July 12, 2017
The Spread of P2P Insurance
While Lemonade gets headlines, the insurance sharing model has, in fact, been in existence in several countries since as early as 2010.
The sharing economy is not just a U.S. experience. It is truly a global phenomenon that has infiltrated and influenced multiple industries in both developed and developing countries. Even the ultra-conservative insurance industry has not been immune to these advancements.
While U.S.-based insurer Lemonade has been receiving much of the recent domestic headlines for being an innovator, the insurance sharing model, or peer-to-peer insurance, has, in fact, been in existence in several countries since as early as 2010. Companies such as Friendsurance, PeerCover, Riovic and Guevara have played key roles internationally in the disruption of the traditional insurance model in countries like Germany, South Africa, New Zealand and France — among others. While peer-to-peer insurers shift focus toward technology, automation and social networking, it is apparent that the core concepts of traditional insurance — such as sharing losses through mutual insurance arrangements, avoiding adverse selection and mitigating moral hazards — remain fundamental to its business model and, quite frankly, its survival.
Peer-to-peer insurance, much like traditional mutual insurance, is a group of “peers” who pool their premiums to insure against a risk and across both types of insurance the perils that buyers are insuring against remain homogeneous. It is, in essence, the centuries-old concept of mutual insurance being given a 21st century makeover.
This new peer-to-peer model of insurance adheres to traditional pooling and sharing of losses, but it is now combined with today’s technology, providing a product for increasingly savvy consumers who require transparency in an on-demand economy. Further, peer-to-peer and traditional insurers also group policyholders in similar ways; however, the peer-to-peer model may provide more refined classes because of advances in computer algorithms and artificial intelligence (AI).
Simply, peer-to-peer companies allow participants to insure a common deductible, while large claims are still covered by traditional insurers. When smaller claims occur that fall within the deductible, this loss is shared among a small circle of friends or similar policyholders. Traditionally, when policyholders had a good year and a favorable loss ratio, premiums would be returned in the form of a dividend. This concept has also been adopted by some peer-to-peer insurers, while others have also designated excess premiums be sent to a charity chosen by the policyholder group. So while peer-to-peer insurance may provide more refined methods of grouping policyholders or more options for distributing unused premiums, the underlying core concepts of traditional insurance are still maintained.
Sharing economy businesses express their desire to reduce costs and increase transparency for consumers. Peer-to-peer companies are working to accomplish this by insuring self-selecting groups. Their philosophy is that they can improve the quality of the risk because of the relationship between the members. The peer-to-peer models strengthen the sense of responsibility within the group, which results in a reduction in both moral and morale hazard. As the two often get confused, we define moral hazard as a situation in which one party gets involved in a risky event knowing that it is protected against the risk and the other party will incur the cost — in other words, an intentional act. Conversely, morale hazard is an increase in the hazards presented by a risk arising from the indifference of the person insured to loss because of the existence of insurance, which, in comparison, is more unintentional behavior.
Allowing policyholders to actively choose the members of their policy group could foster a greater sense of belonging, responsibility and duty to others. Groups in which close-knit friends or family share in losses tend to manifest a stronger aversion to risk with the knowledge that your actions will have a direct impact on your family’s pocketbook. That family vacation everyone was planning — and paying for with the year-end dividend payment — could be put on hold because of a recent insurance claim. Similarly, if any proceeds from premiums were designated for a specific charity (i.e. pediatric cancer research in honor of a niece stricken with the disease), a member of a close-knit group may engage in better driving habits to avoid being the person responsible for a drag racing accident that could result in the loss of that donation. With more at stake, pooling participants are more likely to engage in responsible behavior — better for them and the insurer.
For peer-to-peer models where groups can unconditionally decide on their members, there can be even greater benefits — for both the group and insurer. One such advantage is the reduction of adverse selection. Typically, it can be very difficult for insurers to assess the full nature and habits of applicants at the time of an underwriting review. The insured is typically in a position to palliate their risk, often without making material misrepresentations. However, in peer-to-peer models that rely on referrals from other group members, the likelihood that the complete risk exposure of a potential insured is revealed is much greater. For example, perhaps several family members have decided to submit an application for shared automobile insurance with a peer-to-peer insurer. While most of the members have superior driving history and habits, they all know to never drive with Aunt Susie. She’s known to them as a speeder, tailgater and road-rage extraordinaire; however, she has been lucky enough to avoid any serious accidents, which has kept her record looking clean. Though she may appear to be a good risk for a half-sighted insurer, her relatives know better and, in preservation of their premium and potential dividend, deliberately do not ask her to join their group.
Although peer-to-peer insurance models have promoted their new-age benefits with the introduction of digital platforms, AI and cost transparency, their business model is built on the foundation on traditional insurance, and their ability to succeed will be based on how well they can deliver the best of both worlds. Peer-to-peer insurers will continue to develop their models and philosophies on distribution channels, return-of-premium programs and scope of coverage.
While it is too early to calculate how much market share they can siphon from traditional insurance companies, it is clear they have many valuable attributes both operationally and philosophically that will assist them entrench their business among mainstream competitors.