Insurance- not all fun and game theory


Economic game theory has resided at the core of insurance underwriting for some time but might be losing its luster through the advent of price aggregators. ‘Gamification’ through behavioral economics is gaining traction concurrently in the industry, that is, devising schemes to engage insureds more often with their policy than simply at annual renewal. 

More knowledge, less variability, more balance between insureds and insurers.  Has the industry finally adopted the Nash Equilibrium?

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’.

It wasn’t long ago (maybe yesterday?) that actuaries and underwriters employed game theory to help with pricing decisions with the clear goals of pricing to attract those with overpriced policies and at the same time not under-pricing their respective carrier’s products.  Now enters ‘big data’ and artificial intelligence (AI), and the pursuit of a granular understanding of pricing is easier in terms of where the marginal return of a policy truly is understood in terms of its marginal cost, and the portfolio’s price elasticity is more predictable.  (Don’t you wish you had paid more attention in microeconomics?)

Carriers applying game theory principles was all well and good when carriers held sway within an imbalanced information game, but now the game matrices have become more complex- while the carriers have developed robust data lakes from which to pull their figurative big fish, customers have become similarly empowered through the growing availability of price optimizing companies, websites, and applications, and the complicating fact that these sites are dynamic in the aggregation of price data.  And- the P&C industry’s penchant for marketing based on price will become less effective as price information becomes more accessible and carriers react to find that balance of marginal cost and policyholder retention.  It’s a #newinsurancebalance where customers who have been taught that insurance is a price purchase will hold essentially the same information as carriers, as such the price game attains Nash Equilibrium status.

Perhaps not today but soon carriers will by the default of the market having uniform price information need to differentiate through other means.  Some carriers are establishing their place in this new ‘game’ through application of behavioral economics tied into game theory, e.g., Lemonade, where the firm recognized that insurance is a Nash Equilibrium circumstance, and absent all parties acting nobly no party benefits more than the next.  That being known, the firm applied behavioral economics theory in forming itself as a public benefits corporation, encouraging policyholders to ‘pledge’ being forthright, and making a charitable contribution part of the insured/insurer relationship.  And- through the company’s formation and operation an aspect of game theory, a Ulysses Contract where Lemonade’s ‘hands were tied’ compels the firm to act (at least in theory) in compliance with its mission to its policyholders’ desires to contribute to charities, and customers remain cognizant of that motivation through measured claim activity.  Recognition of the Nash Equilibrium and leverage of same.

Not all carriers can be B Corps, nor would they want to be, but they retain similar motivation as Lemonade- serve, engage, and retain customers.  If it’s accepted that pricing is and will become an essential level playing field, then value and risk analysis become even more important.  Data acquisition and analysis is becoming a competitive advantage- consider the head start Progressive has with its Snapshot telematics tool, similarly Nationwide’s SmartRide ,or Allstate Insurance with its Drivewise program, all collecting enormous volumes of drivers’ performance data- where, when, how fast, how slow, starts and stops, and durations of trips. Metromile takes data acquisition to a next level and utilizes telematics for user-based insurance premiums.  Customers ostensibly benefit from their carrier having knowledge of driving habits, patterns, and duration, and carriers accumulate huge volumes of risk data that can be applied to underwriting methods.  But how to encourage more customers to be engaged, and not only in auto cover?  Pricing has always been the engagement tool, but as pricing becomes less of a lever, what to do?

Why should carriers be concerned if pricing is becoming more of a universally available data set?  Retention and changing purchase behavior, that’s why.  Insurance was (is for many) a service made available through agents, bought but hopefully not used.  As insurance becomes more ‘commodity-like’ in the purchasing eyes of the beholder carriers must find other ways to differentiate their product from the other equivalently priced options.  As customers migrate to apps and online resources for insurance purchases even agents are now subscribing to price aggregation tools, allowing their focus to be on a ‘holistic’ insurance service approach.

Behavioral economics again becomes part of the next iteration of games in insurance- ‘gamification’.  The principle is- find a means to engage customers in activities that have bilateral benefits, aren’t burdensome, and are interesting enough to keep customers as frequent users.  Until now carriers had little idea of what customers were doing, and underwriting was the purview of driving histories, dwelling values and locations, and the Prisoners Dilemma game (among others).  Karlyn Karnahan of Celent writes, “The power of gamification is that, through the use of game elements, activities that might normally be uninteresting and even tedious become fun, according to Carnahan. That can create positive engagement in itself, and, adds Karnahan, “if you can combine fun with rewards, you can motivate people to do what you need them to do.”  Motivate people to do what you need them to do- a more proactive and involving way of understanding risk, and by extension, developing product and pricing.

I reached out to a very knowledgeable colleague, Thomas Verduzco-Weisel of Shift Technology.  In addition to his role with Shift Thomas is an industry expert in Esports activities (see Force of Disruption GmbH ) and gamification.  Thomas noted that the basis of effective gamification of the insurance industry approach includes:

  • Getting the customer engaged in risk awareness
  • Create an experience that is appealing
  • Build an environment of fun or competition within the engagement
  • Build more meaningful interactions where there currently is little or none

It’s a new approach that moves the insurance ‘game’ away from a Nash Equilibrium, isn’t it?  Building choices that are potentially imbalanced to encourage interactions that provide on average more benefit to both the insured and insurer as opposed to a null outcome, or worse, negative outcome from mistrust.

A clear example of a gamification environment result is the ecosystem environment, where purchasers of service A have exposure to easy access to service B and C, and product D.  Can a similar effect be had from auto telematics, for example?  IoT expert Matteo Carbone of the IoT Observatory has supported this effect in many presentations, where value addition not only can positively affect policy/premium and carrier risk decisions, but can be had from complementary services (road service or maintenance, for example) made available through informal ecosystems.

Can insured engagement be fruitful in other examples?  Consider driver training sponsored by carriers using VR methods, where simulation devices are used to show drivers the reality of their methods, or aid new drivers in skill adoption.  Driver ed courses provide insurance discounts now, why not the same with digital education methods?  Or in terms of dwelling IoT devices, what of building points based on regular monitoring of the installed sensors?  A recent case involving an air conditioning compressor that failed might have either been less costly or possibly a non-event if an IoT device had been installed and monitored.  Few homeowners want to have issues or file claims, and all carriers want to limit frequency and severity of claims.  Bilateral gamification benefits.

Moving the insurance industry away from underwriting probability from economic game theory, into robust data acquisition that is equally available to both parties to the contract, and into post-purchase engagement where risk factors are mutually monitored to reduce the cost of risk management.  Working from the customer’s needs backwards, to the benefit of all.  #innovationfromthecustomerbackwards

Quite a game, one might say.  And even John Nash would be comfortable that the new equilibrium is the #newinsurancebalance.

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