Insurance startup Lemonade
opened for business in New York in September this year to great fanfare. If you
haven’t heard, Lemonade is heralded as a mobile-first, legacy-system-free,
peer-to-peer insurance carrier that is poised to usher in a new era of personal
insurance.
When I saw Lemonade co-founder Daniel Schreiber at
InsureTech Connect 2016 I was finally able to confirm the rumors—Schreiber
is a genius.
But the reason why he’s a genius is bigger than Lemonade
itself. With a background rooted in tech, Schreiber has been able to establish
himself on the front lines of insurance and build an audience for his
innovative approach to a legacy-laden industry.
Lemonade introduces a whole new vision of selling insurance.
Time will tell if it really revolutionizes the industry, but one thing is
clear—there are still many questions to answer before we get ahead of
ourselves.
Lemonade
Distribution—Is It Really Peer-to-Peer?
When you look at Lemonade on the surface, it’s clear that
the user experience is amazing. Having a mobile-first approach to selling
insurance will help the industry align itself with the broader scope of digital
transformation that is sweeping businesses in all sectors.
It’s not that Lemonade is the only insurtech application out
there—it’s just that Lemonade simply has the best user interface.
Once you look deeper than the user experience, the
peer-to-peer model becomes interesting. Lemonade’s peer-to-peer insurance model
is based on the insurance carrier model (Lemonade is a licensed carrier in New
York) where policy holders form small groups online and part of their insurance
premiums flow into a group fund for paying claims.
Essentially, Lemonade’s business model calls for users to
divide risk amongst themselves. However, if you look a little closer, it seems
unclear whether Lemonade is actually offering a peer-to-peer approach to
insurance or if it’s a virtual/mobile-first version of a regular insurance
company.
Lemonade has dramatically cut the typical insurance industry
debt ratio by eliminating offices and agents. But Lemonade’s reinsurance through
Lloyd’s of London makes it tough to really understand this peer-to-peer
model.
The distribution model will become clearer over time, but
the bigger question is profitability in this new vision of insurance sales.
Fraud and Insurance
Profitability—What’s the Lemonade Approach?
At the end of the day, it doesn’t matter how much an
insurance company collects in premiums—it only matters how much of that money
is staying in your pocket.
Traditional insurance companies consistently post combined
loss ratios above 100%, so there is an obvious concern for increasing
profitability. Lemonade
has said this led incumbent insurers to put $0.40 on the dollar of their
premiums toward expense ratios. As Dan Ariely,
Lemonade’s Chief Behavioral Officer, puts it:
In the very structure
of the old insurance industry, every dollar your insurer pays you is a dollar
less for their profits. So when something bad happens to you, their interests
are directly conflicted with yours. You’re fighting over the same coin.
Basically if you tried to create a system to bring out the worst in people, you
would end up with one that looks a lot like the current insurance industry.
This contention between insurers and their customers has led
to 25% of Americans believing that it’s okay to embellish claims, according to Lemonade. Fraud
is a real problem that new insurtech players must contend with, and Lemonade is
no exception.
Lemonade has worked to restructure the insurance model in a
way that aligns with behavioral economics and game theory. According to the
company, the current insurance model breeds fraudulent activity because consumers
feel slighted by insurers and their distrust leads to fraud. In response,
Lemonade looks to signal to consumers that they can be trusted by being transparent
about the 20% management fee and giving all unclaimed money to charity.
Lemonade believes that if consumers see that fraud is
slighting charity rather than slighting an insurer, they won’t be pushed to
commit fraud. It’s a little troubling that Lemonade’s Giveback program is an
expression of intent, not a contractual obligation to policyholders nor their
selected charities. But aside from this point, there are still inconsistencies
in the overarching Giveback theory.
The problem with this signaling theory is rooted in Schreiber’s
explanation of the Prisoner’s Dilemma. He says that when playing the Prisoner’s
Dilemma, neither party trusts the other which leads to bad results for both.
However, when you look at real-world
results of the Repeated Prisoner’s Dilemma, an initial defect response will
force punishment that inevitably leads to a cooperate response later. A defect/defect
response is a Nash Equilibrium, but in the long run the optimal solution and
best strategy is cooperate/cooperate. This isn’t necessarily consistent with Lemonade’s
explanation of consumer/insurer distrust.
This inconsistency complicates the signaling behavior that
Lemonade’s model aims for. The 20% management fee and charity policy are
Lemonade’s signals to the other party that the insurer won’t change its
strategy no matter what happens. If we employ Lemonade’s logic, the other party
has no choice but to defect—but we expect the exact opposite. If a policyholder
signals to an insurance company that he/she won’t commit fraud (per behavior
data and shared privacy), the insurance company has no choice but to pay
claims. This isn’t consistent with the current state of insurance as companies
lose money and consumers don’t trust the industry.
As Lemonade matures, we’ll see if this plan works out. It’s just
hard to imagine that Lemonade doesn’t have a backup plan for insurance fraud
(or, maybe we just aren’t getting a complete picture of the business model just
yet).
Lemonade Success
Spells Success for all Insurtech Entrpreneurs
The growth of Lemonade and the insurtech space seems poised
to put an end to the idea that insurance companies can only make money by not
paying claims. Insurtech entrepreneurs are rooting for Lemonade’s success. But
keep in mind that insurance innovation will only take us so far—we have to
address fraud to ensure we’re profitable.
Despite the rise of these “disruptors,” we can be sure that
insurance companies aren’t going anywhere. As Chairman of InsureTech Connect
Caribou Honig says, “Many entrepreneurs overestimate changes that will be in 2
years and underestimate changes that will be in 10 years.”
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