Below is an extract of a recent interview between Jonathan Kalman (Founding Partner at Eos Venture Partners) and Mike Fitzgerald (Senior Analyst at Celent). To access the full article, click here
Jonathan Kalman, a founding partner of a venture capital firm focused exclusively on the insurance industry, weighs in on what it takes to be a successful innovator in the insurance industry in an interview with Carrier Management’s Guest Editor, Celent’s Michael Fitzgerald.
Despite being optimistic by nature, Kalman, a founding partner of global InsurTech venture capital fund Eos Venture Partners, expects that 95-plus percent of the InsurTechs funded in recent years aren’t likely to survive to become large, profitable businesses, nor return capital to investors. “That’s certainly the most likely outcome,” said Kalman. “The InsurTech phenomenon attracted too many startups, which attracted too much capital investing at unrealistic valuations. There is no way that all of these businesses will succeed.”
Kalman began his investment career after over a decade as an entrepreneur. His specific focus was building very large datasets used by the credit card industry to make underwriting decisions. The credit card companies that took a “data and analytics first” focus outperformed their peers, and within five years the entire credit card industry consolidated into less than 10 main credit card issuers, he told Carrier Management Guest Editor Michael Fitzgerald.
After his first exit, Kalman set up shop as a fintech specialist venture capitalist, eventually building a firm of 50 professionals, with offices in Philadelphia, New York and London. It was when he was setting up shop in Hong Kong that Kalman first brushed up against the insurance industry, finding a vibrant expat community of global insurers and reinsurers. “At the time, I really knew nothing about insurance,” he said, “and I was surprised to find that when I asked how long they were in the industry, virtually every executive said the same thing—’I wasn’t planning on being in insurance, but I’ve spent my entire career there.’”
As Kalman dug deeper into the industry, he found striking similarities between his experience in the credit card industry and insurance. “Fundamentally, both the credit card industry and the insurance industry use data to make underwriting, pricing, fraud, collections and call center decisions,” he said.
Kalman’s eureka moment was when he understood that insurance, despite being awash in data, lagged banking and payments in their use of data. “Insurance suffered from a huge legacy debt. Their core transactions systems were old and never designed to provide data-driven analytics, and their top analytic talent was siloed by functional areas.”
“I knew immediately that the insurers who take an analytics-first strategy will dominate,” said Kalman, which led to him pivoting his investment focus from fintech to exclusively insurance. That was in 2005, he told Fitzgerald, a senior analyst in Celent’s insurance practice. “The problem was I was 10 years too early! From 2005 to 2015, the number of interesting investment opportunities for insurance was frighteningly small. And then suddenly in 2015, 2016, there was an explosion of creativity, [and] you had not 10 but hundreds of startup companies…tackling different aspects of the insurance value chain.”
In 2016, Kalman joined up with partners Sam Evans and Carl Bauer to form Eos Venture Partners. “The three of us bring decades of experience in insurance and a complementary skillset,” said Kalman. “I bring the venture capital experience, Sam was a partner at KPMG where he ran insurance deal advisory, and Carl brought the Wall Street perspective where he was former vice chairman of Credit Suisse.” Together the three have the necessary skills to select, build, grow and exit investments.
In Kalman’s view, most of the billions of dollars of capital funding InsurTech startups is speculative. “Silicon Valley has mostly avoided InsurTechs, and there are very few venture capitalists focused exclusively on insurance,” he said. “The majority of capital is coming from investors outside the insurance industry who don’t really appreciate the nuance, the sophistication, the interdependency, the risk profile, the tech stack, the decision-making time frames and the regulatory environment of this industry.”
“If you look in the right places and don’t follow the crowd, there are extraordinary investment opportunities,” said Kalman. “It takes experience and discipline to not be caught up in the momentum of the times.”
Referring to traditional insurers and reinsurers, Kalman continued: “As an industry, most insurers are smart enough to know that this is the time that they must innovate. CEOs are way past the question of “Why innovate?” or “Should we innovate?” The question now should be focused on, “How do I drive innovation throughout my organization?”
The question of “the how” of innovation is foremost for interviewer and guest editor Fitzgerald—one he probes repeatedly in his research work for Celent and in his series of interviews for Carrier Management, including the one with Kalman excerpted below. First, the two set the stage by explaining the role of a professional VC fund like Eos in the insurance industry.
Fitzgerald: How does Eos approach insurance technology?
Kalman: Eos is an institutional venture capital firm. Our capital comes from insurance companies, and we are part of their investment portfolio, which adds a different risk profile from their other instruments. We look for promising investments into startups that are exclusively focused on the insurance industry. Our approach is intentionally global, so we have operations in London and Philadelphia. We also have affiliates located in Paris, Munich, Tel Aviv and Hong Kong.
We look for business models that focus on the use of analytics and data versus investing in improving core systems. A key part of our investment approach is predicated on the fact that when we jump ahead 10 years from now, we want to understand which insurers will be successful and why. We fundamentally believe that the use of internal and third-party data to drive an analytics transformation will lead to winning business models. We’ve seen it in other industries, and we’re confident we will see that in insurance.
Fitzgerald: What role does a venture capitalist play in insurance innovation?
Kalman: First, it’s important to understand that VCs fund losses in a startup until the business can get to the point of generating a profit. That’s why venture capital is so difficult. Private equity investors are able to look back over a three- to five-year operating history and predict the future growth based on that history. Startups don’t have that history. These startups are racing to figure out product and market fit before their cash runs out and have enough traction that the next round of financing can be at a higher valuation. The key for a VC is to not confuse an investment that solves an operational problem—what we call a “band-aid”—with an investment that will allow insurers to more effectively build a profitable book of business, be it niche or otherwise. It is these latter businesses that are “innovative.”
Fitzgerald: Why is there so much interest in insurance innovation now?
Kalman: Insurance is an industry that is behind in not only analytic sophistication but also one that is carrying a tremendous amount of legacy debt in its software platforms. That said, this creates a great deal of opportunity for those insurers that are willing to change.
Plus, now the cost to apply technology in new ways is a fraction of what it used to be. When I started in this business, the big decision in using new technology to become a better credit card underwriter was how could I afford the $20 million to pay for the hardware, let alone the database. Now, that barrier is gone. The world will go from one where people are taking months and years to get things into production to one where they can do it almost within the same day in real time.
The situation today is made more complicated because insurers historically haven’t focused on innovation and change, and now there are over 1,000 InsurTech startups. They are drinking from a fire hose, and without experience they will find the process of selecting great companies frustrating and potentially expensive.
The leaders in the industry started this journey even before 2015, and we see some insurance companies who are just getting organized. That’s why we’re confident that there will be an industry consolidation. It’s hard to catch up when you’re a laggard.
Fitzgerald: Our survey research has quantified this increase in the importance of innovation to corporate strategy execution. But how does an insurer do that? How do they drive innovation into their organization? What are insurers getting right about innovation?
Kalman: Innovation groups are challenged to go out and find and scout for opportunities, to perform proofs of concept to validate propositions with the objective to move them into production and create value. There are some organizations that are doing an extraordinary job of that. For example, Munich Re and RGAx are exceptional at understanding the need to find innovation, get there early and leverage corporate assets to find ways that can be most impactful.
Other organizations like Allianz have taken a slightly different approach. Their objective is: “We’re going to know what’s happening in the world. We’re going to see the different opportunities. And then what we’re going to do is we’re going to put equity, capital and firepower behind those bets that we believe will be successful.” That’s why Allianz has rapidly matured its innovation strategy and has now committed $1.1 billion to place bets on those companies that it think will be transformational.
These organizations are succeeding at innovation, and even if they fail, they are learning. Most importantly, they have the balance sheet to support their efforts.
The challenge for insurers and reinsurers who don’t have the same balance sheet is that they need to be nimble and capital-efficient in their pursuit of innovation. Our conviction is that smaller insurers can combine an internal innovation group with outside expertise. That was the premise in setting up Eos: We partner with insurers to drive innovation. We’ve even named our approach. We call it Return on Innovation and Investment, or ROII. With Eos, a smaller insurer can tap into our global network, and we can help find specific companies and solutions that will “move the needle” for an operating executive. We filter out the noise so that the insurer can focus on results, not activity.
Fitzgerald: What are the things that insurers are getting wrong about innovation?
Kalman: Wow. That’s a critical question. There’s probably four or five consistent mistakes that insurers are making around innovation. They need to:
- Fix the “large, corporate insurer versus small, nimble InsurTech problem.” Nothing will kill innovation faster than dropping a 30-page security questionnaire on a 10-person startup. Insurers must create new processes to make working with InsurTechs easier. The smart insurers are doing that.
- Leverage the fact that they have experience, data and policyholders, and trade that for the entrepreneurial drive of the startups. My message to insurers: What you have is valuable; pick one or two promising startups and forge a strategic partnership. At the very least you will learn something. You may get a jump on your slower competitors, and you might use their energy and technical savvy to solve a critical problem.
- Start with a problem statement, then create a use case, and more importantly, never lead with technology. What is causing your organization pain? What leads to poor underwriting results? Why do you catch fraud after you’ve put premium on the books, and not before? These are all problem statements, then you create a use case to validate a hypothesis.
- Don’t believe that you have to be a corporate venture investor to be good at innovation. You can get the benefit of innovation without having to set up your own fund. Some organizations like New York Life or Mass Mutual are good at it, but this is a hard road and has very different metrics.
- Tackle one or two problems, not every problem. I think that many innovation groups spread themselves too thin and want to see as many InsurTechs as possible. The number is overwhelming. Make the problem smaller. See those companies that can impact one or two areas.
Fitzgerald: How quickly can insurers expect results from their innovation efforts?
I think it’s important for an organization to devote some time to the question, “Where do we need to be in the next three to five years versus the next 12 quarters?”
We advocate building a team comprised of the line of business executive, the people responsible for innovation and some outside resources who bring a different perspective. [At Eos, for example,] we sit down with the CEO and the executive team and we define one or two areas that can be impactful in the next 12 months. We also consider a longer timeline, and then we design what should be rather than looking at what is.
Our goal is to work with the innovation teams to drive measurable value within the year while simultaneously positioning the insurer for new opportunities.
Fitzgerald: Is there a regional difference in innovation that you have seen?
Kalman: I’ve probably spent over 25 percent of my time over the last 20 years outside the United States. I want to understand the U.S. because of the size of the market, but I always spend time in either Canada, Latin America, Europe and Asia to inform my investment philosophy, and it’s the same at Eos. Innovation is occurring all over the world, not just in Silicon Valley or London.
One aspect of great interest is that in Asia you have insurers like PingAn investing over a billion dollars in new and advanced technology, including AI, machine learning and advanced analytics. They understand better than most that this is a world that will be dominated by those who use information successfully. The U.S. is lagging in the investment in third-party data and analytics, and as I’ve said before, the few insurers who master these skills will outperform their peers.
We’ve seen a few promising InsurTech companies who use the regulatory complexity to their advantage. Instead of running from this, they are designing solutions in partnership with the regulators. These InsurTech companies will dominate because they can innovate faster than traditional insurers because they don’t have the legacy technology debt, and they have a culture that can drive innovation.
Fitzgerald: What are the major barriers you see across companies?
Kalman: Future success will come from the use of analytics to transform the existing business and introduce new products and services that have never been available. Those insurers who can move out of their functional silos, break down barriers and use interdisciplinary teams which drive analytics and models into production will win.
Insurers must also stop spending the majority of their time looking in the rearview mirror and complaining about what can’t be done. Our preference is to rip out the rearview mirror and look through the windshield. Rather than being encumbered with legacy thinking, we challenge insurers who are our investors to embrace “what could be.” It’s a fundamental shift in thinking.
However, changing legacy thinking and legacy DNA requires the type of leadership and energy to transform the culture. Insurance CEOs will have more impact on the success of their companies over the next decade than ever before. The CEO must communicate that change is inevitable, so get over it. The choice is to get in front of this transformation or be swallowed up by insurers who use technology to cherry pick the best risks, catch fraud earlier, enter new markets first, etc.
I’m reminded of the expression, “Culture eats strategy.” That’s another area where Eos helps insurers: We are fundamentally change agents, and we help insurers accelerate their innovation strategy.
Fitzgerald: As you listen to discussions about insurance innovation, what is being missed? What are you not hearing that you expect to?
Kalman: I think it is under appreciated, the opportunities for smaller insurers. They do have a smaller premium base against which they can spend, but with the reduction in software development costs, this is not the impediment it used to be. They have more agile and nimble management teams. I think you’ll see them being more aggressive and nipping at the heels of the larger tier 1, tier 2 insurers.
Another point that is not discussed is what a shakeout of startups will mean to insurers. We were recently meeting with one of our investors, a midsize P/C carrier, and we made the point that as InsurTech startups begin to stumble, the carriers will be able to pick up IP and management teams for a fraction of the money that was invested. The key is to know where to look and to build up the mentality and culture in the insurer to be nimble and get ahead of the competition in looking for acquisition opportunities.
Fitzgerald: Finally, what do you see looking forward?
Kalman: Is insurance moving in the right direction? Absolutely. Will the insurance industry get there? Absolutely. Will everybody make the trip? No. There will be a significant number of insurers who can’t reinvent, can’t get rid of their legacy debt, can’t transform their culture and people. There will be other insurers who will figure it out, realize that we are heading into an analytics-driven, real-time world. The insurers that get in front of this transition with successful innovation efforts will see a disproportionate share of profit. Their differentiation will come from a sophisticated use of analytics across the entire value chain of their business.
What’s happening now is that we are in the very early stages of what over the next 10 to 20 years will be an extraordinary reinvention of a wonderful industry. It’s an industry that we all love, that fundamentally helps protect things that we hold dear—like our life, our home, our business. We are seeing thousands of creative InsurTech entrepreneurs bringing new value to the table. Capital is being allocated to discover what works and what doesn’t.
But the real fun will be to see how we use this opportunity to create a world that delivers a better product at the right time, appropriately priced in a way that truly benefits the insured and helps them live happier, healthier and more successful lives