The German Federal Financial Supervisory Authority (BaFin) recently published its stringent new requirements¹ for InsuranceTechs seeking authorization from the German regulator.² The news comes after a tumultuous year for InsuranceTechs in Germany and indeed worldwide, with investment plummeting in Q1 of 2020³ before reaching a record high of US$7.1 billion by the end of the year.⁴ Meanwhile, the European Insurance and Occupational Pensions Authority (EIOPA) published a consultation paper on open insurance from a pan-European perspective.⁵ This consultation gives hope there could be an innovation-friendly European InsuranceTech regulation in the near future.

InsurTech is a term used to describe “young and tech-savvy companies”⁶ that use innovative business models and technology to increase efficiency within the traditional insurance market. Germany has been especially active in this area, having positioned itself as the “de-facto hub for insurance technology.”⁷ This is largely due to Germany’s “uniquely collaborative nature”,⁸ as exemplified by its Munich and Cologne InsurTech clusters as well as the resulting interest from international investment companies.⁹ The initial ‘boom’, however, is now well past its peak. Key players have consolidated their market positions, whilst several others have been forced to close shop. BaFin’s recent announcement may, therefore, increase the already growing divide between these ‘winners’ and ‘losers’.¹⁰

BaFin’s bulletin

In the January 2021 edition of its Journal,¹¹ BaFin announced, rather surprisingly, plans to increase capital requirements for InsurTechs seeking authorization from the German regulator. In future, InsurTechs applying for a license should have sufficient capital so as not to require further financing rounds, a far more stringent approach than applied in the past. The changes only apply to InsurTechs acting as a fully equipped capitalized risk carrier providing coverage in their own right.

Specifically, BaFin expects young InsurTechs to possess sufficient funds in light of their ‘scheme of operations’ under the EU supervisory regime for insurers, Directive 2009/138/EC (Solvency II).¹² Whilst InsurTech start-ups have high costs, especially in relation to IT infrastructure, and are often not profitable the first few years,¹³ BaFin reiterated that consumer protection cannot be diminished simply due to the young and innovative nature of the insurer.¹⁴ Rather, InsurTechs must be subject to the "same business, same risk, same rule" principle that applies to ‘traditional’ insurers.¹⁵

"Blind faith in business plans cannot be expected from BaFin"

According to BaFin¹⁶, the capital requirements of Solvency II are currently not adequately being taken into account by fledgling InsurTechs. As such, the requirements of Solvency II’s ‘risk-based regime’, notably in relation to firms’ schemes of operation, must be better reflected in practice.

In particular, when applying for BaFin authorization, InsurTechs must possess adequate funds. Digitalization has changed the framework conditions for both the start-up and authorization phase of insurance companies. As a result, historic or often low-tech target operating models may have to be strengthened and adapted to suit this new business model.

In BaFin’s view, this change includes funds covering all realistically forecast losses from foundation to break-even, as well as reflecting the ever-growing role that IT plays in the distribution of insurance products. For young(er) digital insurers, IT set-up costs must be sufficiently financed from the outset for their business models to be sustainable in the long-term. These ‘IT set-up costs’ include overhead costs incurred developing software and applications, as well as IT employees’ salaries.¹⁷ Furthermore, young InsurTechs should place less reliance on future business forecasts. These are inherently uncertain and contradict the idea behind Solvency II, which requires insurance firms to value their ‘technical provisions’ prudently and reliably.¹⁸

In making its assessments, which may also affect the funds of authorized firms that materially change their business plans, BaFin will draw on empirical data obtained from its previous supervision of InsurTechs.

BaFin’s announcements have yet to be challenged, in court or by EIOPA, as to whether they comply with Solvency II and the EU treaties’ rights on the freedom of establishment by introducing barriers.

Conceivable consequences

Commentators have expressed concerns about BaFin’s decision. Whilst some assessed the new requirements as “rigorous and extensive"¹⁹, another stated that they were “not aware of any case so far where a startup was able to fully finance itself for the next few years through initial financing rounds”:²⁰ in fact, the average insurer, be it a traditional insurer or a digital greenfield operation, requires eight years before it is fully funded. InsurTechs may, therefore, need to make comprehensive changes in order to conform to the new requirements. This may involve, among other things, larger financing rounds, guarantees from existing shareholders or the inclusion of reinsurance structures.

Not all start-up InsurTechs may, however, be willing or even able to undertake these changes. Instead, some firms might shift their focus to alternative business models that do not require a license, such as a brokerage, claim handling or underwriting. There are currently already a number of startups without a BaFin license providing services to the insurance industry and offering technical solutions to authorized insurance companies.²¹

Alternatively, budding InsurTechs may set up shop elsewhere in the EU, such as Luxembourg or the Netherlands and ‘passport’²² their services back into Germany. Even today, many German InsurTechs are licensed abroad,²³ partially reflecting Germany’s more complex regulatory regime when compared to certain other EU countries.²⁴ In fact, only six InsurTechs (Neodigital, Andsafe, Coya, Mailo, Element and Ottonova)²⁵ are currently authorized by BaFin.²⁶ The German regulator’s new measures may make it harder for other InsurTechs to join the pack, widening the existing chasm between ‘winners’ and ‘losers’.

In addition to the license holders, the ‘winning’ side consists of GetSafe, recipient of the largest 2020 InsurTech financing in Germany²⁷ and a clear candidate for the seventh German license. Others, such as Simplesurance, a vendor of e-commerce product insurance, also had a good year, receiving €15 million in a financing round led by Allianz X.²⁸ Neodigital, which sells a range of policies for private individuals, received eight-figure backing from PayPal-co founder Peter Thiel, whilst Element, creator of policies other firms sell in their own names, received €10 million from, among others, Sony Financial Ventures and VC Global Brain.

Despite these successes, financing for InsurTechs in 2020 was often delayed or cancelled entirely.²⁹ On the ‘losing’ side are InsurTechs such as Joonko, Getsurance and Flypper, all of whom folded their business ventures in Germany last year. Some firms, whilst still afloat, are in a similarly precarious position. BaFin has expressed concerns on the growing number of InsurTechs, often referred to as ‘zombies’, whose business models have failed but who continue to operate in the hope of obtaining funding. Other InsurTechs have been acquired by traditional insurance companies looking to expand their foray in more digital operating models. BaFin’s recent announcement may, unless (re-)structuring and/or preventive measures are taken promptly, finish off many of the remainder of the struggling insurtechs.

Despite a rearrangement of market shares, however, the shift into the digital sphere caused by the pandemic³⁰ is likely to spur further growth within the InsurTech market in 2021.

EIOPA’s consultations in the area of InsurTech and innovations

While BaFin’s announcements gives cause for concern, EIOPA’s January discussion paper on open marine insurance already provided hope for the future. EIOPA plans an overarching regulation for open insurance, which it defines “in the broadest sense, covering the access to and sharing of personal and non-personal insurance-related data, usually via Application Programming Interfaces (APIs).”³¹ InsurTechs, therefore, would also fall under EIOPA’s wide definition. Furthermore, EIOPA’s intended pan-European regulation would take precedence over BaFin’s national requirements. Therefore, it is important to be aware of EIOPA’s key aims, i.e. regulatory solutions that strike a balance between data protection, insurance and competition objectives, while supporting innovation, efficiency, consumer protection and financial stability.

Meanwhile, EIOPA’s January consultation paper focuses on the identification of various aspects, such as regulatory perimeters or licensing regimes, use cases, risks and benefits. This should result in a broader, multi-stakeholder discussion regarding open insurance. Ultimately, EIOPA wants to find out what type of regulation is required, where it is required, and how this regulation can embed the aforementioned considerations in a balanced manner. The consultation process just ended on April 28, 2021. Hopefully, EIOPA’s important regulatory project will lead to a European solution for InsurTechs in the near future.

Outlook

Germany is the world’s sixth-largest insurance market, owing in no small part to BaFin, which works closely with insurance firms to guarantee solvency and “long-term risk-bearing capacity”.³² Yet what has worked well for traditional insurers may work less well for InsurTechs. Whilst long-term financial stability is paramount for ensuring consumer protection, BaFin’s increasingly stringent approach, which follows its previous rejection of regulatory sandboxes,³³ comes at the cost of stifling innovation and ultimately also competition. This may leave consumers choosing between less innovative products offered by fewer BaFin-licensed InsurTechs and lead them to acquire policies from EU-27 insurers and insurtechs offering their products on a cross-border basis into Germany. Any InsurTech should be aware, however, that insurance provided to German customers using ‘passporting’³⁴ is still subject to mandatory German consumer standards and insurance law provisions. Any firm planning on providing insurance policies to German consumers, be it directly or indirectly, should thus familiarize itself with the necessary requirements at both the EU and at the national level. This includes the most recent pan-European developments, notably EIOPA’s consultation and its potential EU-wide solution for InsurTechs.

If you would like to discuss any of the items mentioned above, in particular how to forward-plan any compliance obligations arising from BaFin’s post-Brexit access ruling on your insurance business or your future business with customers on a cross-border basis, please contact our Insurance Hub, which forms part of our Eurozone Hub, or other Brexit Board members or the listed key contacts.

1. ‘BaFin Journal Januar 2021’ (January 2021), accessible here. ↩
2. For Dentons’ previous article on the regulation of InsurTechs please see here.↩
3. ’Quarterly InsurTech Briefing Q3 2020’ (October 2020), p. 4, accessible here. ↩
4. ‘Insurtech investment hit $7.1bn in 2020: WTW’ (28 Janury 2021), accessible here. ↩
5. Discussion Paper on open insurance, 28 January 2021, accessible here. ↩
6. ‘BaFin Journal Januar 2021’ (January 2021), p. 27, accessible here. ↩
7. Simon Moser, ‘Why Germany Is Becoming a Global Hotspot for InsurTech Firms’ (25 February 2020), accessible here. ↩
8. Idem. ↩
9. Idem. ↩
10. Susanne Schier, ‘Die Insurtech-Unternehmen trennen sich immer deutlicher in Gewinner und Verlierer’ (8 December 2020), accessible here.↩
11. ‘BaFin Journal Januar 2021’ (January 2021), accessible here. ↩
12. Directive 2009/138/EC of the European Parliament and of the Council of 25 November 2009 on the taking up and pursuit of the business of insurance and reinsurance (Solvency II), accessible here. ↩
13. Susanne Schier, ‘Bafin erhöht die Hürden bei der Zulassung von Insurtechs’ (21 January 2021), accessible here. ↩
14. ‘BaFin Journal Januar 2021’ (January 2021), p. 27, accessible here. ↩
15. Idem.↩
16. Idem. (Originally in German.)↩
17. ‘BaFin Journal Januar 2021’ (January 2021), p. 28, accessible here. ↩
18. Idem.↩
19. Susanne Schier, ‘BaFin erhöht die Hürden bei der Zulassung von Insurtechs’ (21 January 2021), accessible here. ↩
20. Idem. (Original quote in German.)↩
21. ‘BaFin Journal Januar 2021’ (January 2021), p. 27, accessible here. ↩
22. For more information on passporting in relation to insurers, please see here. ↩
23. Susanne Schier, ‘Bafin erhöht die Hürden bei der Zulassung von Insurtechs’ (21 January 2021), accessible here. ↩
24. Please see here for Dentons’ previous article on how BaFin regulates InsurTechs in Germany.↩
25. Susanne Schier, ‘Bafin erhöht die Hürden bei der Zulassung von Insurtechs’ (21 January 2021), accessible here.↩
26. ‘BaFin Journal Januar 2021’ (January 2021), p. 27, accessible here. ↩
27. Susanne Schier, ‘Bafin erhöht die Hürden bei der Zulassung von Insurtechs’ (21 January 2021), accessible here. ↩
28. Susanne Schier, ‘Die Insurtech-Unternehmen trennen sich immer deutlicher in Gewinner und Verlierer’ (8 December 2020), accessible here.↩
29. Idem.↩
30. Susanne Schier, ‘Die Insurtech-Unternehmen trennen sich immer deutlicher in Gewinner und Verlierer’ (8 December 2020), accessible here.↩
31. Discussion Paper on open insurance, 28 January 2021, p. 11, accessible here.↩
32. Simon Moser, ‘Why Germany Is Becoming a Global Hotspot for InsurTech Firms’ (25 February 2020), accessible here. ↩
33. For Dentons’ previous article on the regulation of InsurTechs please see here.↩
34. For more information on passporting in relation to insurers, please see here. ↩