United States: The Disruption Wave Hits Insurance

David Sofge is an Attorney and Thomas Morante is a Partner in the Fort Lauderdale office

The wave of technological disruption is reaching the insurance business, long protected by social, regulatory and organizational barriers. New competitors buoyed by their familiarity with consumer-facing mobile technology, artificial intelligence (AI) and data manipulation are moving rapidly to exploit opportunities presented by the incumbents' ponderous size and lagging technology, as well as decades of popular resentment for the insurers themselves.

Some of the changes underway are based on opportunities for increased efficiency – faster and better underwriting, more consumer-friendly applications (often with a chatbot on a mobile device) and a less aggravating procedure for claims. Others, however, are going further, and seek nothing less than a fundamental restructuring of the business models for insurance which have dominated the landscape for more than a century.

Israeli-based startups are leading the way in many areas. All (it goes without saying) use various combinations of the latest innovations in data analytics, AI, cloud computing, the Internet of Things and other current technologies. One of them reported earlier this year that it had paid a claim (for a stolen coat) in three seconds, claiming by that act to have set a new record in the 3,000-year history of the insurance industry. Some are focusing on niches in the new economy, or specific markets underserved by the existing insurance industry, such as Hippo's products for underinsured U.S. homeowners with specific emphasis on using distributed sensors and the Internet of Things to prevent mishaps and claims. Others, such as Next Insurance, are reaching out to the beleaguered small business market, traditionally confronted with lengthy, complex "one-size-fits-all" applications and policies. Next Insurance offers coverage tailored to specific types of small and medium-sized business, with processing on the web. (If you're stretching, for example, to find coverage for your yoga business, you may be in luck.)

The highest-profile challenge to date is presented by Lemonade. This startup hearkens back to the roots of modern commercial insurance in the 17th century, when sea captains and financial backers met regularly at Lloyd's Coffee House in London to talk over sharing the risks of maritime commerce, with backers writing their names underneath others on a sheet ("underwriting") to signify participation in the risk of a particular voyage. Syndicates formed by the regulars to insure a number of ships created the pooling and diversification of risk that is at the core of the modern insurance business.

The model shifted in the late 19th century with large-scale urbanization, when millions of people moved into cities to take factory jobs, and new insurance companies (many of them are the same companies as those that still dominate the industry today) were formed to offer insurance to the multitudes of urban dwellers. The new corporations employed and insured vast numbers of people not personally acquainted with one another and operated through massive impersonal bureaucracies. Since the new insurance companies increased their profits primarily by controlling and minimizing claims, an intrinsic conflict of interest (it is argued) was created between customers and their insurers, leading to confrontation and mutual suspicion.1

Lemonade, which has a behavioral economist on its staff, thinks it has found a way to remove this conflict of interest. Discarding the industry's benchmark "combined ratio"2, the company takes a fixed 20 percent of premiums paid as its fee. After the payment of the fixed fee and any claims, the remaining funds are periodically contributed to a charity designated by the customer. The idea is that inflated claims do not harm a faceless insurance company, but instead adversely affect the whales, medical research or some other cause supported by the customer. The company thinks that this change in incentives (combined with big data analytics and AI for underwriting and claims) will bring down false claims and the related expenses of investigation and adjustment.

Will it float? It's early days, and the new models are just beginning to be tested. Many questions lie ahead, including who will dominate the new digital channels – incumbents or insurgents – and how that will change regulation, and whether the "pooling" of risk can survive an increasing personalization of risk based on data analytics. What is nearly certain is that the insurance business, whether it wants to or not, is entering a turbulent age of discovery.


1 Studies for the industry consistently show significant numbers of consumers who consider it legitimate to inflate insurance claims, based on expectations that insurers will try to unfairly reduce them.

2 (Losses + expenses) divided by earned premium

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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