Trust and transparency are like aliens to the insurance industry, largely due to the information asymmetry between insurance carriers, insurance intermediaries and customers. On the customer end, this mistrust is so severe that global customers find the banking industry (among others) to be more trustworthy, according to a study from Ernst and Young.
A new entrant called Lemonade, offering homeowners and renters insurance, is trying to change up the industry’s misalignment of incentives towards customers. Unlike traditional insurers which profit by keeping the money they don’t pay out in claims, Lemonade operates differently. From customers’ monthly payments, Lemonade gears 20% towards a rainy-day fund, 20% towards reinsurance (insurance that insurance companies acquire through partnerships in order to cover bad years), and 40% towards “Giveback”.
It works like this: when customers sign up for a policy, they’re asked to pick a charity, and are then grouped with other policyholders who’ve elected the same one. Any claims are first taken out of the Giveback pool, with the hope that money will be left over to go towards the chosen charity. Should the group’s claims exceed 40% of their collective premiums, money is then pulled from the rainy-day fund, and as a last resort, covered by reinsurance. Irrespective of claims, Lemonade takes a 20% fixed from customers’ monthly payments to cover operational expenses, and of course, profits.
Just three years old, Lemonade’s new way of approaching trust and transparency has caught the ear of many in the industry. Can Lemonade disrupt traditional insurance carriers? We put it to the test with six questions for identifying disruption.
1. Does it target people whose only alternative is to buy nothing at all (nonconsumers) or who are overserved by existing offerings in the market?
Yes. Lemonade is targeting nonconsumers who have never felt compelled to purchase renters insurance prior to Lemonade. Recognizing that its target base is young (82% are 25-44 years old) and presumably tech savvy, Lemonade isn’t conforming to the use of sales teams and agents as a customer acquisition strategy. Instead, it is relying on the internet to reach its young customers.
This preference for digital engagement is also reflected in how Lemonade works with customers once they’ve joined its service. Traditional insurance carriers often provide significant hand holding. Whether it be through their in-house sales teams, or their brokers and agents, someone is available to help customers through every decision and claim. Lemonade, however, is targeting customers who are comfortable giving up these bells and whistles, and may even prefer navigating things on their own.
2. Is the offering not as good as existing offerings as judged by historical measures of performance?
Yes. Industry leaders tend to offer multiple forms of insurance in a discounted, bundled package, allowing customers to make a single monthly payment for most of their insurance needs. Lemonade only offers homeowners and renters insurance. Moreover, it lacks the human touch provided by traditional carriers, instead requiring customers to select their policies and submit their claims with help from a chat bot (and by working with a small claim adjuster team in the event of more complex claims).
3. Is the innovation simpler to use, more convenient, or more affordable than existing offerings?
Yes. Signing up and engaging with insurance carriers is often a laborious process for customers. Typically, when customers want to customize their policies by changing a deductible, adding valuables, or adjusting coverage amounts, they must contact an insurance intermediary or customer care to do it for them. In some cases, they may even be charged for the interaction. Lemonade has automated this process. Through its “LivePolicy,” customers are empowered to customize policies on their own via the mobile app.
It is difficult to assess, however, whether Lemonade’s policies are more affordable than those offered by incumbents. That’s because these traditional carriers can bundle multiple lines of insurance (auto, home, renters) into a single package for a fixed price, whereas Lemonade only offers homeowners and renters insurance.
4. Does the offering have a technology that enables it to improve and move upmarket?
Maybe. For Lemonade to move upmarket it will need to offer multiple lines of insurance. But before it can do that it must scale to reach profitability. Two technologies it’s employing may help: Lemonade’s use of machine learning, and its API platform.
Lemonade uses machine-learning technology in the form of chat bots to engage customers. Rather than hire more sales teams, agents and brokers to acquire and engage more customers, Lemonade’s use of the technology, in this way, may allow it to scale without spending as much as it currently does per customer.
In addition, Lemonade is leveraging machine learning to better assess risk. Traditional insurance carriers use only 40 data points to assess risk and determine their customers’ premiums. Machine learning enables Lemonade to leverage 4000 data points. Accurately assessing risk in this manner should help ensure that the insurtech earns enough in customer premiums to cover its costs and claims, thus positioning it to scale.
Lastly, it’s possible that Lemonade’s API platform could help it achieve scale. For the uninitiated, APIs are software interfaces that enable the exchange of data with third-party apps and services. By making its API platform available to third-party vendors such as home security providers and real estate marketplaces, these vendors may embed Lemonade insurance into their existing offerings, thus enabling Lemonade to reach more customers.
5. Is the technology paired with an innovative business model that allows it to be sustainable?
TBD. Lemonade’s business model is not yet profitable, however some of the company’s early moves indicate that it could be.
As discussed, Lemonade’s ability to reach profitability hinges on its ability to scale. In addition to its use of technology, other aspects of its business model may help in this endeavor. While Lemonade is currently spending heavily on digital advertising to reach nonconsumers, these early costs may come down, proportionally, as Lemonade builds trust with its customers and gains widespread recognition. If customers trust Lemonade, the thinking goes, they will bring more customers through “word of mouth”.
Lemonade is also fostering trust in order to reduce churn rates and incentivize honest behavior. By being transparent in its financial model, Lemonade hopes to limit the likelihood of customers leaving Lemonade for other carriers. Furthermore, Lemonade is applying principles of behavioral science to lessen the likelihood of customer fraud—an issue that’s regrettably common and leads to reduced profits. Through its Giveback program, Lemonade discourages dishonesty from customers who understand that lying on their claims will pull money away from a worthy charity, rather than a faceless insurance company. And, at the start of every claims process, customers are required to sign a digital pledge of honesty and record a video to explain the loss before submitting the claim.
6. Are existing providers motivated to ignore the new innovation and not feel threatened by it at the outset?
No. Traditional carriers like Geico, State Farm, and Liberty Mutual are already copying certain aspects of Lemonade’s model by targeting millennials, giving customers the option to “go digital,” highlighting social impact, and mimicking Lemonade’s policies. In fact, Lemonade published an entry in its blog on this very subject.
In addition, international insurance giant Allianz has made a strategic investment in Lemonade. It’s possible that Allianz may leverage the newcomer’s products and user interface to improve its existing service, effectively using these aspects as a sustaining innovation.
However, Lemonade’s approach to fixing operational expenses and working backwards for profits will be challenging for incumbents to replicate due to their existing cost structures and legacy systems. For this reason, Lemonade’s model seems to be promising. If it is able to scale and gain considerable market share in the industry, incumbents who haven’t invested in the insurtech will face hard times.