Yes, Delightful Commercial Insurance Is Possible

Whether you’re an SMB owner-operator or a trillion-dollar company, commercial insurance is mission-critical. Despite its importance, commercial insurance remains one of the final frontiers of product expansion opportunities for Vertical SaaS companies—and for good reason! Insurance is highly complex and highly regulated and, as a result, has seen little innovation.

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With a sector this complicated, even knowing where to get started is a challenge. For example, there are twenty major standard commercial lines and dozens of specialty products, ranging from general liability to cyber insurance. The types of insurance required vary and are based on a multitude of factors, but workers’ comp is mandatory for any business with more than one employee; general liability for any commercial lease; commercial auto for any vehicle—and the list goes on. The scale of the commercial insurance industry is a whopping $350B+ in premiums per year in the US alone.

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The prize is large if a founder is brave enough to tackle this complex field, but that complexity is the exact reason there are numerous opportunities available:

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• Broken customer experience: There is an old adage that says “insurance is sold, not bought.” If you have ever tried to buy insurance, you will understand the frustration that makes that saying true. Quoting & binding (getting coverage in place) is slow and frequently requires multiple rounds of (often redundant) information gathering. The data captured can be outdated and unreliable, in part because it's self-reported. Whether online or offline, multiple hand-offs make the experience disconnected. The poor experience doesn’t end post-purchase—customer support and claims processes are also notoriously painful.
  
  
• Policies are rigid and expensive: In an ideal world, coverage should be tailored to the specifics of each business and the policyholder’s unique needs. However, insurers continue to use tried-and-tested underwriting models, which are effective in minimizing losses but have resulted in a standard set of off-the-shelf products that can lead to either too much or too little coverage. The non-optimal experience extends to pricing, which remains a black box and comes with long and inflexible commitments.
• There is a difference between “micro” and “small”: There is a vast range of price and coverage complexity between a sole proprietor and a company with multiple locations and fourteen employees—but both are typically considered “small commercial” by insurers. The micro-business is more likely to expect and embrace a purely digital experience. This doesn’t hold for upmarket, “Main Street” businesses that have more complex coverage needs. Their industry may also need unique coverages (e.g., Joe’s Crab Shack, which needs liquor liability, vs. Bob’s Pizza, which doesn’t serve alcohol). Until digital offerings can replace the trust and assurance an insurance agent provides for a more complex business, agents will still control ~90% of the small commercial market. 
  
  
• Attractive economics: Commercial insurance premiums and commissions are higher than personal lines because product implementation requires significantly more expertise and specialization, preventing commoditization. Typically, a commercial insurance premium nets out around 2-4% of sales for an SMB, depending on which lines and limits they choose.
  
  
• Certain segments remain underserved or unprotected: Historically, the self-employed segment and SMBs haven’t been a priority for brokers, who focus on larger commercial accounts. Brokers will give the same amount of effort either way, so asking them to sell to SMBs for lower premiums, and thus lower commissions, is a challenge. This is despite a 2018 survey by NEXT Insurance saying 44% of SMB applicants who have been in business for a year or more have never had insurance. The accounts are there for the taking, but the economics are tough to work for brokers.
  
• Data is not leveraged from source systems: Incumbent insurers are typically architected to distribute products through agents, as opposed to acquiring business through partners (such as vertical SaaS vendors or other small business operating systems). Their systems aren’t agile or flexible enough to compete as effectively as the emerging full-stack insurance companies. Not only do incumbents find it difficult to deliver an embedded solution, but they also are not equipped to leverage the data they could gain about prospective customers from the source systems of vertical SaaS vendors (VSVs).

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The Insurance Opportunity for Vertical SaaS

Like Payments and Payroll, commercial insurance represents an opportunity for a VSV to create a new revenue stream, increase loyalty and stickiness for the overall platform, and solve universal pain points for its customers. It’s a win-win product. Customers will no longer perceive the VSV as simply a technology vendor, but as a platform that provides them with access to additional value-added services. Selling business insurance is providing peace of mind. VSVs who are at the forefront of integrating business insurance will stand out from the competition of other SaaS vendors. 

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Merchants benefit because, according to Steven Hauck, VP of Partnerships for NEXT Insurance, “small businesses would rather buy more products from within one operating system and from a single trusted supplier.” While the business case/upside for VSVs is clear, what makes them right for the job? We would argue that VSVs are uniquely equipped to offer insurance.

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VSVs are in a distinct position to affect both the top and bottom lines (loss and expense ratios) of commercial insurance. This is largely due to their unparalleled repository of data, which enables them to i) better understand their customers’ preferences & needs; ii) better identify and select risk; and iii) more accurately and flexibly underwrite risk. In turn, this allows VSVs to properly classify the business and extend more relevant coverage to customers that were previously underserved. It also means insurance can be priced more accurately, based on the customer’s risk profile. This superior ability to optimize price and coverage drives higher conversion rates and lower losses—customers experience this as cheaper, better, and more tailored insurance coverage. 

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Again, this is a win-win for everyone, with the optimal outcome being the flywheel effect: the best-performing merchants work with the VSV to obtain the best rates & coverage, which drives higher win rates for the VSV’s core products, allowing them to offer even better rates thanks to improved overall unit economics.

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Depending on the VSV’s approach to offering insurance, this wealth of data can further empower them to build their own customized insurance products. Accompanying these new products, VSVs can create new billing models—for example, using a Pay As You Go workers' comp that dynamically flexes premiums based on fluctuations in the number of employees. If the VSV is embedded in the payroll and/or payments flow, they can offer adaptive payment arrangements (e.g., premium payments based on payroll or sales volume that month). Steven Hauck explains further with an example: “Through NEXT’s Pay As You Go workers' comp partnership with Toast, we are providing restaurants with material cash flow benefits. For common restaurants experiencing seasonality, or a stop-and-start scenario like COVID, pegging premium collection to the payroll cycle smooths payments over the course of the year. This decreases the audit burden at the end of the policy lifecycle.” Innovations like these drive long-term competitive advantage, especially as offering off-the-shelf insurance products becomes table stakes.

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Beyond superior products and billing models, VSV customers also benefit from significantly improved buyer journeys and customer service. VSVs are already trusted vendors and have access to granular customer data. They are able to simplify, personalize, streamline, and expedite the purchasing process through:

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• An integrated UX 
• Digital underwriting
• Faster quoting & binding of policies: one-time, short applications or automated data pulls, ideally being able to pre-quote your customer base and have them purchase with a one-click buy
• A seamless renewal motion and timely up-sell and/or cross-sell of coverage, triggered by key milestones like opening a new location or hiring new employee types

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The benefits of VSVs entering this space extend to stakeholders beyond their customers—predominantly agents and risk capital providers. The value prop for these actors includes lower-cost distribution, access to new customer segments, and higher underwriting profits with improved risk selection and pricing accuracy.

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Paths to Insurance & The Financial Opportunity

A VSV’s approach to offering insurance, and the financial opportunity and economics, are tightly coupled. There are several execution models for VSVs; each differs in their level of investment and complexity, with the more rigorous offering greater financial rewards. We’ve ordered our list going from the least to the most complex, and least to most return:

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Referral Partner:

In this affiliate model, the customer is pushed to the insurance partner’s website to purchase the policy. The VSV only receives a referral fee if the customer goes as far as to get a quote (typically $25 per quote, net to the VSV). This is the path of least resistance, but the benefit is lesser than other models. The economics are minimal and you don’t own the customer relationship—nor the invaluable insurance data—and thus can’t control the customer experience.

Licensed Distributor:

A significant step up is to undergo the 3-6 month process (per state) to become a licensed agent or broker¹ in each of the states where you intend to offer insurance. You’ll then need to be appointed as a producer by any insurance carrier that you will want to do business with (this can be challenging when you have no track record). Then, the VSV may need to build the in-house tech and broader teams (sales, CS, claims, etc.) to support this, which is also a substantial upfront investment. The upside is that agents and brokers earn net commissions²—these are typically between 3-10% of the premium sold, but can vary based on the industry type, coverage, and the state in which the policy is sold. 

The beauty of insurance is the recurring revenue dynamic: commissions are paid on both new policies as well as on policies that are renewed (though the 1st-year commission is typically 10-30% higher than the renewal commission). Couple this with the fact that commercial insurance is sticky, and you essentially have an annuity stream. End customers benefit the most from the brokerage model because the VSV is acting in their best interest as a fiduciary, providing them with the best price and the right coverage.

Embedded Partner: 

VSVs can short-circuit the broker model by using digital insurance agencies that have already done all of the hard work of integrating with insurance carriers. These digital agencies provide APIs that VSVs can use to seamlessly incorporate insurance into their existing UI & buyer journeys. These agencies handle everything: sales, support, and the claims process. If VSVs are looking to have more influence across the insurance lifecycle, there are several embedded insurance providers (NEXT, Boost, Sure, Coterie, Cover Genius) that empower them to sell new or customized white-label insurance products. 

White-labeling the UX, or embedding the offering via APIs, leverages the affinity the VSV has with the buyer to strengthen conversion and provide a consistent user journey. This ultimately removes the pain of building internal insurance capabilities (compliance, risk, tech) while still providing all the data and customer engagement benefits of the do-it-yourself path.
A brokerage license is still a requirement for either of these options. Embedded offerings typically allow for net commission in the 5-10% range (while still not managing claims, support, end sales, etc.) with profit sharing based on portfolio performance adding an additional 0-10% net commission earning potential.

Do-it-yourself: 

VSVs in later stages of expansion are well-positioned to move beyond partner or embedded arrangements, which can significantly improve their economics and give them full control of the customer journey. In this scenario, the VSV would either become a Managing General Agent (MGA³) or create an insurance carrier. There are pros and cons to both options, but the MGA route is recommended, as it provides a faster route to market and a capital-light model while still allowing for control over the insurance value chain⁴. In addition to owning new and renewal commissions (15-25%), MGAs have additional benefit because they can share in the underwriting profit (0-10% premium) despite not holding any of the direct risk. 

The MGA model can be used as a stepping stone towards becoming a carrier, but there are a few downsides: MGAs will always need to get product sign off from their risk-taking partners, and the insurer/reinsurer relationship can be fragile. It’s imperative to have multiple partners/carriers, as unexpectedly high losses could cause the insurer to terminate the program, or carriers may not expand capacity as their risk tolerances change. Going full-stack provides complete control and 100% capture of the profits, but can be cost prohibitive, expose you to more risk/losses, and is an arduous, 2-year+ journey that entails new entities, regulatory hurdles, capital requirements, and more.

The DIY approach is a formidable mountain to climb and not for the faint of heart. However, VSVs are better positioned than their horizontal brethren (Intuit, Amazon, Paypal, etc.) who have to satisfy the entire small business commercial landscape from a classification and product/coverage perspective, which is a vastly different business than their core offerings.

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Commercial insurance is a large and complex TAM. It’s a product that all SMBs need to buy to protect their businesses, and many VSVs are well positioned to provide a significantly improved product and customer experience. VSVs have inherent advantages to offer differentiated insurance coverage, whether in a referral relationship, as a broker, via an embedded/white-label partnership with underwriting input, or with deeper control as an MGA or carrier. For those who are courageous enough to tackle this market, serious financial rewards await. There is significant nuance required in making the right decision for your VSV—drop us a line at knowledge@tidemarkcap.com if you’d be interested in learning more.

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_{1. Insurance agents and brokers sell insurance to customers and are licensed at a state level. The difference is that insurance agents represent insurers while brokers represent the customers. Brokers act in a customer’s best interest, but can’t bind coverage and must work with agents to complete the sale.}

_{2. Assuming the VSV isn’t doing the full sales, support, claims administration, etc.}

_{3. MGA is a special type of insurance agent / broker that can perform functions ordinarily handled by insurance carriers (underwriting, marketing, claims, customer service, etc.), but doesn’t assume any risk. Insurer or reinsurer partners take on the risk. Need state by state licensing, which is expensive and time consuming}

_{4. The insurance value chain can be split into: product & service development, S&M and distribution, underwriting & pricing, policy admin & servicing, claims & benefits management, risk management}