Overcoming Inefficiencies of Traditional Insurance Through Embedding

Laura Fritsch
August 30, 2022

Customers increasingly demand convenience and self-service when transacting but the insurance industry has failed to rise to the challenge. The traditional insurance model is fraught with inefficiencies that harm both the insurer and the insured. These inefficiencies are common in selection markets.

What is a selection market? Markets where consumers vary in their risk and high-risk consumers are more expensive to insure, because each counterparty selects the other based on their own private information. As a result, competition among insurers is focused not only on selling more insurance policies, but also on identifying and attracting buyers that are less costly to cover. Both buyers and sellers incur costs in searching for a counterparty.

In the traditional insurance model, insurers must acquire customers—an expensive process involving advertising, sales agents’ commissions, and the time-consuming task of underwriting risks associated with each new customer. Together, these costs are known as customer acquisition costs, or CACs, and must be included in the premium charged to the average customer so that the insurer can break even in expectation. Today, most customers are acquired through a switch-and-save model whereby insurers offer lower premiums to customers of other insurers to switch to their services. This model is particularly costly because it relies on costly advertising at the detriment of the insurer’s current customers, who must pay an increasingly high premium for the same level of coverage. As a result, many customers choose to self-insure or opt for suboptimal levels of coverage. From the insurer’s perspective, however, these tend to be the least risky customers. In the long run, switch-and-save is a zero-sum game because ever increasing advertising budgets are the only way of growing the insurer’s market share.

Enter Embedded Insurance®.

Embedded insurance allows all customers to be profitably matched with a willing insurer through a frictionless process at the point of purchase. Information is painlessly acquired through the associated transaction involving the underlying risk to be insured. With customer acquisition costs at effectively zero, premia should reflect only expected claims expenses, taxes and administration costs, so that almost all customers will be willing to acquire insurance. The resulting market is as large, and therefore as low risk, as it can be. Moreover, the switch-and-save model restricts the customer pool to higher risk customers that are already in the market for insurance. Embedded insurance also reaches lower-risk customers that wouldn’t have searched for insurance in the first place or whose reservation price was lower than the premium charged under the traditional model. In doing so, it allows for the expansion of established markets but can also create insurance markets that wouldn’t have otherwise existed by minimizing frictions and offering coverage to potential customers at the point where they are most likely to buy them.

The Demand Effect

The Supply Effect

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