Peer-to-peer (P2P) insurance is one of the InsureTech trends to watch out for. Its proponents claim it will shake up the insurance industry and benefit policyholders (see this Infographic on 6 InsureTech Trends to Know to find out what else is disrupting the insurance industry).
If you're not familiar with the concept, it can seem obscure. But it's not an intimidating concept and I'm confident you'll understand the basics by the end of this article. So read on to find out how P2P works and what it might mean for your insurance coverage.
What Is P2P?
Even if you're not familiar with the term, you've probably used a few different services that run on a P2P model. Napster, LimeWire, Uber, and Airbnb are among the most familiar P2P platforms.
Although many people are only hearing about it now, it's a bit of an old concept. P2P first came about in the early days of the internet as a way of distributing computer resources by decentralizing storage and processing power. It's what made the file sharing service Napster so efficient and popular.
Napster and the P2P Model
Napster didn't invent music downloads. Before its arrival, internet users could visit websites that hosted music files and download songs of their choice. When Napster hit the scene in 1999, it provided an alternative to this direct download model. Instead of downloading music from a website, Napster users downloaded the files from each other. Most often, users would download a portion of each file from a series of users who had copies on their hard drive and were logged in to Napster.
What made Napster a P2P platform is this decentralization. Users did not download files from Napster, nor did the service host any music files of its own. Instead, it created a network that tapped into each user's computer resources, both in terms of storage space and the bandwidth required for uploads and downloads.
Rise of the P2P Economy
Napster became a hub for the illegal distribution of copyrighted music and was forced to shut down its operations in 2002 following a lawsuit. But the model it popularized gradually gave rise to a market driven by the same fundamental principles.
Companies like Uber and Airbnb use P2P technology to create decentralized business models where buyers and sellers use an online platform to interact directly with each other, instead of dealing with the companies or their representatives. The corporations supply the platform and some security and guarantees, but it is largely hands-off beyond that.
Major P2P services are reshaping the economy. So, it comes at no surprise that even the notoriously slow-moving insurance industry has taken notice and some cutting edge insurers are already offering or developing P2P insurance products.
How P2P Insurance Works
With conventional insurance, the insurance company acts an as intermediary that pools every policyholder's resources by collecting a premium from them. Then, it uses these funds to pay claims to those policyholders. It also performs the general administrative tasks involved in issuing policies and processing claims.
The insurance company, in other words, centralizes all of the resources used to maintain policies and pay out valid claims.
P2P insurance attempts to make insurance more efficient by decentralizing the role of the insurer and relies instead on the resources of a network of policyholders.
Early Hybrid P2P Prototypes
Early versions of this concept still involved insurance companies and were sometimes organized by insurance brokerages.
Essentially, groups of people who held similar insurance policies would band together and pay part of their premiums into a trust fund, with the remainder going to a traditional insurer (to see how this would work, check out Your Basic Guide to Trusts). Members of the group would then draw on the group fund to pay for claims that fell below the insurance policy's deductible (larger claims would simply be filed with the insurer and handled in the usual manner).
At the end of the policy period, any unused funds from the trust would be divided and returned to the group members.
Modern P2P Insurance
These proto-P2P arrangements were attractive, but the insurer still pocketed the bulk of the unclaimed premiums. But with modern technologies like the internet, smart contracts, and blockchain ledgers, networks of policyholders can eliminate or drastically reduce the role of the insurer.
Instead of dealing with an insurance company, individuals can band together to form a risk sharing network whose members can pool their money in the form of a membership fee or makeshift premium and use it to insure against a particular peril.
When a member of a P2P insurance network files a claim, money is withdrawn from the pool to pay for it. At the end of the year, any unused funds are divided and redistributed to the members.
As an additional safeguard, these P2P networks can purchase reinsurance. In that case, if the pooled funds are depleted and a member files a claim, the reinsurer pays it out (see An Intro to Reinsurance to learn more).
One of P2P insurance's biggest draws is the cost. Eliminating many of the functions played by an insurance company means lower administrative costs and overhead, which translates to lower premiums.
The ownership structure also keeps costs minimal. Since the policyholders control the organization, there is no profit motive beyond each individual hoping for a return of premium at the end of the policy period. With no profits funneled into salaries, bonuses, benefits, and corporate profits, the premium rate simply represents the amount required to ensure that the pool can handle the claims filed by the members.
Another major appeal of the P2P model is its transparency. Anyone who has dealt with an insurance company knows that the process is opaque at best. How much of your premium is used for administrative costs? Exactly how is your premium calculated? How much money does the company have available to pay for claims? With a P2P network, you don't have to wonder. The information is typically readily available and the processes are clear.
Drawbacks and Risks
P2P insurance is certainly attractive, but it isn't perfect. There are downsides to consider.
In my view, the biggest risk with P2P insurance has to do with underwriting. One of an insurance company's main jobs is to screen out applicants who are at a high risk of filing claims and draining the asset pool.
For P2P insurance to work well, decentralized groups need to find some way to do the work of underwriters, either with some in-house process or by using an external firm. Ensuring a healthy resource pool requires high risk applicants to either be screened out or be asked to contribute a higher premium according to their level of risk.
Regulation is another major issue. Insurance is a heavily regulated industry, with licensing schemes and stringent financial requirements. But it's not yet clear just how governments around the world will regulate P2P insurance networks. If the regulations are too stringent, it could stand in the way of the mainstream adoption of P2P insurance.
An Emerging Player
Companies like Friendsurance in Germany and Besure in Canada are already offering P2P coverage. If they can work out all the kinks, P2P insurance promises to really disrupt the insurance industry. It's bad news for traditional insurance companies, who are bound to see their operations shrink and their revenues drop if this model becomes widespread. But the picture is rosier for policyholders. Making insurance lean could translate into lower costs, returned premiums, and greater self-reliance.
We've yet to see whether P2P coverage will get a foothold or whether states will regulate it into oblivion. But anyone interested in better coverage and better rates should keep an eye on how things play out.