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Insurance Industry Sips A Bitter Lemonade

“Everyone has a plan, until they get punched in the mouth,” Mike Tyson – world famous boxer.

The internet was lit up last month when insurance history was shaken to its roots by a nondescript New York based startup called Lemonade. The urban legend is quoted thus:

“At seven seconds past 5:47pm on December 23, 2016, Brandon Pham, a Lemonade customer, hit ‘Submit’ on a claim for a $979 Canada Goose Langford Parka. By ten seconds past the minute, A.I. Jim, Lemonade’s claims bot, had reviewed the claim, cross-referenced it with the policy, ran 18 anti-fraud algorithms on it, approved the claim, sent wiring instructions to the bank, and informed Brandon the claim was closed.”

In Kenyan-speak, Brandon lost his fairly expensive winter jacket valued at about Kshs 98,000 two days before Christmas. He submitted a claim on his phone using his insurance company’s app. Within 3 seconds, a robot had reviewed and approved the claim, sent EFT instructions to his bank and closed the whole unpleasant maneno. Brandon breathlessly gave his side of the story thus:

“I signed up for Lemonade because it was no frills, the most affordable option, and took no more than two minutes on my couch. I try to avoid making claims but the process with Lemonade was so simple. I already assumed there was no way that I’d recover my losses: other insurers either pile paperwork or deduct tons of charges that I don’t understand. But this time was different. I signed an honesty pledge, answered a few questions, and Lemonade reimbursed me in a matter of seconds! Their service is amazing and I am so happy that I signed up!”

I see my insurance industry friends rolling their eyes as they read this. I would too if I worked for an industry that had more gobbledygook than an advanced fluid mechanics class in Swedish. “We provide WIBA cover with a minimal excess payable”. How in the name of logic does that sentence make sense to the ordinary man on the Rongai matatu? And no matter how many times you speak to insurance industry managers and tell them to communicate simpler to customers, you’re more likely to get an underwritten, indemnified ode to jargon.

Lemonade is a young company, set up less than two years ago and funded with $13 million (About Kshs 1.3 billion) of seed capital. Its premise is peer-to-peer insurance (P2P) aiming at reducing costs by cutting out the middle fat made up of brokers and agents and issuing policies directly to clients. It donates unclaimed money to good causes. Yes: it gives away what the ordinary insurer on the Syokimau train would deem as profit. According to Paul Sawyer writing on the Venture Beat blog, clients select a cause that they care about through the app that they use to sign up. Clients who select similar causes are bundled into peer groups. Premiums from this group cover any claims by individuals and any money left over is sent to the common cause. Lemonade makes money by taking a 20 percent flat fee from monthly policy payments. The whole premise of the Lemonade model is understanding human behavior so they hired the renowned behavioural economist Dan Ariely as the company’s Chief Behavioral Officer. “Since we don’t pocket unclaimed money, we can be trusted to pay claims fast and hassle free,” says Ariely. “As for our customers, knowing fraud harms a cause they believe in, rather than an insurance company they don’t, brings out their better nature too. Everyone wins.” The policy that Brandon had cost him $5 (Kshs 500) per month and, according to the Lemonade website, was 5.6 times less than what a similar policy from a legacy insurer cost. Unlike many other insurance start-ups, which have focused on distribution, Lemonade has become a fully-fledged insurance company. It takes on the risk from the policies it writes, but also has reinsurance deals at Lloyd’s and with Berkshire Hathaway.

Look, we are not there. Yet. But Kenya is on the global map of fintech innovation and has demonstrated a population that is inarguably made up of large-scale early adopters across a wide spectrum of age groups. Shifting to insure-tech, particularly in matters that are pertinent to Kenyans and inexorably linked such as road transportation and health is simply a matter of when, not if. The number of road accidents caused by the public transport industry be it via matatu or bodaboda transport lends itself to short term, bite sized policies that are cheap and fit well into our “kadogo” economic model. One insurance company has already began to pilot this. However the problem in the Kenyan insurance industry today is the middleman legacy system made up of brokers and agents that create a fairly healthy cost layer that tags onto the fractious margins. Add to that the high level of frauds as well as increasing regulation and you see an industry that has to die and be cremated before any practical innovative solutions can ever emerge that make sustainable financial sense to Victorian age balance sheets.

Before 1954, the athletic world did not believe that a man could run a mile in under 4 minutes. However, on 6th May of that year, Roger Bannister broke that psychological barrier by running a mile in 3:59:4. I call it a psychological barrier because within a year of Bannister’s achievement, 24 other people had followed suit in running the sub-four minute mile. What Lemonade has done is to break the psychological barrier where a claim is paid out without filling in reams and reams of paper, and answering all manner of questions short of what color underwear one was wearing when the event leading up to the claim occurred. I don’t think legacy insurers will fall over themselves to copy this new model. But new insuretechs can and will. The barriers to entry for insuretech are fairly low. And that would be a resounding blow to the old school insurers. To be precise, it would be a punch in the mouth for even the best laid strategic plans.

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A Short History of Banking in Kenya

[vc_row][vc_column width=”2/3″][vc_column_text]A lobbyist on his way home from Parliament after a Parliamentary Enquiry into Trading Practices by Britain’s leading bank executives is stuck in traffic. Several of the former Bank Executives and CEO’s have agreed to return their extravagant Pensions. Noticing a police officer, he winds down his window and asks: “What’s the hold up Officer?” The policeman replies: “The Chief Executive of the U.K.’s largest Bank has become so depressed he’s stopped his motorcade and is threatening to douse himself with petrol and set himself on fire because of the shame of what he has done.”
“Myself and all the other motorcade police officers are taking up a collection because we feel sorry for him.” The lobbyist asks: “How much have you got so far?” The Officer replies: “About 40 litres, but a lot of officers are still siphoning.”

It’s not that hard to find bad banker jokes these days, they are the most vilified professionals after tax collectors. But malign them as we will, the banking industry has been a key driver of the economy through provision of working capital facilities for businesses, unsecured loans for individuals and employment for many Kenyans, not to mention a safe place to keep our funds. The attached table demonstrates the phenomenal growth that has taken place in banking in the last thirteen years.

Kes Millions Dec 2002 Dec 2015
Government Securities 100,458 658,361
Net Advances 172,169 2,091,361
Deposits 360,642 2,485,920
Shareholder Funds 50,540 538,144
Interest Income 41,495 359,493
Non Interest Income 17,367 97,317

*Source: Central Bank of Kenya Banking Supervision Report 2002 and 2015

It’s evident that there has been exponential growth in banking, all driven by Kenyans contributing to economic growth and generating more capital. Deposits have grown by a factor of almost 7 while loans have grown by a factor of 12. Look at what the Central Bank (CBK) said in 2002 while reporting about the state of the industry: “Traditionally institutions in the local market have relied on interest income on loans and government securities as their major source of income. In the last few years, there has been a shift to government securities owing to lack of borrowers due to the depressed state of the economy. In the last one-year, the Treasury bill rates have been falling dramatically, thus compelling institutions to look for alternative sources of income to meet their operational costs and report profits for their shareholders. Some of these sources, especially increased fees and commissions have placed them on a collision course with the public. In an attempt to reduce their costs, some institutions have initiated restructuring programs that include staff retrenchment and rationalisation of their branch network. These measures have met resistance from the general public and trade unions.” A few years later CBK legislated that banks required their approval before introducing new fees in a bid to reduce the collision course so identified.
The result is that as the economy took an upswing following the Kibaki administration’s fairly successful macroeconomic policies, loans ended up being an easier way to grow the bottom line. In 2002, interest income of Kes 41.5 billion (which includes interest from loans, government securities and placement of funds with other institutions) made up 70% of the banking industry’s income. In 2015, the interest income of Kes 359.5 billion made up 78.7% of the banking industry’s income. Put it another way, innovation has been the furthest thing on the minds of bankers over the last decade. With the requirement to seek approval for new fees as well as the voracious appetite for loans, lending in this country has been a no-brainer for years.
But Kenyan banks are also responsible for a fairly broad financial access, at least compared to its neighbors. The CBK Banking Supervision Report 2015 reports as much by quoting a joint study with FSD Kenya and the World Bank titled “Bank Financing of SMEs in Kenya” that was published in September 2015: “A) Involvement of Kenyan banks in the SME segment has grown between 2009 and 2013. The total SME lending portfolio in December 2013 was estimated at KSh. 332 billion representing 23.4 % of the banks’ total loan portfolio while in 2009, this figure stood at Ksh. 133 billion representing 19.5% of the total loan portfolio.
B) The preferred source of financing for a large number of SMEs is overdrafts despite the fact that banks have introduced several trade finance and asset finance products designed for the SME market. C) The share of SME lending relative to total lending by commercial banks is higher in Kenya (23.4%) compared to other major markets in Sub Saharan Africa like Nigeria (5%) and South Africa (8%). According to a study quoted in the report, this ratio is at 17% in Rwanda and 14% in Tanzania placing Kenya as the leading country among the five countries referred to in the study.”
SMEs are the cogs that move the wheels of this and many emerging market economies. They cannot survive without bank funding and the interest rate regime change is very likely to upset the status quo and roll back the gains made by Kenya in deepening financial access to this critical sector of the economy. This is largely because SME lending has typically been collateralized to mitigate the risks. A reduction in the interest rate without a reduction in the corresponding credit risk of the SME borrower, together with no improvement in the legal framework for realizing collateral from defaulted borrowers is a recipe for reduced SME lending appetite.
However as a bank CEO said to me a few days ago, “I asked my staff today: is there no other way to make money apart from loans?” and all he got were blank stares in return. The ground is shifting under the feet of banks, not only legislatively but even technologically with the entry of Fintechs in the same lending space that banks have traditionally played in. We might very well be standing on the cusp of a financial innovation wave in Kenya.
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Disruptive Forces Needed In Banking

[vc_row][vc_column width=”2/3″][vc_column_text]Mark Zuckerberg came, saw and conquered. Kenyan social, print and television media was alight with highlights of his visit and for good reason. Our hotbed of innovation is presumably a key driver for choosing the country in his Africa tour. And given the rate at which banks are submitting themselves to the interest rate capping law, financial innovation should now be a logical outcome of the compressed margins and resultant lower profitability within the banking industry.

But let’s park that aside as this was all about Mark and his globally transforming social media platform that has now become a rapidly growing business tool. I first heard about the disruptive use of Facebook as a credit scoring mechanism at a G20 financial innovation conference in Turkey last year. A panelist from the American online lender Kabbage Inc. informed participants about how their credit lending algorithm went beyond the traditional, historical and fairly outdated banking industry credit assessment mechanisms. They used a borrower’s online persona to determine ability to repay using a variety of parameters and one of those parameters was the borrower’s activity on Facebook.

In a Forbes Magazine article titled “The Six Minute Loan: How Kabbage is upending small business lending” the genesis of the growth of Kabbage is well articulated. “The seeds of Kabbage, founded in 2008 and based in Atlanta, were sown by Rob Frohwein, an intellectual property lawyer. Now CEO, Frowhein saw how much data was becoming accessible via the cloud and that companies like eBay and PayPal were providing application programming interfaces that a lender could use to get real-time access to a business’ customer transaction data. Kabbage, Frohwein says, put the two concepts together. One reason Kabbage has been able to attract capital is its loan default rate. Even though it can assess applicants in minutes and never demands a personal guarantee, Kabbage says its loans are as likely to be repaid as those of traditional banks, which routinely take weeks to make a decision.”

Now this is a very interesting concept. While interest rates are coming down rapidly within the banking sector, loan approvals for unsecured personal and SME loans will not necessarily increase in tandem as the risk profiles of customers is not in any way changing. Yet these borrowers need a source of financing and Kenyans are about to wake up to the often beaten, but much ignored, drum that pounds the message: borrowers are as indifferent to rates as they are as desperate to get a loan approval. Back to the Kabbage story from Forbes, “Frowhein says Kabbage targets established businesses rather than startups, with its automated model assessing three factors: capacity to repay, character and the consistency or stability of the business. ‘We believe we get to know a small business better by being connected to their data sources electronically than any loan officer can do by sitting down at a desk with the borrower,’ says Frohwein. He says Kabbage incorporates nontraditional metrics such as a company’s Twitter or Facebook followers, as well as the online reviews of its customer’s posts as a way to round out an applicant’s story. ‘You won’t get a loan because you have 7,000 likes on your Facebook page,’ he says. ‘But we might increase the cash available to you if you have an active social media following because it establishes the credibility of your business with its customers.”

Now for all the banter I saw on social media about the number of countries that have interest caps, with some pundits including the United States in that category, this will come as a surprise. The average annual percentage rates (APR) of Kabbage’s loans to its American small business customers are 40%! The same article quotes Frowhein as saying “the rates range form 1.5% to about 20% for the first two months of the loan, depending on a variety of risk factors and how long the cash is kept, and then drop to 1% for each subsequent month.”

Yes. I see you. I see the wide saucers that your eyes have become. Let me provide you with the definition of APR: An annual percentage rate is the annual rate charged for borrowing and is expressed as a percentage that represents the actual yearly cost of funds over the term of the loan. This includes any fees or additional costs associated with the transaction. So your Kabbage borrower is someone who has been unable to get a loan approval from a bank for whatever reason (more often than not a poor credit rating score, or worse, no credit rating score as the borrower has not built enough of a credit history) and will take what’s given since it is approved in six minutes, rather than weeks and does not require collateral such as a log book or title deed. In case you’re wondering whether Kabbage is a two-bit flash-in-the-pan player, it’s not. Since it launched in 2009 the company has lent more than $750 million (Kshs 75 billion) to small businesses and expected to lend $1 billion (Kshs 100 billion) in 2015 with revenue exceeding $100million (Kshs 10 billion).

The winner of this interest rate capping law is not the individual or SME borrower. Their risk profiles are such that they will be unattractive to lend unless a secure mechanism for quickly collateralizing and liquidating fixed and movable assets is put in place in Kenya. Such a system has to be backstopped by an efficient and incorruptible judiciary that will allow realization of securities to occur thereby reducing the drag currently endured by banks in liquidating bad debt. The true winner will be the fintechs that can very quickly dis-intermediate the banking system by providing credit to individuals and SMEs a) without collateral and b) within minutes. Timing is key in business, as it enables quicker turnover leading to conversion of goods into cash that is used to pay off the high-interest loan and put debt free funds into the pocket of the borrower.

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That used to be a bank over there

[vc_row][vc_column width=”2/3″][vc_column_text]A woman visits a fortuneteller who tells her, “Prepare yourself to be a widow. Your husband will die a violent and horrible death this year.”

Visibly shaken, the woman takes a few deep breaths, steadies her voice and asks, “Will I be acquitted?”

In the last couple of weeks, I’ve been focusing my column on disruption and its effect on society. This is for no other reason than I have been assailed with data, real and anecdotal, on the same. So it is with great interest that I continue to write about the death of banking, as we know it. This is not because I am a sadistic fortuneteller, but because of the fact that banks are caught between heavy financial regulation on the one side and nimble fintech innovation, bereft of legacy issues plus clunky physical infrastructure on the other. Charity (not her real name) is a specialist, providing specialized advice to a wide range of clients since 2013. Her clients pay her using cash or Mpesa. Due to the runaway success of her product, she began to consider expanding her business. Coincidentally, KopoKopo approached her early 2015 to advance her funds based on her Mpesa payment receipts. A little about KopoKopo first: This fintech acts as an intermediary to help streamline payment collection for businesses using the Mpesa platform. It works for SMEs that have got multiple sales points as it consolidates the payments and gives a platform to enable the business to bank their collections. It provides data analytics to help the business owner identify sale trends, peaks and troughs and average transaction sizes. It also provides the client a web based, secure interface that permits not only the monitoring of customer payment collections, but enables payments to suppliers using EFT or Mpesa as well. To quote Charity: “In mid 2014, KopoKopo launched “Grow Cash Advance” for their clients. When I clicked on it, it said I qualified for an advance of a certain amount. They had prequalified me based on my till turnover. Several clicks later and I had my first advance. You choose the amount you want and what percentage of till inflows then can take to pay themselves back – up to a maximum of 50% of inflows, which matches the highest amount you are eligible for. A commission is worked into the total amount payable.” By this time, Charity had my rapt attention as I mulled over the intelligent use of data analytics to anticipate and pre qualify client needs. She continued. “Terms and conditions are just one click and then a day later you receive the advance in your till and can then transfer the funds to your main bank account. No other requirements. This year, they introduced a new requirement for a board resolution and ID copies of the company directors.” Alright then, Know Your Customer documentation check as well as legal appropriateness for borrowing done. Tick! She went on. “Once you have drawn down you can choose to repay the loan from the balance in your till or repay faster by upping the percentage they retain from 50% all the way to 99%. Once you pay back, they refresh your new limit based on the turnover in your repayment period. And so on and so forth.” Charity has accessed Kshs 5 million since the product started, an amount she says that her bank “scoffed at” following her request. Charity’s needs have been met, without her ever asking. Someone (or something) analyzed her turnover and predicted her needs for borrowing and her capacity to repay, for a business that had been in existence for two years!

Which is why I was tickled pink when I received my weekly article that I subscribe to from the McKinsey & Company website. The article, dated February 2016, is titled “The Future of Bank Risk Management” and articulates 5 future proof initiatives for banks to build the essential components of a high performing risk function in the year 2025. I won’t highlight all of them, just the first two that say: “1. Digitize core processes. By 2025, the risk function will have minimized manual interventions. Modeling, simplification, standardization and automation will take their place, reducing non-financial risk and lowering operating expenses. To that end, the function should push to digitize core risk processes such as credit application and underwriting by approaching business lines with suggestions rather than waiting for the businesses to come to them.” Cough, cough. Charity’s example above is dated 2015. Not 2025. Just in case you missed it. The second McKinsey future proof initiative states thus: “2. Experiment with advanced analytics and machine learning. Risk functions should experiment more with analytics, and particularly machine learning to enhance the accuracy of their predictive models.” Again, Charity’s example above refers. Data analytics helped to provide the pre-qualification for her loan. In 2015, not 2025. Remember I did start by saying that banks do have legacy systems and clunky infrastructure. As do their advisers. If banks wait until 2025 to do this, they will be dead in the water and cremated in the kiln.

At the danger of repeating what I wrote last week, banking compliance is horrendously expensive. And the Basel 3 rules only seek to tighten capital and liquidity based ratios following the basket case of bank balance sheet inadequacies that surfaced after the global financial crisis of 2008. Granted that the implementation of Basel 3 has been pushed 3 times from 2013, to 2018 to 2019, it only gives rise to fintechs to increase their scope of lending beyond just small businesses to medium and large corporates. The cost and administration of borrowing will significantly grow globally in line with the increased capital and liquidity requirements that will accrue for banks once Basel 3 is implemented. Can banking truly survive this regulatory and fintech onslaught? Fintechs may be the black widow that kill it.

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Banks are the new slaves of technology

[vc_row][vc_column width=”2/3″][vc_column_text]$300 billion. Let me translate that into Kenya Shillings. Roughly, Kshs 30 trillion. Now let me put that into perspective. The Kenyan Government budget for the current financial year 2015/2016 is Kshs 2.1 trillion. So about 15 times that number. What is this $300 billion I’m going on and on about? That is the size of penalties that had been levied since 2010 to global financial institutions by June 2015 as reported by the Financial Times. These included fines, settlements and provisions for various levels of misconduct some of which is related to the global financial crisis of 2008. The culprits read like a who’s who on the red carpet to punitive pain: Bank of America, JP Morgan Chase, Standard Chartered, Citigroup, Barclays, Deutsche Bank, HSBC, BNP Paribas and on and on.

And the natural reaction for all these institutions is to tighten controls, seal loopholes, grow the compliance function and generally create enough bottlenecks internally to ensure regulatory compliance. The winners: audit and compliance teams who rule the roost over every single non-compliant new customer onboarding and new product approval process. The losers: the concept of the big, global monstrosity bank that straddles continents like a financial ash cloud. Compliance is expensive. Non-compliance is astronomically expensive. So it was with great interest that I listened to a talk by a renowned futurist called Neil Jacobson last week.

Neil paints a bleak future for the traditional global bank citing six reasons why there is a perfect storm in the global financial industry. First off, there is trust crisis. Even with pedigree board members, highly experienced (and paid) executives in management as well as world class operating systems and processes, many banks clearly can’t get the back end right. The chase for profit trumped controls many times. Secondly he cites the security and regulatory firestorm. I don’t need to harp on it as the number is clear: $300 billion and counting. Regulators are licking their chomps at the highly lucrative knuckle rapping that they have been undertaking. If nothing else, it’s a back alley way to raising more taxes. Thirdly is a technology tsunami. You don’t have to throw a stone very far today before it lands on a code writer, developing one app or the other as there are so many financial technology companies (fintechs) willing to throw money to anyone who comes up with the best app to help provide access to credit or money transfer. The classic thing is this: with the Internet, it doesn’t matter if that developer is sitting in a bedsitter in Kayole or a one bedroom flat in Silicon Valley. The one with the best solution wins. Visit iHub on Ngong road and see what I’m talking about. Facebook, as a matter of fact, is already running app competitions in Kenya. The demonetization of transactions such as matatu fare, paying for food at a restaurant, receiving payment for supplying milk or vegetables is very quickly democratizing the role of money movement beyond the traditional banking space. And banks are too clunky and too heavily regulated to make the quick changes that fintechs are able to exploit. Which brings me to the fourth reason for the perfect storm: an explosion of new, different and rude competitors who are not members of the “old boys club” (which requires academic and professional pedigree) and are alternative thinkers. At this point Neil introduced the audience to the acronym GAFA -which acronym derisively originates from French media – that stands for Google, Apple, Facebook and Amazon. None of which, with the exception of Apple, existed twenty five years ago and together virtually own the technology space. Three of these powerhouses got together in November 2015 under the auspices of “Financial Innovation Now”. Together with Intuit and PayPal, the other three giants Amazon, Apple and Google put together the coalition to act as a lobby that would help policy makers in Washington D.C. to understand the role of financial innovation in creating a modern financial system that is more secure, accessible and affordable. This is where it gets interesting as they twist the knife into the back of traditional banks, “Financial Innovation Now wants policymakers to understand how new technologies can help solve today’s policy challenges.” In other words, we need lawmakers not to be bottlenecks as we help sort out critical voter issues like access to financial tools and services as well as helping voters to save money and lower costs. Win-win for everyone, except the banks.

Once lawmakers start to understand the benefits of low cost, secure financial solutions that do not require deposit taking mechanisms, it is likely that they will apply a much lower prism of regulatory restrictions that are currently straitjacketing the financial industry. You don’t have to go far: look at the Mpesa functionality and the strict segregation of Mpesa funds from Safaricom deposits which was the regulatory compromise for accepting the service in the first place. Neil’s fifth reason for the financial perfect storm is that pressure from customers, staff, regulators and all stakeholders is growing. And his final reason was the ultimate challenge for all businesses beyond the financial industry: Customers are changing. A study presented at Europe’s Finovate 2015 showed that 30% of today’s workforce is made up of millenials, 85% of who want banking to be disrupted. Have you seen those young people whose eyes are constantly glued to their devices and would rather starve than not have data bundles? The solution is hand held and your solution had better dovetail into their solution.

Closer home, the impact may be less harsh. For now. But our homegrown financial institutions are morphing into regional powerhouses and it won’t be long before a few float to the top of the pan-African heap. The successful ones will be the ones that grow their customer base on the back of technological innovation rather than bricks and mortar. To quote Larry Page, one of the founders of Google: Companies fail because they miss the future.

[email protected]
Twitter: @carolmusyoka[/vc_column_text][/vc_column][vc_column width=”1/3″][/vc_column][/vc_row]