In the opening segment of this series on complexity, I discussed the three network graphs that have emerged in the risk markets and which business models embody them. For quick reference:
In the second segment, I discussed the emergence of peer-to-peer insurance, which will accomplish the three core functions of the risk markets that currently exist in a “black market” unformalized state by using distributed managerial methods, which are:
- Risk transfer;
- Escrow of funds for a defined purpose; and
- Management of reallocation of escrowed funds.
In the third segment, on distributed ledger technology, I looked at how it can be configured as a cohesive platform that would embody all three network graphs. I discussed how the roles of individual peers, along with carriers and agents, can work together to formalize the P2P methods in the risk markets. For a quick reference:
In this final segment, I will look at the current balance of the market share of each graph type in the risk markets, how the balance may change and what the new equilibrium state might look like in the risk markets.
Before doing that, I would like discuss an important idea that emanates from the blockchain and cryptocurrency communities: the idea that there could be “one ledger to rule them all,” or, asked another way, “Could a single ledger be an all-encompassing ledger, accounting for all value?” The simple answer here is “no.”
No single ledger, technology or network will ever be all-encompassing. That would be silly, as it would reintroduce the systemic weakness inherent in centralized system structures, namely the risk that by taking out a single central node (or ledger, in this case), the whole system could collapse.
See also: 4 Marketing Lessons for Insurtechs
Just as was realized in the blockchain and cryptocurrency communities, the idea of a “risk ledger to rule them all” is not a desired structure; in the risk markets, a single distributed risk ledger to account for all funds escrowed against all risk types is not a desired structure. Because of the nature of risk and the diverse set of risk exposures in the world, there will need to be a diverse set of risk ledgers. We may see something materialize that looks like the following as an example of four distributed risk ledgers, each for a specific category of risk exposure.
Hold on to that thought for now….
I would like to again reference some of the work done by the Ripple team and their thought leadership toward a solution to address the concern of “one risk ledger to rule them all.” The Ripple team has introduced a protocol that will enable value to move in a cryptographically secure way between two or more distributed ledgers. It is called the Interledger Protocol, and more information can be found on their site here.
Using the Interledger Protocol, the Ripple team has articulated how various types of distributed ledgers, each engineered for a specific strength, can be networked together to create a term they have coined the “Internet of Value.” Without a single shred of doubt, it is a true statement that “finance is getting its internet,” and it is already here, albeit in a state of maturity similar to the internet circa the late 1990s. Unlike the slow pace of the internet’s growth, however, finance’s internet will not take as long to mature — mainly because it received an advantage from the preexistence of the internet itself and all that has been learned. Insurance and the risk markets of all the various financial services are the lowest-hanging fruit.
This might seem like a stretch in today’s environment, but it is not hard to imagine that by connecting many risk ledgers (each escrowing funds against a specific risk type) and using the methods outlined with Interledger protocol, that we will see the emergence of an internet of risk. Just like with the internet of value we see emerging today, the internet of risk will be made of many different distributed risk ledgers networked together.
I would define the internet of risk as a network of distributed risk ledger networks. The technical name for a “network of networks” in complexity science is a “multiplex.” Risk markets have been operating with an informal and non-digital multiplex structure for some time. Because each insurance company manages a risk ledger and because reinsurance companies function to connect insurance companies’ risk ledgers together, the reinsurance industry effectively embodies a decentralized network of insurance companies — and both graphs combine to embody a multiplex of risk ledgers.
In all likelihood, over the coming years we will observe the digitization of the existing multiplex of risk ledgers that is the risk market into a network of digitally connected distributed risk ledgers, with each individual risk ledger serving the specific needs of a specific risk exposure.
KarmaCoverage is intended to be this “multiplex of risk,” organizing the connections between the risk ledgers of all types of P2P risk sharing. And it aims toward the goal of insuring that, as the P2P segment of the risk market grows, it maintains a high degree of resilience, enabling society to transfer risk efficiently among individual peers, successfully addressing the various risk exposures of those peers. You would expect to ultimately see this play out and create an internet of P2P risk ledgers that looks something like this:
To be fair, it is not possible to know the ultimate structure (or graph) of this multiplex of risk. It will emerge by a process of self-assembly. It must employ distributed managerial methods to avoid reintroducing the fragility inherent with its centralized structure. That said, many portions of it can (and should) be centralized for efficiency purposes. Distributed systems have weaknesses, as well, one of which is the introduction of some degree of inefficiency. We would not want to act out that behavior where “if all you have is a hammer, everything looks like a nail.” The functions that should be centralized combine a make the business case for something like KarmaCoverage.
Now, let’s take a look at how this may have an impact on the existing balance of market share where each graph serves as a percentage of total risk. Using data on the currently formalized methods of total risk and by assigning a percentage to each graph in the risk markets, you find that the graphs settled at roughly these percentages:
- Reinsurance: 40%
- Insurance: 60%
- P2P coverage: 0% (This does not account for all the risk transfer activity that occurs informally in the black market of P2P risk transfer.)
There are two factors to consider when thinking about how the equilibrium state of the risk markets will balance out in the information age. To answer this, first we need to consider market growth and look at how the size of the risk markets will grow as a result of formalizing the P2P black market activity. Second, we need to consider the market share split among the three graphs, given that P2P will no longer continue to be 0% of the formalized market.
Let’s look at Uber and the taxi market for a benchmark.
Uber CEO Travis Kalanick, speaking at the 2015 DLD conference in Munich, said the taxi market in San Francisco was about $140 million per year, while Uber’s revenues in San Francisco were running at $500 million per year and still growing at 200% per year. Ignoring the continued growth, these numbers indicate roughly a 350% growth in market size.
See also: How to Outfox Our Brains About Risk
Approaching this question about the growth in market size from another angle, and after reviewing various sources, the global formalized taxi market size is roughly $20 billion in revenue per year, while Uber’s annual revenue is only about $5.5 billion. These numbers would indicate roughly a 25% growth in market size.
While this is a simple and quickly obtained benchmark, it would be easy to conclude that the process of formalizing the P2P segment of the risk markets will drive somewhere between 25% and 350% growth to the size of the risk markets. This would take the roughly $5 trillion in global annual premiums of the combined insurance and reinsurance industries and, after adding the P2P industry segment, bring the size of the risk markets to somewhere between $6.35 trillion (on the low side) and $17.5 trillion (on the high side).
Reality check: There is a big difference between risk and taxi rides! Taxi rides are more prone to growth in market demand because of economic activity and population growth than the risk markets are.
Risk, on the other hand, is more prone to shrinking demand because of improved mitigation of actual risk because of safer technology and other factors driving the reduction of risk. As one example, let’s look at auto risk as we make the transition into driverless cars, which stand to make a very significant dent in auto risk exposure. We are already seeing a 40% decrease in accident rates from mere “accident-less” cars equipped with accident-avoidance technologies.
Using these benchmarks (and my crystal ball), the fact that the frequency of small loss events is much higher than large and catastrophic loss events leads me to predict that the formalizing of P2P methods in the risk markets will result in the doubling of the size of the formalized risk market at some ambiguous point in the future. I will also assume that the ratio between insurance and reinsurance shown above does not change. This would end up with risk markets growing to nearly $10 trillion, with the market share being split among the three segments like this:
- Reinsurance: 20%
- Insurance: 30%
- P2P coverage: 50%
Surely these assumptions and predictions are wrong, but this is more of an exercise in trend observation, not an attempt to actually predict the state of the risk markets at some specific future point.
There will be other drivers that will have an impact on the shifting balance. One easy-to-understand but powerful and potentially market-driven force would be consumers voluntarily choosing significantly higher deductibles. This trend is already in motion. One indication of this trend on home insurance policies is that in California, on policies covering more than a million dollars, the lowest deductible that is compliant with regulatory rules is for $10,000. While that example is imposed on the industry, here in Florida, we saw the industry self-impose an increase in deductibles from hurricane losses after the 2004-05 seasons — while, at the same time, many large carriers simply pulled out of the state, leaving a vacuum to be filled by newer, smaller Florida domestic carriers.
Using formalized P2P “networked self-insurance” methods, it is possible for consumers to achieve an average of $10,000 in coverage on an annual basis for less than $100 per month and to simultaneously fill the deductible gap all the way down to the first dollar of loss, fully addressing total risk exposure. That could easily lead to enabling consumers to request $10,000 deductibles on all their insurance policies, which would have a material impact on gross premiums.
On home and auto insurance losses, more than 90% of claims are less than $10,000. If the consumer behavior of requesting ever-higher deductibles on their traditional insurance policies occurs, it becomes easy to consider that premiums on traditional insurance may currently be at or near their historical high.
See also: 4 Steps to Integrate Risk Management
Obviously, this process of formalizing the P2P segment of the risk markets will face headwinds, but since I entered the industry with an eye on the intersection of risk markets and crowdfunding methods back in 2013, we have seen the number of P2P insurance companies grow from one to dozens all over the world. It seems like the moment for the formalization of P2P methods in the risk markets is here.
Because of the convergence of factors discussed in this series (and a few others), I believe we will see a Napster-, an Uber- or an AirBnB-type of service emerge for the risk markets in the coming years.
I have started a LinkedIn group for discussion on blockchain, complexity and P2P insurance. Feel free to join here.
The whole mini-series is available for download at KarmaCoverage.com.