The innovation, creativity and agility of insurtechs make them a perfect fit for captive insurance when the time is right
As global investment in insurtechs reached US$1.27 billion in Q2 2024 — the highest level since Q1 2023 — deals focused on risk origination, pricing, underwriting and portfolio optimisation attracted the lion’s share of funding.
According to Gallagher Re, 33 insurtechs focused on these areas raised a collective US$742.45 million in Q2 2024, with the average deal size for this category reaching US$23.95 million, 29.7 per cent higher than the overall insurtech average.
Furthermore, AI-centred insurtechs attracted US$445.81 million in funding across 27 deals, representing a third of the total deals in Q2 2024.
Rising influence of AI
In its Global InsurTech Report for Q2 2024, Gallagher Re highlights the growing role of AI in underwriting and risk functions, driven by evolving trends in the industry. The report emphasises that the effectiveness of AI in underwriting, pricing, and risk management relies heavily on the availability and quality of data.
“Data is crucial for the initial training of algorithms and for powering them to achieve superior outcomes,” the report states. Access to the most relevant data sets provides insurers and reinsurers with a significant competitive advantage.
According to the report, insurers are shifting their focus towards leveraging their internal data assets, which have often been underutilised, to improve pricing and underwriting. This trend is particularly pronounced when internal data offers unique insights into customer behaviour or risk profiles, especially when insurers partner with retailers, banks, or other affinity groups.
Additionally, insurers are increasingly turning to third-party providers to enrich their data, such as verifying identities to bolster counter-fraud efforts.
The broader retail market now relies on AI to monitor and analyse customer behaviour through customer-facing systems and real-time market data.
“The recognition of the need for a proactive data strategy is now widespread among insurers, driven by the imperative to keep pace with competitors,” the report observes. This data-driven arms race is accelerating across the industry, extending beyond high-volume personal lines business.
Gallagher Re also highlights in the report the staggering level and granularity of data now available to (re)insurers. Motor insurers have used telematics as a tool for two decades, and it has undergone significant evolution.
Insurers today can employ various movement sensors in mobile phones to detect phone usage while driving, enabling them to make more sophisticated pricing and underwriting decisions.
Similarly, AI is helping underwriters, providing them with new, usable insights from previously inaccessible (or nonexistent) data sets. Gallagher Re uses the example of property insurers, which may now be able to derive fresh insights gleaned from AI-driven analyses of large data sets of properties’ roof conditions or flood plain location.
“In doing so, insurers can gain a greater understanding of a new market they are looking to write business in. They may also be able to improve their existing models’ ability to gauge the multiplying risks from climate change,” Gallagher Re explains in the report.
These are the data that insurers themselves are able to collect and analyse. Insureds, particularly those in industries that produce, manufacture, store, and transport, have access to much more data than ever before, such as the machinery that powers production, the refrigerators that stop goods from spoiling, or the trucks that travel countries with full loads.
Because of this, insurtechs that focus on these customers, and want to become general underwriters as part of their strategy, can create new products that are centred around the customer, like parametric insurance that pays out based on very accurate assumptions. The opportunity exists, but their development may require alternative risk financing structures.
Mikhail Raybshteyn, Americas Financial Services tax partner and Americas Captive Insurance Services co-leader at EY, remarks: “Businesses have an opportunity here with better management and even potential retention of certain risks. They know the data better than insurers, so why not?
“It seems logical and prudent that such companies use their telematics data and partner with insurtechs focused on better ways of underwriting risk to co-create alternative risk financing structures. This could enable them to collaborate with the commercial insurance market and help (re)insurers feel better by spreading the risk."
He continues: “They, insureds and commercial insurers, have long realised that data is truly an asset, but not all data is yet what or where it needs to be.
"This could be about data protection and insureds worrying about giving away their trade secrets, but companies can focus on improving such data protection, focus on improved risk management and claims mitigation, and coordinate such an approach with various market players to ease the residual struggle of pairing insurtechs with data holders and carriers."
As it stands currently, insurtechs are not turning to captive insurance ownership in droves, but there is movement in that direction, according to Raybshteyn.
Those that do tend to develop agency or group captives. "There is lots of innovative thinking from insurtechs but very few decide to go for pure captives immediately and own them.
“They consider their business plan, usually well into the future, and elect to walk before they can run. Setting up a captive is a significant investment of resources and time. It is also dependent on the kind of insurtech we are talking about.
"Those insurtechs that focus more on technology than insurance, such as those that provide a tool or platform instead of underwriting, may not utilise captives as much as those insurtechs that are primarily focused on insurance. Insurtechs with captives are not a pervasive trend, but the conditions can be there, and the key is innovative thinking and understanding where a captive may play its vital role."
Opportunities for captives
One insurtech with its own captive is San Francisco-based Coalition, a cyber insurer and security provider. It announced plans to launch a new captive to begin taking risks on its cyber insurance programmes back in 2021.
Speaking at the time, Shawn Ram, head of insurance at Coalition, said: “Today’s announcement demonstrates our unwavering commitment to protecting businesses from cyber risk and our confidence in Coalition’s approach to underwriting and risk management. Coalition provides businesses with the most comprehensive insurance available, backed by the financial strength of multiple A+ rated insurers.
With our new captive, we add another layer of security and stability and more closely align our financial incentives with our customers."
A number of milestones in 2021 supported the announcement, indicating that the time was right for Coalition to transition into captive insurance.
For example, its technology-driven approach was powering a new, more successful model of risk management, resulting in its policyholders experiencing 70 per cent fewer cyber claims when compared to other carriers in the market, as well as validation of its underwriting model through long-term capacity agreements from multiple 'A+' rated carriers.
Coalition also delivered superior claims results amid significant growth, crossing US$400 million in run rate premium, an 800 per cent increase over the previous year.
The Coalition's captive has now been up and running for more than two years. The captive, named Palekana and incorporated in Hawaii, participates in all Coalition's US and Canadian cyber programmes as a reinsurer for the company's carrier partners.
"In the coming years, we plan to use the captive as a risk-taker in Coalition programmes in additional markets," Ram says.
For the commercial insurtech provider, captives represented “a flexible vehicle” that Coalition “could use to capture additional profitability on the insurance programmes” that it underwrites. And, as Ram said in 2021, the company aimed to “more closely align our financial incentives with our customers”.
Ram confirms that Coalition has achieved this objective, noting that the captive structure has enabled the company to share in the profitability of its US and Canadian cyber programmes while aligning its financial outcomes with carrier partners.
“The captive has [also] allowed Coalition to build surplus on its balance sheet, which can be utilised as capacity to fuel additional growth.
"In addition, our captive has demonstrated to our carrier partners our belief in the underwriting profitability of our programmes and that our incentives are aligned with those partners to ensure a sustainable level of profitability on our portfolio."
Raybshteyn comments: “Insurtechs are learning from the insurance industry. Over the last 10 years, some of the large insurance companies have spun out units because they want to focus on their core competencies. They want to focus their resources on where their growth is and what their core business is.
"It has to do with an insurtech's business case. Such companies are no longer jumping into opportunities, including captives, just because they think it can make some money. They ask if this is essential and if wanted. A lot of my conversations with clients, especially successful ones, consider first if it fits into their business plan and what is the potential ROI."
For insurtechs such as Coalition, a captive clearly does fit into its business plan. However, it took the company four years after its launch to reach a point where captive insurance made sense.
Until more insurtechs reach this point in their journey, it is unlikely to see large numbers move towards captive insurance, particularly when the majority may have no interest in underwriting and retaining risk.
For many insurtechs, their platform or tool is their primary business. Take the example of AI Insurance. Founded in 2018 by founder and CEO Cameron MacArthur, AI Insurance digitises and automates the policy, insured and claims management processes in support of captives, captive managers, and risk retention groups (RRGs).
MacArthur explains: "Captives, due to their size, have historically faced the challenge of lacking software, as incumbent systems are not designed to cater to their specific needs. For example, operating a small deductible reimbursement captive does not justify spending US$500,000 on a system when the premium is only US$2 million. The maths just doesn't make sense, so captives are often priced out of using software and have to run on spreadsheets."
The second major problem, according to MacArthur, is fragmentation. "Even if you could afford a system, captives typically operate through a network of vendors, such as a captive manager, an underwriter, an actuary, a TPA, an investment manager, a broker, and so on, all of whom are employed by different companies.
“These companies don't want to pay to let other vendors that serve their clients have access to their systems, so instead everyone just sends each other spreadsheets. That fragmentation issue is difficult to overcome when most systems charge by logins." AI Insurance solves this fragmentation issue by not charging for logins or premiums and "is purpose built for captives".
“So, in the example of our deductible reimbursement captive above, the entire system would be US$1,089 per year, and users from every vendor would get logins for free,” MacArthur explains." This means renewal, actuarial studies, board meetings, etc. can all share the same data set and work together."
With this fragmentation seemingly reduced, captives can also benefit from increased visibility of the many vendors they traditionally have to work with. MacArthur says: “Visibility is a huge factor. If you can see what all of your vendors are doing, you get significantly more ownership and accountability in the running of the captive.
"There's also significant cost savings: AI Insurance programmes have two-times faster audits. Because everyone is working together, email sending and report generation are reduced. For instance, a captive manager no longer needs to conduct a check run because payments are processed through the system; they also don't need to compile and distribute a bordereau since everyone who needs it can generate what they need out of AI. The same goes for TPAs — they no longer need to generate and send out loss runs."
How receptive have captives been to the platform, and have they truly embraced the innovation, creativity, and agility that insurtechs such as AI Insurance can deliver?
MacArthur says: “Like anything in business, there are early adopters, the majority, and then the stragglers. AI is running in some capacity in close to 100 different captives and RRGs today, so certainly the change has happened.
“When young businesses are setting up captives, they now often come to me first and say, ‘Hey, we know we need software, but how do I actually set up a captive now?’, and I'll send them over to a captive manager, which is definitely a different order of operations than it used to be.
“Similarly, I think the forward-thinking captive managers know that technology is going to be how they separate from their competition and are starting to make big bets on it. It's exciting!”
