As a kid, I loved watching Hogan’s Heros. There are so many funny episodes, I couldn’t choose one to highlight here. The show was set in a German POW camp during World War II and followed the antics of a group of Allied prisoners led by Colonel Robert Hogan. They consistently outwitted their captors and conducted espionage and sabotage missions right under the noses of the German guards. That seems too similar to what has happened to many Insurtechs. They conducted antics under the noses of their investors. Perhaps, far too often, investors and advisors thought they were Seargent Schultz. I see nothing, I hear nothing, I know nothing.
Vesttoo, a Tel-Aviv-based insurtech, was established with the ambitious goal of bridging diverse insurance risk sources with potential investors. Founded in 2018, it swiftly secured $100 million in funding from venture capital firms, valuing the company at a staggering $1.1 billion. The core of Vesttoo’s business model revolved around utilizing letters of credit (LOCs) to collateralize insurance transactions. These LOCs serve as financial guarantees, ensuring payment in case of a default.
However, the company’s trajectory collapsed in July of this year when it was embroiled in allegations of fraudulent collateral, with some estimates suggesting the fraud could surpass $4 billion. These claims originated from a whistleblower who accused Vesttoo of leveraging counterfeit LOCs to back insurance deals. Although Vesttoo initially refuted these claims, they later conceded that a portion of the collateral was indeed fraudulent.
The repercussions of these allegations have been severe for Vesttoo. A wave of senior executives has exited, and the FBI is now probing the company. This debacle has cast a shadow over the insurtech sector, prompting introspection about its rapid growth. The pressure to expand quickly, often fueled by venture capitalists prioritizing growth over profitability, has led some insurtechs to allegedly cut corners. Vesttoo’s CEO had previously boasted about the company’s profitability, but the recent events have painted a different picture.
The ripple effects of this scandal have touched not only other insurtechs but also stalwarts of the traditional insurance sector, including:
- Clear Blue Insurance Group: Engaged with Vesttoo for reinsurance, they had entered into a $1 billion reinsurance agreement. Due to the scandal, they are now under review by AM Best. Some of the Insurtechs that use them include Rhino (Renters Deposit Insurance), Inshur (Commercial Auto) and Core (Habitational).
- Aon: This insurance broker had transactions facilitated through Vesttoo’s platform.
- China Construction Bank: Fraudulent LOCs bore the name of this bank.
- Corinthian: This reinsurance firm utilized Vesttoo for collateralized capacity.
- Acrisure Re: They brokered deals via the Vesttoo platform.
Furthermore, Vesttoo’s investor roster, predominantly A-Rated, comprised names like Goldman Sachs, Mouro Capital, Gramercy Ventures, Blackriver Ventures, Hanaco Ventures, and MS&AD Ventures. Notably, only one of these investors have a background in insurance. Traditional insurance investors understand that profit margins in insurance are often modest compared to tech sectors. For example, the large brokers like Marsh and AON generate between 10% – 15% profit, or an Insurance carrier who is more likely to generate sub 10% profit. Venture capitalists, accustomed to high returns from tech startups, might have inadvertently set unrealistic expectations for insurtechs.
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The Contrast Between Insurtechs and Incumbent Carriers
While insurtechs, driven by venture capital, chase rapid growth, incumbent carriers prioritize profitability and risk management. Their longevity in the industry has ingrained in them the significance of risk management, shielding them from the pitfalls that newer insurtechs might face.
Vesttoo’s downfall serves as a stark reminder of the perils of prioritizing growth over risk management. For long-term success, insurtechs must strike a balance between growth and robust risk management.
The Future of Insurtech
Though Vesttoo’s collapse has jolted the insurtech landscape, it doesn’t spell the end. Insurtech holds the promise of reshaping the insurance domain, but it must heed the lessons from Vesttoo’s missteps. By emphasizing risk management, compliance, and profitability over mere growth, insurtechs can indeed usher in a transformative era for the insurance industry.
- Insurance Carriers: It’s crucial to diligently vet partnerships with Insurtechs, perhaps even more meticulously than with other providers. Please reach out if you’d like to discuss the potential concerns we’ve identified elsewhere.
- Insurtechs: Ensure you have a comprehensive understanding of the inherent risks in your business and establish robust, unchangeable compliance and controls. We’re here to assist if you need guidance in setting those up.
A teaser on Lemonade and Roots latest results
I am waiting for Hippo to release their latest quarterly results before I deep dive into analyzing Lemonade and Root. However, tied to the above discussion, I will highlight one area of Lemonade’s quarterly report which I will delve into deeper in the next article.
Lemonade is now touting the creation of “Synthetic Agents”. It almost sounds like something that should be regulated by the FDA as a Schedule 1 drug — something likely to be highly addictive.
The Synthetic Agents program is being touted as a new way for insurance companies to finance their growth. Under the program, General Catalyst will finance up to 80% of the cost of acquiring new customers for Lemonade. In return, General Catalyst will receive a commission of 16% of the premiums generated from the insurance policies that it helped finance. How does this work? It allows Lemonade to amortize their customer acquisition costs — allowing them to claim lower marketing expenses each quarter and thus potentially higher net income and lower their cash burn.
What I don’t understand is no one is focusing on the fact that realistically this makes their acquisition costs 16% more expensive, and it already appears that they lose money on each customer given the high acquisition costs and low retention rates.
Are the public markets asleep at the wheel? Maybe not completely, as their stock dropped about 23% after their posted results. However, there has been little coverage about these new agents. More to come after Hippo releases their results.
At Insurtech Advisors, we recognize that each business is unique, and we tailor our approach to meet your specific needs. Our goal is to help you innovate quickly, saving you time and money by focusing your team on the right areas for your organization. By working with us, you can leverage our extensive knowledge of the insurtech landscape to adopt best practices, implement cutting-edge technologies, and develop customer and broker-centric solutions that drive growth and profitability. Together, we can create a brighter future for your business, delivering unparalleled value to your customers and stakeholders.
Kaenan is a professional in the areas of block chain, telematics, wearables, analytics, artificial intelligence (AI) and Insurtech. He has played a key role in innovating many start-ups and established carriers. His advice has been widely appreciated in the financial community, which resulted in multiple quotes and publications in various media.
Most recently he was Practice Lead for Innovation, Fintech, and Strategic Insights at EY. Throughout his career he has held leading roles within Marketing Strategy and Decision Management with top Insurance, Banking and Finance companies, including USAA, Citibank and Sallie Mae.