One of my colleagues often asks me “What’s new in insurance”. For an industry that is risk adverse, change does not come easily. In the past we have discussed innovations concerning telematics, drones, wearables devices and even weather data. However when he asked me last week and I responded that the newest topic is “Lemonade”, he looked at me with a very puzzled face. I then went on to explain the growth in peer-to-peer (P2P) insurance, especially insurance technology start-up companies like Lemonade and Friendsurance.
P2P insurance works similar to a mutual society. A group of members or customers, often friends or neighbors, form a small network that shares the risk. The members pay a portion of their premium into a common shared pool and another portion of the premium to an insurance company. Any claims submitted by these members are paid out of the shared pool. The insurance company acts as a reinsurer, paying out catastrophe claims or when the shared pool is exhausted. At the end of the year any funds left in the pool are either carried forward to the next year or shared amongst the members.
The simplicity of this type of insurance means there are many advantages to the members:
- Members are unlikely to make fraudulent claims since they are run the risk of being ostracized by their fellow members.
- Members know more information about themselves. Hence can self-select which risks to insure and which to exclude or reinsure.
- Reduced premiums since administration and claims costs are estimated to be lower. In fact, Guevara, a UK P2P insurer, estimates that its members can save up to 80% on their premiums.
P2P insurance can lead to adverse selection with poor risks being excluded and transferred to the traditional insurance companies. Whether P2P insurance will revolution the industry, only time will tell. But at the moment Lemonade is not just a cool drink, but the hottest thing in the industry.