Last month the Economist suggested the greatest threat to the insurance industry came not from periodic natural disasters–which require paid claims–but with Insurtech entrepreneurs who have taken aim at a “distrusted, antiquated and hopelessly unreformed” industry. Lemonade, a New-York based insurer founded by Daniel Screiber and Shai Wininger, who have no prior experience in the insurance industry, seeks to disrupt the property insurance industry. The company went live last September with a mobile app meant to appeal to the digital generation; it offers homeowner’s insurance for as little as $25 a month and renter’s insurance starting at $5 a month. Within the first 100 days the company had sold over 2,000 policies with over 80% going to first-time buyers. Impressive! And how can the company offer such low rates? Simple, “enlightened self-interest.” Color me skeptical. Let’s discuss:
The Lemonade model, which some describe as ‘peer-to-peer’ insurance, claims superiority for several reasons:
- Eliminates the “adversarial” dynamic. Lemonade claims traditional insurers are haunted by the “reality” that insurers profit by denying claims, while customers retaliate by filing false or inflated claims. Lemonade estimates fraud accounts for 40% of industry payouts, which only inflates industry premiums. The company’s solution is to charge a flat fee of 20% of the policy rate to provide coverage. If premiums exceed claims for the given period, Lemonade does not pocket profits, but instead donates the excess cash (up to 40% of premiums) to a charity chosen by the customer. Voila! Lemonade has no incentive to fight payouts, and Lemonade customers knowing fraud harms to charities, have less incentive to commit fraud.
- Insulated from losses. In the event of natural catastrophe, losses are first absorbed by charities (up to 40% of premiums in any given year), then the company will turn to internal and external reinsurance led by Lloyd’s of London and Berkshire Hathaway, who collectively, like Lemonade’s internal reinsurance, are taking roughly 20% of Lemonade’s premiums (40% combined).
- No underwriters/brokers drives cost savings. Lemonade’s app does not use brokers (which the company estimates account for 25% of the cost of insurance) in favor of an automated Maya chatbot. Further, the company uses algorithms, artificial intelligence, and machine-learning to handle the underwriting and claims process. In January the company proudly boasted of a new world record, whereby the company’s claims bot AI Jim, “reviewed a $979 claim, cross-checked it with the policy, ran 18 anti-fraud algorithms, approved it, sent payment instructions to the bank and informed the customer” in 3 seconds….3 seconds!
As noted, I don’t buy it. Here’s why:
- Risk transfer, not innovation. Property insurance, like most CAT businesses, is exposed to infrequent, but occasionally substantial, losses. Typically underwriting profits earned during profitable years between catastrophes are used to build a company’s balance sheet for periods of turbulence. By transferring up to 40% of premiums to charities, the company apparently intends to rely on reinsurers to back a larger percentage of its program. Surely the reinsurer would expect to be compensated for the additional risk? And wouldn’t the increased risk to reinsurer substantially reduce the donations available for the customer’s charity of choice?
- Walks like a broker, talks like a broker. Lemonade is divided between a traditional risk-bearing insurance company and a brokerage. The insurance company is a B-Corporation, requiring Lemonade to meet high “social and environmental performance standards,” which the company clearly does through charitable donations in good years. However the insurance agency, which collects a 20% origination fee, is very much for-profit. Once fees are collected by the brokerage from premiums, they no longer bear insurance risk. Nothing wrong with the model, but call it what it is: an advisor to the B-Corp, which collects a 20% commission for selling a narrow set of products.
- Likely to attract fraud “super fast”. Lemonade believes automated of underwriting (in as little as 90 seconds) and the ability to pay claims “super fast” provide a competitive advantage when coupled with customers who want to give back to personal causes. But what about customers who want to abuse the system to commit fraud? Common sense dictates individuals willing to commit fraud on the Lemonade platform do not have many charitable causes in mind.
- The cost of cost savings. While technology provides opportunities to reduce underwriting and claims processing costs, it’s naïve to think that Lemonade, which has raised $60 million in equity funding to date, has developed a technological edge over industry incumbents that have collective IT budgets estimated to total $185 billion across the globe in 2017. And, while I recognize Lemonade is an online-only firm unburdened by legacy retail locations, let’s wait and see how Maya handles Lemonade’s first natural catastrophe before declaring the end of human interaction. My guess: the ‘juice ain’t worth the squeeze’.
What do you think? Let me know!