Tag Archives: loss ratio

Lemonade: Chronicle for 2017

In late 2016, we were as nervous as could be. We were about to launch a challenge to a $3 trillion industry, and it was anyone’s guess how we’d be received.

Within hours, feedback from users and influencers allayed our worst fears.

But as the hours turned to days, and days to weeks, questions remained. A full year’s worth of data now offers some answers, and what follows are the highlights, and lowlights, of 2017.

1. “Nobody will trust a company called ‘Lemonade’!”

A major early question was whether a newborn company, with a juvenile name, could engender the necessary trust. Everything was riding on our contrarian theory: that Lemonade’s newness and uniqueness would make it more trustworthy, not less.

You see, traditional insurers often equate trustworthiness with financial strength, which they project by erecting monumental buildings that dominate the skyline.

Skyscrapers weren’t within our budget, but in any event we believed such extravagance sends the wrong signal. People worry their insurer lacks the will to pay, not the means. So we established Lemonade as a public benefit corporation, with a view to signaling something very different. We hoped today’s consumers would find our approach refreshing and trustworthy.

The data suggest that they have.

Since Jan 1. 2017, Lemonade insured more than 100,000 homes, with our members entrusting us to insure them against more than $15 billion of losses.

See also: Lemonade’s Latest Chronicle  

Our total sales for 2017 topped $10 million, with ~5% of our sales materializing in the first quarter, and more than 50% in the fourth. This means our sales are on a strong and exponential growth curve.

On launch day, we thought of our team as pioneers and true believers. But after our first year, we know it is our community of more than 100,000 who deserve those accolades. It is they who entrusted billions to a brand new insurer, and it is that trust that is powering the change.

Which brings us to the second thing we now know. We know our customers.

2. “Being the cheapest attracts customers — but the wrong customers”

The boogeyman in insurance is adverse selection. As an insurer, you set your price based on what a customer should cost you on average. But if, instead of attracting average customers, you attract the kind who switch frequently, or claim excessively, you’re selling at a loss, and your days are numbered. Adverse selection is a particular threat to price leaders.

And we were determined to be a price leader.

But while we designed our business for value, we also designed it for values – and it was important to us that our customers appreciate both. Value alone selects adversely, but values select advantageously.

We breathed a sigh of relief when customers tweeted about Lemonade’s low prices a lot, but about its B-Corp and Giveback even more. The tweeting was an encouraging early data point.

As more data came in during the course of the year, our assessment of the adverse selection threat became more rigorous. See, throughout the many decades, the insurance industry has learned that people’s education and job are highly predictive of what kind of risk they represent. If Lemonade’s customers were below average by these measures, we’d have a problem, no matter what our Twitter feed said.

Good news: They are not.

The stats on Lemonade customers (who, by the way, are 50:50 male and female) suggest our members are more than 100% over-indexed for both graduate degrees and really high-paying jobs. All this notwithstanding the fact that 75% of our members are under the age of 35!

The upshot: Lemonade is attracting the next generation of outstanding insurance customers.

3. “Making claims easy will lead to a flood of claims”

It’s an open secret in the insurance industry that a painful claims process discourages claims. There’s only so many times you can hear that “your call is important to us and will be answered in the order in which it was received,” before you say “to hell with it” and give up on your claim.

Instant claims? That could unleash a torrent of frivolous claims.

Truth be told, things were hairy for a while. Early in 2017, a couple of large claims arrived in rapid succession. We only had a few customers at that time, and as a proportion of our revenue (known as a “loss ratio”) these few claims were daunting. Statistics taught us to expect this kind of lumpiness in the early days, but we still slept fitfully until our business grew and our loss ratio began to normalize. We were in a much healthier place by year’s end (we report our 2017 loss ratio to regulators next month), and the frequency of claims is in line with our modeling.

Beyond the noisiness that is a byproduct of small numbers, our system seemed to have improved as we fed it more data. For example, our loss ratio among policies sold in 2016 is more than 2X that of policies sold in 2017. This suggests that our underwriting was pretty shoddy in our early days. Definitely a lowlight.

Since then, we’ve taught our systems to be far more careful when underwriting policies, and our bot Maya declined to quote more than $17 million of business in 2017. This has markedly improved the underlying health of our business – but there’s still a ways to go. Early mistakes will continue to drag down our reported loss ratio for awhile.

Our knight in shining armor? That’d have to be our claims bot, Jim. When we announced his ability to review, approve and pay a claim in seconds, we surprised a few. Happy to report that, during 2017, AI Jim grew his capacity to pay claims 40X.

Our algorithms are getting better at flagging attempts at fraud, and we reported several of these to the authorities. Yet overall the data shows that honesty is rampant among our members, and what behavioral economists dub reciprocity is alive and well: About 5% of our customers contact us, after their claim is paid, to say their stuff turned up and they want to return the money. Our team has centuries of combined experience in insurance, but this was a first for them all!

A quick look at the instant claims suggests our members spend a lot of time on phones and bikes. But this year had all kinds of losses: big ones like fires and smaller ones like stolen headphones.

We are proud to say that we were (and are!) there for our community in times of need.

Positive reviews of Lemonade’s instant claims

Stopping to smell the roses

2017 wasn’t all roses. We saw shockingly high loss ratios in the first half of the year, some vicious responses to our stand on guns and knock-off attempts by some of the Goliaths of the industry.

At the same time, we saw tremendous adoption by our customers, exciting advances in our tech, licenses from 25 states and a Giveback that amounted to 10% of our revenues.

We’re extremely grateful to our team, our customers and our regulators for making 2017 all that it could be. No doubt 2018 won’t be all roses, either, but we will stop to smell them whenever we can. ?

5 Challenges Facing Startups (Part 5)

The insurance industry is a $4.6 trillion market worldwide that lags when it comes to digitization and providing consumers with a great experience and service. We are looking at the five main challenges that startups face. We have covered Challenge No. 1 here, Challenge No. 2 here, Challenge No. 3 here, and Challenge No. 4 here. In this article, we will look at Challenge No. 5.

Challenge No. 5: Tuning the economics to achieve profits will require time and capital

We expect that the time to profitability will be 10 to 15 years. And many startups will never reach that point as there are two competing challenges: growing revenue and generating profits. Furthermore, flaws in the underlying economic models cannot be pivoted away from as easily as with other digital startups. After all, there is no such thing as a beta insurance policy, and it is more difficult to find additional or new revenue streams in insurance.

See also: Shark Tank Secrets for Startup Success  

Insurance is, at the end of the day, a high-volume business with challenging economics. Margins are small, especially on new sales. Typically, customer prices and broker commissions have been falling, with the advent of online insurance. And, with a raft of competitive startups, the long-term trend can only continue. In addition, maintaining a healthy underwriting margin is challenging, with premiums changing due to claims rates and industry competition and capacity.

Startups must deal with dynamic pricing and claims forecasting, coupled with upfront acquisition costs that are paid back over a long time and with a complex operational structure, given the need for multiple partners and service providers.

Insurance is such that claims because of unforeseen events, fraud and mispricing can potentially have a major detrimental impact, especially with fast scaling of customers and growing revenue. Companies require robust systems and experience and large insurance portfolios to manage and the capital and time to get right.

Insurance is different than many industries, where you can achieve a positive gross margin with increased sales and expect that to continue because of improvements in production and scale economies. 

The cost of acquiring an insurance customer is relatively high given that insurance is a low-turnover product. After all, you don’t buy more insurance than you need just because you see a good advertising campaign or you are targeted on social media. This means that the relationship between marketing and sales is different than in other consumer products, and it can result in a longer conversion funnel.

Typically, the time between when a person first gets attention and the purchase could be three to 12 months or longer. In addition, retaining a customer is crucial for the profitability of the business, and digital solutions make it easier to switch.

Regulations may constrain pricing options and in some cases raise hurdles to dynamic pricing. Regulatory and consumer legislation can also affect the scope for upselling of ancillary products and cross selling of other insurance and products.

Traditional retail car insurance targeted a 60% to 80% claim ratio (as proportion of premiums) and 40% to 25% operating and acquisition cost levels, compensating with additional investment income to target an overall profit of 8% to 15%. The insurers were helped in improving profitability by a large and static pool of customers who rarely switched carriers and required minimal administration support.

With the emergence of direct telephone insurers in the 1980s and 1990s and online insurers in the 2000s, premiums fell 15% to 30%. The new models could bring operating and acquisition costs down to 15% to 20%, with loss ratios still in the 60% to 90% range. The challenge was that initial acquisition costs for new customers could be at least 20% to 30% of premiums, and the rate at which existing customers switched to new carriers each year rose from the historic rate of 5% to 10% to a churn rate of 20% to 40%.

Can new digital startups create as much as 30% savings for consumers, which normally is considered sufficient to encourage switching? And will savings on claims be sufficient to support this sort of cost cut? Can the startups build an efficient operating platform to reduce costs to around 5% to 10% of the premiums and still improve services?

Takeout

Working on building the team, data analytics, pricing engines, processes and systems to ensure in-depth control on not only revenue generation but profitability will be critical. Just as a low-cost airline has to have in-house expertise in capacity utilization and pricing, this ability to both generate revenue and profit must eventually be a core function of most digital insurance startups. This will be an important differentiator for successful startups.

Providing new services and rewards for certain behaviors will be critical to avoid competition on price only.

See also: Should Incumbents Ally With Startups?  

In addition, further reducing claims frequency and costs by enhanced data analysis and focus on prevention will be one of the success factors.

Customer service and retention will become even more important to recoup upfront acquisition costs. Best that this focus is embedded in the business model!

Having a low-maintenance cost platform covering the complete value chain is an important factor. The platform needs to be robust and agile enough to provide the relevant information and easily adjustable for dynamic pricing, marketing and services. Although there are many off-the-shelf solutions, will these be sufficient?

We are curious about your perspective.

Are Market Cycles Finally Ending?

The property/casualty industry has been characterized by its market cycles since… well, forever. These cycles are multi-year affairs, where loss ratios rise and fall in step with rising and falling prices. In a hard market, as prices are rising, carriers are opportunistic and try to “make hay while the sun shines” – increasing prices wherever the market will let them. In a soft market, as prices are declining, carriers often face the opposite choice – how low will they let prices go before throwing in the towel and letting a lower-priced competitor take a good account?

Many assume that the market cycles are a result of prices moving in reaction to changes in loss ratio. For example, losses start trending up, so the market reacts with higher prices. But the market overreacts, increasing price too much, which results in very low loss ratios, increased competition and price decreases into a softening market. Lather, rinse, repeat.

But is that what’s really happening?

What’s Driving the Cycles?

Raj Bohra at Willis Re does great work every year looking at market cycles by line of business. In one of his recent studies, a graph of past workers’ compensation market cycles was particularly intriguing.

chart1

This is an aggregate view of the work comp industry results. The blue line is accident year loss ratio, 1987 to present. See the volatility? Loss ratio is bouncing up and down between 60% and 100%.

Now look at the red line. This is the price line. We see volatility in price, as well, and this makes sense. But what’s the driver here? Is price reacting to loss ratio, or are movements in loss ratio a result of changes in price?

To find the answer, look at the green line. This is the historic loss rate per dollar of payroll. Surprisingly, this line is totally flat from 1995 to the present. In other words, on an aggregate basis, there has been no fundamental change in loss rate for the past 20 years. All of the cycles in the market are the result of just one thing: price movement.

Unfortunately, it appears we have done this to ourselves.

Breaking the Cycle

As carriers move to more sophisticated pricing using predictive analytics, can we hope for an end to market cycles? Robert Hartwig, economist and president of the Insurance Information Institute, thinks so. “You’re not going to see the vast swings you did 10 or 15 years ago, where one year it’s up 30% and two years later it’s down 20%,” he says. The reason is that “pricing is basically stable…the industry has gotten just more educated about the risk that they’re pricing.”

In other words, Hartwig is telling us that more sophisticated pricing is putting an end to extreme market cycles.

The “what goes up must come down” mentality of market cycles is becoming obsolete. We see now that market cycles are fed by pricing inefficiency, and more carriers are making pricing decisions based on individual risks, rather than reacting to broader market trends. Of course, when we use the terms “sophisticated pricing” and “individual risk,” what we’re really talking about is the effective use of predictive analytics in risk selection and pricing.

Predictive Analytics – Opportunity and Vulnerability in the Cycle

Market cycles aren’t going to ever truly die. There will still be shock industry events, or changes in trends that will drive price changes. In “the old days,” these were the catalysts that got the pendulum to start swinging.

With the move to increased usage of predictive analytics, these events will expose the winners and losers when it comes to pricing sophistication. When carriers know what they insure, they can make the rational pricing decisions at the account level, regardless of the price direction in the larger market. In a hard market, when prices are rising, they accumulate the best new business by (correctly) offering them quotes below the market. In a soft market, when prices are declining, they will shed the worst renewal business to their naïve competitors, which are unwittingly offering up unprofitable quotes.

chart2

Surprisingly, for carriers using predictive analytics, market cycles present an opportunity to increase profitability, regardless of cycle direction. For the unfortunate carriers not using predictive analytics, the onset of each new cycle phase presents a new threat to portfolio profitability.

Simply accepting that profitability will wax and wane with market cycles isn’t keeping up with the times. Though the length and intensity may change, markets will continue to cycle. Sophisticated carriers know that these cycles present not a threat to profits, but new opportunities for differentiation. Modern approaches to policy acquisition and retention are much more focused on individual risk pricing and selection that incorporate data analytics. The good news is that these data-driven carriers are much more in control of their own destiny, and less subject to market fluctuations as a result.

Why Obamacare Is Unraveling

President Obama’s announcement during a Nov. 14 press conference that he would like to see insurance carriers extend non-complying health coverage after Jan. 1 may be the event that unravels the Affordable Care Act (ACA).  Carriers and health plans have worked hard for several years, have spent millions of dollars complying with ACA, have fought with insurance department regulators getting policies approved and, in many cases, have notified consumers of the need to terminate non-compliant policies. Now, carriers and health plans have a new wrinkle thrown their way.  What is going to happen next?

Some of the key principles of ACA are:

  • Clear definition of Essential Health Benefits (i.e., EHB)
  • Clear definition of metallic or metal level plans based upon the actuarial value of the benefit plan
  • Restrictions on premium format and methods to derive premium rates
  • Rigorous rate review and approval process coordinated by a combination of state insurance departments and federal oversight
  • Mandates for participation in some type of health coverage
  • Large number of taxes and fees to help fund ACA
  • Assumption that there would be a reasonable risk pool so carriers could appropriately price and predict future costs of care

Minimum loss ratio requirements to ensure that a reasonable portion of the premium rate goes toward the payment of claims

Carriers have worked hard to comply with the new regulations, which for many have involved significant shifts in the methods used to conduct business.  The rate development process for a typical carrier follows this process:

  • Review of prior claims experience and profitability
  • Determination of what rate increase will be required to maintain a profitable product offering
  • Development of proposed rate for various rate cohorts with competitive comparisons
  • Potential benefit redesign to meet regulatory changes or competitive pressures in the marketplace
  • Obtaining independent actuarial certification regarding proposed rates as a reasonableness test (e.g., Section 1163 required in California)
  • Filing of rates with regulators for approval and follow-up with regulators until rates are formally approved
  • Communication of rates to those insured, and implementation of the new rates

This process can require four to six months to complete.  It is actuarially complex and requires careful analysis of many factors and variables. 

As ACA emerged, carriers had to adjust benefits covered in prior products where they failed to meet the minimum EHB required.  In some cases, products were terminated because they did not meet either the EHB or the minimum actuarial value of 60%.  Carriers worked hard to develop replacement products, filed these with regulators and started to present these to their customers. 

It was obvious that some customers would be concerned about the impact of rate changes associated with ACA-approved benefit programs.  Rates would increase for a variety of reasons:

  • Health care inflation continues
  • Mandated benefits required broader coverage than previously purchased
  • Elimination of gender rating generally increased rates for insured males
  • Minimum Actuarial Values (i.e., > 60% AV) raised benefits for some insureds
  • Assumed average risk score for the individual market was higher than in the past because medical underwriting is no longer appropriate, and, in some cases, carriers raised the average assumed health status built into the rates to reflect the enrollment of additional Medicaid- or Medicaid-like lives.
  • Age rating was affected, requiring higher rates at younger ages to offset some of the reductions at the older ages (i.e., 3:1 limits on age rating curve).

The concerns expressed by the public on higher rates, the concerns expressed about policy cancellations, the delays caused by website challenges, the continued frustrations about ACA all combined into a situation where a large portion of public were frustrated with ACA.  The president’s announcement was a response to many of these concerns and frustrations.

However, there are several complications facing the carrier community as a result of this suggestion or proposal to the insurance departments and affected carriers.

  • Rates for terminated programs were not updated for 2014.  Rates can’t be extended without adjustment because rates were established for a previous time period, and there has been inflation.  Updating would require a minimum of 4 – 6 months.  The software implemented by the federal government and used at the local insurance department level is built around the new ACA requirements and would likely reject restored versions of terminated policies.
  • The risk pool for all of the ACA-approved rates will be changed significantly if individuals are able to continue their prior programs.  Selection bias issues would be significant.
  • The individual mandate for credible health coverage would be compromised if individuals continued their prior, non-compliant coverage.  The anticipated tax base would be jeopardized with the continued offering of non-compliant coverage if penalties were forgiven.
  • The disruption to the insurance industry involved in the exchanges would be significant and potentially would permanently damage the risk pool.
  • More importantly, the public’s perception of the benefit of ACA to them will be affected as changes were required, then they weren’t, then they will be, etc.

Although there are many features of ACA that potentially provide value to the public, the flawed rollout, the delays in implementation and now radical changes to the structure of the ACA program very likely start to unravel the viability of the program.  Only time will tell.

The State Of Workers' Compensation

There are three major concerns and opportunities that must be considered. First, is the impact of SB 863, the major reform legislation bill passed late in this year’s session of the legislature. Second is the continued increase in loss cost on prior years’ claims. Lastly, will the weak economy improve enough to start bringing new workers into the workplace and what impact will that have on Workers’ Compensation costs?

SB 863 holds the promise of lower claims costs, improved efficiency in claims processing procedures, and ultimately rate relief for California employers. At issue is the time frame for writing new regulations that will implement the new law. They are scheduled to take effect on January 1, 2013 which may lead to rushed procedures and unintended consequences. Also major parts of the law will be challenged in court. The Independent Medical Review procedures raise the issue of right to appeal. The injured employee attorneys have already indicated they will challenge this portion on constitutional grounds. Time will tell what the ultimate impact of the new legislation will be on the system, but immediate reduced costs are not expected.

Unfortunately, increasing premiums and rates will almost certainly continue into 2013. The Workers’ Compensation carriers are spending 138 cents for every dollar of premium. The overly competitive marketplace coupled with medical cost inflation has led to large developments in claims settlements beyond case reserves. The collapse of the economy has also led to decreased premiums, while claims have increased.

It will take at least 24 months for this cost bubble to work its way through the system. The most recent actuarial review of past years’ claims cost indicates that rates are over 9% lower than they should be. While the Workers’ Compensation Insurance Rating Bureau governing board, in a purely political move, decided to recommend no increase in rates to the Department Of Insurance, underlying costs continue to increase.

Finally, as the economy slowly recovers and payrolls increase, we will see hiring pick up. While it seems like this would lead to lower loss ratios as premiums go up, just the opposite is true. As you add employees in general, they will be less skilled, need more training and will be less able to work safely immediately. Increasing workforces will lead to increased accident rates and increased loss ratios.

The carriers will always compete for very clean, well-managed and low loss ratio accounts, so now is the time to redouble efforts with safety programs, training and claims management.