How Peer-to-Peer Companies Are Transforming the Insurance Sector

Financial technology firms continue to reinvent the entire financial sector.

The modern wave began about 10 years ago, when peer-to-peer lenders first emerged. Since then, the low-cost, high-efficiency P2P business model has spread to a number of other segments that had long been the province of banks and other financial institutions.

Today, P2P firms are expanding into a wide variety of financial markets, including equity crowd funding, mortgage finance and even the insurance sector.

Insurance companies, and especially insurance carriers, face a great deal of regulation at the local, state and federal levels and must raise a lot of capital to back their policies, so it isn't surprising that it has taken a little longer for the P2P model to penetrate this sector.

On the other hand, many think that the insurance sector is ripe for new business models that bring operational efficiency to what could be considered a bloated, bureaucratic industry with high overhead costs.

The P2P players in the insurance industry can be broadly divided into insurance brokers and insurance carriers, with brokers attempting to make insurance less expensive by pooling policyholders together online in small groups. This way, those with fewer claims can receive discounts on their premiums, with P2P carriers actually underwriting their own insurance policies.

Almost a dozen P2P insurance brokerage firms have popped up across the globe in the past few years, including Bought By Many, Friendsurance, Guevara, InsPeer and PeerCover.

Lemonade is the first U.S.-based P2P firm to officially announce plans to operate as an insurance carrier, and late last year the Chicago-based company applied to become a licensed insurance provider in New York State.

Daniel Schreiber and Shai Wininger, the co-founders of Lemonade, have said that they chose the name for the business because it expresses the idea of turning the "lemon" of an insurance experience into something sweet like lemonade.

At the announcement of a $13 million Series A funding round in December, Wininger told Insurance Journal how Lemonade is challenging the way that insurance companies work "with a peer-to-peer business model fueled by self-serve technology."

New P2P insurer Uvamo, which plans to launch by the end of the year, will also operate as a carrier.

In an interview with CNBCVisar Nimani, the firm's founder and chief executive, explained how Uvamo plans to reduce administrative expenses by offering both property and casualty insurance direct to consumers online.

The policies are diversified and grouped into pools, which collect the premiums paid by policyholders.

The insurance industry has high overhead costs, and too much of the premiums paid end up being spent on costs rather than covering losses, Nimani said.

The business model also offers investors an opportunity to participate by investing money into the various pools, making up the required capital reserve.

Investors and the company divvy up any remaining funds in the premium pool after all claims are paid out. The investors' funds would cover additional claims if there isn't enough cash from premiums in the pool.

Moreover, investors can only lose their original investment. Uvamo covers any claims above and beyond the total amount in the pool.

The P2P insurance business model leverages the buying power of groups and then takes advantage of the leverage to provide lower premiums to those who seek similar insurance coverage.

Bought By Many has claimed that it is averaging around a 20% decrease in premiums for its groups.

But beyond the savings, the firm is also making coverage available to customers who have been marginalized or shut out of traditional insurance markets.

For instance, pet owners had long been requesting more comprehensive policies that covered specific health problems unique to a particular breed. Exploiting this niche, Bought By Many offers more than 100 different pet insurance groups.

The online P2P model and group buying power provide the ability to create a wide variety of specialty groups so that under-served insurance consumers can find the exact policy they want at a reasonable price.

Although P2P firms bring an innovative business model and efficiency to the table in the insurance sector, they aren't exempt from the heavy regulatory burden that applies to the sector, nor to the high capital requirements to start an insurance enterprise.

In a recent interview with CNBC, Terri Vaughan, the former chief executive of the National Association of Insurance Commissioners, said that P2P insurance providers must deal with securities regulations and insurance regulators whose job is to guarantee "any insurance company has enough money there to be paid to policyholders."

The real promise of the P2P insurance model is removing the basic conflict between the insurer and the insured.

With the fully transparent P2P insurance model where people with shared affinities form groups and pool premiums, there is no fundamental conflict of interest. Moreover, when the insured are the insurers and they share affinities (i.e., they are family, friends or and colleagues), there is much less motivation to make false or inflated claims, keeping premiums lower.

This article is commentary by an independent contributor. At the time of publication, the author held no positions in the investments mentioned.

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