Investment thesis
- Insurers measure profitability using a metric called the combined ratio. This is calculated by adding incurred losses plus expenses and dividing that by earned premium. The combined ratio is usually expressed as a percentage and a ratio below 100 indicates that the insurer is making an underwriting profit while a ratio above 100 percent means that the insurer is paying out more money in claims than it is receiving in premiums.
- An insurer can increase premiums, often this is implemented on existing customers on renewal in a tactic called “price-walking” where your premiums are raised for staying loyal to one insurer. Fortunately, the UK regulator has indicated they are going to publish rules in 2021 banning “price-walking” across mainstream insurance lines.
- The next option is reducing the incurred losses by insurer reducing exposure to high-risk customers. ByMiles, for example, have solved this by underwriting low mileage drivers. This is difficult for large insurers as it would involve significantly reducing the number of customers they can cater to and therefore reducing the gross written premiums for them.
- The last option is to reduce operating costs involved in underwriting insurance and process claims in a more efficient way. There is a significant operating cost differential between the top quartile and bottom quartile insurers. A recent McKinsey report found that the differences in operational costs between top-quartile players and those at the bottom of the stack are consistently higher than 60 percent across every business function, and differences of over 100 percent are not uncommon. In a market where premiums and losses are consistent across the industry it is more often than not the efficiency of the insurer that dictates profitability.
- The largest cost burden is the claims management function (widely recognised in the industry). This is due to the huge amount of unstructured data involved in processing claims which leads to small armies having to be hired by insurers to process claims and spot fraudulent ones. It is because of this acute pain that insurers are willing to spend large amounts of money on claims processing software. The market size in the US for the Insurance Claims Processing Software industry is $9.3bn in 2020 (in revenue).
- Sprout.ai has built some incredible technology to supercharge the claims handling teams ultimately reducing the insurer opex whilst helping customers have their claims processed in 24hrs or less!
