Embedded Insurance: Supporting Underinsured and Uninsured Markets

Laura Fritsch
September 13, 2022

The traditional insurance model requires customers to be previously aware about the need to insure a product against certain risks. This perceived risk has to be sufficiently salient for the customer to search for coverage; search costs act like a tax on the insurance eventually acquired, borne by the customer. Therefore, the value of the insurance to the customer must exceed not just the premium paid by the customer but also these additional convenience costs. In this article, we explore how embedded insurance can penetrate underinsured and uninsured markets.

1. Embedding Makes Insurance Salient at the Valuation Maximum

Embedded insurance removes most of these costs by offering insurance at the point of need, eliminating all search costs because the customer no longer needs to search for insurance policies by themselves. Embedding also maximizes the distance between valuation and perceived cost, or the customer’s reservation because of two behavioral phenomena, namely salience bias and loss aversion. The customer’s maximum valuation of a product happens at the point of purchase, because the importance of this new good to the customer’s endowment is particularly salient. They are, thus, more likely to pay to insure it than at any later point in the future. By making insurance salient at the valuation maximum, embedding also maximizes the loss aversion experienced by the customer. The customer is more likely to overweight the risk of losing the product, increasing their reservation price.

What is salience bias? Salience bias is a cognitive bias that predisposes individuals to focus on items that are more prominent or emotionally striking and ignore those that lack prominent, even though this difference is irrelevant by objective standards.

What is loss aversion? Loss aversion refers to a well-documented tendency in behavioral economics whereby individuals prefer avoiding losses to acquiring equivalent gains.

2. Embedding Increases Pre-Existing Insurance Markets

The main customer acquisition strategy used by the insurance industry today, namely switch-and-save, fails to capture most lower risk customers. Only higher risk or very risk averse customers that are aware of the need for insurance will actively seek out insurers. Because of the obstacles to the acquisition of insurance, lower risk people will not go out of their way to seek insurance or won’t even consider the potentially low probability of needing insurance in the first place. 

By capturing the entire pool of the customers of the embeddable product, embedded insurance can secure a lower-risk customer pool. By offering coverage at the point of need, embedding can capture customers who wouldn’t have incurred the search costs of finding an insurance policy after the purchase or wouldn’t even have thought about searching for insurance in the first place. By adding these lower-risk customers to the insurer’s pool, the average cost of insurance decreases and drives down the price charged to customers. This, in turn, attracts even more customers that would have otherwise chosen to self-insure. In short, embedded insurance creates a virtuous cycle whereby the more customers it can capture from the product’s wider customer pool, the more customers are likely to join the insurance market.

3. Embedding Creates New Insurance Markets

Embedding can play a pivotal role in creating insurance markets that wouldn’t otherwise have existed because customers never thought to insure them. For example, many customers wouldn’t have thought of insuring carbon credits, despite the increasing risks of re-sequestration associated with global warming. If they didn’t even consider the risks associated with the product, they definitely wouldn’t go out of their way to insure it. By highlighting the risks and offering coverage at the point of purchase, therefore, embedding would generate a market that wouldn’t have existed in its absence. This represents an outward shift of the insurance production possibility frontier for many insurance products and for the insurance market as a whole.

The availability of insurance in a previously uninsured market will increase the number of players in the market, especially if the associated risks were deemed a deterrent to market entry. It will also shift down the supply curve because some or all of the risk will be shifted from the supplier to the customer, who will be able to choose their optimal level of insurance at the point of purchase. In the case of carbon credits, carbon registries currently lock 10-20% of carbon credits registered by developers in a buffer pool. This significantly reduces their profit margin. A more efficient alternative would allow project developers to register all the carbon credits sequestered by their projects. These credits could be sold at a lower price and the customer could then choose the optimal level of coverage according to their individual risk preferences.

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