VC @ Runa Capital
In times of social distancing, most people spend more time at home. A short series I can recommend for your next evening on your couch is Bad Banks. In the second season, the investment banker Jana Liekam and her team of trusted accomplices move to Berlin to take over a sustainable robo-advisor. The viewer is pulled into the power struggle between the incumbent Deutsche Global Invest with its fintech incubator in Berlin, and the rivalling robo-advisors fin21, and Jana’s Green Wallet.
Fig. 1: Google searches for the term “fintech”
Both pop culture and Google search trends speak a clear language: fintech and its smaller cousin insurtech have been a phenomenon in the startup world. In the last couple of years, my hometown Berlin has seen a surge of neobanks, robo-advisors, payment solutions or scoring providers appearing out of nowhere. In a move formerly unheard of, bankers have relocated to the German capital to build the next big thing. And with Finance Forward, the fintech community now even has its own magazine and conference.
In our new world we pay with credit cards issued by Revolut, N26, Penta or Oxygen; get consumer credits on Smava’s loan marketplace; or deposit our money all over Europe with Raisin. Even the process of lending and underwriting, perceived as the incumbent’s core business, has been revolutionized by companies like auxmoney, finiata and Monedo.
How did all of this happen?
Rampell recognizes three successful strategies fin- and insurtech startups have used to enter the juicy markets of incumbents:
Let’s assume you want to start an insurance company. In a simplified view, the price of the insurance is calculated based on the average claims. A good example would be car insurance in which a group of people pay the same fee. Naturally, some people in this group will tend to be better drivers than others and cause less damage.
Positive selection takes advantage of this imbalance. People that are on the better-than-average side of the distribution may feel treated unfairly. They do have to pay the same as everyone else, although they invoke fewer costs. Smart insurance companies may take advantage of this and offer better rates to these people and these people only. An interesting example is the insurance company Friday. Note that it is not a startup in the strict sense as it is part of the Swiss Baloise Group. However, Friday’s main USP is their pay-per-kilometre model. If you drive just a little, you may have been in the better-than-average bucket of a traditional car insurer, but now you have the option to pay much less.
Your credit scoring or underwriting is just as good as your statistical model. These models in turn strongly depend on the quality and quantity of your data — the more you know about your clients, the better you can estimate the risk. Quite a few companies entered into the industry via this path. Examples are Monedo using masses of digital data to provide loans to the previously unbanked or newer companies like Myos or fulfin providing growth financing to small Shopify or Amazon sellers after analyzing their sales numbers instead of their credit histories. An interesting insurtech with this strategy is Descartes Underwriting, focusing on complex risk modelling as a service to large insurers.
The most interesting entry point is to encourage behavioural change. It allows entering a market that is deliberately ignored by others. Think of someone, who will not get a loan by a bank because he has a bad credit history. Who would dare to give money to people that are not creditworthy? However, if one could make sure by some means that these borrowers pay up, a new and untapped opportunity appears. An example of this strategy is the peer-to-peer lender LendingClub. It started out as a social networking service bringing lenders and borrowers together based on affinities and social relationships. LendingClub's theory was that people are less likely to default on individuals in the same peer group. After initial success and despite a few scandals that lead to the resignation of its CEO, LendingClub has outgrown its initial target group and moved towards a broader offering.
There also has been a battle-tested way to disrupt the old economy which I will add to the discussion as my plus one: solid, flexible technology and a good UX. Core banking startups like Mambu, for example, enable banks to develop their platforms in a fast and flexible way and banking-as-a-service providers like solarisbank and their Estonian competitor modularbank are forming the backbone of many a fintech. So-called neobanks like Revolut and N26 are popular amongst the young and digital because of their slick UX, fast signup and simple features like N26’s spaces. Similar things are bound to happen in the insurance space. Companies like Popsure or Clark broker the same insurances you get everywhere else, but offer comfort features like a central app to report claims or an overview of all your insurances.
Less and less new financial startups are entering the space as demonstrated by Fig. 2(a) in which we see a decline in the numbers of new fintechs during the last years. Meanwhile, investment in the space is rising steeply (see. Fig. 2(b), investment in fintechs per year). It does not seem to be only a subjective feeling that the market is saturating and maturing. On the adjacent playing field of insurtech there are still some opportunities up for grabs, but the dynamics at play are very similar.
Fig. 2: (a) Fintechs founded by year and (b) Investment in fintechs by investment year — source Deloitte Center for Financial Services
Let’s take a minute to think about the 3+1 strategies that have been successful in the past. It is pretty obvious that at least two of them, the strategies of positive selection and better data, are interconnected and on the verge of disappearing. Let’s for a moment assume that lenders and insurers collect more and better data in order to improve how they assess risk profiles. They will simply be able to price their services more individually and the marginal value of new data will decrease. This makes it difficult for early startups to move past incumbents on this basis. More individual pricing means that pricing errors will become much smaller. While some in the less-than-average bucket will have to pay more for their credit or insurance, it is obvious that using a positive-selection tactic is becoming increasingly difficult to pull off as the feeling (and the reality) of being treated unfairly will have been reduced.
The most difficult strategy to enter lending or underwriting is to build cutting edge and flexible technology with an amazing UX making the use of your product very simple and intuitive. Keep in mind that while previous startups were competing with old-school banks and insurances and a lot of paperwork, today’s founders have to compete with advanced core banking platforms and the incredible user-friendliness of the first generation fintechs. It is getting increasingly difficult to use tech as a sole USP. Nonetheless, there may still be a small window of opportunity in the world of insurance as this area is lagging slightly behind the more advanced fintech space.
Focusing on encouraging people to change their ways in order to cause fewer damages, be more healthy or pay back credits on time is a difficult task. We know this from ourselves when in February every year we give up on our new year’s resolution, stop going to the gym, cancel our daily meditation routines or start ordering junk food once again. But creative and unique ways to enable behavioural change will always be found by smart entrepreneurs. But as soon as a company starts scaling and coming out of its niche, it will have to compete with all the competitors that have mastered data collection and invested time in developing their platform.
In general, it is fair to say that it will become more and more difficult for new lenders and insurers. As we have seen, proven go-to-market strategies and USPs are slowly being taken off the table and the startups from today are on the verge of becoming some badass incumbents. Opportunities will arise elsewhere though — of that I am sure. And I am really excited to follow the competitive fin- and insurtech market in the months and years to come.