Everyone buys insurance. But Geico car insurance shares little in common with liability insurance for the tap water that comes out of your faucet. For those diving into insurance: How should we extrapolate from our personal experiences buying renters, car, health insurance into a robust understanding of the broader marketplace?
To simplify the property and casualty insurance landscape (for our team at Wunderite, and for our network), I illustrated the insurance supply chain. The illustration is based on my experience as a credentialed insurance agent/broker, MBA student, and now insurtech founder.
Insurance is the 3rd or 4th largest industry in the US, and it is notably fragmented and competitive. Tens of thousands of firms compete to insure everything from cars, planes, and businesses, to a $1 million haircut. There are a lot of ways to make (and lose) money in insurance.
The Traditional Supply Chain
In a traditional supply chain, suppliers provide raw materials to manufacturers. Manufacturers turn the raw materials into products and sell their products through distributors. Distributors get products from manufacturers into the hands of customers. Customers use the product.
Insurance Supply Chain: High Level
In insurance, reinsurers supply financial capacity to insurance companies. Insurance companies “manufacture” insurance policies. Insurance agents/brokers distribute policies to customers (for a commission or fee). Customers use the product. Notably, the product is risk transfer: customers trade risk for a premium. Thus, customers use the product even if they never have a loss or file a claim.
Supply Chain broken into segments
Supply Chain with extra manufacturing and distribution
Supply Chain with recognizable logos as examples
Supply Chain with approximate count of firms
Reinsurers supply financial capacity to insurers:
Insurance companies have substantial surplus capital requirements to pay for claims (in addition to regulatory oversight and underwriting and accounting guidelines). This capital sits on the sidelines of an insurance company, in conservative investments, ready to pay for losses. For example, surplus capital is ready when a house burns down. Or even a few houses in a large fire. But what happens when a whole region burns to the ground? What happens to an insurer with heavy customer concentration in areas affected by catastrophe? When wildfires ravage all the houses in a region or a hurricane flatten swaths of property on the East Coast? Insurers cannot carry such catastrophic burden alone. So insurers buy insurance. Reinsurers are like an insurance policy for insurance companies in a bad year. Reinsurance is a key raw material for an insurance policy that many insurers cannot provide on their own. Similar to how individuals transfer their risk through an insurance policy, insurers transfer their risk through reinsurance. Reinsurance allows insurers to manufacture and sell insurance policies.
(I say many insurers cannot provide reinsurance, because some insurance companies can and do provide reinsurance. They do this by moving up and down the supply chain. An insurance company can backward integrate into reinsurance, and forward integrate into distribution). I suspect many insurance companies are better off buying reinsurance in an efficient marketplace (lots of players, enormous volumes) than by doing it themselves, for economic and strategic reasons.
One of the early forms of reinsurance were Lloyd’s “names” (basically rich people) who were willing to lend their name to back risks. More recently, incorporated names are Lloyds “members,” or corporate backers of Lloyd’s syndicates.
For reasons discussed later, some large businesses choose to create their own insurance companies to insure their own business exposures. These insurance arrangements are called captive programs. The owners of the captive, the captive owners, are another type of supplier. Captive owners include one or multiple companies that fund, setup and own their own insurance company exclusively to insure their company exposures.
Capital markets are another piece of the supply layer.
With reinsurance backing them up, Insurance companies manufacture and issue insurance policies.
Insurers manufacture policies by combining financial capacity from reinsurers, together with their own surplus claims capital, underwriting and actuarial expertise, claims management, regulatory filings in the states they do business, and standardized legal contracts (specimens, which become insurance policies).
Stability and Regulation
Stability is important in insurance. In the same way you don’t want a run on your bank’s deposits, you don’t want your insurance company to become insolvent when your house burns down and you need them most. When someone buys a whole life insurance policy today, the insurance company needs to be around to pay the death claim when the person dies. When a storm takes out a region, it is important that the insurance companies involved can pay all claims, quickly, without becoming insolvent.
Regulation gives the public oversight and helps the public enforce that insurance companies are stable and playing by the rules. Insurance is regulated mainly at the state level. But there is also federal regulation. Regulatory filings are a non-trivial core competency of an insurance company.
Direct insurers are insurance companies that have forward integrated into distribution. In other words, direct insurers both manufacture and distribute insurance policies, either using their own in house sales and marketing channels, or through captive insurance agents. (Captive agents are different from a captive insurer, more later). Examples: Geico, State Farm, Federated.
Some insurance companies market that they return unused premiums to members (or charity). This is actually an old and established concept: Mutual insurance companies are owned by their policyholders, meaning policyholders have a say in management, typically through voting. Profits are (theoretically?) returned to members, often in the form of reduced premium.
A Lloyds Syndicate is a collection of members (rich people or companies that back stop the risk being transferred) that work with special underwriting teams (Coverholder, similar to MGA) to underwrite risks.
A Captive Program is an insurance company wholly owned and controlled by the organizations it insures (the captive owners). Captive programs can be thought of as a backward integration of an organization’s financial department: a company expands its financial role, in a way, to become an insurance company, rather than buy from an insurance company. Captive Programs are typically appealing to companies with strong (much better than average) risk management and controls, companies that are safer than average and want to buy-in, exert control on risk management, and reap the rewards of lower risk costs. Additionally, captives can be appealing when there is a market failure to efficiently insure a class of risk, for example, due to an increase in litigation or rapidly rising insurance prices.
Captives may pay insurance companies a fee to borrow their “paper” — their state licenses/regulatory filings so they can legally do business. This is called a fronting arrangement.
There is a lot happening in the distribution layer, and technology and digitization is certainly promising to make distribution more efficient. But, as anyone who has helped a grandparent use a computer probably knows, technology isn’t always easier or faster for everyone, especially in the beginning. Adoption and implementation at scale are key to recognizing these efficiencies. As a side note, and something to come back to in a future post, it is worth asking “for who?” has a technology made something more efficient. Like many small businesses across the country, independent insurance agencies are responsible for sourcing their own technology systems, while working within industry constraints. This brings pros and cons which we can discuss later.
The key thing to size up at the distribution layer is that it is fragmented: there are over 36,500 independent insurance agencies. That is nearly three agencies for every Starbucks. Add on top captive agents, direct insurers, and aggregators, and you have complex distribution.
Insurance agents (who get their name from the legal concept of the principal-agent relationship) distribute policies to customers (often for a commission or fee) by helping match customer needs (and customer data) to available products, often with local or niche knowledge.
Captive Agents only work for one insurance company, and mostly cannot sell products from other insurance companies. State Farm is a good example. (Don’t confuse captive agents with an insurance captive).
Independent Agents sell policies for multiple insurance companies. Independent agents and brokers often offer a layer of advice, expertise, and advocacy. Independent agents are not held “captive” to any one insurance company and can therefore help a customer evaluate and buy multiple offerings. IAs can also be an intermediate to speak and fight on behalf of the customer (or the insurer).
Brokers technically represent the customer to the insurance marketplace, whereas agents represent insurance carriers to their customer. However, insurance salespeople often fulfill both roles simultaneously. The difference is legal, contractual, and perceptual, and has an impact on a salesperson’s fiduciary responsibility.
Retail agent / broker means an agent/broker who sells to the end customer. (Agents/Brokers may not self-identify with the term “retail agent”).
Alliances and Clusters provide their agency members insurance company market access. For example, a cluster could provide an agency access to an insurance carrier the agency does not otherwise have access to (perhaps because the agency has insufficient sales volume to justify another carrier supplier contract). Additionally, clusters leverage their size to negotiate higher commissions from insurers and lower IT costs from vendors to their agent members, along with sales training / assistance / expertise.
Managing General Agents / Managing General Underwriters perform functions like an insurance carrier (underwriting, quoting, dealing with claims), without financially holding the risk that an insurance carrier does. Because entrepreneurs can (somewhat quickly) spin up an insurance-carrier-like entity by creating an MGA, without the same regulatory and financial burden, there is a lot happening in this space. Those interested in insurtech should do some additional reading on MGAs. Parker Mckee from Pillar did a nice writeup on MGA for starters.
Wholesale Agent / Broker (Wholesaler): Insurance distribution organization that specializes in placing insurance for retail agencies and brokers. Retail agencies use wholesalers for enhanced market access, specialization, and expertise.
Lloyds coverholder: Underwriting, distribution, service team authorized to sell insurance for a Lloyds syndicte
Associations / Risk Pooling: Sort of like a captive. In a phrase, the Massachusetts Interlocal Insurance Association explains: “We provide insurance for you, our members, but our products and services exist only to meet the needs expressed by our members – not the needs of an insurance conglomerate”
Lead Generation / Aggregators: Notably, when prospects put their info into various websites to buy insurance online, some websites are lead generators that sell leads to one or multiple agents. These businesses are not agents, but serve a distributing part part in the supply chain. Lead aggregators are different from websites that actually sell insurance. Websites that sell insurance are frequently an online-first 21st century independent insurance agency.
Understanding whether a website is an aggregator or an agency can be confusing, even for insurance industry veterans: some aggregators may actually act as agencies to sell insurance, and then, sell that closed deal to a servicing agency, almost like executing a mortgage and selling it to a servicing company. By doing this, the aggregator/agency could potentially capture higher revenue per “lead”. Furthermore, some insurance agencies may sell leads that they have passed on (leads that are not a good fit for their business model).
The three types of customers
For simplicity, I segment customers into three buckets:
- Individuals/Families that buy home, car, life, pet, boat, (etc) products
- Organizations / Small Businesses, and
- Middle Market / Large Corporations.
This is an oversimplification. There are many types of buyers. It also is worth mentioning that the ones buying insurance are not always the beneficiaries.
Recap & Further Thoughts
The insurance industry is large. There are many ways to make (and lose) money in insurance. There are many business models to facilitate insurance creation, distribution, and consumption.
Anyone who has been around in insurance for a while has heard about “getting rid of the middle-man” forever. Many approaching insurance for the first time think that technology may be the key to disintermediation. However, economics is a key driver of industry dynamics and a key driver of the current supply chain makeup. Technology will not “disrupt” the supply chain overnight. But, there is certainly a tremendous amount of change and innovation today and on the horizon worth a follow-up post.
CEO & Co-founder, Wunderite
Peter MacDonald is the Co-founder & CEO at Wunderite. Before founding Wunderite in 2018, Peter worked at a family insurance agency selling most types of insurance. In this role, Peter earned industry licenses and credentials (CPCU, CRM, CIC, LIA), represented independent agents to lawmakers in Washington DC with the IIABA, and built and implemented technology for the agency. Peter earned an MBA with distinction from Boston College as a Dean’s Scholar and a BS in Mathematics Cum Laude from Wheaton (IL).