Pondering the cool discussion of InsurTech carrier Lemonade- is it as sweet as presented?

TLDR As discussed in the prior post Lemonade is many things, per CEO and co-founder, Daniel Schreiber– revolutionary tech platform, charitable giver, P2P service provider (no, strike that), but at its core it is a property insurance company.  The hows and whys matter not when the application for license goes before the respective jurisdiction’s regulators.  The company must be organized and operated in a manner that is recognized as secure for its policyholders and adequately financed as such, must comply with the same accounting standards as other insurance carriers, and must be ready and able to comply with the agreements, provisions, and conditions its policies include.

Why belabor these points?  Because the company leads with its innovation chin, its behavioral economics, and its promises to act as a totally different insurance company than what those crabby octogenarians (who) think we are making too much noise companies do.

One of the foundational points the firm makes at its outset is that there is a recognition by Lemonade’s founders that, “There’s an inherent conflict of interest in the very structure of the insurance industry.”  (Chief Behavioral Officer, Prof. Dan Ariely, see around 0:54 of the video).  He continues, “Every dollar your insurer pays you is a dollar less for their profits.  So when something bad happens to you, their interests are directly conflicted with yours.”  

Of course there is conflict between payment of premiums and indemnification- absent the ‘tension’ insurance would not exist, or perhaps would be free! It might be said that Professor Ariely’s perspective has an inherent flaw in not acknowledging that an insurance policy is a contract for risk sharing between an insured and carrier, that a respective policy premium and deductible are the insured’s agreed cost of sharing the risk covered by the policy, and that the carrier promises to indemnify the insured for damages due to causes of loss the policy covers.  It’s not a pure quid pro quo financial agreement because the cost of underwriting, selling and administering the policy falls upon the carrier, and the deductible and premium cost falls upon the insured.  The use or equality of the costs are only considered upon inception of a claim.  In addition, the insured is not involved in devising the terms of the policy, as a contract of adhesion a prospective insured’s sole power is accepting the contract in its entirety or not.  Absent optional inclusion of additional contract scope or details (endorsements and/or coverage limits), the insured is powerless in respect to a contract that ostensibly is in equilibrium between the parties- premium on one side, equivalent policy benefits afforded by the other side.

The price of the risk is determined by the carrier and approved by regulators based on volumes of data, actuarial smarts and with an eye to profitability balanced with service.  The frequency of CWPs (closed without payment) and paid claims is part of the actuarial machinations (regulators are comforted by carriers whose data are in concert with the industry at large), as such denials of coverage are, if absent, a concern for regulators. Is there an undue conflict of interest for incumbent carriers where policy provisions apply, or is Lemonade leveraging a message based on clever marketing?

Consider the typical property insurance claim pool:

Not every policyholder has a claim each premium period; in fact less than 20% of a typical insurance carrier’s homeowner’s customers experience a claim during a policy year.  Of that pool of claims the  frequency of denial is on average less than 30% of the total claims closed.  Extending the thought process, a carrier with 500,000 policyholders experiences on average 100,000 claims during a year, and of those 100K customers 30,000 may be denied coverage, so one can say approximately 6% of the subject carrier’s customers’ insurance services end in coverage disappointment.  Compare that with the carrier’s YOY customer retention rate and it may be clear that denials of coverage are not the only factor in customers’ renewal algorithms.  Is that the basis upon which differentiation can reside?

There may be a stronger position for the firm to take that the inherent issue may be in pricing losses, confirming losses at FNOL, or sorting out the spurious (read as fraudulent) claims.  Per the firm 90% of FNOL reports are through Maya or similar service bots, and since that service entry is tied to the entire suite of AI it can be said that FNOL may be the best vehicle to mitigate the effect of any ‘inherent conflict.’ 

Why that?  The firm (through marketing and per discussion) relies on the position that a ‘Ulysses Contract’ is in place for the firm- a figurative ‘tying of hands’  for Lemonade in focusing on denials of claims since any excess of earned premium over the firm’s flat fee is donated to the policyholders’ charities of choice.  No path to the bottom line, no incentive for capricious denials.  Is there legitimacy to this position?  Insurance is a contract, 90% of Lemonade’s claims are being handled by bots, pricing is established by regulated filings, and claim denial ‘touches’ affect only a small percentage of customers.  It’s probable that most denials of coverage are due to contractual reasons, i.e., policy provision reasons including the cause of loss not being a named peril.  At this juncture the carrier has primarily renters’ policies as its portfolio, and claims are comprised of unscheduled personal property that has relatively concrete pricing.  In addition, claim customers have limited knowledge of what comprises effective claim handling- other than prompt receipt of proceeds into one’s account.  If there’s a Nash Equilibrium in place, customers seem to be unaware, and can a bot be adversely subject to the vagaries of Game Theory?   

Lemonade must be respected for its InsurTech effect on the property insurance industry- everyone knows of the Lemonade entry and journey.  The growth of the firm (while overall PIF is small) continues to engage the attention of all.  As Daniel Schreiber said in our discussion and in his recent blog entry Two Years of Lemonade: A Super Transparency Chronicle, “ the fact that our reinsurance agreements protect us from too many claims can’t hide the fact that, since launch, we’ve paid out more in claims than we’ve collected in premiums. Clearly, that can’t continue indefinitely.”

As the carrier evolves into a multi line policy organization (renters’, condos, homeowners) the bot approach to claim handling will be tested.  Renters’ claims are personal property tasks- named peril, concrete loss description, concrete valuations.  A house claim may involve multiple parties- the insured, emergency services vendors, public adjusters, field adjusters, third party administers, and so on.  The Nash Equilibrium will be complicated to affect in that multi-player game, and a Ulysses Contract will be toothless to address the covered damage, partial denials, additional living expense wranglings, and other unknown factors. 

Regardless of the company’s cover portfolio, the need to become viable within the framework of insurance accounting looms over the discussion of social good. To quote from a October, 2018, article posted by Coverager, “Lemonade’s Cards“,

“And while Lemonade ‘solved’ this conflict by only taking a flat fee and giving unclaimed money to charity, are they really a conflict-free company? Do they not have a strong desire to improve their loss ratio? Isn’t the loss ratio an important part of their business? Will they be able to attract investors or potential buyers with a high loss ratio?”

The firm will find its data aggregation, analysis, and predictive capabilities invaluable from underwriting to claim settlement, and may find the expected diversity of its claim portfolio meaningful in building its flow of ‘excess’ to charitable organizations. There’s a cadre of claim staff developing their service skills- in other words they are learning to be insurance pros.  And at a minimum Lemonade has been patient with the industry placing them under a magnifying glass, watching every step being made- that’s not a bad thing and has added to the collective knowledge of insurance innovation. However, at this juncture having a Ulysses Contract as a mainstay of its business model appears to serve Lemonade’s marketing more than it does its loss ratio.

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Patrick Kelahan is a CX, engineering & insurance professional, working with Insurers, Attorneys & Owners. He also serves the insurance and Fintech world as the ‘Insurance Elephant’.

I have no positions or commercial relationships with the companies or people mentioned. I am not receiving compensation for this post.

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