This article was republished with permission from Risk & Insurance.
By Mark E. Watson III,
Significant volumes of new capital now flow steadily from institutional and individual investors into the insurance industry. Some of this capital backs new entrants as they compete with legacy companies to disrupt the value chain and achieve greater returns than they might get elsewhere. Who will win?
When investors move their capital into insurance, the returns they expect are not high, just higher than the market average. Since investment returns have stayed near rock bottom for years, particularly in fixed income markets, any investment with expected returns of more than four or five percent looks good to the investors who supply the capital to new entrants.
This influx of funding with lower return hurdles has been disruptive in places and the disruption is irreversible, but change is nothing new to the insurance industry. Our industry has been rumbling for two decades. I first noticed individual investors in capital markets outside our industry moving into insurance back in the mid-nineties. Flush with cash and ambition, these entrepreneurs engineered a class of investments we now call catastrophe bonds. The capital flow into our industry has increased every year since. Twenty years later, it accounts for a significant amount of the industry’s catastrophic capacity.
Aggregate data does not yet beat deep domain expertise
What’s ahead? The steady stream of capital into insurance has produced over-capacity, which has in turn pushed margins down to historic lows as capitalists compete for the right to put their money to work. In some markets, the resulting margin pressures make it all but impossible for legacy businesses to generate a profit.
Will all-digital companies backed by billions of dollars of fresh investor capital shake up our industry even further? I don’t think so.
While they may be well funded, these new entrants are not having an easy time going it on their own, for three reasons. First, insurance is tough to underwrite without deep domain expertise. The aggregate data that disruptors in other industries tap into is not openly available in most corners of insurance, where much of the most prized data is proprietary.