P2P Insurance: Tricky social risks in need of bespoke regulation

     

Peer-to-peer (“P2P”) lending has been gaining pace in banking since Zopa was launched in the UK in 2004.  Lending Club and Funding Circle are some of the other household names for US retail and SME respectively.

It’s no surprise, therefore, that P2P has also emerged as a concept in insurance over recent years.  Friendsurance is arguably the best known European P2P insurance name, with several others recently appearing, for example Hey Guevara, Inspeer and Lemonade.

But to what extent is P2P a homogenous concept across insurance and lending?  In this article, we argue that P2P insurance and P2P lending are similar in name only, and P2P insurance creates some tricky social risks.

First, let’s consider how P2P lending works.  Broadly speaking, an investor deposits a sum of money with the P2P lender.  This sum is then broken up and lent out to borrowers.  Normally any one investor would only have a very small exposure to any one borrower.

There is no single, established model in insurance yet, but the concept is something like this: a number of insureds, perhaps a group of friends, pay into a common pool and that pool covers losses up to a certain amount.  Any losses in excess of the pool are covered by reinsurance-like structures.

In other words, P2P insurance is essentially taking insurance back from being a large, anonymous pool of risk to a modern-day version of Edward Lloyd’s coffee shop, where a small group of people shares risk.

The argument goes that this “personalization” of insurance is good for insureds.  Fraud is reduced, claims frequency is reduced, premiums are reduced.  What’s not to like?

There are two things not to like and both relate to what happens if someone does actually have a legitimate claim.

First of all, the “micro” social risk.  Let us assume that the group self-administers claims.  (If this were not true, then it is difficult to see how different the P2P model would be to the standard model, and any cost advantage would be significantly eroded.)  Who will decide if a claim is valid?  Is there a disincentive for the group to accept a claim?  Are people with a valid claim reluctant to notify it because they are worried about their social relations?

There is also a long term financial risk for members of the group.  As the pool is much smaller than that of a traditional insurance company, the long term premium volatility for each member must be much greater, and premiums could, in theory, become higher than those a traditional company could offer.

Second, there is a “macro” social risk.  Let us assume that the risks above are overcome in some way or other and P2P insurance becomes the market standard.  This reduces the amount of risk pooling in society as “good risks” (possibly richer people) extract themselves into private risk pools.  One could even argue that it might fall foul of the EU’s gender-neutral pricing requirements if a group of men pays less than their spouses in another group.  The US equivalent is redlining.  Whilst P2P insurance may be constructed with a way that is compliant with these rules (which were designed, of course, for the traditional insurance model), is this what society wants?

 

In summary, whilst P2P was created as a fairer alternative to the anonymous pool of traditional insurance companies, we see major challenges at both the individual and societal level.  We believe that this is an area that the industry and regulators should work together on early to identify some high level principles and ensure that P2P is a genuine force for good.

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Charlie is an alumnus of Oxbow Partners.

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