Big names in insurance are throwing their weight behind peer-to-peer insurance startups like Lemonade, which tap the power of the crowd. Do these new companies have serious potential for disrupting the industry?
Their names alone speak volumes: Friendsurance, Lemonade, Guevara.
These new insurance companies in the fast-growing peer-to-peer (P2P) insurance segment are using crowdsourcing and social networking to create a shared insurance experience. Peer groups, such as owners of autos, houses and small businesses, team up to absorb each other’s risks, with everyone contributing money to insure each other’s losses. The startups promise a welcoming, satisfying and even rebellious insurance experience, in contrast to the creaky, centuries-old insurance model.
What’s not to love? P2P insurance groups have a lot going for them. Unencumbered by conventional insurers’ legacy information technology infrastructure, they can build sleeker, less expensive and more customer-focused, data-driven insurance systems. By relying on peer group members to sell and market insurance and assist each other’s risk management and loss prevention needs, P2P groups appear to eschew traditional brokers and agents, chipping more off the cost of products.
Not so fast. Like all insurance industry disruptors, industry observers say P2P groups will face plenty of obstacles on the road to success.
Behind the Curtain
P2P startups have struck a chord with venture capitalists by offering a technologically sophisticated alternative to the prevailing insurance business model. Their management teams generally consist of high-level staffers formerly employed with technology firms and insurance companies.
These businesses are part of a new industry category: the so-called InsurTech segment. Although their technological approach to marketing insurance is novel, their underlying business model is suspiciously familiar.
“It’s a throwback to the concept of burial societies, which can be found in ancient Greece,” says Robert Hartwig, chief economist and president at the Insurance Information Institute. “People then got together and pooled their resources to pay for each person’s burial. In the 19th and 20th centuries, this idea of sharing costs was applied to farmers, firemen and lumbermen—hence the insurance companies containing those names. To call your company the ‘first peer-to-peer insurer’ is off by several centuries.”
P2P companies are marrying this shared insurance concept with another risk transfer strategy: captive insurance companies owned by corporations. Captives are a way for their owners to internally fund the first layers of financial loss, as opposed to transferring these risks to an insurer. Above these layers, the companies buy excess insurance or reinsurance.
Altogether, the concept is considered less expensive than buying insurance from the first dollar of loss up. “P2P is based on the premise that people pay high premiums each year and get nothing in return, even if they do not suffer any claims or losses,” says Fred Eslami, senior financial analyst at insurance ratings agency A.M. Best & Co. “Through social media, friends and family members can get together, each paying a nominal premium that is pooled together and from which small claims can be paid.”
At the end of the year, if there is any money leftover in the pool, individuals with no claims receive a dividend or reduced premiums for the next policy period. “If the claims are high, then there is still the traditional insurer that covers these losses,” Eslami says. “It’s an old concept, but it could be revolutionary.”
Hundreds of startups in the InsurTech space are eyeing traditional insurance as the next industry ripe for disruption. “Together, they’ve raised an astonishing $2.5 billion in capital in the last year alone,” says Kaenan Hertz, insurance innovation and financial technology leader at global professional services firm Ernst & Young, which is tracking these developments.
Why are companies so eager to invest in these startups? One reason is widespread customer dissatisfaction with conventional insurance. “The insurance industry offers a devastating user experience,” says Tim Kunde, co-founder and managing director of Friendsurance. “From the customer view, it is not fair to pay insurance fees year after year, even if you have not made any claims.”
A radical approach to insurance is direly necessary, according to Dan Ariely, Lemonade’s chief behavioral officer and a psychology professor at Duke University. “If you tried to create a system to bring out the worst in humans, it would look a lot like the insurance of today,” he stated in a recent company update, which also asserted that Lemonade plans to rebuild insurance as a “social good, rather than a necessary evil.” Lemonade declined a request for an interview, as did Guevara.
Similarly, Friendsurance’s vision “is to make insurance more affordable, customer-friendly and fair,” Kunde explains. “There is a great need for user-focused innovations.”
One way the startups respond to these needs is membership selectivity. “If you have a group of people who know each other and are willing to pool their funds, this means they have faith in each other’s ability to keep losses down to a minimum, benefitting everyone financially,” Hertz suggests.
Consider the analogy of employee referral programs: Mary won’t refer her cousin Bob as a great hire to a recruiter if she thinks Bob will be a terrible employee, since this will reflect poorly on her career prospects. The same due diligence should apply in forming a group with one’s peers for insurance purposes.
Once a group forms, peer pressure helps ensure members toe the line. For example, Friendsurance offers a claims-free bonus to its peer groups insuring their cars, homes, legal expenses and private liabilities through the German company. To date, more than 80% of members have received a portion of their premium back.
All for One, One for All
Accounting in part for the savings is a P2P group’s lower customer acquisition costs. Through social networking and crowdsourcing, groups of insureds form cheaply and rapidly across countries and continents. “By relying on the expanding use of social networking to reach out to end consumers and small businesses, you’re somewhat taking the middlemen out of the picture,” Eslami explains.
In this sharing experience, consumers and business owners effectively assume responsibility for the P2P group’s risk selection, underwriting, risk management and marketing, with guidance from the companies’ management teams. Members exchange information to improve their respective management of risks.
For example, dentists are likely to know more about causes of loss and ways to manage risks than an insurance agent or broker who never handled a dental drill. “These are social platforms where people advise each other about their loss experiences and successful management of different exposures,” says Anthony Abbattista, U.S. insurance technology practice leader at Deloitte Consulting. “That potentially makes the role of agents and brokers irrelevant.”
Data analytics further enhance loss prevention, helping members identify and track the risk profiles of current and prospective members. “With technology that monitors how people drive, you can find people who drive like you drive,” says Marie Carr, a partner in professional services firm PwC’s insurance practice. “Peer pressure is then applied to make sure everyone continues to drive safely.”
Lastly, buying excess insurance or reinsurance on top of the group’s shared risks helps reduce overall costs. “These companies aren’t putting lipstick on a pig here,” Abbattista says. “They’re leveraging social media and other networking technologies to create an insurance infrastructure at lower expense. They’re doing it with a high degree of transparency, in the sense that members get what they’re paying for—which makes them more comfortable making the transaction.”
Where’s the Rub?
The concept seems straightforward, but P2P groups have specific drawbacks. The growth strategy for a P2P group is for members to leverage their social networking contacts to bring new members into the group: One person invites 10 people to join, who each invite 10 people in turn, and so on.
“The challenge is that what used to be a close-knit group is now so large and has such a complicated risk profile that it ends up looking much like a traditional insurer,” Hertz points out.
Hartwig agrees. “As their risks grow in number and magnitude, a pure P2P model will be tough to maintain, which history has taught,” he says. “The reason the insurance industry looks the way it does today is associated with the realities of operating a company in a complex business world.”
Thanks to state insurance regulation, P2P companies also confront 50 different regulatory hurdles in the U.S. “It is a slow and gradual process to become accepted and penetrate the market,” Eslami says. “The insurance regulatory compliances are unclear, and there are some actuarial challenges and uncertainties with regard to underwriting and risk management practices.”
Yet another business obstacle: spreading the word. “Social marketing demands a different kind of preparation than traditional product pitches,” Eslami says. “You need substantial knowledge of consumer marketing, social networks and social marketing techniques to converse directly with customers on an ongoing basis. This tireless effort can be an emotional roller coaster.”
While Abbattista finds a lot to commend in the P2P concept, he believes the companies’ market share will be small at first. “You don’t wake up on a Saturday and say, ‘I’m going to create an insurance company,’ and then expect to beat industry giants overnight,” he says. “These aren’t taxi companies. These are highly regulated complex businesses.”
“The dominant carriers aren’t going away, not for a long time,” Hertz agrees. “Our great grandchildren times eight will still be buying from them.”
Russ Banham, a Pulitzer-nominated business journalist, has been an IA contributor for more than 25 years.
What About Us?
Peer-to-peer (P2P) insurance groups undoubtedly pose a threat to independent insurance agents and brokers. But experts agree that disruption and competition will be a long time coming.
“The traditional intermediaries should do what they’ve always done as trusted advisers,” says Kaenan Hertz, insurance innovation and financial technology leader at global professional services firm Ernst & Young. “If agents can deliver a policy at lower cost or provide a carrier with stickier policyholders, bringing them more revenue over time, their future is not in jeopardy.”
“The tough part is explaining what these organizations are to current clients and leaving the decision to them,” Hertz adds.
And remember: P2P group formation is not confined to the startups. Brokerages and agencies could potentially form their own P2P-like groups by creating captives and employing social networking across the current policyholder base.
“Many agents are already using social networking. There’s no reason why they couldn’t take their knowledge and subject matter expertise and put it to work in an advisory capacity with different pools of insureds,” suggests Marie Carr, a partner in professional services firm PwC’s insurance practice. “They’re the experts here.”
It’s a good point: The core competency of dentists is dentistry, not risk management. “Brokers and agents don’t just sell insurance products,” Carr says. “They’re your first line of defense in understanding risk.” —R.B.