The Realists knew not to write Florida home!

With hurricane season officially beginning this week, I thought it would be a good time to write a bit about Florida, specifically personal lines in Florida. At the same time, I thought I could share a little bit of my thinking about my plans for Florida for Informed and how they might be a little different than other startup carriers and maybe even throw in a quick art history lesson!

So, yes, this will be a little bit of infomercial, but not too much, don’t worry. It’s really a strategy discussion about how to think about growing as a new company and, rather than me focusing solely on what I think the others are doing wrong, I’ll share a little bit of our plans to think differently.

(One last infomercial…reminder you can learn more about Informed at www.joininformed.com).

The New Business Penalty

It’s well known when a company, whether established or starting out, enters a new line of business, or even a new state in an existing line of business, they are subject to a new business penalty. This is another way of saying there is adverse selection when you know less about your customers than your competitors do.

There is a learning curve to entering a market, partially because you aren’t going to see the better risks to quote them, but also because you don’t have the data to accurately assess a good risk when you do see it and probably price it the same as a poor risk.

Note, this risk is particularly high in the independent agency channel where agents will show you their worst business and hope you take it. IAs don’t charitably show you their best business because they feel like you’re a good guy who needs a chance. It’s your role as the carrier to be careful and make sure you aren’t growing too fast in certain cells or with certain agencies.

The New Company Penalty

While the new business penalty is well known, there is another penalty out there. The noobie penalty. Startups don’t have the data established carriers do when entering a market. They typically will rely on “me-too” filings where they copy the rate filing of an established carrier as a starting point until they have enough data to build a proprietary model.

Established carriers though are smart (at least sometimes). They make sure their filings have “traps” so that if a noob carrier copies them in toto they will end up with some poorly priced cells that come back to haunt them.

Think of it as a map that leaves out that the bridge is out or the tunnel is closed. The legacy carriers make sure the public filings don’t reveal all their secrets.

However, if you’re a new carrier, you may not have better options than to start with a me-too. This means your initial pricing model will have mistakes. Possibly large mistakes, especially if you are naive to the perils of using a me-too and pursue growth aggressively.

Now, you can limit those mistakes if you are prudent and manage your growth until you figure out your blind spots, but even still, there will be a new company penalty.

One note before moving forward. A lot of the newer companies blame their poor loss ratios on the new business penalty. While there is an element of this, the bigger cause is likely the new company penalty. New companies improve their underwriting model by finding the mistakes…which means you obviously made some mistakes.

I can assure you Informed’s first pricing model will not be as good as it needs to be. The goal is for it to be less bad than the typical startup and to find the mistakes quickly. When we make those mistakes, I will not blame them exclusively on the new business penalty.

Deciding on the Initial States

When you start a new carrier, one of the major decisions you face is which states to enter first. There are many things you want to consider: growth potential, shopping activity, distribution, loss volatility, claims capacity, regulatory climate, etc.

There are typically two approaches companies follow. You can either go where the most growth is, which is typically the larger states that have more churn but are tougher to navigate, or you can go to the more predictable states that are a bit harder to grow quickly in but will produce more stable results.

In a world obsessed with TAM, you can imagine what most carriers do. They start in California, Florida, or Texas. They’re big states and there is lots of shopping activity! What could go wrong?

Well, people are shopping for a reason and you are the rookie fighting the double whammy of the new business and new company penalties.

Much of the shopping activity in Texas is driven by increased cat activity over the last few years leading to large price increases. If you think your pricing is model is as good as the established carriers, there is a reasonable case for entering Texas early given some good customers have likely been dislocated. However, we saw in Q1 that the insuretechs got stung in Texas.

While Texas is challenging, Florida and California are different animals altogether. The reason for shopping there is the regulatory burden. Namely, both states limit the amount of price increases you can take each year and, in some cases, limit your ability to non-renew customers.

This means if an incumbent carrier realizes they need to raise pricing more than the caps, they may pursue a non-renewal strategy. Others are careful about pursuing new business in the first place, as they know it will be hard to get off it if they are wrong about the customer, and limit their market share in these states.

In other words, shopping activity is high because there is a lot of underpriced business in these markets and the established carriers don’t want the business. Thus, if you, as the new entrant, pursue an aggressive growth strategy in these states you are likely to pay an excessive new business/new company penalty!

Worse, as mentioned, your ability to re-underwrite the book is limited by the caps on annual rate increases. It will be a long time before you can get the book to an acceptable margin. But hey, there was big TAM!!!!

(Brief aside: If you work at an insuretech and think I may be talking about your company, don’t overthink it. Lots of carriers are following this strategy. I’m not trying to call out anyone in particular.)

Contrast this to entering more stable states where, since you know your first pricing model will be wrong, you expect that you will need to re-underwrite as you go along. You might have less new business, but you will also have higher retention on what you do write, so net-net your in-force is probably similar in size over time to starting in one of the larger states with a smaller new/new penalty.

Florida Will Be Informed’s 50th State

Given the difficulties of writing homeowners business in Florida, a startup carrier should wait to enter until they are sure they have their pricing model as good as it’s ever going to get. The long term results in the Florida market suggest it is very difficult to make money as an underwriter, even with experience. Informed will wait until we have that experience in order to have a fighting chance.

California may well be our 49th state for similar reasons. While the market is more profitable than Florida (at least if we continue to have a dearth of meaningful quakes), the caps on pricing mean you have to have a very strong pricing model before you enter.

Will this result in less growth? Perhaps initially, but not ultimately. I believe it is more important to establish credibility in our underwriting as that will eventually let us grow faster (because we won’t be distracted fixing problems and because we will have the confidence to expand in more states quickly).

We can also service customers in Florida without writing them directly. There are plenty of other markets who specialize in Florida that we can make arrangements to send our customers to (if you want to be one of them, send me a note!).

In fact, a big part of our model is deciding when to act only as an agent and when to act as a full service carrier, but I’ll save that for a future post. Suffice it to say, we can have a presence in Florida before we decide to underwrite Florida.

Realism vs. Romanticism

What this really amounts to is a worldview. A company which attacks the hard states first because the rewards are high you might think of as a romantic. They assume things will work out for the best and there will be a happy ending. They overlook obstacles and go for it. Now, sometimes that works, but often you end up broken hearted.

I would argue, while that works well in some ventures, that is probably not the right attitude for an insurance company. Insurance isn’t for optimists. It’s for realists. The key to success in insurance is having as much information as possible, understanding what can go wrong, and evaluating the distribution of outcomes to decide when it makes the most sense to take on risk.

Realists know that, in the face of uncertainty, you look to reduce the number of unknowns. They don’t believe their own hype or assume they have all the answers just because they asked new questions.

Realists also know that the new business and new company penalties are real and don’t romanticize that they can avoid them. Therefore, a wise realist accepts that their will be mistakes in the beginning and seeks ways to minimize the impact of those mistakes.

That is why the realist starts at a smaller scale, makes its mistakes quickly, learns from them, adjusts, and then later enters those challenging markets in a more informed (Informed?) way…with better data, more accurate pricing, more responsive claims, etc. which greatly increases the odds of success.

Fail Fast

The goal isn’t to grow as fast as possible. It’s to fail as fast as possible. That may sound crazy, but return to my earlier premise. No startup gets its pricing (or operations) right on the first try.

The faster you grow out of the chute, the more likely you are to compound your errors. If you seek to fail fast, you will learn fast and avoid that compounding and find yourself able to achieve good growth a lot sooner.

It’s a very similar concept to an established company writing business where claims inflation has changed. The first company that realizes the problem, adds to IBNR, and slows their growth is always the first mover to take advantage of the better pricing that comes later when others eventually recognize the problem.

They say the first rule when you find yourself in a hole is to stop digging. Well, the first rule when trying to grow a new business too fast is to stop growing. Be humble, be agile, and be open minded and you will be rewarded in the end.

After all, while the Romantics had a great run, the Realists eventually replaced them. Will life imitate art once more?