The next BIG WIN in the Insurance sector: Future of Insurance through Business Model Innovation

In case you haven’t followed my last article, you can read it here – Insurance Industry Conundrum – to ensure a better connect with this article. Thank you??)

We’ll continue from where we left off and try to understand how insurance firms have till now alleviated and how they can further alleviate the various concerns arising from the traditional business model!

The traditional business model suffers from the following problems –

1.     Extremely low customer trust in the system

Information asymmetry around claims acceptance and processing coupled with customers’ belief that an insurance firm makes money by denying their claims has led to extreme distrust in the system.

The high levels of distrust in the system have led to the following –

Poor Customer Retention

Insurance firms proudly make claims of having 85 – 90% customer retention rates per year, on an average, however, this figure is extremely misleading and doesn’t account for the true customer sentiment. Here’s why –

An insurance firm celebrating an 85% retention rate per year is equivalent to a property broker proudly stating that 85% of the tenants stick or adhere to the broker’s contract for the year. Given that the most insurance plans are annually subscribed (just like our rental agreements are of 11 months), it is but obvious that the customer retention rates will be closer to 100%.

If we look at the ‘celebrated’ 85% annual customer retention rate now through this angle, these claims surely look surprising and don’t reflect well on the industry! So what should we look at to capture the true customer sentiment?

Instead, we should look at customer retention rates over a period of 2-3 years, this metric would be a true reflection of the actual customer behaviour (understanding the level / scope of customer distrust). When looked at a 2 to 3-year timeframe, we see that, on an average, an insurance firm sees about 40 – 50% customer defection (churn-rate) to competitors.

We can also safely assume that of the remaining 50 – 60% customers that don’t churn a decent % of customers are those that have to stick with an insurance provider because of their firm’s tie-up with a particular insurance firm. Therefore, had they been independent employees, there’s a very high chance that these customers would have defected to another insurance firm as well.

Extremely high Customer Acquisition Costs (CAC)

The insurance industry has the highest customer acquisition costs of any industry. It is 7 – 9 times more costly for an insurance firm to attract a new customer than to retain one.

Customer referrals show immense positive income statement effects since for these customers CAC = Rs 0 and 25% of such customers stick for 3 years organically i.e. with minimal / 0 marketing spend, however the existing customer distrust with the traditional business model makes it very difficult to create a lovable relationship with a customer.

High levels of Claim Embellishment and Fraud

The high level of distrust makes the customers want to get back to the firm and hurt the insurance firm, which they do by embellishing or falsifying claims.

2.     High expense ratio

The traditional business model hinges on lots and lots of middlemen / insurance-brokers to sell insurance. The over-reliance on middlemen for selling insurance plans sucks up a good amount of an otherwise fully available corpus.

This leads to a big reduction in the profit-generating capacity of the firm owing to high salary and incentive-based cost-burden on the firm, without any salary or incentive component linked with customer retention.

Additionally, having a lot of employees also requires physical infrastructure to house them. This creates an asset lock since once an office and culture are established it’s very difficult for a firm to change these elements for optimization.

Shifting to a new smaller office, changing the culture of an insurance firm that employs ~10k people, on an average, or even reducing the headcount of the firm either involves a large amount of investment and/ or hurts the top-line of the firm (revenue scale) since most of the business is through legacy customers or through physical plan selling.

This asset lock further adds to the cost burden in terms of high variable costs for the firm w.r.t rent, electricity, PF etc.

3.     High incurred claims ratio

Lack of data capture and low / no focus on using data analytics to understand / predict patient behaviour, no impetus on maintaining the risk profile of the onboarded customers, and no emphasis on helping patients maintain their health makes an insurance firm susceptible towards incurring a high claims ratio.

A high incurred claims ratio figure implies that the firm has less corpus available at its disposal for further investments thereby directly affecting the profit-making capacity of the firm.

4.     Full industry focus on targeting only one customer segment

All the insurance firms create and curate their offerings only for those segments of the Tier-1 urban population that have a high paying capacity since insurance firms want to ensure timely insurance payments made to them.

This has caused excessive crowding in the targeted market segment, which has led to intensive competition. The intensive competition makes it nearly impossible for insurance firms that follow the traditional business model to either have a unique selling proposition or to even enjoy 1st mover advantage in case of a new offering for too long.

Hence, the Tier-1 urban population market has become a red ocean market (synonymous with extreme cut-throat competition in the market) with the traditional business model.

All these factors contribute negatively towards the income statement and hence firms that can alleviate concerns around each factor will create unique market value to capture more and more customers.

Limited Innovations in the Insurance space: A chronology

Having said that, over the years since the internet boom, there have been efforts made by technology-driven firms to alleviate the above concerns, to a limited extent though, through phased business model innovations.

These limited innovations have been implemented in 3 phases (Each phase builds over the last phase) –

Phase 1: Controlling / Reducing the Expense Ratio

Through the advent of the internet and its increased adoption throughout the country, insurance firms with an online heavy focus (as opposed to the traditional offline based selling) thronged up. E.g. - Policybazaar.

These firms were able to heavily reduce the over-reliance on middlemen and instead focused on a much more cost-effective web-based insurance selling. This decrease in Expense Ratio led to a decent increase in the available corpus.

Phase 2: Controlling / Reducing the Incurred Claims Ratio

Due to enough streamlined data capture in Phase-1, insurance firms were able to use data analytics to better manage the risk profile of their customers. The risk score generated for each customer was used to charge appropriate premiums from the customers (optimize premium pricing models).

Optimally priced premiums along with customer risk management (i.e. onboarding only those customers having a risk score lower than the firm defined threshold) helped in the reduction of Incurred Claims Ratio.

Additionally, because of customer education achieved through Phase-1 and with greater internet penetration, the customer onboarding process was improved, fastened, and made organic (customer self-driven as opposed to middlemen driven to a larger part).

This reduced lead time (customer on-boarding time to an insurance plan) owing to customer education coupled with targeted marketing based on risk score led to some reduction in customer acquisition costs. This decrease in the Incurred Claims Ratio and Customer Acquisition Costs further led to an increase in the available corpus.

Phase 3: Improving Customer Retention

Case in point: Healthcare Insurance

To reduce customer defection to competitors that were either undercutting the price on the premium or providing better claim handling services, insurance firms came up with unique offerings –

• Providing extra insurance coverage for disease profiles earlier not covered in the generic insurance plans. Disease profiles belonging to Dental, Mental (recently started) etc. were covered on top of pre-existing diseases
• Increasing hospital coverage to ensure that customers could avail insurance at any hospital without worrying about any per day minimum spending restriction (Some Insurance plans are also doing away with a minimum 1-day hospital stay requirement as a criterion to avail claim)
• Premium rollbacks for critical diseases: To retain customers, insurance firms started luring customers with the option of returning back premiums in case the customer doesn’t claim insurance for the plan period

Having said that, phase-3 implementation though intended towards winning over the customer trust has instead made things worse for the insurance industry in terms of increasing customer distrust.

A fancy trap: Return of Premium Plans (Premium rollbacks) are priced 2-3x of the normal plans, and the only difference they have w.r.t a normal plan is that premiums are returned in case no-claims are made for the term period.

If we do simple math, investing the additional premium amount in an FD would give us much more returns and hence reinforces the fact that insurance firms are out there to game the customer and only make money out of them.

The 3 phased innovation in the insurance space though has alleviated some concerns around high expense ratio, high incurred claims ratio and customer retention. However, customer distrust, claims embellishment and fraud, and over-focus on 1 customer segment concerns still remain at large.

Enter Lemonade, Inc.: Business Model Innovation – A much-needed shift away from the traditional model

So what is Lemonade’s business model that makes it worthy enough to disrupt the entire insurance industry?

Lemonade Inc.’s (US-based firm) concept is simple – They want to remove the information asymmetry that exists between a traditionally run insurance firm and its customers so as to create a highly trustworthy brand!

Lemonade’s business model – Flat fee structure + Instant No-questions asked claim processing + Give-back program

• 25% of the corpus (net aggregated premiums collected from all the customers) would be retained by the firm as direct income / profits in the form of a flat fee. The remaining pool – 75% of net aggregated premiums collected from all the customers – would be used to settle customer claims
• Give-back program: The corpus amount that goes unclaimed / unused from the 75% aggregated premium pool, if any, is not retained by the firm but instead is donated to a charity of the customer’s choice
• 100% AI-bot based insurance plan selling with minimal paperwork – It takes less than 2 minutes to sign-up
• Instant no-questions-asked claims processing: 50% of the raised claims are settled within 2-3 minutes

This looks fascinating in theory, but what levers are Lemonade pulling to bring about such a drastic change in the insurance industry? How does the business model work at its core? 

Let’s try to dissect the strategy behind this too good to be a true business model

Lemonade’s business model is hinged on Behavioral economics and Data Analytics

Flat fee structure (25% of the corpus) + Remaining 75% corpus to be used to settling claims

How does Lemonade ensure that it doesn’t deny anyone’s claims?

On average, insurance firms try to incur a claims ratio in the range of 70 – 75% to maintain enough corpus with them for investment. This indirectly means that a healthy insurance firm tries to keep a 25 – 30% margin for their operations.

The 25% flat fee structure is a very smart way of maintaining the 75% claims ratio as is present in the traditional business model since keeping a 25% flat see ensures that the maximum Incurred Claims Ratio would be 75%.

But how does Lemonade ensure that the maximum Incurred Claims Ratio would be ~75%? It does so by –

100% AI-bot based insurance – High pedigree of Data Analytics

A traditional insurance firm captures a limited number of data-points in order to determine the risk of the customer, if at all, for appropriate premium pricing.

Lemonade goes beyond that and apart from capturing data-points that a traditional insurance firm captures, it gathers 100s of additional data points that help it in creating an extremely accurate premium pricing plan. While signing up on its website, Lemonade’s very humanified AI, called Maya, asks you to fill an interactive survey (which is not boring), the results of which are used to determine the risk score of an individual.

For e.g. – While signing up a user for home fire insurance, it captures data points such as the age of the building, number of occupants in the house, number of houses in the vicinity, how frequently does construction occur etc. to create a digital image of an individual.

The back-end proprietary Machine Learning (ML) models are used to help predict the risk and hence appropriate premiums for the customer.

Extremely low Expense Ratio

With a strong data analytics base, Lemonade doesn’t hinge on middlemen for its operations –

Operations during Insurance sign-up: 100% AI-based, completely free from middlemen

Operations during Claims processing: 50% AI-based + 50% Human Interaction

The insurance sign-up process is completely free of middlemen and hence the firm saves a lot of money that otherwise would have gone in salaries and commissions.

Similarly, 50-50 AI-Human interaction split during claims processing serves 2 purposes –

AI-based processing: Approximately 50% of the claims are processed within 2-3 minutes

On average, ~50% of the incoming claims are genuine. The ML model again confirms the ‘genuineness’ of the raised claims and if found genuine (which ~50% of them are), the claims are processed within 2-3 minutes.

This serves dual purposes of increased customer satisfaction owing to fast, hassle-free claim processing and cost-reduction since no employee is required to process 50% of the incoming claims.

Human Interaction: Controlling fraud and embellishment and making the ML model even more robust

The remaining raised claims have high elements of fraud linked to them, in general. Hence, investigation agencies / employees are needed to confirm the validity of these claims before they are processed.

The investigation agencies / employees though add to the cost component, however, claims parameters observed in such cases are fed back into the ML model to increase its accuracy for future anomaly detection.

As the ML model becomes more and more robust, the reliance on investigation agencies / employees would further go down thereby further reducing the operating costs of the firm.

So is the flat-fee structure only a marketing / communication gimmick or does it do something else?

The other aim of the flat-fee structure is to increase customer trust and increase customer retention

Flat-fee structure changes the incentives for both the firm and its customer (Behavioral economics)

The firm has no incentive to not process claims since it already has the flat fee and the remaining unclaimed amount again is not kept by the firm but instead donated to a charity of an individual’s choice.

The information symmetry around the flat fee (customers know there’s no other way the firm earns money) brings out the best behaviour from individuals. Since the customers realize that the new business model is not here to cheat them and make money off them, there’s low motivation to embellish / falsify claims.

Additionally, the customers know that embellishing claims in this new business model is not going to hurt the company but instead hurt the charity of their own choice. Additionally, this new business model has a ‘values’ component attached to it. This helps add a personal / social cause to the overall firm and improves the customers’ association with the brand.

This increases the customer stickiness with the firm (increasing customer retention) and helps build a trust-worthy brand.

Having said that, Lemonade has incorporated innovative measures to control embellishment / fraud

These innovative measures are based on core behavioural economic principles!

Before providing details of the claim, an individual has to sign a declaration right at the start stating that he / she is providing the correct details, with the caveat that fabricating lies would directly lead to charity not receiving money. This creates an incentive for an individual to not cheat since cheating would mean compromising the social cause.

Lemonade also provided the option to customers to upload claims using video by recording themselves. While the base for the video-based claims uploading feature is to fast-track claims processing it serves a much deeper purpose.

People tend to cheat much less when they see themselves directly doing the task i.e. seeing yourself getting recorded reduces the temptation to cheat and brings out the best behaviour (Read the candy-mirror experiment).

Do you think Lemonade’s business model can be replicated in India? What challenges can this model expect in India?

Lemonade’s strong business model innovation has alleviated major concerns around high expense ratio, high incurred claims ratio, customer retention, customer distrust, and claims embellishment and fraud. However, the issue of over-focus on 1 customer segment still remains at large.

How else can Indian Insurance firms capture the market value and build / maintain customer trust?

We will be expanding on this by considering the Indian healthcare industry as a case in point.

Tapping into Tier-2 and Tier-3 market

Why tap the Tier-2 and Tier-3 market?

The next big disruption would be brought about by a firm that is successfully able to capture the immense scale (details below) that the Tier-2 and 3 markets provide either through a unique offering and / or by moving first into the market.

Even a 20% coverage of a Tier-2 and Tier-3 sub-segment of low-income households can create an ET-100 firm of its own.

However, given the notion around insurance being an expense and with customers in Tier-2 and Tier-3 markets being price-sensitive how can a firm position itself to cover this market?

The answer is by setting the base for insurance not as a spend but as a money-saving enabler – How can a firm do that?

Directly trying to sell an insurance plan to these customers wouldn’t be that beneficial because of customer’s inherent distrust in the system coupled with the notion of ‘insurance as an expense’.

The average household expenditure on healthcare is increasing year-on-year. Approximately, 60-70% of the healthcare out-of-pocket expense can be attributed to medicinal supplies.

An insurance firm can hence create a winning proposition by helping customers in the Tier-2 and Tier-3 markets with sourcing and delivering generic alternatives for otherwise costly drugs to create a trust-worthy brand (obviously doing this won’t be a mean feat given the doctor-pharma firm nexus, and linked pharmacy incentives)

What benefits would this entail?

• High trust with the firm right at the start: Customers will know that the firm is here to help
• Reduced customer acquisition costs for future insurance selling: Word-of-mouth travels very fast in these markets
• High customer retention
• Data capture opportunity to understand health patterns thereby providing a base for optimally deciding premiums and curating customizable insurance plans

An insurance firm after depicting the cost-benefits of providing generic medicines can then use it as a base to introduce insurance plans in the market later.

Increasing personalization / customization in providing insurance and focus on healthcare and not sick care

Insurance firms can further create unique value for the customers by –

• Giving customers the ability to curate their own plans: Each and every person is susceptible to different kind of diseases, and hence customers should be able to optimize their insurance plan
• Focusing on the total physical and mental well-being of a person, the firm would be able to control both the disease incidence and also control the claims ratio thereby creating a win-win scenario for both the involved parties
• The shift from sick-care to health-care: Incentivizing customers to maintain their health by introducing compulsory Ayurveda. Ayurveda would be provided as a basic add-on to each onboarded customer to ensure not only that long-term medicinal benefits are maintained but also that processing costs per customer are lowered
• Providing individuals with the option to select certain time based – such as weekly, monthly, yearly – and disease-based add-ons. Add-ons will ensure increased corpus while also ensure low claims since the smaller the time period the lower the probability of getting sick. E.g. Customers can buy 2-month dengue insurance during the rainy season to safeguard themselves from water-borne diseases, similar plans can be taken for physiotherapy, dieticians etc.

Helping hospital with their operations

With enough data capture from processing claims and understanding the patient population gives the Insurance firms an opportunity to monetize this data by providing consulting services to hospitals.

Providing details around patient flow, doctor-burden on different diseases area, bed occupancy rates (and their prediction month-over-month) helps a hospital to manage operations better thereby creating a winning proposition for both hospitals and insurance firms.

Are there other ways through which insurance firms can capture the market value? What would they look like? Let's comment and discuss!

References -

1. Customer retention rate information – https://www.iiadallas.org/page/75
2. Lemonade Business Model – Excerpts from an interview involving Lemonade, Inc.
3. Lemonade snapshots – Lemonade website
4. Tier-2 and Tier-3 market assessment – A good chunk of 5.5-10 lakh population works with bigger private players, which already provide group insurance. Low earning Business owners and 2-5.5 Lakh earning population have very low coverage
5. Tier-2 and Tier-3 market assessment – https://www.livemint.com/Politics/5eDYPGMword7Lx6sitUR3L/Are-singleearner-families-different-from-others.html