It has been said that complacency in financial services has created an opportunity for disruption by start-ups. And that ‘business as usual’ is the death spiral for legacy organizations … no matter what industry, and no matter what size organization. We see this cultural challenge in all financial services categories, and in all types of organizations.
We have seen that innovative firms change their business models, products and services before it is required, usually expanding beyond traditional comfort zones. The traditional model of avoiding risks must be put into context with the need to change as the marketplace changes. Clayton Christensen has a great quote on this principle,
“It’s not incompetence, but competence, that causes companies to be disrupted. That applies to big companies and small, as well as people too.”
– Clayton Christensen
When I first heard about a well-funded insurtech in stealth mode that planned to reinvent the insurance business model and to disrupt the 3.5 trillion USD global insurance industry – well, I was a little skeptical. But then I saw Lemonade demonstrate their artificial intelligence fueled sales and claims process for their renters and home insurance on YouTube. Frankly, I was blown away. A few swipes and typed information after the download later, the customer would be insured – no agent, no paperwork, no hassle. Pure convenience.
A Radical Customer-Centric Sales and Claims Process
Having worked in sales and process-optimization projects in Germany’s largest insurance company, it was clear to me that Lemonade, regardless of its future success as a company, had changed the global insurance industry forever. First, Lemonade showed that it’s technically possible to build a radically customer-centric sales and claims process.
Lemonade demonstrated with a live product that the use of chat-bots, artificial intelligence and big data analysis can be implemented in the core of the insurance industry business model. Furthermore, it provides the customers with “instant everything and killer prices” in one of the most regulated places on earth: New York City. Traditional insurance companies can no longer claim that such products and services can’t be provided, or that old processes have to be followed. Lemonade deconstructed that myth for good.
However, the radically customer-centric sales and claims process is – in my opinion – not even the most disruptive aspect of the Lemonade business model. Lemonade Inc. improves existing processes in an amazing way, but does not reach a different level. In fact, traditional insurers could catch up by investing wisely in agile, proactive, visionary and hands-on digitalization units, independent of their old corporate core.
The true disruption may come from one strategic decision by Daniel Schreiber, Shai Wininger and Dan Ariely: They killed the combined ratio. The founders of Lemonade Inc. have waived this very profitable source of income, resulting in a wholly new business model.
The Combined Ratio as a Source of Considerable Profit
The combined ratio is a KPI that describes the difference between the total insurance premiums collected by an insurer and the total amount returned to the customers due to claims. Normally, insurers try to pay out less in claims than is collected in premiums. The difference has an immediate effect on the profitability of the insurance company – in some cases billions of USD. In one interview, Lemonade-CEO Daniel Schreiber argued: “Insurance companies make money every time they decline a claim. At the end of the day, when you’re demanding money from an insurance company, every dollar they can avoid paying you drops to their bottom line. You end up with a business model where there’s a conflict of interest at the very core of the sector.”
Lemonade refuses to accept profit from the combined ratio. Instead of adding the profit to their bottom line, they donate the money to charities (here’s a great blog post by Lemonade’s Jim Hageman about this). The customer even can co-decide which charity receives the donation.
Consequences for the Insurance Industry
Studies of EY or Accenture indicate that many customers don’t trust their insurance to pay claims. If a new product of a new company enters the market without that conflict of interest, the impact could be enormous. Customers could switch in large numbers to the product they could trust.
In the long term, this could trigger a discussion about the core role of the combined ratio in the current insurance model. Large insurances may need to change their product lines, refraining from using a positive combined ratio to boost their profitability, because customer behavior and customer demands change. This would put tremendous pressure on the other pillars of profitability: the efficiency of internal processes and the sales channels. Considering the maturity of most insurance markets in the Western world, the loss of profitability probably could not be compensated for with moderate restructuring or an uplift of sales, perhaps causing distress in some industry sectors. As Victor Hugo once said, “Nothing is stronger than an idea whose time has come.”
Most insurance companies currently need tremendous resources to modernize their technical, organizational and cultural legacy systems, and at the same time build customer relationship and claims tools that can keep up with the customer experience that Lemonade or other tech-companies offer.
From Problems to Possibilities
For some of the smaller or slower insurance companies, this challenge could be too great. However, there is tremendous potential in combining artificial intelligence, big data analysis and customer-centric products and services with a large company’s century-plus of experience and data. First and second movers could use this challenge as a tremendous opportunity.
In conclusion, I wanted to underline that – for me – the disruptive potential of Lemonade lies not only in their beautiful user interfaces, impressive artificial intelligence and big data use but in the explosive power of killing the combined ratio.