Fintech startups seem to be the biggest followers, looking to experiment, pivot and iterate till they succeed. The thinking among startups has been to remove any excess (perceived or imagined) which directly does not help in business “growth”. Insurance then is obviously not the first priority for startups especially since few insurers understand or appreciate the risks associated. But startups and especially Fintech must understand the nuances of the regulatory landscape they are operating in and need to ensure that one mistake does not jeopardize their companies and the VC money invested.
The different risks
A Fintech faces multiple risks on a daily basis. The biggest one is a Data Breach. Marketplace Lenders need to store mountains of personal information on their borrowers. A major data breach can literally finish a startup as it would directly become liable even though it is using a third party processor. Cyber liability insurance can be the only life jacket available for the startup to hold on to in this case. Errors and omission Insurance would be necessary to protect the company from the risk of a technical bug affecting its programs, leading to malfunctioning and erroneously lending to the wrong person. As the startups mature and expand across multiple states and raise growth capital from outside shareholders, Directors, and Liability Insurance would ensure that the personal assets of the management of the company are protected in case of a regulatory or shareholder lawsuit.
As this segment of the industry is still in its nascent stage, there are not many players offering startup-friendly insurance packages. But some insurers have entered to capitalize on the growth of startups and have launched startup focused products. Major players in this niche are Foundershield, Virado, and Hiscox. Foundershield has raised a round from Interplay Ventures and existing players like Marsh, Beecher Clarson etc are also beefing up their startup division with a special focus on Fintech needs.
In an interview with Lending-Times, Paula Miller, Senior VP at Beecher Clarson explains the contours of the market and what factors are currently shaping this small but growing segment of the industry. Paula’s first introduction to Fintech insurance was via Peerstreet.com when only one insurer was ready to take a risk on the lender (at exorbitant rates). Her research across the sector had the same underlying story of lack of knowledge among brokers and insurers and cost prohibitive insurance, in the lucky case a startup was even presented with an option. Just to highlight the difference, private companies have access to at least 30 different insurance companies whereas the entire Fintech startup sector has less than 5 companies. Despite the dismal options available, she has been able to structure insurance contracts for Peerstreet and Peerform and is in discussions with Cross River Bank as well.
Lender’s exorbitant insurance premiums
Even more absurd is the pricing of insurance for Fintech startup Lenders. The three insurance contracts required for basic risk cover are Directors & Officers Insurance (D&O), Cyber Liability Insurance & Errors and Omissions Insurance (E&O). For a million dollar limit on each of the three policies, the premiums will amount to 100-150 Thousand dollars. That is a figure very few early stage Fintech startups can consider blowing on insurance. These figures, when compared with the general market, become even more incredulous. A typical non-fintech startup would have to pay only 10-15 Thousand dollars each for a similar policy as compared to the Fintech who could be shelling out 40-75 Thousand dollars. This translates into a 400% to 600% premium over other private companies at a similar lifecycle.
Why the mispricing ?
The cause of this mispricing is a lack of education in the market, according to Paula. Underwriters don’t like the space due to their belief that Fintech startups are completely unregulated and on the business side, the volume is not large enough to hedge their risks adequately. European Markets are far more developed with specialized insurance available for loan originators. But sooner or later, institutional investors looking to invest in p2p sites would demand insurance and would be comforted by the fact that some business risk can be passed to insurance companies. Though specialized players in the insurance industry are moving aggressively to cover both the basic and exotic risks associated with p2p lending, no insurance will cover the risk of the site being a Ponzi scheme or if the money is lent to a fraudulent borrower.
Will the insurance pay or deny ?
Due to the industry being in a nascent stage, it is vital for startups to work with specialized brokers who understand the ins and outs of Fintech insurance. Case in point: Prosper was served with a cease and desist notice from SEC and even though the company had “Directors and Officers” & “Errors and Omissions” Insurance, the insurance company refused to honor the claim. This is because according to the insurer- Greenwich Insurance Company, the contract excluded any banking and lending activity. Prosper brought a suit against the company and Greenwich had to cough up more than 2 million dollars as claims and penal interest. Though Prosper won, it is not an endearing sight for startups looking to insure themselves if they have to drag their insurer through court for claim settlements. This only highlights the importance of having insurance (because it did save Prosper 2 million dollars at the end) and obtaining proper advice from an experienced insurance broker.
Will insurance startups provide insurance to other startups ?
Innovation in the insurance industry is always slow due to regulatory factors, as compared to other segments of the economy, but increased demand and expectations will definitely drive the insurance companies to frame policies for covering business risks and supporting start-ups. The insurance startup Unicorn- Oscar, is redefining the insurance space and the entire insurance industry is ripe for disruption. It seems the answer to Fintech’s insurance problems is another Fintech company which can understand their risks and accurately price the product.
Author: George Popescu and Heena Dhir