In praise of InsurTech due diligence

May 28, 2024

Last week, Wefox, the German InsurTech is reported to have sent a letter to shareholders warning them that it could be insolvent by the summer. This is the same Wefox that was valued at $4.5bn less than two years ago, and which is reported to have raised $160m in 2023 alone including an equity follow-on round and two debt financing rounds from J.P. Morgan and Barclays, and Deutsche Bank and UniCredit.

It is also the same Wefox whose new CEO said in that letter: “My key deduction is that Italy has been running on systematically false operating assumptions…and is now insolvent without ongoing Group cash support.”

How can investors get it so wrong? It’s simple: not doing commercial and operational due diligence on InsurTechs.

Oxbow Partners has been an enthusiastic if constructively (we hope) sceptical observer of the InsurTech scene since 2016. Even in our 2018 Impact 25 report we noted that technology had the impact to change insurance but was unlikely to turn the industry on its head due to some of the unique features of insurance (see page 7).

Nonetheless, many investors have until recently thrown money at InsurTechs in the same way that they have thrown money at businesses in other sectors hoping to find the next overnight unicorn. We have observed that many investors have invested without commissioning professional commercial and operational due diligence. Even in larger, later stage rounds, diligence has often covered only the legal basics.

In this brief article we lay out some of the learnings we have made in diligences so far.

1. Even core investment hypotheses can be flawed

If there is one thing that you would expect an entrepreneur to be solid on, it is the robustness of their business idea. However, this is not always the case.

In one diligence, we looked at a business that claimed to have a unique business model. Within a week we demonstrated that it had simply overcomplicated how it talked about its model and that its core proposition was being executed more successfully by several other InsurTechs. In another case, we proved that an embedded insurance proposition’s addressable market calculation was unachievable because the particularities of their distribution partners had not been accurately considered.

All too often, early stage investors buy into clichés like “insurance is a market ripe for disruption” and “embedded insurance is the future” but without clarity on execution. For example, how do you make product innovation count in an intermediated market where customer engagement is low? Will consumers really buy delivery insurance for a candle, or is the total addressable market a small sub-set of a market.

2. The grow-at-any-cost model does not work in insurance

Seasoned insurance practitioners will know the old cliché about growing an insurance business being easy, but growing it profitably being very hard.

VCs often do not know this and force InsurTechs to chase volume at any price. Quality of earnings is secondary. This seems to have been the case at Wefox.

In one of our diligences, we reviewed an InsurTech’s pitch deck for a trade investor. The revenue forecast was based on a top-down view of the market – the kind of ‘big thinking’ a VC investor loves. We rebuilt its forecast model using actual and potential revenue. The company agreed with our insights and reduced its in-year revenue forecast by over 90% (yes, ninety percent).

3. Governance is sometimes inappropriate for a business in a regulated industry

Finally, we have uncovered some unusual governance practices in our diligences, for example surprisingly lax expense policies for immature businesses or hiring practices. In fact, this appears to have been a feature of Wefox: a recent Manager Magazine article (German, paywalled) noted that a building had been rented off a company owned by a relative of the senior team and various relatives had been employed. All very WeWork!

It is surprising how tolerant VCs are of poor governance. Arguably it is a consequence of the soft funding environment that has prevailed over the last decade, during which too much money was chasing too few opportunities. Instead of being robustly tested by investors, we heard of one InsurTech that received a significant consulting budget, separate to the investment funds, as a kind of present from their investor seeking to differentiate themselves.

Oxbow Partners InsurTech Diligence is designed for early stage businesses with evolving business models

With the funding environment tightening, diligence should now be much more rigorous. This is good for both investors and InsurTechs, who benefit from their business model being rigorously tested periodically by professional advisors.

Over the years we have developed our InsurTech Diligence Framework. We have validated the business models of several InsurTechs for investors.

We recognise that one cannot apply the same financial analysis to early stage businesses that one would use for an established insurance business. Instead, we look at three things: the achievability of the company’s ambition, its ability to deliver and feasibility of the financial case. Rather than simply critiquing, we lay out what investors need to believe for the investment to make sense.

We are not accountants and may not have spotted Wefox’s Italian challenges. However, we firmly believe that our InsurTech Diligence Framework is an effective tool for assessing a high growth business, finding the right balance between track record and opportunity. Most importantly, our experience and insight across the industry allows us to point out risk factors to investors.

If you are looking at an InsurTech investment, please reach out to our team.

About the author

Chris Sandilands is a Partner at Oxbow Partners. He leads engagements across strategy and transformation, focusing most of his time on global reinsurance and UK & Ireland retail insurance.