InsuranceTechs, or InsurTechs for short, have been playing an increasingly prominent role within the insurance sector in recent years. Their burgeoning presence has resulted in an evergrowing need for suitable regulation. However, as InsurTechs are distinct from traditional insurance firms due to their focus on technology, innovation and customer centricity, the regulatory approach reserved for established firms could end up stifling these fledgling companies and rob them of their advantages. On the other hand, incumbent insurers call for equal treatment for all market players in the insurance space. Against this background, the European Supervisory Authority (ESA) recently released a report on FinTechs and InsurTechs, detailing two regulatory models referred to as "innovation facilitators": innovation hubs and regulatory sandboxes (the ESA Report).1 This edition of our Insurance Insight Client Alert will provide some background on InsurTechs and their development before discussing the two proposed models of regulation and their impact on InsurTechs in further detail.
InsurTechs are companies that combine innovative business models and technology in order to enable, enhance and disrupt the insurance industry or part of its value chain. Looking at this in respect of Germany, InsurTechs have predominantly established themselves as intermediaries, acting in areas such as distribution and contract management. Both in Germany and internationally, their development is very much in a state of flux; in Germany alone, the number of InsurTechs has grown from around 20 to 134 over the past nine years.2 Over the past three years, there has also been a trend to set up in not just part but rather the entire value chain of insurance companies. Pursuing this approach, five digital insurers were founded in Germany, one health3 and four non-life insurers.4 Where InsurTechs have set up in just one part of the value chain, the area in which they have done so has developed. Two years ago, two-thirds of all InsurTechs were active in "distribution"; nowadays, the amount of InsurTechs active in the "distribution", "proposition" and "operations" segments are spread out fairly equally.5
Some of InsurTechs' major contributions to the product cycle include using big data and mobile technology to determine new target markets and develop new products, creating new digital distribution models and platforms, creating new underwriting rules, and effectively using blockchain and distributed ledger technologies. By combining technology and insurance knowledge, InsurTechs aim to promote competition and make insurance more customer-friendly, cheaper and simpler.
They are able to achieve these aims partially due to their long-term disruptive low-cost base as well as their capability to exploit the potential for innovation in ways that traditional insurance companies do not. This includes a quick reaction time to changing market demands, which has seen several InsurTechs shift from a product-centric to a consumer-centric business model. Due to changing customer expectations and regulatory changes, the overall trend will likely shift even more towards customer-centricity.
The speed of technological innovation has made it difficult for regulators to stay abreast of InsurTechs' developments, particularly when they fall outside the scope of existing regulation. The issue is exacerbated by the fact that a supervising authority may lack the technological knowledge to effectively regulate InsurTechs. This regulatory drag has resulted in issues for the industry, as regulators may not always understand how and why the markets use technical innovation. Keen to avoid regulatory issues and insufficient consumer protection, the EU has therefore become more involved, as evidenced by the New Deal for Consumers6 but especially the ESA Report. By means of its two models, innovation hubs and regulatory sandboxes, the ESA Report aims at a solution that protects companies' ability to innovate whilst ensuring consumer safety and market stability.7
A tale of two models
Innovation hubs are dedicated points of contact where firms can raise queries with and seek non-binding guidance from the regulator and conduct non-binding discussions regarding the conformity of proposed models, processes and technology with regulatory requirements. Their ultimate aim is to promote financial stability and to protect consumers.
As they follow the traditional regulatory approach, innovation hubs are generally not viewed as controversial. In fact, they are currently established in 21 Member States and frequently involve a joint and cross-sectoral approach by many regulators. For instance, the German Finance Ministry initiated a series of events aimed at facilitating dialogue between FinTechs and the ministry, central bank and the Federal Financial Supervisory Authority (BaFin).8
Regulatory sandboxes are schemes that allow for deviations from regulatory requirements, enabling firms to test new concepts according to a specific testing plan agreed and monitored by a dedicated function of the regulator. Their aim is to promote financial stability and confidence in the financial sector as well as to protect consumers.
The baseline assumption for regulatory sandboxes is that firms are required to comply with all relevant rules applicable to the activity they are undertaking. In order to guide both InsurTechs and supervisory authorities, best practice rules that focus on local expertise, clearly defined objectives, entry conditions, processes, functions and transparency are set out in Annex B of the ESA Report.
Sandboxes are currently being used by regulators in Denmark, Spain, Hungary, Lithuania, the Netherlands, Poland and the UK, with the latter being the first mover in 2016. The reason so few countries have chosen to introduce sandboxes may have to do with uncertainty surrounding a sandbox's legal basis. In Germany, for example, the BaFin has taken the view that the legal basis for its mandate excludes the possibility of sandboxes9, and German market players must therefore comply with all regulatory requirements to ensure uniform customer protection and equal treatment of companies.
Despite some countries' hesitance, however, regulatory sandboxes can generally be described as a win-win situation: firms are able to enhance their regulatory understanding, while regulators can stay up-to-date with market developments −provided they have a proper mandate to conduct a sandbox and have processes in place which reflect the standards of the ESA Report.
Sandboxes: boxed in or free to play?
As a rule, regulators should maintain a neutral attitude towards technology, i.e. refrain from implicit value judgments and regulate in order to support innovation, interoperability and transparency. Against this background, sandboxes can be regarded as a neutral foundation for innovation, where positive and negative developments naturally occur.
In terms of positive developments, sandboxes have enormous innovation potential for the financial sector, as they require smaller investment sums and allow for greater dissemination. Furthermore, they enable the review of legal requirements under real conditions with complete control over the process and thus allow the regulator to learn from the process and better regulate in the future. They also allow for the formation of coordinated house opinions through supervision of real cases thanks to active monitoring of trends and information (e.g. suitable needs analyses and investment proposals by robo-advice). Lastly, sandboxes offer planning security for InsurTechs, not least during financing rounds.
Despite these advantages, sandboxes still raise some concerns. They may, for example, distort the European market: an InsurTech may locate themselves in a sandbox country and then use passporting to conduct business licensed in its home state in a country that does not provide for a sandbox process (e.g. Germany). Another potential concern is the lack of distinction between InsurTechs and traditional insurance companies in sandbox applications. Some may posit that fledgling companies deserve a helping hand when competing with the status quo, especially as their technological innovations may directly benefit consumers. However, it is actually in InsurTechs' best interests not to be granted special advantages − these may make them look frail and cast doubt upon their ability to survive in a free market, deterring investors. Furthermore, any such aid might lead to tension with traditional insurers and obstruct their cooperation with InsurTechs, which would be disadvantageous for both parties. At the end of the day, sandboxes' "free for all" status has allowed them to avoid excessive controversy and survive the scrutiny of their legal basis in various countries. They are, ultimately, nothing more than a binding agreement with the regulator, and as such, fairly uncontentious.
All measures facilitating innovation can enhance firms' and competent authorities' understanding of relevant issues. However, whilst InsurTechs are having a noticeable impact on the cycle of digitization, they must nevertheless face up to the various legal requirements of the insurance industry. Simple, understandable but sufficiently comprehensive customer processes are of central importance for the online conclusion of insurance contracts, both from a legal and a digital perspective. Interdisciplinary work in small teams at the interface between marketing, IT and law may accelerate the digitization process and help develop further regulatory guidelines for InsurTechs. Additionally, effective reporting technology and the exercise of control functions by insurance firms will help ensure that InsurTechs are spared strenuous reporting obligations, thus limiting adverse impact on their businesses.
Overall, the ESA Report throws a positive light on FinTechs, including InsurTechs, and their contribution to financial services in Europe. Based on proportionality principles, regulators can use Annex B to develop an evenly balanced approach between innovation and regulation. As a recent European Insurance and Occupation Pensions Authority paper noted, proportionality is not a question of if, but how.10 It remains to be seen whether sandboxes will strike the right balance and whether more countries will "step into the box" in the near future.
1 The ESA Report on FinTech: Regulatory Sandboxes and Innovation Hubs, dated January 7th, 2019, available here and a Dentons article covering the report, available here.
2 Page 2 of Oliver Wyman's report titled "The Future Of InsurTech In Germany - The InsurTech Radar 2019", available here.
3 Ottonova (accessible here).
5 Page 6 of Oliver Wyman's report titled "The Future Of InsurTech In Germany - The InsurTech Radar 2019", available here.
6 The European Commission's press release on the New Deal for Consumers, dated 2 April 2019, available here.
7 The ESA's Report on FinTech: Regulatory Sandboxes and Innovation Hubs, dated January 7th, 2019, available here.
8 The German Federal Ministry of Finance's notice on FinCamp, available here.
9 §296 of the German Insurance Supervision Act (Versicherungsaufsichtsgesetz), available here (German text only).
10 See EIOPA's Report on Best Practices on Licensing Requirements, Peer-To-Peer Insurance and the Principle of Proportionality in an InsurTech Context, dated 2019, available here.
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