In January, BaFin published an article and technical explanations on the capital adequacy requirements for insurtechs in its journal. This caused a storm in the German insurtech scene, which has few genuine insurers, as the players believe it makes the license and operation of a young insurer considerably more difficult, precisely because as BaFin itself makes clear in its headline “All beginnings are expensive”.
According to BaFin’s definition, insurtechs are tech-savvy young insurance companies with a licence to operate insurance business under the Insurance Supervision Act (VAG). This does not include the numerous insurtechs that are licensed as MGAs, brokers or other forms of intermediaries, nor all tech start-ups that do not require a licence and have separated out parts of the process in the life cycle of an insurance contract and only digitise one process step.
Solvency II with its risk-based approach applies to the operation of the insurance business throughout Europe, in each case according to national implementation. The primary objective is to adequately reflect the risks of all insurance companies, in governance as well as in the capital required by supervisory law. In this qualitative consideration of the risks of the individual insurance company or a group of similar insurance companies, BaFin has now clearly communicated which risks – deviating from the already established insurers – must be taken into account for insurtechs and thus – according to BaFin’s expectations – be reflected in the capital requirement.
The organisational fund and the technical provisions must be reassessed.
Accordingly, BaFin assumes a higher organisational fund in the future, which every insurer has to fund in order to pre-finance the build-up and development of business operations. According to the German Commercial Code (HGB), the organisational fund is an equity component as profit reserve and thus also own funds according to Solvency II. BaFin clarifies for insurtechs that IT set-up costs must be financed in the long term in order to enable a sustainable, successful set-up. The Orgafund should provide for all costs and expense until the first profit is made – and this requirement is painful for every start-up – taking into account all expected, realistically forecast losses from the establishment until the time of the first profit. It is set-up for a specific purpose, the funds are only calculated on the basis of the projected expenses for the start-up, they do not cover unexpected losses. Accordingly, it should only be completely used up when the company makes a profit, meaning that a “set-up grant” is no longer necessary.
Combined with the funds required for the sustainable development of IT, this requirement is diametrically opposed to the structure of financing for insurtechs, which raise more and longer-term capital from investors through financing rounds in each development phase, and thus actually have to overcome the uncertainty associated with investor decisions, which are also influenced by the economic environment, in each round. When it comes to raising capital, it is generally easier for start-ups that already have a licence to operate, as they can demonstrate the trust of BaFin and, to a certain extent, the viability of their business model by having obtained a license. For the insurtechs in development, this may become a classic chicken-and-egg problem that fewer investors are willing to solve.
Calculating the technical provision
None of this would actually be an issue, as the organisational fund does, after all, increase own funds according to the German Commercial Code and Solvency II. In the technical explanations, BaFin also sets out the expectation in this regard:
Insurtechs at the beginning have to consider start-up costs, administrative costs and overhead costs (with a focus on IT costs (architecture, claims costs, costs for digital distribution and advertising) in the technical provision and to reflect the higher uncertainty. In the projection, the companies have to allocate the costs to existing business and not to uncertain new business. This increases the technical provision not insignificantly and the advantage from the higher regulatory fund is completely neutralised. Again, BaFin makes clear, the build-up phase only ends when the company is profitable without a need for further capital injections. BaFin expects detailed, auditable explanations of these forecasts in the SFCR report. Finally, the technical explanations present two calculation methods, an add-on approach and an approach via discount factors, and point out once again that not all reinsurers do fund the early stages.
The importance and uncertainty associated with financing rounds is indicated above. It does not always depend only on the quality of the idea, the team and the status of the insurtech, the overall economic environment also plays a role. Currently, there is a lot of investor money in the market. But it tends to go to brokers and established insurtechs, or those insurtechs that have been through the difficult start-up phase a while ago. The ORSA should therefore take into account the possible outcome of such financing rounds in its scenarios and also price in the results.
It is clear that there is no rookie protection after the approval for business operations, and relief in accordance with the principle of proportionality hardly seems achievable; rather, the impression arises that the case-by-case consideration increases the capital requirement and the technical provision in principle for young companies.
This is not a “sandbox”, this is the real insurance business, which fully covers costs and claims from day 1. The open question is what the justified criticism of the insurtech scene is aimed at; it will not be possible to free oneself from the existing EU-wide supervision once authorisation to do business has been granted. Is what we are missing in Germany simply a sandbox that certifies viability before “the expensive beginning” is made?