In 1970, I graduated from college with a degree in economics and accepted a job with The Continental Insurance Companies in their management trainee program. I started in June and the first formal classes wouldn’t begin until that following February in Chicago. In the meantime I was to work in the various departments of the Minneapolis branch to start to learn the industry. At the time, we didn’t discuss the sharing economy very much.
I was eager to know as much as possible about insurance, as quickly as possible, so I decided to take a night course at the University of Minnesota. The course was titled Risk Management. My preconceived notion was that the class would be devoted to how to be a knowledgeable insurance buyer. I remember wondering what they could possibly teach us after they suggested making mimeographed copies of the specifications for bid.
I soon found that risk management involves understanding risk and peril . . . and the techniques for properly handling them.
“Risk” as it pertains to insurance is the probability that something bad and fortuitous will happen. “Peril” is probable cause (such as an flood, wind, hail, etc.) that exposes a person or property to the risk of damage, injury, or loss, and against which an insurance policy is purchased.
Since it was a night class I expected many of the students would be older. I was pleasantly surprised to find that one of the thirty students was a person I had known in college in North Dakota. He also was in a trainee program with another insurance company and was trying to broaden his knowledge base. What we learned over that semester was directly applicable then and now.
Handling risk properly is basic to the success of any business, especially so in the “sharing economy” which seems to, at least at times, ignore risk, and thereby gaining a false economy.
The world is changing and there is steady movement to a sharing economy in the P2P marketplace. The “shared” movement involves using goods and services more fully through efficient methods. A prime example would be AIRbnb.
AIRbnb is a community marketplace for people to list, discover, and book unique living accommodations around the world. This can be done online or from a smartphone. Whether you’re looking for an apartment for a night or a villa for a month, Airbnb connects people in more than 33,000 cities and 192 countries. Airbnb is a way for people to monetize their extra space and showcase it to an audience of millions.
AIRbnd has been replicated in a dozen different areas, including cars and boats. As in any business venture the handling of the risks involved is quite important. And, in some instances this handling of risk is the difference between success and failure, apparent and unapparent.
Risk Management is a process that helps organizations understand (identify), evaluate (assess), and take appropriate action (or inaction) on risks with a view to increasing the probability of success and reducing the likelihood of failure.
Risk management gives comfort to shareholders, customers, employees and others that the business is being effectively managed and helps the organization comply with statute and law.
Once the risk has been identified and assessed, the management of risk will fall under four techniques:
After consideration and analysis, the decision could be made to not proceed with whatever activity is likely to generate the risk (eliminate, withdraw, or not become involved). The prospect of loss through risk outweighs the probability of profit.
Includes reducing the probability of the risk occurring through pro-active and reactive methods and also reducing (mitigating) the consequences (severity) of the loss.
SHARING / TRANSFER
Involves other parties through a risk bearing agreement such as insurance, contracts, outsourcing, partnerships or joint ventures.
This is usually either small potential losses that can be handled through proper budgeting, such as most stores do with shoplifting, or uninsurable risks, such as war. In either case, the most effective solution is awareness and management.
On January 1, 1012 TechCrunch published an article announcing the shut down of HiGear.
According to the article, the closure was due to theft incidents. HiGear was a P2P car-sharing service focused on luxury vehicles. For example, through the site you could rent a 2008 Dodge Viper for $600 a day, or $9,000 per month. Or, you could rent a 2006 Lamborghini Gallardo for $895 a day, or $12,000 per month.
In an email to the HiGear members its CEO, Ali Moiz, explained:
“Last month 4 cars were stolen on HiGear by a criminal ring. The total value of these cars was around $300,000. While our insurance is processing the claims for reimbursement, and the police have since recovered some of these cars, this incident involved sophisticated criminals using identity theft, stolen credit cards and stolen IDs to bypass all the background checks that we had put in place. This incident exposed us to the worst-case risks inherent in our service. Even by improving security and processes, we are not completely sure we can prevent an incident of this sort from happening again given the peer-to-peer nature of our service.”
When I first read this article I wondered if HiGear had applied basic risk management techniques to their exposure to theft. It seems they went for the AVOIDANCE card quite quickly. I don’t have access to their insurance policies, TOS and other information I need to understand their situation, so I have to make a lot of assumptions.
They probably had a good insurance agent/broker involved and had a well-planned TRANSFER of risk. It has been years since I was an excess and surplus lines underwriter, but if I had been asked to underwrite this risk, I would have probably wanted a rate that would equal average auto value times total number of rental days times 15% divided by 365.
Using that rate would result in a per rental fee of $30, which is about the cost they were passing along to their clients in the form of an insurance fee. That fee was less than 10% of the rental fee. Although the fee seems relatively right, I wonder if they considered raising it $10 to cover internal costs.
As an underwriter for an insurance company I would have demanded a $10,000 deductible. HiGear should have considered as high as a $25,000 per loss deductible. The increased income would have helped cover the cost of RETENTION which comprises a larger amount of the total risk.
I believe HiGear should have considered a deposit by the renter of at least $20,000 on their credit card. That amount would have set off some bells at the credit card company, which might have prevented the loss that occurred. At the very least, they would have enjoyed a REDUCTION in the probability loss.
The article stated that “some” of the cars had been recovered.
I would have considered charging the owner of the car enough to cover the theft exposure. The HiGear site is no longer around, but, given the decision reached by management, I can only speculate. I will assume that HiGear was charging 20% of the rental, much like Lyft.
I will further assume that HiGear retained 100% of the insurance fee. Given the exposure, had I been in HiGear’s place, I would have considered raising the rental rates by 10% and increasing HiGear’s retention to 30%. Again, the increased income would have helped cover the potential increase in cost of TRANSFER (or INSURANCE) of the risk.
I’m not sure what procedures HiGear had in place, but I would not have allowed the rental of high-end autos immediately. It would have been much better (admittedly in hindsight) to have a plan that would force the new customer to start with an auto with a value of less than $25,000 the first time they use the service.
The second time they can rent a car with a value up to $35,000. The next time the maximum value would be $45,000, and so on until they’ve used the service ten times and have unlimited ability to rent. This also would result in a REDUCTION in the probability loss.
Given the decision that was reached, I wonder if all of the above was weighed and the decision was made that the loss potential, if handled through the above techniques, would have reduced the usage of the service to such a degree that the service would not be profitable.
Insurance splits into two camps regarding the length of time between the payment of the policy premium and the settlement of the claim. Property losses are normally short-tail in that the loss occurs and is normally reported during the policy period and the claim is paid within days or weeks. Casualty losses (liability) are normally long-tail in that the loss is many times reported a year or two after the policy has expired and the loss is actually paid months and years after things have worked their way through the legal system.
Again, I did not see the Terms of Service for HiGear, but given the tone of the letter regarding the settlement of the claims, it would appear HiGear did not try to TRANSFER the risk of theft to the owner of the car. I have reviewed the TSO for Lyft and other “ride-sharing” services and have found them to be quite explicit in TRANSFER of the risk to the rider and the owner. Had HiGear taken a similar approach with their TOS, the car owner would have had to look to their own carrier for coverage . . . that probably would not have existed, because they are renting out their car.
The main exposure to services such as Lyft are long-tail in that accidents with large financial consequences take months and years to be resolved. Whereas the chickens came home to roost for HiGear, it might be that they are yet to arrive for several other of these services.
Or, it might be that the officers of HiGear have exceptionally high integrity as suggested in the comments attached to the TechCrunch story.
After reading the various TOS for the “sharing economy” companies, I’m amazed at the attempt to solve risk management by TRANSFER to the users and owners. I’m reminded of a situation I watched unfold in the late 1980’s.
A Fortune 500 company wanted to sell a subsidiary, which was a property and casualty company that insured mainly long-tail liability policies. The buyer was interested, but was projecting months of due diligence. The Fortune 500 company explained that they were a motivated seller and would like to close within three months.
At that time companies like theirs were selling for a multiple of 1.5 times the policyholder’s surplus (net worth). The buyers were willing to pay that multiple but balked because they would need to study the loss reserves and other key financial numbers before making a firm offer. The Fortune 500 company offered to guarantee the accuracy of any key numbers on the insurance company’s financial statement that would reduce the amount of due diligence needed.
Given those assurances in an iron-clad contract, the sale went through within the 90 day window. The buyer had TRANSFERRED the risk of a misstatement of financial condition to the seller.
Less than six months later the Fortune 500 company went into bankruptcy rendering their guarantee practically worthless.
If a claim results in a loss that is large enough, every pocket involved is going to be in jeopardy. Even if a TOS that TRANSFERS the risk to the owner and rider is upheld by the courts, when they’re found to be judgment proof the chickens could come home to roost.
Forty years ago a judge in Minnesota said, “Don’t talk to me about liability, a child has been hurt and someone is going to pay for it.” Courts are strange places housing weird people with all sorts of ideas about what is just.
Another comment on the TechCrunch story stated a side to the “sharing economy” that exists and seemingly is going unquestioned.
Bad Things Do Happen
The Airbnb guys are not dumb, they are well aware of the fault-lines in their model, they know the problems inherent in the accommodation industry, they know that at some point, someone will be beaten or molested or murdered, they know that a host will return home to the horrifying sight of a guest suicide, they know exactly what the media reaction will be, they know exactly what will happen to the notional value of their company, they know that one big compensation order will completely destroy the tenuous math upon which their company is based.
My forty-three years in the insurance business has taught me that bad things do happen. I once placed my Lloyd’s contract on a crane rental operation for the physical damage on the crane. The person who rented the crane had the required hours of experience but had never demolished a building. For some imponderable reason, he decided to swing the big steel ball back and forth instead of from side to side.
A crane has a warning buzzer that sounds when a ball is being improperly used. The operator decided the warning buzzer was malfunctioning, disconnected the buzzer and went back to the improper swinging. By the time he was done he had completely destroyed the cab, causing over $100,000 in damage.
NASCAR has a great saying about “Drive it like you don’t have a dollar in it.” I was taught early on in my career training that pride of ownership is a huge factor in property underwriting. Had the crane operator owned the crane it’s doubtful he would have self-demolished it.
Some ride-sharing companies have come to realize that an important component to a successful transaction is having the property owner look the rental-user in the eyes when the keys are transferred. That is far from the initial concepts of a pristine handoff where everything happened in cyberspace without human touch. This face-to-face handoff not only allows a person one last chance to decline turning over their car to a would be renter, it puts the renter on notice that the car owner is a real person who values their possessions. This is a prime example of REDUCTION of risk.
As pointed out by the above comment from the TechCrunch story, bad things sometimes happen in motel rooms. I once insured a motel that was badly damaged in a fire. A person rented a room for the night who had a terminal illness. That client required oxygen, which he carried with him in tanks. He supposedly touched off an explosion while apparently smoking. Given the extent of the damage and the person’s death, what actually occurred in that motel room will never be known.
A well-known Australian study found that almost 15% of those who were planning a suicide had conceived a motor vehicle accident.
Bad things will happen in a “sharing economy” setting. To prepare for that by TRANSFERRING the liability to owners and users and maintaining the posture that they’re simply facilitating the process may or may not prove to be accepted by the courts. One would hope that they would at least look at the feasibility of a TRANSFER of risk to an insurance company.
As an excess and surplus lines underwriter I was governed by guidelines that included, “Never let the sweet perfume of the premium the insured is willing to pay mask the stench of the risk.” The sharing economy is opening huge doors of opportunity that possibly should be left unopened.
That risk management course I took at the University of Minnesota over forty years ago obviously stuck with me. I think it served me well. The other guy . . . the fellow I had known in college who also was in that night course did okay as well. He’s currently the Chairmen/CEO of Auto-Owner’s Insurance Company.
I’m writing this from the perspective of the cheapseats. I have had to make many, many sweeping generalizations and conclusions based on incomplete facts. However, from what I have seen and read, the insurance industry needs to do more than turn its back on the sharing economy. There are ways for the two worlds to co-exist and find profitable solutions.
*** Since writing the above blog in late 2013 Uber has disclosed it’s excess auto policy. That policy, issued in a surplus lines company states that it becomes primary under certain circumstances. This would appear to be in violation of insurance rules in my homestate and several others. The policy is silent on no-fault coverage which makes it severely inadequate in my homestate. It also raises many other questions. Answers will come over time in this new state of “shared economy“.
Other Enhanced Insurance articles related to the sharing economy:
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