About ten years ago, the world was introduced to social media platforms like Facebook and Twitter. It was called “Web 2.0”. This peer-to-peer interaction has been followed by the creation of the sharing economy that helps people to share their resources. Whether you want to share your house, car, office space, or even your financial capital with entrepreneurs and artists, there’s an opportunity out there for you. Now, there’s even a sharing economy for insurance policies. But, is peer-to-peer insurance like Friendsurance and Lemonade a good idea?
What Is It?
You may have never heard of a peer-to-peer (P2P) insurance policy. You might find yourself asking, “What is it?” and you wouldn’t be the only one. P2P insurance is a relatively new concept. In 2010, the first insurance brokerage based on the P2P model was Friendsurance in Germany. Since then, many companies in other countries have followed suit, including Guevara in the United Kingdom and TongJuBao in China. In 2016, the United States will see the start of its first P2P insurance company: Lemonade.
Each of these companies follows the idea of the sharing economy and offers a variety of insurance policies. For example, Friendsurance provides protection for your household property, legal expenses, and personal liability. Guevara offers car insurance. The type of insurance offered by Lemonade has yet to be disclosed, but the company is set to begin offering P2P insurance sometime in 2016.
How Does It Work?
As part of the sharing economy, a insurance policy through a peer-to-peer insurance company operates differently than a policy through a traditional carrier. Prior to the existence of P2P insurance, an individual would generally purchase a policy from an insurance company and pay the required annual premiums. If there were an unexpected event, then the policyholder would file a claim, pay a deductible, and then receive financial assistance from the insurer.
A P2P insurance policy is a bit different. First, you are not an individual consumer interacting one-on-one with the insurance company. Instead, you are part of an insurance group. Depending upon the company, this can be a group of individuals that you form on your own, or the insurance company can match you with other people who you may not know. Either way, everyone in the group is looking to purchase a similar insurance policy
Each P2P company is a bit different, but once you are a part of an insurance group, you will typically pay a starting fee. This amount is then divided: a portion goes to pay the group’s insurance fees and the other portion is put into a group pool. If anyone in your group files a claim during that year, the group’s pool of money helps to pay for that claim. At the end of the year, the money left in the pool remains in there for the following year. Each person in the group is responsible for paying a fee to increase the pool to the original amount (prior to the claims) plus an annual fee.
Let’s look at an example. Imagine you are interested in purchasing insurance to protect your household items. With a peer-to-peer company, this means that you will be placed into a group (or form your own group) with other individuals who also want household property insurance. You pay $300 as a starting fee. This gets combined with the fees of 20 other people. Of the $6,000 contributed, $4,000 goes toward insurance fees and $2,000 toward the group pool. Those insurance fees are used to help fund larger claims. Depending on the company, they may have partnerships with traditional insurers who would also help to cover large claims. The bigger the group, the higher the percentage of funds that gets placed into the group pool rather than toward insurance fees.
From your insurance group, two people file claims, each for $500. That money is taken out of the group pool, leaving $1,000 left over at the end of the policy year. The next year, each person pays $50 to raise the pool back to $2,000. This is added to your annual insurance premium, which may be less than your original starting fee. So, it is likely that the amount you pay will be less than the previous year. As the group grows, there will be more money in the pool and possibly less money required for each person to pay at the end of the year.
What are the Pros and Cons?
Industry experts and entrepreneurs have wide-ranging opinions on the peer-to-peer insurance concept. The following is a brief overview of the pros and cons to purchasing a P2P insurance policy.
The fact that Lemonade was able to raise $13 million in seed funding demonstrates the extreme interest that investors have with this new insurance concept. One of the founders of Lemonade, Daniel Schreiber, states that P2P insurance will be less expensive and simpler compared to traditional insurance products. He argues that many of the oldest insurance companies like Lloyds of London also started out as small groups of people who “joined together to share risks” and it could become a reality again.
You may be wondering about the possible state regulatory hurdles that a P2P insurance network would have to overcome. Other companies that are involved in the sharing economy like AirBnb and Uber have fiercely and publically fought back against local regulations, but Schreiber contends that they have been working directly with the regulators to find a common ground. Screiber contends that Lemonade’s “experience has been very positive so far.” In New York, Lemonade will be a licensed insurance company rather than a broker.
Proponents of P2P insurance claim that individuals who are pooling their insurance funds with friends are more likely to be honest when filing claims. The number of claims is likely reduced, as is the amount taken from the group pool. There is more peer pressure to avoid fraudulent claims when everyone in your group is contributing toward the reimbursement. This idea may still be up for debate. Relying on everyone in the group to be honest is one thing, but it is still too early to tell whether or not this will be the reality. Additionally, if there are enough claims in a year to deplete the group pool, then each person is left paying more the following year.
It also may be possible for you to be in an insurance group with people who have had a difficult time getting insurance through traditional routes. They may be a larger risk and therefore file larger and/or more frequent claims, decreasing the amount of money in the group pool faster and increasing the amount of money required to refill the pool each year. Lemonade and other companies are trying to mitigate such risks by hiring insurance professionals, actuaries, and even a behavioral scientist. Again, it is still too early to tell the number and type of individuals who will be interested in P2P insurance.
So, is peer-to-peer insurance a good idea? The industry is relatively new and there is still a lack of information available on customer satisfaction, retention, customer service, or value. In order to decide if it’s right for you, ask yourself why you are buying an insurance policy in the first place. Some people do not place any value on insurance and only buy it because they are legally required to have it. They just want the cheapest option possible. Many other people view insurance as a way to ensure financial protection in a time of crisis, to provide peace of mind, and maintain a certain standard of living. It just may be the differing viewpoints of these two groups that separates buyers of traditional insurance from contributors to a peer-to-peer network.
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