Everything one needs to know about insurance I learned back in 2004, when I spent 3 weeks interviewing dozens of employees and executives of a small insurance company in Chartres, France.
To sum it up, there’s the cash an insurance company brings in by billing premiums to its customers. And there’s the cash it sends out when one of those customers claims money because they’re confronted with a loss. The company profits only if the total amount of premiums is higher than the total amount of claims over a long period of time.
Therefore the fundamental law of insurance is that you can never be sure about your business’s profits and losses so long as customers can claim money from you. It’s easy to bring in more customers and cash premiums over the short term. But you can lose all that money (and more) if those customers experience losses that you’re obliged to cover over the long term. This is why every insurer has to be selective when bringing in new customers. It’s fair to say that selection is the core business of an insurer.
Like every industry, insurance is being radically impacted by the digital transition and the related deformation of the industry’s value chain:
New entrants are bursting into the bottom of the value chain, in direct contact with the end customers. That’s the position from which they’re able to collect large amounts of data and generate powerful network effects, thus taking over the entire industry. In insurance, these are digital marketplaces as well as various tech companies providing insurance products—like can be seen with travel, car rental, or platforms such as Airbnb, BlaBlaCar, and Tesla.
A significant part of the value in the industry is retained at the top of the chain. It’s at the top that the raw material that makes it possible for the entire industry to exist is extracted. In insurance, which is a part of the financial services industry, that raw material is capital. I know that there is an excess of capital these days, but still, are among those who have a good chance to survive the transition in the insurance industry.
The situation is harder for large companies dominating in the middle of the chain. In insurance, these are the insurance and reinsurance companies that were used to dominating their industry because they controlled strategic assets: the balance sheet that makes it possible to operate as well as the agreements granted by government authorities. In the past, having those two things was enough to dominate the industry. But it's clearly not enough anymore, and competitive pressure as well as tougher prudential regulation are putting some legacy players into serious trouble.
Why is it so hard for insurance companies to reposition themselves where today’s value is—that is, close to the end consumers? There are many obstacles. Selling insurance policies is clearly not an insurer's strength, as they’ve long outsourced that to insurance agents and brokers. Above all, it’s difficult to provide your customers with an exceptional experience, as all tech companies do, when your main obsession is making sure the ones who most need help eventually find their way out of your customer base (something that, by the way, is made easier by the abundance of data).
Fortunately for insurance companies, there’s more in the transition than the mere deformation of their value chain. The market is also changing as the digital transition brings about new "jobs to be done" that traditional players could learn to do in order to reposition themselves closer to their customers.
In particular, as I argue in Chapter 11 of my new book Hedge, I think that in the current Entrepreneurial Age the market can take over insurance mechanisms that were previously operated by the state and do the job in a fairer and more effective way:
“State intervention in insurance was originally developed in certain sectors such as healthcare and agriculture to protect individuals against the most critical risks: professional hazard, old age and illness for employees; illness and crop loss for farmers. Because those risks were so critical, it was worth it to deploy the complex mechanism of pooling resources, imposing constraining rules such as a mandate and forbidding selection, and adequately compensating those confronted with a loss. But today technology makes it easier to incentivize the market towards an approach resembling social insurance, this time without the top-down, one-size-fits-all approach.”
Fort those who haven’t read Hedge yet, I admit this is an idea that requires a large context that is best found in the book itself. I’m not making the case that the market is always better than the state when it comes to covering risks. I’m also not saying that there wouldn’t need to be any mechanisms in place to regulate how a new insurance market would work. What I’m convinced of, however, is that technology makes it possible to design a market-based insurance business that fulfills all the needs of what we used to see as social insurance: covering everyone; not selecting customers based on their risk profile; affordable for the vast majority, not the few; and providing access to high quality care whenever and wherever you need it.
In other words, it would be the Amazon of insurance rather than an insurance company obsessed with serving as few customers as possible. And , it seems that Amazon is working on precisely that in partnership with Berkshire Hathaway and JPMorgan. But as we don’t know much about that initiative yet, here are a few broader readings on insurance and better covering risks in the Entrepreneurial Age:
Data open doors to financial innovation (Richard Waters, The Financial Times, December 2012)
The End of Asymmetric Information (Alex Tabarrok and Tyler Cowen, Cato Institute, April 2015)
Tech’s Next Big Legal Clash Will Be Over Selling Insurance (Issie Lapowsky, Wired, July 2015)
Microinsurance Is The Answer To The Insurance Industry (Raj Ramanand, TechCrunch, December 2015)
The Next Billion-Dollar Insurer (Jay Farber, TechCrunch, February 2016)
Insurance sector worried as insurtech start-ups cosy up to customers (Oliver Ralph, The Financial Times, October 2016)
Insurance policy: How an industry shifted from protecting patients to seeking profit (Elisabeth Rosenthal, Stanford Medicine, Spring 2017)
How to fix the welfare state for the entrepreneurial age (me, The Financial Times, May 2017)
Thoughts on Insurance (Aaron Harris, Y Combinator Blog, June 2017)
Platform Business Models Are Transforming Insurance (Sangeet Paul Choudary, Pipes to Platforms, December 2017)
The Decline of Life Insurance Is a Mystery (Peter R. Orszag, Bloomberg, February 2018)
Whose Data, Which Commons, What Tragedy? (John Battelle, NewCo, July 2018)
If you want to learn more about the new challenges of covering social risks, you should buy and read my book Hedge: A Greater Safety Net for the Entrepreneurial Age. We've had readers buying the book across the globe, from the US to Italy to Hong Kong to Australia, and are hoping to keep pushing the message forward. So get yours today and spread the word 😘! Simply follow the relevant link, depending on where you are: 🇺🇸US, 🇬🇧UK, 🇫🇷FR, 🇩🇪DE, 🇮🇹IT, 🇪🇸ES.
Best regards (from Normandy, France),