Peer Pressure

“When life gives you lemons, make lemonade.” The proverbial phrase encouraging optimism in the face of adversity is the underlying principle of insurtech startup Lemonade, the nation’s first peer-to-peer (P2P) insurance company but undoubtedly not its last.

Lemonade has loudly broadcast its intentions to disrupt traditional insurers and intermediaries. The “lemons” represent what the company contends is the sour aftertaste that many of today’s personal lines insurance buyers take away from their buying experience; the “lemonade” is the supposedly sweeter alternative.

Lots of people with deep pockets are lining up at the Lemonade stand. So far the company has attracted $13 million in seed funding from big venture capital firms like Sequoia Capital and Aleph. Its global reinsurer partners are a Who’s Who of the industry, including Lloyd’s of London, Everest Re, Hiscox, XL Catlin, and Berkshire Hathaway’s National Indemnity. Reinsurers are particularly interested in Lemonade’s business model, which cedes the entire risk to those companies. In effect, Lemonade acts like a captive, though it isn’t. Captives insure a special niche of policyholders who all have something in common, such as obstetricians, who historically are at a high risk for lawsuits.

Lemonade’s clients, on the other hand, represent a broader range of policyholders seeking renters or homeowners insurance. To fit clients into the peer-to-peer mold, Lemonade uses a unique method to divide policyholders into individual peer risk pools.

Lemonade is licensed to do business in New York State—for now. The insurer has plans to plant flags nationally and enter other lines of both personal and commercial insurance.

First P2P?

While Lemonade claims to be the first P2P insurer in the country, the most recent roots of this model stem from Europe, where P2P insurance has been operating successfully for several years.

At its core, P2P is a risk sharing network where a group of associated or like-minded individuals pool their premiums together to insure against a risk. But there is a wide range of variations on that theme and Lemonade is only one of them.

For example, Friendsurance—the first brokerage version of P2P insurance—was launched in 2010 in Germany. Friendsurance is backed by large investors like Horizons Ventures and the European Regional Development Fund. Guevara made its debut as a P2P automobile insurer in the United Kingdom in 2014. Both predate Lemonade.

These companies use crowdsourcing and other forms of social networking to create a shared insurance experience. In their model, peer groups team up to absorb each other’s risks, with everyone contributing premiums to a pool to insure each other’s losses. In effect, policyholders reach out to each other to form peer groups—risk pools—for insurance purposes.

Lemonade departs from that model. It has no crowdsourcing or social networking—no policyholder generating leads. Instead, Lemonade forms peer groups based on each policyholder’s choice of a charity. The carrier apparently differentiates its peer groups by the psychographics of a policyholder’s choice of good will. Could animal lovers be a better risk than someone who contributes to the American Cancer Society? And do all animal lovers have similar risk? Lemonade thinks it’s got the answer.

This risk pool method might be due to the influence of Dan Ariely, the insurer’s chief behavioral scientist. Ariely’s research into how people feel about insurance has been crucial in creating Lemonade’s business model. His dislike for the traditional insurance industry is evident in his harsh pronouncements.

“Imagine that you wanted to create a system that would get the worst out of people,” Ariely says in a promotional video. “You would start by getting people to give you their money, and then you would promise to give them things back later when bad things happen to them. But when something bad happens, you would start fighting with them. Plus, you would show them you don’t trust them, and you would have extra-small print that says we don’t cover this and we don’t cover that.”

Ariely is the founder of The Center for Advanced Hindsight and is the James B. Duke Professor of Psychology and Behavioral Economics at Duke University. His TED talks have been watched more than 7.8 million times. He’s also a New York Times best-selling author of books such as Predictably Irrational and The Upside of Irrationality.

Ariely’s altruistic attitude appears to influence Lemonade’s view on claims also. Once the peer groups are formed, claims are paid out of each group’s pool of capital. If claims exceed the money in the pool, Lemonade’s reinsurance absorbs the remainder. If not, what’s left over in the pool of collected premiums at the end of the policy period goes to the group’s charitable cause, minus the 20% that goes to Lemonade.

Lemonade claims this business model reduces the possibility of claims frequency and severity since group members ostensibly care about the charity they’ve chosen. Theoretically this reduces the group’s potential for aggregate losses, as more money would then flow toward the chosen charity instead of claims. Ideally, it also decreases the likelihood that someone would commit insurance fraud, since the unspent premium goes to the common cause.

The Millennial Mind

OK, so it’s a strange concept, but it’s one that is predicated on some savvy marketing. Lemonade’s target market for renters insurance is young people just starting their careers. Not only does it offer a very competitive price for renters insurance to these individuals at a time when their pockets are thin, it adds a dose of altruism with the charity concept. When are people apt to be most altruistic? Generally, when they are young.

Lemonade’s policies also are purchased online, using the company’s smartphone application. Millennials can buy the insurance the same way they order a pair of shoes from Zappos or arrange for Uber to take them to the airport. You get the picture.

Do brokers and agents need to be concerned about Lemonade, which has no use for these intermediaries? Not right now, since the carrier is competing in just one market in just one state. But down the line, there is reason to give pause for consideration. That’s because of the insurer’s plans to broadly expand into other lines of insurance and geographic markets. Assuming it gains a foothold with all those cost-conscious, tech-savvy and selfless millennials, as those individuals age—and possibly own or manage businesses in future—they may decide to sweeten their relationship with the carrier.

“The P2P carrier model has the ability to potentially disrupt niche insurance markets, both personal lines and commercial lines,” says Francois Ramette, a partner in the advisory insurance practice at PwC.

Other top-tier industry consultants concur. “If P2P works in personal lines, there is no reason why it would not work in other lines, including commercial,” says Tanguy Catlin, a senior partner in the insurance practice of McKinsey & Company.

Test and Learn

In September, New York’s insurance department—considered one of the country’s toughest regulators—gave Lemonade the green light to sell renters and homeowners insurance. Now that New York has opened its doors, other states are sure to follow.

While Lemonade’s current claim to fame is that it is the first P2P insurer in the United States, it won’t be the last. Other P2P entities dot the global landscape, in addition to Guevara and Friendsurance, which recently raised $15 million to expand beyond Germany into other parts of Europe.

In 2014, P2P Protect Co. opened for business in Hong Kong. In 2015, PeerCover was launched in New Zealand, Riovic in South Africa, TongJoBao in China and insPeer in France. And there are others.

At present, the different P2P startups are testing the waters. Like Lemonade, most are engaged in just one or two lines of insurance. If their tryouts are successful, the presumption is they will learn from these experiences to branch out into other lines of insurance.

What might some of these markets be? “Doctors could come together as a pool and insure themselves in a captive through Lemonade, as could truckers and other professions and industry groups,” PwC’s Ramette says.
Catlin, from McKinsey, has a similar perspective: “I don’t see why 20 pizzeria owners in Chicago couldn’t put their business risks together in a peer group to buy business owners insurance.”

Friendsurance has already extended its model into additional lines of insurance. “So far, we offer car insurance, home contents, legal expenses, private liability and electronic insurance,” says Tim Kunde, the firm’s co-founder and managing director. “In the future, we plan to add additional insurance categories.”

So will Lemonade. Asked if the sky is the limit insofar as the company plans to become a multinational multiline insurer, Daniel Schreiber, Lemonade’s co-founder and CEO, replied, “I don’t see why not.”

Not that this will occur any time soon. “Lemonade has been very careful and methodical, selecting lines of insurance that are very safe from a risk assumption standpoint,” says Fred Eslami, a senior financial analyst at A.M. Best. “The combined ratio for renters and homeowners insurance in New York State is about 78%. Even tacking on their 20% fee, that’s 98%—still quite safe. The assumption is that they will continue to be very conservative going forward.”

This cautious approach is evident in the time it took Lemonade to get its insurance license and enter New York’s marketplace. “For nearly a year, they whipped up a lot of intrigue about their business model, without informing us and others what exactly it might be,” Eslami says. “They’re extremely savvy, marketing-wise.”

Lemonade is in no rush to grow, agrees Dax Craig, CEO of Valen Analytics, a provider of predictive analytics solutions focused on insurance underwriting. “Like other P2P startups, they’re in a ‘test and learn’ environment, which is something traditional insurance companies don’t do well,” he explains. “Most traditional insurers want to ‘go big or go home.’ Lemonade, for now, wants to be small and nimble, learning from its experiences to improve its processes and technology to the [benefit] of the customer. These lessons will then be applied to the other lines of insurance it enters.”

And that’s not just traditional lines of insurance, Schreiber projects. “We’re looking to develop new forms of insurance that have yet to exist,” he says. “We’re not burdened by legacy technology and distribution costs to make this happen.”

While Schreiber is mum on what these new insurance products might be, Craig says Lemonade is “well positioned for microinsurance opportunities like insuring film sets for short periods of time or developing unique cyber-risk policies that transfer discrete risks the industry has yet to touch,” he says. “There will be some throwing of spaghetti against the wall to see what sticks.”

Uber Insurance

Lemonade is essentially a technology company that markets, underwrites and sells insurance without taking on any risk. The obvious comparison is Uber, a technology company performing the same functions as a taxicab dispatch service without actually being one. Lemonade sells insurance policies to consumers at a flat fee that represents 20% of the premium, similar to the percentage fee-based revenue model of Uber, Airbnb and other tech companies in the sharing economy. Like these Internet stalwarts, Lemonade does what it does at a lower operating cost than traditional competitors, which allows for extremely competitive prices—as low as $35 a month for homeowners insurance and $5 a month for renters insurance.

The company’s extremely competitive prices are based on several factors. One is Lemonade’s unique structure, which allows for lower operating costs than traditional insurers’ underwriting expenses (about 27.5% in 2015).

The industry’s high expense ratios are caused in part by many carriers’ legacy IT infrastructures. A July 2015 report by McKinsey & Company criticized the industry’s antiquated IT networks and systems as the “root cause for [insurers’] failing to leverage economies of scale, driving high IT costs, as well as mushrooming operational costs.”

A 2016 report by Deloitte also castigated insurers’ IT infrastructures as a factor creating “existential challenges” for the industry. The report’s title succinctly summed up the gloomy situation: “Insurers on the Brink.”

By contrast, Lemonade has brand-new, state-of-the-art technology with all the expected bells and whistles—fully mobile, digital, frictionless and embedded in an app. Instead of agents and brokers, the company uses chatbots, a computer program simulating intelligent conversation via text and other methods, to automate the marketing and business interactions between the company and prospective customers.

“There’s this widespread realization today that agents and brokers are these people you went to lunch with in the past, whose only job was to protect their books of business over the next two decades,” says Scott Walchek, CEO of Trov, an insurtech startup that received $25.5 million in new funding in August to launch on-demand insurance policies for specific devices like a laptop computer, smartphone or a musical instrument. “Why pay for something you may not really need?”

Lower Overhead

By removing brokers and agents from the picture and adapting sophisticated technology tools to its purposes instead of having to rely on an aging IT infrastructure, Lemonade is able to charge lower premiums than other insurers in New York state.

Lemonade potentially saves on costs in yet another way. There is vivid marketing cachet to its charity angle, which Lemonade takes advantage of. “Not a penny of the money left over after losses are paid goes toward underwriting profit—the case with traditional insurance companies,” says Schreiber. “Since we don’t absorb this unclaimed money, we have no reason to ever want to deny a claim or delay its payment.”

But there is a flaw of self interest in Lemonade’s charity structure since policyholders don’t receive an annual tax deduction for their philanthropic contributions, even though it is their money going to the charity. Instead,

Lemonade gets a healthy tax break because it can write off the donations. That has the potential to save the company millions in the future. From Lemonade’s perspective, maybe that’s not a flaw at all, but Schreiber sees otherwise.

He projects policyholders will be able to receive the tax break in future, if the company can persuade New York state legislators to rewrite current laws that disallow insurers from providing rebates to customers. While rebates are viewed favorably in many consumer transactions, this is not the case in the insurance industry, where they are illegal in many states. The question is whether providing the tax deduction to a consumer fits the definition of a rebate. For now, Lemonade is taking a conservative stance and not risking reproach.

A spokesman for the New York Department of Financial Services says officials discussed this option with Lemonade but are not considering any changes to the law at this time.

There are obvious reasons to give Lemonade more than cursory attention. Since the insurer foregoes the use of brokers or agents in its current incarnation, expectations are that this will remain the case in the future—if and when it expands geographically and into other lines of insurance. Asked if this will indeed be the case, Schreiber replied in the affirmative. “We fully intend to become a national multiline insurer, and someday an international multiline insurer,” he says.

For competitive reasons, he did not elaborate on what these plans were, how they would be achieved (a key question with regard to complex commercial lines products), or a time frame in which they would occur.

For now, the overwhelming consensus of several interviewees is that Lemonade will make a significant dent in New York City’s homeowners and renters insurance markets, given its competitive premiums and the large population of young people who rent in the Big Apple and love high-tech, high-touch solutions.

Whether the company’s ambitions to become a successful multiline, multistate insurer will prevail is uncertain, although Lemonade does have its admirers.

“Dan is blazing trails in an industry like insurance that is old, slow to react and unsophisticated technologically,” says Craig, of Valen Analytics. “When you’re old and slow-moving, you tend to get a lot of arrows in your back.

That’s why the industry—carriers, agents, brokers and the entire distribution network—all want Lemonade to fail.”

The competition presented by the country’s first P2P model is not being taken lightly. “Even if traditional carriers changed the agent-broker dynamic,” Walchek says, “they’d still be stuck with legacy technology, antiquated distribution structures, and heavy brands.”

Harsh Words

Lemonade is one of hundreds of startup insurance businesses in the fast-growing insurtech space, which together have attracted billions of dollars from top venture capital firms. All are aimed at an industry they consider to be ripe for disruption. The difference is that most insurtech startups target discrete aspects of insurance, like claims administration, underwriting or marketing. Lemonade is fully an insurance company, albeit a very unusual one.

“In tech parlance, they have the full stack, doing everything traditional insurers and brokers do but doing it less expensively while providing a better customer experience,” Craig says.
Ariely blames the insurance industry for becoming a Goliath amidst these many Davids. He maintains that insurers have squandered the social value of a common cause in the name of money. In other words, the industry has figured out how to fleece consumers, who give carriers money for little or nothing in return.

Undoubtedly, this caustic description will not rest easy with many insurance companies, particularly those that have built their reputations and brands on a sincere desire to pay all fair claims quickly and in full.

Ariely nonetheless lumps all insurers together as some sort of international crime syndicate, without actually calling it that. “Sadly, this is where the insurance industry is right now,” he says.
Schreiber does not disagree. “There is a profound conflict of interest at the core of the insurance industry’s business model,” he says. “That’s because carriers view every dollar they pay consumers as a dollar less to the bottom line.”

In numerous articles touting Lemonade in messianic terms, Schreiber and other senior executive leaders of the company denounce the traditional insurance industry as capitalist kingpins.

No punches were pulled in his interview with Leader’s Edge. “The public no longer views insurance as a social good but as a necessary evil,” he says. “People just don’t trust insurance companies, knowing that insurers either won’t pay their claims or won’t pay them in full.”

What really gets Schreiber’s goat is that, when insurance companies have an underwriting profit, they keep this capital. Lemonade does not. “It’s not our money,” he says. “Ethically, it belongs to the policyholders.”

Lemonade, he says, is “spiritually” a mutual insurer in the original conception of this type of insurance company, in which groups of farmers, lumberjacks or firefighters pool together their resources to insure each other.

Lemonade is not registered or organized as a mutual insurer, which is owned by policyholders who have little in common except for their ties to a carrier. Schreiber is simply borrowing the communal feelings of the word “mutual.” In fact, he blasts current mutual insurance companies. “What used to be mutual insurance decades ago has lost its way,” he says. “As these small mutual insurers—formed by covering different groups—grew to be gigantic organizations, the sense of community they started out with went astray.”

Schreiber is not alone in this assessment. “If you look at Lemonade and other P2P models, they’re a throwback to the earliest days of the insurance industry, similar to mutual insurance companies insuring farmers and lumbermen,” says Pradip Patiath, senior partner in McKinsey’s insurance practice. “People knew each other and pooled their resources to insure themselves. Everyone had the interest of the group at heart in keeping claims down. But as these groups got larger and larger, they became today’s insurance companies, bad reputations and all.”

Of course, not everyone in the industry concurs with this assessment, among them Chuck Chamness, president and CEO of the National Association of Mutual Insurance Companies.

“Mutual insurance companies operate in a complex, competitive and heavily regulated market to provide their member policyholders with a legal contract backed by large pools of capital available to pay future claims,” Chamness says. “Lemonade is attempting to leverage mutuals’ proven advantage of policyholder alignment, but only time will tell if it has the ability to win in the long term—and it’s a long-term business.”

Lemonade is not a captive either, although some smaller captives may appear to be similar to a peer-to-peer business model since all of the policyholders are part of a community of sorts.

While Lemonade officials say their business model can easily be converted from personal to commercial lines and still disintermediate brokers, just how scalable is it to make a meaningful move into the commercial arena?

And would that disintermediated model even be competitive with what already exists?

Already, some brokers have innovated looking for other ways to serve niche markets, similar to the peer-to-peer risk pool option. Dan Keough, CEO of Holmes Murphy & Associates, created Innovative Captive Strategies back in 1999. It offers several types of commercial insurance through various captive insurers. While the bottom line has some similarities to Lemonade—they pool the risks of like clients and can dramatically cut premium costs over time—their similarities may end there, which is a good thing if you’re a commercial broker:

•  ICS policyholders take risk and ownership of their individual captives. This allows for larger commercial risks. The Lemonade policyholders take no risk.
• ICS captives have proven their effectiveness in taking on large scale complicated commercial risks. They’ve got 18 years of history behind them. Lemonade, so far, is in its infant stages of risk taking and there are only large scale questions in its portfolio about what kinds and sizes of commercial risk it could take on.
• ICS captives work with brokers around the nation to service clients and still show large savings in premiums for their clients. Lemonade must disintermediate brokers as part of its cost cutting.

While these different types of risk transfer don’t line up exactly, they do share many common attributes. As the industry slowly settles on a common definition of peer to peer, it could become apparent that this “new” approach to insurance could substantively have existed all along.

You could even question Lemonade’s insurance carrier bona fides. Although New York officials assure it is a properly licensed insurance carrier, Lemonade assumes no underwriting risk like a normal insurer. Instead, after taking its 20% cut, the entire risk is assumed by its policyholder risk pools and reinsurers (the type of behemoth carriers for which it holds so much disdain). In effect, Lemonade is little more than a management company relying on reinsurers to make it profitable.

Disruption or Interruption

Few would disagree the insurance industry has a poor reputation among much of the public. But does Lemonade change the paradigm in such a way that its more communal, technologically sophisticated, altruistic and cheaper version of insurance will bury traditional insurers in its dust? That’s doubtful. Even with bargain-basement prices, Lemonade isn’t likely to take the lion’s share of New York’s renters and homeowners insurance markets.

“With a combined ratio of 98—give or take—they’re at 2% breakeven, and that’s in a good year,” Best’s Eslami says.

The analyst recently visited Lemonade’s website to get a feel for what he would be charged to buy renters insurance. “They ask a bunch of good questions,” he says. “The end result was that their premium was definitely lower for me but not by much. They’re competitive but not to my mind at the point of stealing the market.”

Ramette from PwC has a similar perspective: “They might gain some traction, but it is way too early to talk about them in terms of market disruption.”

Lemonade’s first two days in business appear to affirm these views. In the interest of “transparency” and “honesty,” the company released a blog by Lemonade’s chief Lemonade maker, Shai Wininger. Wininger disclosed several metrics, including the insurer’s first 48 hours of sales, which added up to $14,302 in gross written premiums. Assuming this $7,000-plus rate of business per day continues over the course of a fiscal year, the company would take in the less-than-staggering sum of $3 million.

Wininger needs to make more lemonade.

With regard to the disintermediation of brokers and agents if Lemonade enters additional lines of insurance, some in the industry think the impact will be minor.

“My short answer is that brokers will not be disintermediated any time soon,” says Ramette. “The potential success of renters insurance in New York may not be repeatable in other states or in other classes of risk. New York City, for instance, is a very concentrated market with similar demographics.”

On the other hand, Craig projects that Lemonade and follow-on P2P startups will disintermediate agents and brokers over the next 10 years in high-transactional volume markets like personal lines, “much like Progressive and Geico have done without brokers in personal auto insurance,” he explains. “But agents and brokers will continue to win when it comes to more complex transactions that require professional, trusted advice. Were I an intermediary, that is where I would focus my energies in the future.”

Asked to elaborate, Craig says instead of competing in automobile, renters/homeowners insurance and small business owner policies, “agents should focus on things like workers comp and specialty markets like mining or trucking.” Midsize and larger brokers, he says, with sophisticated risk management expertise in areas such as directors and officers liability insurance and employment practices liability insurance, have little to fear, although they should not be complacent.

“Lemonade and other startup P2P companies may chip away at some specialties as they grow,” Craig explains.

Brokers and carriers might also consider the old maxim “If you can’t beat ’em, join ’em” and form their own P2P models or buy existing entities. “I don’t see why traditional brokers in the states can’t form similar P2P models as an alternative option for buyers,” Ramette says.

Eslami has the same view about traditional insurance companies. “The big insurance companies definitely have the resources to buy these tech startups and use them for their own benefit,” he says.
McKinsey’s Catlin agrees. “I can see major insurers start up their own P2P ventures or simply buy one of the companies that are out there, taking equity stakes in a Lemonade or the ones that follow,” he says. “Look at all the insurance companies that have recently launched venture capital funds to do just that—to buy technologically proficient startups.” Among these insurers are Axa, XL Catlin, MassMutual and Aviva.

Taking Stock

All in all, consumers have different expectations now about how they want to buy products and be served by sellers. They purchase shirts, shoes and gadgets on Amazon with a single click. They’re eager to lease unseen homes for weekends on Airbnb. And they routinely arrange for cars driven by nice people at Uber and Lyft to pick them up at airports and street corners.

In all these transactions, there is no exchange of cash or handing over a credit card. Such effortless and pleasant interactions have become table stakes.

Much of the traditional insurance industry is not yet in the game, but it’s getting there.

“The big insurance companies are coming closer to these startups in terms of efficiencies, developing smartphone apps to take pictures of insured losses and to make the filing of a claim and its payment easier and quicker,” Eslami says.

There’s no question the image and operating structure of the insurance industry needs to change. Its reputation is as tarnished as Grandma’s silverware in the attic, and its IT infrastructure is creaking like Grandpa’s knees. But are traditional insurers and brokers bound to end up in the same heap as taxicab companies, record stores, video rental businesses and travel agencies?

Not by a long shot. There’s just more competition, something the industry has dealt with since the days of Lloyd and his London coffee shop. In the near term, insurers and brokers can even bide their time, thanks to Lemonade’s conservative “test and learn” approach.

There’s even the risk that, once Lemonade and other P2P startups grow, their social, communal aspects will fade. “While digital and social media have enabled Lemonade and others to re-create these types of peer groups, as they grow they, too, face a very similar future,” warns McKinsey’s Patiath.

If this happens, the sleek, fashionable insurer may become just as dowdy as the companies it decries.

Put that in your lemonade and stir it.