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In-depth: InsurTech valuations – What’s holding a recovery back?

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In this in-depth article we take a closer look at the state of InsurTech valuation and investment, and ask what is needed to reignite the investment market, with an additional focus on specific Chinese concerns.

Key points:

It’s been a turbulent year for the tech sector, with half a trillion dollars removed from the value of previously buoyant fintech companies that listed over the last two years.

Since the beginning of 2020, more than 30 fintechs listed in the US, supported by investors convinced these businesses would capitalise on the shift towards digitalisation that was advanced by the effects of the pandemic.

But economic uncertainty has undermined their position, and share prices of fintechs have fallen on average by more than 50% since the start of 2022 (see FT Partners chart below).

According to research by the Financial Times, that’s considerably more than the 29% drop in the NASDAQ Composite. And the cumulative market capitalisation has fallen by $156 billion this year alone. If each of those stocks was measured from its all time high, that fall would be closer to $500 billion ($460 billion).

Turning the tap off

Fintech funding for Q2 this year was down a third on Q1, and is at its lowest level since 2020.

FT Partners’ Quarterly InsurerTech Insights for Q2 2022 show that financing volumes were $2.6 billion, but volume and count were both down, mirroring the weakening activity across the whole of fintech as inflation rises and interest rates follow suit to try and curb the causes.

But in truth, financing has been on the slide since the first two quarters of 2021. There was a fall in InsurTech financing deals of almost a fifth (19%) since Q1 2022, and more than a third (35%) against 2021’s peak. The total fall in terms of  US$ is 42% since the same record peaks of 2021.

There were still some large deals being done this year, including Acrisure’s $725 million financing in Q2 2022, Newfront Insurance’s $200 million fund raise, and the France based digital health insurance platform Alan’s $193 million deal, among others.

But there were no new fintech or InsurTech IPOs in the first half of 2022, and only one InsurTech M&A deal valued at more than $1 billion in 2022, so far. But what should we expect of the rest of the year, or, given the current economic environment, perhaps the next few years?

It’s not just InsurTechs feeling the pain

The good news for InsurTechs – and those who have invested in them – is that it’s not just them feeling some pain. There are macro events InsurTechs have been caught up in, and some of them are tech specific, like the end of software, and the growth of cloud. Much of the rest concerns the capital markets, because for more than a decade, borrowing money has been cheap.

As a result InsurTech has attracted a huge amount of investment, and at times due diligence may have been less than diligent.

And it’s only once the tide goes out that you can see who’s been swimming without any pants on, says Chris Ford, head of growth equities, Sanlam Investments.

“So over the past eight months, the market is doing what it always does in this circumstance, which is to shoot first and ask questions later.

“There’s not a lot to choose between those companies that have not just got cash generative business models today, but sustainable ones for the next decade or three.

“So the market has got to a place where if you can believe the expectations for revenue growth, the expectations for future cash flow generation are reasonable,” says Ford.

“So the question becomes much less now about whether the valuations are reasonable and much more about whether the modelling of the business is sustainable.”

Managing different expectations

It should be remembered that there is a world of difference between valuations made before and after a company has gone public.

Early stage venture capitalists – pre series A – are trying to invest in businesses they can convince other people to invest in later, at a higher valuation.

In the InsurTech space this part of the investment cycle has now run its course, with companies like Lemonade going public. And the macro environment has shifted investor expectations.

While we know that not every new startup is going to survive, Sanlam’s Ford says investors are increasingly impatient about waiting to see results.

He uses the US digital insurer, Lemonade, as an example for what is happening in InsurTech – and fintech more broadly.

“It’s a bit of a poster child for the market as a whole. Like much of the InsurTech space, it is yet to be profitable, is still burning cash, and the upshot of that is it’s one of the companies caught in the eye of the storm,” he says.

At peak valuation in December 2020, Lemonade was trading at more than 50 times its Enterprise Value to Revenue ratio (total enterprise value divided by estimated forward sales). At the end of July that multiple was under three.

“We’ve seen an absolute cremation of valuations, yet it’s one of the fastest growing and one of the least profitable,” says Ford.

The Lemonade consensus revenue expectation for 2023 was around $290 million, but the current expectation for 2023 revenues  is $370 million. While the valuations have been compressed, this is far beyond the influence of rising interest rates.

“The issue for Lemonade and other parts of the fintech market, is that they simply are not are not profitable,” says Ford. “While revenue numbers have moved higher, earnings expectations have significantly deteriorated.”

This didn’t matter at a time when the market placed potential above profitability. But all of a sudden, interest rates move up and risk appetites came down.

“People have switched from looking at the top of the P&L to the bottom,” he adds.

As these bottom lines have deteriorated, so the stocks have underperformed. And what does that bottom line performance look like over the course of the next five to 10 years?

“Ultimately, an InsurTech company is just a stream of cash flows, just like Procter and Gamble, Unilever or Nestle,” says Ford. “We have to understand all the things that go into facilitating those cash flows, but these companies need to demonstrate these are robust, and that the value that they purport to offer to clients is consistent, meaningful and real.”

The problem for most of these companies is that they haven’t experienced a full economic cycle, so the sceptics will be listened to, as there’s incomplete data to back up the business plan.

An example of this is Upstart, which is filling a gap in the US, by offering lending to those with little chance of getting a good enough credit score to buy a house or fund college studies. Those people are disproportionately ethnic minorities and of them, disproportionately women.

So it’s about access to the American dream and providing a social good. However, Upstart hasn’t been through a credit cycle before, so there’s no hard factual data they can point to that might suggest there won’t be a problem.

However, Upstart is different, says Ford, because it is cashflow positive and self financing.

“It’s delivering positive earnings this year with negative earnings revisions. This is not a problem that you might associate with Lemonade.”

The Chinese experience

The global investment slowdown has not been as shuddering as expected (see Statistica chart below), yet China’s fintechs have found themselves with two lingering problems.

The first is that Chinese regulators have decided that several InsurTechs have sacrificed insurance product protocols in favour of growth. Many short-term products, hybrid agents, and internet-orientated customer journeys have now been restricted or forbidden entirely. Although these new regulations may benefit those embracing offline methods, they do represent a challenge for lead generation models in particular.

The second is the pandemic spread confusion among Western investors about the state of China’s InsurTech market. This is particularly relevant for some of the recently public companies that are trying to communicate their business models to Wall Street.

Regulatory pressure in China

As outlined China’s InsurTech ecosystem has receded under the twin pressures of government regulation and covid isolationism. In fact, a third of Chinese InsurTechs have decided to alter or stop their current path. Although the failure of startups is a fact of private markets, what is interesting to note is the re-emergence of fundamental insurance business practices such as agency optimisation and long-term product development efforts (as opposed to short-term).

Bihubao, Instony, Insbox, Datebao, and Lanbaoxian have all stepped out of the race. For those that remain, the China Insurance Regulatory Commission (CIRC) has been clear that many of the products that fuelled InsurTech growth for the past five years will now be restricted. For example, ‘Million Dollar Medical’, a product which has more than 90 million users in China can only be sold under specific conditions. the regulator is concerned that consumers may confuse short-term health insurance products with long-term health ones, due to misleading policy wording that includes expressions that may make consumers confuse short-term products with long-term products.

Although this may seem like a minor factor in the demise of InsurTech valuations, the popularity of short-term health insurance and its role in the rise of China’s InsurTechs should not be overlooked.

Ping An

Ping An can be seen as a case study of the above issues, as despite being an established insurer, it has fallen victim to both macro and local market volatility, highlighting how issues in China have spread beyond just startups. Ping An has lost half its market cap since the pandemic and regulatory actions took hold. Although still a beacon of digital insurance, it has been forced to curtail many of its efforts and is also not immune to new borrowing restrictions in the property market.

For example, Ping An recently reported its biggest annual profit fall since 2008 owing to a $6.5 billion write off on its investment in China Fortune Land, a real estate developer. To its credit, Ping An has managed to weather this storm by doubling down in other areas. The pinnacle of Ping An’s digital agenda remains Good Doctor, which now boasts co-operation deals with more than 3,600 hospitals – including more than 50% Grade A tertiary hospitals, and 202,000 pharmacies, covering 34% of all pharmacies across China.

The company also set up 225 central warehouses enabling drug delivery within one hour in 140 cities. It also has 48,000 in-house and external doctors. Although the numbers are staggering for most industry onlookers, it’s worth noting that the e-pharmacy operation drives most of the revenue for Good Doctor as opposed to its telehealth service.

Conclusion

Of course, it’s not all bad news. Investments are still taking place, and tech valuations are beginning to recover (See CB Insights graphic below).

One InsurTech benefiting from this is Wefox, which raised a further $400 million in series D funding in July, to push its valuation up to $4.5 billion, from its previous position of $3 billion.

And bucking the trend is Indian insurer Digit, which is planning an initial public offering (IPO) to raise about $440 million while most of its peers within Asia have shelved similar plans.

The auto, health and travel insurance startup saw its valuation jump to $3.5 billion following a financing round last year that was led by Sequoia India.

In a local regulatory filing, Digit said it plans to raise up to $157.5 million through issue of new shares, while existing shareholders will put around 109.45 million shares up for sale.

Ultimately, a hardening of the funding market doesn’t necessarily mean the money men have got things right. Ford says there are two distinct groups – the first are the technologists who don’t really understand finance, and they’re not financial analysts.

On the other hand you have the second group, the financial analysts who understand all the financial stuff, but don’t have a coherent view of the likely outcome for a company like Lemonade or Upstart or any other company.

Ford is backing the technologists to be right, and then it will be down to who is able to exploit those technologies.

“It could very well be the case that in three years’ time, these technologies are absolutely mainstream, and it is the existing major players who have managed to exploit it, because they were able to take a 90% solution and get it over the line,” says Ford.

The companies that survived the internet bubble bursting in 2000 didn’t necessarily have the best tech, but they did have sustainable business models. And now, they’re some of the biggest companies In the world.

The announcement of the death of funding for InsurTechs is premature. There’s plenty of cash still around, and that needs to find a home, because short-term interest rates are a long way behind inflation.

Ultimately it could be that the biggest problem right now is that there’s money, but not enough really compelling ideas from an investment perspective – and like wider economic factors – that’s a cyclical phenomenon, and one that InsurTech can overcome.

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