Insurance is a tough sell. Everybody needs it in some form, but nobody really wants it. It is strange to think that the highest value of a purchase consists in never needing it. Life insurance is an obvious example: it’s binary and never benefits the insured except in the sense of peace of mind for the beneficiary. Property and casualty is different – claims are more frequent and the insured can receive direct benefits – but the principle of paying to protect against a contingency that ideally will never occur is similar.
Insurance is complicated. There are several types: life; property and casualty; and within property and casualty, there is auto and home. The key concepts are: loss spreading through assembling large pools of risk (ensuring there are enough insureds who never claim to balance out those who do); underwriting (making sure that the quality of risks insured do not diverge from the statistically expected loss experience); and, much popularized by Warren Buffet (of Berkshire Hathaway fame), the concept of float. Float means that, because the insurer collects the premium in advance of paying out on claims, there is a surplus of funds that can be invested. The returns on the investment of float produce extra revenue beyond the premiums collected from the insureds.
The economics of float explain the behavior of many insurance companies in seeking to delay payment of claims: the delay works in their favor by increasing investment returns.
A New Model
Lemonade aims to do things differently. Set up in the fall of 2016, as a B-Corp (held to a specified standard of social impact), Lemonade offers renters, condo, co-op and homeowners’ insurance. The pitch is: easy access through an app; transparency; quick claims payment; and a slice of social impact. The details are as follows: 20% of premiums pay overhead and shareholders’ return; 20% purchases reinsurance; 20% funds insurance reserves; the balance of 40% is available to be given back to certain designated causes, assuming it is not needed to pay for claims beyond what are expected.
The B-Corp certification has no particular tax advantages compared to a regular C-Corp. It is a for-profit, rather than not-for-profit status. The key differentiators are:
- Use of proprietary algorithms and chat-bot technology to reduce expense ratios to among the lowest in the industry;
- Use of algorithms to reduce fraud and underwriting losses;
- Alignment of policy-holder interests through giveback program
Lemonade‘s history is too short to draw meaningful data from reviews. There are complaints, but complaints are always a self-selecting group and are by definition noisy. There are satisfied reviews also. There is necessarily tension in resolving claims and insurers are obliged to take steps to protect the insured pool from frivolous and fraudulent claims.
History is also too short to determine whether Lemonade’s algorithms will produce consistent loss ratios. Currently, Lemonade operates in four states – New York, New Jersey, Illinois and California. Its stated goal is to operate in 47 states by the end of 2017. Regulation in the insurance business is state by state and standards vary. What worries insureds is whether the insurer will have enough capital to pay claims when made. Lemonade aims to address this concern by ensuring that it buys reinsurance, pushing off responsibility for a portion of claims paying to other insurers, in Lemonade’s case, Lloyds of London in addition to setting aside a disclosed portion of premium for claims payment. Whether this is sufficient remains to be seen – so far, so good.
So, how disruptive is Lemonade? It is required to submit to the same state by state regulation as other insurers. It is not immune to underwriting losses and it is certainly utilising the traditional reinsurance markets. How is Lemonade improving the insurance experience for the insureds? Perhaps by reducing costs. Perhaps by increasing ease of access. Perhaps by easing the process of claims processing. Perhaps, finally, by increasing insured’s understanding of how their insurance policy works, what the costs are and how the price of insurance is derived.
Lemonade is not disruptive in the same way that Uber or Airbnb have been in allowing drivers and homeowners to tap into underutilized capital resources to generate a new source of income. Transparency and enhanced understanding are not, however, trivial. They help increase the accountability of service providers. While the principle of profit sharing in the mutual insurance industry is not new, the frequency of policy rebates in recent years has not been high. If Lemonade is successful in delivering its givebacks as advertised, this will raise expectations among the insured community and put pressure on the other mutual. Not spectacular yet and clearly too early to tell, but a promising start.