Customers don't just appear out of nowhere. It is therefore not surprising that the community of policyholders of young digital insurers is initially quite small (see info box “Insurtechs“). The premium income of insurtechs is low at the beginning, but at the same time, these companies need to invest a lot, especially in IT. They therefore start their operations in the red - and then struggle to get into the black. If the often overly optimistic business forecasts are not met, the companies depend on supplementary financing to maintain their business operations. Since the onset of the coronavirus crisis, however, investors have been tightening their purse strings, and their willingness to inject additional funds is declining with each round of financing.

And what about the customers? Their level of protection should not fall just because they decided to take out insurance with a young, innovative company. This is where BaFin comes into play. “Everything we do – regardless of who we are dealing with – must be measured against the protection we achieve for the policyholders and beneficiaries,” said Dr Frank Grund in his speech at the Digital Conference “Insurance Today and Tomorrow” in September 2020. BaFin will therefore continue to scrutinise both existing companies in the start-up phase and future start-ups. In this task, BaFin benefits from a great deal of experience gained in supervisory practice.

More own funds

The European supervisory regime for insurers, Solvency II, is principle-based, but above all risk-based. However, with regard to Pillar I of the Solvency II regime, which determines the own funds requirements, supervisory practice has shown that insurtechs have not been paying enough attention to the risks involved in the start-up phase.

BaFin objects to this and requests that companies in the start-up phase reflect their risks more adequately in future than has been the case to date. In addition, future start-ups are to hold significantly more own funds when they are launched than comparable start-ups in the past. They must be fully financed when they apply for authorisation so that supplementary financing rounds are no longer needed. This means that their business development forecasts must also include potentially negative trends.

Larger organisation fund

In order to obtain authorisation, insurance companies must set up an organisation fund. As digitalisation has changed the framework conditions for the first authorisation and the start-up phase of insurance companies, it is necessary to strengthen the organisation fund and adapt it to the actual business model of the companies in question. With regard to future new start-ups, BaFin will ensure that the level of the organisation fund reflects the increasingly important role of IT in the distribution of insurance products. This is because, for young digital insurers, the design of a successful and sustainable business model often depends on whether the IT set-up costs are adequately financed in the long term. The organisation fund should be set at a level that covers all losses that can be expected, on the basis of realistic projections, from the company’s establishment up until it generates profit for the first time.

BaFin’s experience has shown that merely estimating the costs incurred in the analogue world for the set-up of administrative services and the sales network will no longer be enough in the future. In the event of material changes to an already existing business plan, i.e. if an authorised company makes drastic changes to its operations, BaFin will continue, on a case-by-case basis, to examine whether a new organisation fund must be set up.

To ensure that new start-ups provide their organisation fund with sufficient financial resources and refrain from using overly optimistic forecasts, BaFin can now draw on empirical data from its supervision of older insurtechs when reviewing the profit forecasts. As Chief Executive Director Grund also said at the “Insurance Today & Tomorrow” conference: “BaFin cannot be expected to put blind faith in business plans.”

Higher technical provisions

Under Solvency II, insurance companies are required to include IT set-up costs in the calculation of their technical provisions. This includes not only any overhead expenses incurred to develop software solutions and apps for insurance operations, but also the salaries of the relevant IT employees.

When calculating their technical provisions, all companies in the start-up phase should allocate most of their expenses to existing business. This is because projected new business in the start-up phase is subject to too many uncertainties: companies cannot, with a clear conscience, allocate the majority of their expenses to this part. This would also contradict the principles of Solvency II, which require insurance companies to value their technical provisions in a prudent and reliable manner. All in all, predominantly allocating expenses to existing business will result in higher technical provisions.

Conclusion

A larger organisation fund and higher technical provisions help to ensure that future start-ups have more own funds when they apply for authorisation. Given the potentially high expected and, in particular, unexpected losses that may occur in the start-up phase, this is necessary and appropriate from a supervisory perspective.

Other factors being equal, higher technical provisions lead to reduced coverage ratios for the solvency capital requirement and the minimum capital requirement. This has the positive effect that the actual risk profile of companies in the start-up phase becomes more apparent.