Happy Presidents Day! Hopefully you are on vacation and reading this a day late. However, if not, we hope this installment of InsurTech analysis serves as a nice and informative break from the rigors of your work day. This week we move further into our overview of the insurance industry for InsurTechs, we move away from the things the general public is familiar with (Distribution and Claims), and we peer into what’s behind the curtain. And despite what the Wizard of Oz says, you should definitely pay attention to what’s behind the curtain.
Today’s focus is on understanding how InsurTechs partner with insurance carriers to better price their insurance products (Underwriting) and manage their financial positions (Finance and Reinsurance).
Underwriting is the bedrock of insurance. One could argue that without the rational and reasoned pricing of insurance, the industry would be little better than betting on whether a coin will land heads or tails. Fortunately, actuarial science has grown a great deal over the last few centuries. Insurance actuaries attempt to model everything from the weather (just think about what hail damage can do to crops), to the likelihood of future car accidents (even those that “weren’t your fault”), to how long you will live (a necessary evil for life insurance and annuity pricing).
As you can imagine, Underwriting and Distribution go hand in hand. If an insurance carrier’s actuarial models are too conservative (i.e., seeing risks behind every lurking corner), their premiums will be higher and it may be tougher to sell the coverage. On the other hand, if the carrier’s models are not risk averse enough, premiums may be so low that the company won’t collect enough to cover all of its claims. The goal for InsurTechs in this space isn’t to lower the price of coverage, but to offer more accurate models, which in some cases may mean higher premiums for some. In addition, InsurTechs can help carriers develop underwriting guidelines for brand new areas of coverage, from insuring the cannabis industry to providing drone insurance to fantasy sport injury insurance (yes, that’s really a thing).
Of course, underwriting standards are driven by market forces and insurance regulation as well. While the most successful insurance carriers will often separate themselves by developing sophisticated and accurate actuarial methods, if the competition consistently offers lower premiums for similar coverage, a tough decision will need to be made as to whether to deviate from actual analyses or even whether to enter to marketplace at all. In addition, depending on lines of coverage (and whether insurance is written through the admitted or “surplus lines” markets), rating guidelines are often imposed on insurance companies from the states themselves in order to protect both the consumers (from unduly high premiums) and the carriers (from offering unsustainable quotes).
A. Underwriting Related Insurance Licensure
For purposes of this analysis, we are assuming you are not forming or buying your own insurance carrier, something we’ll cover in greater detail next week. The good news is that unless your InsurTech has the ability to force a carrier to actually issue a policy (in insurance parlance “bind coverage”), you likely won’t need an insurance-related license to run your Underwriting-focused business. As with our prior post on the Distribution and Claims side of the house, Underwriting licensure requirements largely depends on whether your InsurTech is focused on the P&C or A&H / Life.
With respect to P&C underwriting, if your InsurTech is in charge of Distribution, Claims and Underwriting for a carrier for a line of business, there is a good chance that your carrier partner will refer to you as a Managing General Agent, or “MGA.” While in all likelihood your InsurTech does not meet all the criteria necessary to meet the regulatory definition of an MGA (spoiler, you likely won’t produce enough premium volume at first), carriers will likely require that your contract with them containing all of the same statutorily mandated provisions. The good news is that, assuming your InsurTech is already licensed as an insurance producer, there are no additional licenses to obtain and the contract provisions are generally not too onerous (although notably you will likely need to obtain a Surety Bond in favor of the carrier with a value between $100k – $500k).
Notably, if your InsurTech is not engaged in Distribution or Claims, and is instead solely focused on Underwriting, there is very little in the way of licensure for P&C products. While this may seem odd on its face, especially given what we said above about how crucial Underwriting is to the industry, it is important to remember that one of main benefits of any licensure regime is as a signaling device to consumers that an entity is trustworthy to do business with. Consequently, because Underwriting is not consumer facing, there is less of a need for an entity to be licensed, especially when the underlying insurance carrier is already subject to substantial regulation on its Underwriting.
In contrast to the above, the A&H / Life space is governed by Third Party Administrator licensing requirements. As with our discussion last week, because the standard statutory definition of a TPA is so broad (and unlike the MGA laws utilizes the word “or” instead of “and”), if your InsurTech does have the authority to bind coverage for a carrier based on your Underwriting then you likely will need to obtain a TPA license or registration, where applicable.
B. Three Key Regulatory Regimes to Know for Underwriting-Focused InsurTechs
- Restrictions on Underwriting Factors: In general, insurance laws require Underwriting and resulting rates that are not excessive, inadequate, or unfairly discriminatory. While relatively clear on its face, regulators over the years have used this general principle to restrict everything from the use of credit scores, to price optimization, to blackbox underwriting. In fact, New York regulators recently issued guidance that puts life insurers on notice regarding their statutory obligations when utilizing Big Data and algorithms in their underwriting. Also, remember that for major medical health insurance, PPACA is still technically the law of the land, and therefore there is generally little to no underwriting in the individual and small group market.
- Privacy: One of the key ways InsurTechs are disrupting Underwriting is through the collection of more and more individualized data. From the devices in your car tracking every illegal U-turn you take to that free Apple Watch or Fitbit you got along with your life or health policy, all of that data is uniquely personal. And while that’s great from an Underwriting perspective (especially after you spent the last 20 minutes shaking your arm while sitting on the couch to trick that Fitbit into thinking you were running – but did you just commit insurance fraud?), it means that there is a greater chance that all that personal data may be exposed or stolen. Knowing your obligations under both the relevant laws and, just as importantly, your contract with the carrier is crucial to your InsurTech’s survival.
- Understanding Rate Filings: While rate filings may be a bit of “blocking and tackling,” understanding even the basics of SERFF (note – no one calls it by its full name: The System for Electronic Rates & Forms Filing) will likely set you apart from many of your competitors. In addition, knowing if your Underwriting algorithms are impacting rates which are “file and use” vs “prior approval” will also be useful in your pitches to industry insiders (hint: it’s almost always better when you don’t need to get approval to do something). Unfortunately, the same rate filing may be filed and used in one state, while requiring prior approval in another. Just another joy of 50-state regulation.
II. Finance and Reinsurance
Because of the implicit trust the public must put in insurance carriers when they purchase a policy (i.e., that the carrier will be around and have enough money if/when a claim is made), insurance carriers are subject to a staggering amount of regulation and restriction on the types of investments they can make. When combined with that fact that insurers often have assets running into the hundreds of billions of dollars, even incremental improvements in managing both a carriers assets and liabilities can result in profound impact on a carrier’s bottom line.
In addition to traditional asset management, one of the unique ways that the insurance industry often manages its liabilities is through reinsurance, which is essentially one insurance company (the “cedent”) buying insurance from another (the “reinsurer”). While we will be doing a separate post exploring the details of the reinsurance ecosystem, at its heart reinsurance is about an insurance carrier spreading its risks to other insurance carriers to mitigate potential downside of losses. Just like insurance carriers who sell to the public, reinsurers also deal with Distribution, Claims, Underwriting and Finance issues, with the main difference being that their counterparty is another insurance carrier, not the public.
One important fact to remember is that, in a typical reinsurance arrangement, the reinsurer is liable only to the cedent, not to the consumer. Therefore, the cedent is generally free to enter into any contractual arrangement it would like in order to offload some of its risk, provided that in order to “take credit” for the risk ceded away (i.e., have its home state recognize that it has ceded risk away for reserve purposes), the reinsurer and the reinsurance agreement must meet certain qualifications, as discussed further below.
A. Finance and Reinsurance Related Insurance Licensure
By and large there are no insurance specific licenses required to manage an insurance carriers finances; however, it is possible that if you are providing investment advice to carrier or issuing reports or analyses regarding securities and getting paid for it, you likely will need to be registered as an “investment advisor” with the SEC.
On the reinsurance side, if your InsurTech is engaged in helping cedents find coverage from reinsurers, you will likely need a reinsurance broker license. Think of this as the reinsurance equivalent of a producer license. In turn, if your InsurTech is helping reinsurers manage their operations, including underwriting, you will want to research whether you will need a reinsurance manager license (think TPA/MGA type activities).
B. Three Key Regulatory Regimes to Know for Finance and Reinsurance-Focused InsurTechs
- Understanding Investment Restriction Regimes: Generally insurance carriers usually only invest in what are called “Admitted Assets” (i.e. those assets that regulators allow them to account for on their balance sheets). Not only must these assets be highly stable, they also usually must be liquid. As such, Admitted Assets usually include mortgages, stocks, bonds, and government obligations, although insurance carriers can often invest in “riskier” investments (such as equities) but such investments are usually limited to a small percentage of total Admitted Assets. Layered on top of the “Admitted Asset” regime are additional requirements related to asset liability matching and risk-based capital requirements. RBC requirements attempt to ensure that carriers have capital appropriate to support their operations in consideration of their size and risk profile. Any Finance focused InsurTech hoping to manage a carrier’s investments should tailor their product to account for these restrictions on a granular level.
- Understanding How Reinsurers are Regulated: Reinsurers and reinsurance transactions are subject to substantially different regulatory regimes than ceding companies, in part because the transactions are between two sophisticated entities. In general, the regulations focus on when and how ceding companies are able to take credit on their financial statements for the risks they shifted to their reinsurers. At the most basic level, under these regulations reinsurers have to show they can back up their promises to pay and if not reinsurers will need to post some form of collateral. Because posting collateral is inherently inefficient, and because many reinsurers are located outside the United States, regulators and the industry are constantly working to eliminate this impediments. For example see our recent post on the U.S. and EU Covered Agreement.
- Reinsurance Related Privacy Issues: Because of the huge amount of data flowing back and forth between ceding companies and reinsurers, blockchain offers huge potential technological efficiencies in the exchange of information. While the immutability of data on a blockchain makes it attractive for the reinsurance industry, blockchain platforms and service providers need to be aware that they may not only be caught up in U.S. based privacy and data security requirements, but also those found in the E.U. and other international jurisdictions. And if you thought penalties and fines for data breaches in the United States were high, European regulators recently fined Google $57 million for fines of the EU’s GDPR.
Next week we make the jump from working with insurance carriers to forming or buying your own. While maybe not as exciting as owning your own basketball team or a tropical island, it is often the next step in the evolution of many successful Insurtechs!