Decentralizing the Insurance Industry

Level 1 -NGMI

Welcome Avatar! One of the critiques of DeFi and the sector as a whole is the “lack of real world use cases”. While the main use case is simply borrowing/lending major crypto assets we’re going to take a quick turn and cover insurance. Insurance is yet another area where smart contracts can become disruptive. For paid subscribers, we will cover Nexus Mutual beginning this weekend. This free post is designed to help you decide if that is an interesting area for financial disruption (or not!)

Quick Explanation: Right now insurance companies incur significant costs: 1) Product development, 2) Sales and marketing, 3) Operations, 4) Support and 5) Standard IT spending. While the exact math isn’t important the 2015 overview from McKinsey is worth a look (LINK). We will refer to a few exhibits from this overview to set the table.

McKinsey Snapshot of Costs

More importantly the report quotes the following “we found that management often matters more, and that’s how a handful of players have been able to demonstrate successful long-term cost management.” - Björn Münstermann, Georg Paulus, and Ulrike Vogelgesang

McKinsey Snapshot of Management Cost Differences

Does this sound familiar? It sure does! The entire banking/financial industry is full of costs. We’ve provided a high-level overview here (LINK).

Okay Okay So What? Well for anyone who has had to deal with an insurance agency, you know that there are huge headaches in getting your money. You can only get a certain amount, there are usually delays and more friction/time = more costs.

Now what if there was a new technology that allowed you to settle these claims without human overhead? There is: smart contracts.

Now you might be wondering, why would the insurance industry want faster settlement. The idea of insurance is to delay drag out and penny pinch to increase margins. Well? If you use smart contracts you would reduce operational costs, IT costs and product development costs.

New Model: You take your high quality actuaries and they build the model for each segment. After this you create a smart contract for each claim. Boom! You’ve removed a huge chunk of the IT costs overnight. Support/operations functions are now minimized.

All you really need is a team of people to field the calls and make sure there is insurance fraud. After that it’s two button clicks and release funds or don’t release funds since the claim was fraudulent.

How Big is This Industry?

The insurance Industry is pushing up on a trillion dollars. There is no way to know the exact revenue of a industry of this size, however the $900B rough estimate is good enough for the purposes of this explanation.

Insurance Industry - Statistica Revenue in Billions

High-Level: Since we know that smart contracts (DeFi) reduce operational costs *AND* overhead costs, we can go ahead and make an assumption based on the numbers from the Statistica + McKinsey.

Quick Calculations: We know that $900B is the top-line and we know that profit margins are in the ~10% range. We can see this from Progressive by looking at their financial statement. (LINK to September Earnings). No need for exact math once again, they make about $3B in profits on $30B in revenue.

Progressive financial statement for YTD 2021 and YTD 2022

Now the fun part. What’s a good way to estimate the friction? How about if we simply use the underwriting costs? We won’t touch anything else. Progressive is an extremely large company with over 43,000 employees (LINK to 10-K) and a large frictional sales and marketing department (you know this is true based on all the HR disclosures in the filing!).

Doing another quick calculation we can say an 11% reduction in total operational costs. This would be 11% times the total market which is $900B or $99B (we’ll just round up to $100B). That is a substantial cost bloat. $100 billion that can be addressed by removing paperwork and other IT/operational issues by simply using smart contracts.

Autist Note: we know that it is dangerous to build on the basic assumptions above. That said, this is a big picture post and the exact numbers are not as important as the market size/opportunity. If we know that DeFi market cap is in the ~$160B range and the total cost reduction from the insurance industry is already ~$100B it shows you how early we are. Even if we cut the numbers in half, the value shift is still ~33% if the entire industry based on one sub-segment of finance alone.

How Big is This Industry?

We’re no where near the beginning of this transition. However, we suggest everyone takes a look at Nexus Mutual before we begin the overview this weekend. (LINK)

Examples from Nexus Mutual

Like anything in crypto you have to start off by insuring against crypto related assets and crypto related industries. There is just no way to get around the red tape. However, we think this is where the world is going over the long-term!

Hope you enjoyed this short overview on why insurance is ripe for disruption.

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Disclaimer: None of this is to be deemed legal or financial advice in any way shape or form. You are reading opinions from an anonymous group of Wall Street and Tech Engineers in Cartoon format.