Three Reasons Why Start Up Insurers Face an Uphill Climb

Last week I wrote about Property & Casualty insurers that began operation within the last five years. I outlined that of the rated ones, a majority are considered vulnerable, with a “D” or “E” safety rating from Weiss.

But why is that? What makes it so hard to start a successful insurance company, and earn a top-notch rating early in the process?

It all stems from three major challenges insurers face as new businesses …

#1 Building Up Adequate Capital and Reserves

Whatever else, it doesn’t matter what an insurer does if it starts off with inadequate capital and reserves.

This is the money used to set up the company and provide the ability to pay out on your claim for a new kitchen when you forget that you left a pan of fries on the stove and it catches fire.

Having inadequate capital and reserves means your insurer will not be able to honor its commitment to you and all that goes along with that inability.

This includes a frustrating claims process, denial of claim, and possibly even the failure of the insurer.

Failure then leads to an even more frustrating process when you simply hope that you will get some money eventually for your claim … but will probably be relying on your state’s insurance guarantee fund. Good luck with that one!

Imagine how you would feel if you were unfortunate enough to have your house severely damaged and unlivable. All you want to do is have it fixed and get home.

But in the meantime, you need to live somewhere and monitor what is happening to the repairs — all at the same time your normal life is continuing apace.

Now imagine your insurer, because they had inadequate cash to pay all the claims that they had, decided to play hardball with you. First, it might start with nothing. I mean nothing.

For example they say they didn’t receive the claim that you sent in, or maybe it was misplaced. Or the Claim was denied which happens, so they tell you to send in paperwork. Well that was lost, so you can’t.

Then you get a low-ball offer, or the claim is denied again. Then you hear: “What claim?” Wrong department, wrong person, vacation, application for coverage was fraudulent, and so on.

Yes, all these stalling tactics have been used in the past … but they may not have happened if your insurer had a better level of capital and reserves in the first place.

You wouldn’t deliberately drive around on tires that barely meet the minimum tread guidelines, would you?

That’s not a good idea when unexpectedly bad road conditions occur, and you need every bit of grip you can get.

The same thing applies with insurers. They might meet the state’s minimum capital requirements. But is it a good idea to do business with them? You’d rather deal with a well-capitalized business, not one that is barely hanging on.

#2 Developing a Viable Business Plan

So, assuming adequate capital and reserves, what else does a start-up insurer face as a major challenge? Simply put, one of the biggest challenges is having a viable business plan.

As with any business, if a company enters a market, creates a new market, or seeks to disrupt an existing one, then its business plan has to be sound.

With insurance companies, this means that, in addition to the normal planning that goes on, it has to build a plan based on actuarially sound calculations. An actuary measures risk and predicts outcomes.

For insurers this is essential. They need to be able to estimate what happens if they offer insurance. They need to know about projections for the level of claims and how much they would need to charge customers to cover those costs.

Factor in other variables, such as location, what is being covered, customers’ details, etc. and it starts to quickly get complicated. The more data you have, the better. The more history with that data, even better.

But when you enter a new market or disrupt an existing market, the actuarial science becomes harder to predict because it is not established.

In other words, no matter how brilliant your algorithms or actuaries are, the entire business plan is predicated upon a series of guesses and those guesses are based on the best calculations which are also based on other guesses.

This is an enormous challenge — and clearly a business plan would need to be extremely flexible and prepared for a very large number of possible outcomes.

Of course, that is why actuaries are hired and extremely well paid. The viability of the business plan depends on them.

#3 Growing (Wisely) in a Competitive Marketplace

The third challenge faced by new insurers is growth. As I mentioned earlier, attracting new customers and differentiating yourself is difficult. That’s especially true when your customers would probably choose to have a tooth yanked rather than deal with you.

This is where traditional agents and advertising come in. They’re the way you can give your customers that “warm and fuzzy” feeling that they’re doing the right thing.

The agents, of course, will also focus on the price because you probably told them to! This approach somewhat insulates a customer from being introduced cold turkey to a new insurer.

Most of the time, the agent has already had an opportunity to become familiar with the company and its products well in advance of you seeking a policy.

Some direct-to-consumer companies may find this hurdle a little harder to overcome.

They have to introduce themselves to you, the consumer, and at the same time, convince you that you should look nowhere else. And they have to do it all in the space of one advert, or series of adverts.

These direct insurers might even rely on tech-savvy customers by using mobile apps to attract new business. They may also use those apps to complete the application process, maintain your account, and handle claims.

This can be very daunting for some consumers who haven’t been brought up with mobile technology, and therefore restrict the potential pool of customers.

At the same time, there is no question that all insurers will have to migrate to mobile platforms partially, if not entirely, for a substantial part of their customer-facing activity.

Overall, an insurer has to grow quickly or it will simply not be able to maintain the infrastructure that it had to build — whether physical, people, or financial.

Normally this growth for a homeowner’s insurer will be through an underwriting process that ensures that undue concentrations of risk are avoided.

That isn’t necessarily just by zip code, either. It could also be by type of coverage, customer profile, or even property type.

As we discussed earlier, insurance products are designed around actuarial statistics and concentration of risk is a factor that they consider.

At the same time, uncontrolled growth is potentially just as bad a problem as insufficient growth. Everything needs to be in balance: Technology, capital and reserves, staffing, and cash, as well as risk exposure.

Bottom line: Insurance is a funny thing. It’s the attractiveness of the value proposition to us, the customer, that matters.

How much will I have to pay to get this coverage that I resent in the first place?

Frankly, most of us see insurance as a commodity. Cheapest price wins. But that is not necessarily the best way to view it.

We tend to overlook the obvious part of that decision-making process led by our wallet: Can the insurer comfortably meet its obligations to us if the worst happens and we do need to file a claim?

Of course, this is where Weiss Ratings can help you make the right decision.

We have reliable ratings of insurers all over the country, which you can check out online, and get notifications on any rating changes for the companies you choose to do business with.

Think Safety,

Gavin Magor

Insurance Insights Edition, By Gavin Magor, Senior Financial Analyst Gavin has more than 30 years of international experience in credit-risk management, commercial lending and insurance, banking and stock analysis and holds an MBA. Gavin oversees the Weiss ratings process, developing the methodology for Weiss’ Sovereign Debt and Global Bank Ratings. Gavin has appeared on both radio and television, including ABC and NBC as an expert in insurance, bank and stock ratings and has been quoted by CNBC, The New York Times, Los Angeles Times, and Reuters as well as several regional newspapers and trade media.