance-driven insurance and protection-oriented insurance. In fact, online is primarily considered a compliance market by SMBs, i.e., an avenue for buying the cheapest insurance to comply with the requirements of trade counterparties and lenders (including banks). However, protection is an unmet need for SMBs, especially in the middle segment (10–250 Cr). They complain about complex policies with unclear inclusions and exclusions, not knowing what they are signing up for, and consequently, surprises at the time of a claim, which lead to claim rejections or material haircuts on claim amounts.

In fact, SMBs are of the view that the problem lies in the intent of insurance companies when it comes to paying out claims, as they always find reasons to reject them. In addition, the documentation process is onerous and not amenable to SMBs, as it is designed for enterprises and seems to be copy-pasted for smaller businesses.

We believe this is a greenfield market with a clear problem statement. In terms of investable opportunity, we believe one will have to take a full-stack approach here, owning the underwriting, distribution, and claims, and focusing on one supply chain or industry at a time. Key questions that need to be addressed include market size and an economically viable GTM approach.

lots of liquidity (cash, bank limits) is stuck as guarantees due to the absence of a robust surety bond ecosystem

Companies, especially in the infrastructure and construction sectors, are required to provide a set of ‘guarantees’ during the course of a project. These act as security for the beneficiary of the project in cases where, for instance, the service provider does a subpar job or does not complete the service at all. This guarantee usually comes from a trusted third party that ensures payment in case of defaults.

The most popular means of providing this security in India today is a bank guarantee (BG). Banks, of course, charge a fee/commission for this guarantee (ranging from 50–130 bps) but also require collateral (in the form of cash/physical assets) for their own safety, similar to a collateralized loan.

Collateral stuck with banks, often in the form of fixed deposits, is a very clear pain point for construction companies – something we validated via various interviews. Given the high cost of capital/ROCE of such businesses, freeing up capital provides major economic benefits. Sometimes, this process is also slow and inefficient, with delays in collateral freedom.

Surety bonds are an alternative to BGs. Think of surety bonds as the unsecured equivalent of a BG, issued by an insurer instead of a bank. While the explicit commission for this is higher, it frees up capital for the service provider.

They have seen high adoption in the US, where they have replaced bank guarantees for a multitude of use cases. Given that IRDAI only introduced the framework for surety bonds in 2022, this is also a developing market in India; insurers are not sure how to underwrite them, and buyers are not yet well aware of the offering. As a result, there are opportunities for startups to aid the journey across the chain.

However, the industry comes with its own risks. There is limited proof of adoption from insurers, service providers, and beneficiaries alike. The market, while rising fast in India, is exceptionally tiny; future value is, therefore, tough to estimate. Additionally, a new player will have to crack GTM for insurers and buyers alike, especially given the relative complexity of the product. As a result, we’re cautiously optimistic about new players in this broad space.

There are other problem statements in the industry as well, though it’s unclear if they can translate into large new business creation. Nevertheless, we keep an open mind. These include:

Mistrust between cashless hospitals and health insurers that leads to approval delays and a high cost of transactions

• No standardized medical coding to auto-reconcile discharge summaries, bills, and policies, leading to manual reconciliation
• No centralized AML-like database to penalize fraud-engaging hospitals
  Regulatory tailwinds to reduce claim decisioning TAT

A manual and documentation-heavy claims process that hampers the adoption of low-value claim categories (e.g., micro-insurance, crop insurance)

• Micro insurance is presently a distribution-centric category with limited/no underwriting, with distributors capturing almost all the value (e.g., Ola capturing value for Ola trip insurance)
• No automated or parametric claims process, even when one can be implemented (e.g., rainfall/weather cover for farmers, delayed flight cover, cab-hailing trip insurance, etc.)

Life agents and banks mis-sell and force-churn policyholders, leaving them with subpar policies and low sum insured

• More than 95% of distribution is via third parties (3Ps), mostly individual agents followed by banks
• Agents optimize for their financial remuneration and do not act on behalf of customers (as agents get a 20% commission on new premiums and only 4% on renewal premiums)
• Agents sell investment products disguised as life insurance with subpar sum coverage
• 50% of life policies churn within just 5 years
• Of the total amount paid out by life insurers in FY23, INR 199K Cr was due to policy withdrawals/surrenders, INR 213K Cr was due to maturity payouts, and only INR 41K Cr was for death claims

The insurance industry’s tech stack is even a decade behind that of banks

• Inertia for change management and lack of a compelling value proposition to justify the change are the top reasons for a legacy stack
  
  

Ultimately, at its core, the insurance industry is burdened by an outdated tech stack and resistance to change. Nevertheless, the sector offers massive opportunities for startups willing to tackle specific pain points. Success in this sector will depend on the founders’ ability to develop economically viable GTM strategies, build trust, and leverage technology to modernize underwriting, distribution, and claims processes.

If you're innovating in this space, write to us at mayank@stellarisvp.com or shreyan@stellarisvp.com

This article originally appeared in moneycontrol.com

appendix

‍Insurance P&L 101

Below is the actual P&L of the general insurance or non-life insurance industry in India in FY23.

Key takeaways

1. As an industry, non-life is loss making with regard to underwriting, however the real source of income for the industry is what is called as investment income (also called float income) arising because of cashflow mismatch in terms of timing (i.e. premiums collection is upfront, while claims payout is downstream)
2. There are really three business models in the industry i.e. insurer /underwriter, distributor and claim processor (also called as TPA); there is a fourth one too i.e. providing software to insurers or claim processors, though we don’t believe it’s a sizeable revenue pool as of present

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Insurance market size (Category X Business model)

Prominent InsureTech players in India and where they innovated

Popular global insurance products that don’t exist in India or are tiny 

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• Surety bonds: Unsecured alternatives to Bank Guarantees. Detailed above. 
  
  • Surety bonds, primarily for infra projects, was a ~$20B market in 2021 by GWP in the US
  • Sum insured versus BGs can go up to 90% depending on geo (for instance, in Canada, Denmark)
  • Use cases apart from infra also exist- Brazil GWP is ~$500M, driven by judicial bonds
  • India adoption limited due to only recent regulatory push

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• OPD + IPD insurance: Combines outpatient (doctor visits) and inpatient (hospitalisation) coverage in a single policy
  
  • OPD expenses form 30-40% of total healthcare spending in India
  • Popular among private insurers in the US and public insurers/governments in UK, South Africa and China
  • OPD ends up almost being a subscription. However, it psychologically acts as additional incentive to purchase overall health insurance due to perception that insurance premium will not go waste
  • High potential for fraud, difficulty for insurers to create a reliable hospital network and higher premiums have been barriers to adoption in India till date

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• Parametrized insurance: Pays out a pre-agreed amount when a specific event or trigger (like a natural disaster or weather condition) occurs, rather than based on actual losses. Small base but growing across geos, even smaller Asian geos. Tailwinds include regulatory push via Bima Vistaar in India and more accurate for specific cases (e.g., climate data for agri)

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• Cyber insurance: Against losses caused by cyberattacks, data breaches, etc. GWP for standalone cyber insurance in the US grew from ~$1.2B in 2019 to ~$5B in 2023

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