Assessing the Long-Term Viability of the Insurance Peer-to-Peer Business Model

By Damiano Pietroni

Management Consulting Manager – Insurance, Accenture

Background

The peer-to-peer (P2P) insurance sector is enjoying significant growth because of the linearity of its business model:

  • Customer premiums are pooled by the P2P insurer into risk-specific pools; for example, motor risk or mobile phone risk pools.
  • Customer claims are paid from the pool; where the pool is insufficient to cover a claim, the P2P insurer acts as reinsurer.
  • Funds remaining at the end of the year after all claims have been paid are either returned to customers or carried over into the next year.
  • The P2P insurer makes a profit by extracting a percentage of the funds in the risk pools to cover costs and margin.

This type of business model is the focus of this chapter. We will first cover how the business model of three major P2P insurers (Lemonade in the US, Friendsurance in Germany, and Guevara in the UK) compares to the business model of three large general insurers (Allianz, AXA, and AIG), before listing and analysing key advantages and limitations between the two groups. We will then determine the long-term viability of the P2P insurance model.

Comparing Business Models – Common Elements

Lemonade, Friendsurance, and Guevara leverage the same risk pooling mechanisms as Allianz, AXA, and AIG.

Comparing Business Models – Differing Elements

  • With 2016 revenues of €122 billion (Allianz),1 €100 billion (AXA),2 and US$55 billion (AIG),3 the three general insurers are significantly larger than Lemonade, Friendsurance, and Guevara.
  • The business lines transacted are more diversified and therefore generate greater opportunities to attract customers (see Table 1):

Table 1 Insurers and their business lines

Company Lines of business
Allianz + AXA + AIG
  • Personal (motor, home, travel, pet, equine, musical instruments, legal expenses, personal liability)
  • Life (annuities, critical illness, life assurance)
  • Commercial (small/large business, directors, engineering)
  • Specialty (space, energy, marine, aviation, Alternative Risk Transfer)
  • Reinsurance (Allianz Re, AXA Partners, AIG-Ascot Re)
  • Asset management (Allianz Asset Management, AXA Investment Management, AIG Asset Management)
Lemonade
  • Personal (home, renters, condo, co-op)
Friendsurance
  • Personal (home, electronics, personal liability, legal expenses)
Guevara
  • Personal (motor)

Key Advantages of the P2P Insurance Business Model

  1. Fraud risk is minimized. Customers are disincentivized to commit fraud due to three factors. Firstly, P2P insurance risk pools are significantly smaller than general insurance risk pools, and as such the connection between claims paid from the pool and premiums paid is more obvious, prompting customers not to fraudulently claim knowing that doing so would increase their own end-of-year premiums and impact the relationship they have with other pool participants. Secondly, P2P insurance has a social element, lowering fraud levels as defrauding other individuals is perceived as less acceptable than defrauding insurers.4 Thirdly, where premiums, in excess of claims paid, are returned to customers, as is the case for Friendsurance, the benefit of claims fraud is reduced, as the payout from the fraudulent claims is partially offset by the reduced returned premium at end of year.
  2. Digital-first. The P2P insurance business model is Internet-first and leverages automated online interactions with customers to underwrite risks, manage policies, and pay claims, leading to:
    1. Lower payroll costs; once the automated underwriting and claims handling systems are functioning the human effort required to run the operation is limited.
    2. Lower acquisition costs due to its disintermediation; selling directly to the customer via web or mobile means that broker fees and white label distribution costs are both avoided. Furthermore, the direct engagement with the customer allows P2P insurers to build a brand that resonates with the customer.
    3. Lower system maintenance costs; front-end applications powered by lean back-end systems are significantly less expensive to maintain than complex, often legacy-based, IT architectures that insurers use to service multiple business lines, to deliver single customer views, and comply with regulation.

Key limitations of the P2P insurance business model, and how they can be addressed, are shown in Table 2. Key limitations of the P2P insurance business model mapped against limitation’s severity and each solution’s complexity are shown in Figure 1.

Table 2: Key limitations of P2P insurance business model and solutions

ID Limitation Solution
1 Smaller risk premium pools cannot cover black swan claims events, namely events that deviate from what is expected and have a significant impact; this is particularly an issue for P2P insurers covering cars, such as Guevara, as claims can exceed £1m where an insured faces permanent disability through the materialization of a liability risk. It is key to purchase reinsurance cover to overcome weaknesses of the model (e.g. Lemonade reinsures with Everest, Hiscox, Munich Re, Transatlantic, and XL Catlin).5
2 Whereas in P2P lending the trust burden is on the customer, who must repay the loan, in P2P insurance the onus is on the P2P insurer, which must indemnify customers’ valid claims. This implies that P2P insurers require significant trust “equity” to operate, as customers will not transact business with any P2P insurer that they believe is unlikely, beyond reasonable doubt, to trade over the long term. To make this work P2P providers must:
  • highlight the experience and calibre of the P2P insurer’s leadership team
  • demonstrate the stability of the organization by reviewing the financials
  • gather and display the positive feedback provided by customers
  • have the organization’s business model reviewed by authoritative bodies (e.g. the Chartered Insurance Institute).
3 Specialty lines of insurance such as energy, satellite, and political risks cannot be covered by the P2P models because the current P2P insurance business model relies on commoditized risks for automated underwriting. Extend the P2P insurance business model to cover specialty risks by pooling them in the same way personal lines risks are pooled. The business model could be designed as follows:
  • The P2P insurer enlists enough specialty risks operators for digitally-led mutual insurance to be feasible, finding, for example, eight satellite operators willing to mutually insure.
  • The P2P insurer collects premiums from the operators, and in exchange both purchase reinsurance cover and provide technical expertise to the risk pool in the form of:
    • large claims adjusters
    • technical underwriters
    • maintenance experts
    • specialist lawyers.
  • Where for a given pool for a given year premiums are in excess of claims, the subsequent year’s premiums are adjusted to compensate.
4 Due to its short lifespan in the UK, P2P insurance as a framework for transactions and next generation mutualized agreements is not yet supported by a legal framework or volumes of legally binding contracts sufficient to provide some level of certainty for delivered outcomes. Examples of grey areas:
  1. Do the concepts of subrogation, namely the substitution of a party by another with regard to an insurance claim, accompanied by the transfer of relevant rights, obligations, and contributions, namely the principle that two or more insurers, each liable for a claim, should participate in indemnifying such loss, apply to P2P insurance contracts in the same way they do for standard insurance contracts?
  2. Can P2P insurance disputes in the UK be handled within the small claims procedures, or must they follow the procedures determined by the P2P insurance platform?
  3. In the event of a cross-border dispute, such as a German motorist insured by a German P2P insurance scheme raising a claim following an accident with a French driver in France, who determines what law is applied to the claim?
  4. Is the standard of disclosure concerning material facts for P2P insurance customers aligned to the principle of utmost good faith, or is it regulated by platform-specific guidance?
 The best solution here would be to:
  • set up a work group composed of insurance P2P executives, representatives from the Financial Conduct Authority (FCA), and insurance-focused lawyers, with the aim of providing authoritative answers to open questions through written guidelines relating to the application of UK legal frameworks to P2P insurance contracts
  • instruct a group of legal professionals to track and document the progress of disputes relating to P2P insurance through the UK courts, and then create a website that specifically calls out such information, ensuring in doing so that P2P insurance legal doctrine can be easily retrieved.
Image described by caption and surrounding text.

Figure 1: Key limitations of the P2P insurance business model – mapped against limitation’s severity, and solution’s complexity

Conclusion

The P2P insurance business model relies on three key advantages. Firstly, it is linear and easy to understand, leading to increased interest from customers. Secondly, it discourages fraud through premium payback mechanisms, and should inherently attract less fraud due to the social nature of the interactions occurring among peers. Thirdly, the P2P insurance business is digital-first, leading to lower staff costs due to the automation of underwriting and claims handling. The model reduces acquisition costs due to direct interactions with customers, and maintenance costs due to the lack of legacy IT architectures.

That said, the P2P insurance business model has four key limitations, which need to be addressed to support its growth. First, smaller risk pools cannot accommodate black swan claims that are today overcome by reinsurance. Second, P2P insurers require significant trust equity to operate. This is addressed by investing in trust-building exercises. Third, the current P2P insurance business models do not accommodate specialty risks. This is tackled by extending the existing model to cover more complex risks. Last, the legal framework for P2P insurance is not yet fully established, which can be addressed by partnering with regulators and courts to agree both new operating frameworks and precedents.

Overall, the P2P insurance business model is viable. It is a simple response to a group of customer needs for transparency. It has inherent advantages over the traditional insurance model, which means that it could grow to the point of becoming an accepted alternative. However, for this to occur key limitations must be addressed as a matter of priority, by focusing first on building trust within the P2P insurance model. This is the most important and complex step in this process. Then a legal framework able to accept specialty risks must be established and accommodated, supported by reliable reinsurance solutions.

Notes

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