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Valuing InsurTechs is still hard - but it's one of the most exciting opportunities of this decade

"Can InsurTechs can use tech and data to gain a sustainable advantage?"

For all the reasons why 2020 will be remembered as one of the most significant years in recent years, it will also go down in history as the year of the very first InsurTech IPOs, write Remus Brett, partner at LocalGlobe and Ferdinando Sigona, associate at LocalGlobe. Insurance is one of the world’s oldest and intermediated industries, yet it has been largely resilient to disruption. It’s been dominated by a handful of established underwriters and none have really emerged at scale since as far back as the 1950s.

For investors, this is a very attractive sector, because new technology and data make it possible to transform not just the underwriting model, but also how policies are distributed, how claims are filed and resolved, and even how customers can be catered to in new ways that lower risk and increase engagement. Yet, no new players had yet scaled enough to debut on the public markets.That was until Lemonade went public in July 2020.

Valuing InsurTechs: The first public benchmarks

Lemonade was only five years old when it floated on the New York Stock Exchange. On the first morning of trading, shares in the home insurance startup more than doubled, valuing the company at more than $3bn, making it 2020’s biggest debut IPO of a US firm at the time of floatation. This is despite the fact that many of the assumptions behind such InsurTech businesses are yet to be truly tested.

This was then followed by car InsurTech provider Root’s IPO in October.

Both have become leaders by, as Lemonade's S-1 puts it, "rebuilding insurance from the ground up on a digital substrate and an innovative business model." They are leveraging technology, data, artificial intelligence, contemporary design, and behavioural economics across the entire value chain, from re-insurer to consumer.

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A myriad of startups are following suit: some have focused on established market segments, using technology to innovate a part of the value proposition; some are betting on segments that are entirely new or have so far been badly served, such as gig economy workers; some innovate mostly on distribution, rather than on product; and others are building out emerging components of insurers' own tech stack and value chain, including data collection, claims handling and fraud detection.

And just as these firms are using data to evaluate risk, each time there is a successful outcome – such as an IPO – investors can validate the market and use them as the first public benchmarks for future dealings.

Past results to predict future success

New InsurTech players and the established cohort have very different success benchmarks.

In fact, the 12 insurers in the Fortune 100 are on average 125 years old. They have low revenue growth, are profitable, and typically trade on multiples of earnings forecasted for the next 12 months, or on book value.

By contrast, the likes of Lemonade, Root, and virtually all InsurTechs have very different characteristics. They have impressive growth rates with negative net income, and this means they can’t be valued in the same way as the public incumbents. Nor can IPOs of software companies (who have very different business models and metrics), be a reference here.

Instead, we take an approach that combines evaluating traditional insurance company metrics, with the numbers VCs like to look at in the context of consumer businesses.

How to value the next generation

Looking at the kinds of growth Lemonade and Root saw before going public, and how they’ve performed since, can help investors spot similar patterns in up and coming InsurTechs.

Gross Written Premium (or GWP) and growth

GWP refers to the amount customers have agreed to pay on new and existing insurance policies. Both Lemonade and Root experienced exceptional GWP growth prior to going public.

Lemonade’s GWP grew 90%, to $84.8m, in just one year between the first half of 2019 and the same period in 2020. As the company hit the public markets, it’s valuation reached $3.8bn – 22 times the size of its 2020 GWP. The stock has trended up since, and Lemonade is worth a staggering ~$9bn at the time of writing.

Similarly, Root’s GWP in the first half of 2020 was $306.5m – a 63% improvement on the first half of 2019. Root’s valuation hit $6bn during its October IPO, or over 10 times its 2020 figures. The stock has trended down since, and Root’s market cap is ~$5.6bn at the time of writing.

Revenue and growth

For insurance companies, most of their revenue is driven by the portion of GWP its customers have already paid minus acquisition costs and what is owed to reinsurers.Lemonade and Root both experienced impressive revenue growth ahead of their respective IPOs. Lemonade’s revenue in H1 2020 was $54.5m – a ~130% improvement on H1 2019. At its IPO, Lemonade was valued at 37 times its 2020 revenue.

Root’s revenue for the same period in 2020 was $245.4m. This was a similar ~135% improvement on the year before. At its IPO, Root was valued at over 20 times its 2019 revenue, and over 12 times its revenue in 2020.

Lemonade’s multiples are likely higher because its target market is more than twice the size of Root’s. Lemonade has captured a smaller percentage of this larger market, and its focus and innovation has centred on customer experience and engagement, meaning it can more easily grow with its millennial customers to cover their other insurance needs and increase their lifetime value to the company.

Conversely, Root’s innovation has been in its underwriting model and it applies more specifically to auto insurance — as such, it might be harder for Root to be the natural choice for its customers’ other insurance needs.

It’s also worth noting that multiples for both Lemonade and Root have gone up significantly with their IPOs. Whilst we should expect lower multiples for private companies in the space, looking at available revenue and valuation data for companies like Hippo, Alan, Next Insurance and Oscar Health, yields an average valuation to revenue multiple of 12.8x.

LTV/CAC (Lifetime value/Customer Acquisition Cost) Ratio

This is a metric frequently used by VCs and helps determine how effective a company is at generating revenue from customers. LTV/CAC calculations are not clearly illustrated in companies’ public accounts, but many have tried to estimate Lemonade’s and Root’s ratios based on the numbers we do have.

In VC circles, it’s a widely-held view that companies should aim for a 12-month payback of CAC. That is when the amount spent acquiring the customer – whether that’s on marketing or onboarding – is returned through retention and revenue.

Yet for InsurTechs, as is the case for incumbent insurance providers, this target isn’t helpful. It can take several years to recover the initial cost of acquisition, however many people stay with their insurer for a longer time than the average software product VCs tend to look at. During that time, traditional insurers have tended to gradually increase premiums, but insurtech startups don’t necessarily need to do this, if they can command higher LTV by offering relevant, value-add services as their target millennial customer grows older.

Loss Ratio

An insurer’s Loss Ratio is the leading indicator of its ability to underwrite risk: more claims mean a higher ratio. This number will also be affected by the amount of risk that’s offloaded to reinsurers. The more risk that is offloaded, the more positive the impact is on the loss ratio.

A loss ratio under 30% is one underwriters would love, but the average tends to be somewhere between 30% and 60%. Both Lemonade and Root, and indeed many InsurTechs, start out with a bad loss ratio, as the new technologies and business models they promote take time to demonstrate their effect on underwriting risk.

Lemonade has greatly improved its loss ratio (from 87% in Q1 2019 to below 70% in Q2 2020): they claimed to have achieved this by using AI to better detect fraud. Root has been less disciplined in improving its loss ratio, as, again, it has prioritised growth. The right loss ratio target also depends on the given company’s reinsurance model: for example, Lemonade’s reinsurers make money when the company’s loss ratio is below 75%.

So where does this leave us?

Publicly traded company multiples are useful in setting the valuation for a company in our portfolio, or one we’re trying to evaluate. Similarly, they are useful for founders fundraising. Root’s IPO, for example, makes it easier to value a company with a similar insurance type and innovation approach, like Cuvva.

Lemonade’s and Root’s valuations also tell us markets are buying into these first movers’ revenue growth stories, and focusing less on long-term profitability plans. These plans are destined to reveal whether InsurTechs can use tech and data to gain a sustainable advantage over incumbents.

Given Root and Lemonade are only two public benchmarks, and enjoy particular market enthusiasm as first movers, most valuation exercises in InsurTech will remain somewhat creative, with considerations ranging from market size to regulation. As more companies start, scale and float, we’ll be able to more accurately create a playbook for this sector.

It is worth noting that whilst the InsurTech unicorns sound huge compared to your average startup, they are dwarfed by their incumbents. Lemonade’s revenue is less than 0.0005% of the world’s biggest insurance providers, such as UnitedHealth and AXA.

That number alone explains why insurance is, and will continue to be, one of the opportunities most suited to venture scale returns. At LocalGlobe, we've already invested in 10 InsurTech companies but there are many opportunities out there for investors and the potential is only growing.

See also - Dr Louise Beaumont: Financial services has long been a “fat complacent oligopoly with zero innovation”