Making Lemonade out of Lemons: Behavioral Finance applied to Insurance

I am completely enthralled by the potential of applying Behavioral Finance to the Insurance Industry. I am using the term Behavioral Finance instead of Behavioral Economics. It`s a subtle but important change. The term Behavioral Economics has now branched out to include Behavioral Finance as a stand-alone, sub-field that specifically focuses on influencing Financial habits (e.g. buying Insurance) leveraging Behavioral Economics.

Lemonade Insurance is now the poster-child for how Insurance can be shaken and stirred using Behavioral Finance. I fret that by the time this article is posted my comments will already be outdated since Lemonade is moving at lightning speed throughout the United States as it seeks to seriously disrupt the traditional insurance market.

So why am I enthralled with Lemonade? here are a few points

Decrying the morality of Insurance

Lemonade publicly makes provocative statements like

· Instead of fighting with our customers over the same coin, we join our customers in fighting for a common cause.

· Lemonade is remaking insurance as a social good, rather than a necessary evil.

· Traditional insurers have a conflict of interest in that they make money by denying claims.

Lordy, it`s as if Amazon started preaching the virtues of embracing a minimalistic lifestyle (adopting a lifestyle where you spurn material goods) before bombarding you with pop-ups urging you to buy stuff. It`s certainly attention grabbing when an Insurance company starts off its sales pitch first by decrying the morality of Insurance.

Social norms that leads to a standing ovation

Think of the last performance you saw that ended with a standing ovation. As more people around you join in, do you feel the urge to get up and start clapping too? If you are like most people, you’ll likely find yourself rising to your feet, even though you hadn’t planned to do so. Why does it feel so difficult to resist that urge? It’s largely thanks to the well-known principle of social norms. Lemonade is seeking to exploit this need for people to normalize, the fact that we’re social animals and we let our friends and family and tribes do our thinking for us. I identify myself as an Actuary, an alumnus of the University of London, West Ham United Supporter (best UK soccer team), I compete in marathons using the club t-shirt of `Adriano Bastos Running Club ` etc. Does anyone publicly identify themselves as a client of an Insurance Company?

Lemonade allows clients to nominate a charity when they buy a policy. Lemonade will then pool the premiums of everyone who has chosen the same charity, and pay their claims out of that pool. Anything that is left at the end of the year will go to the charity. The link to charity is brilliant in its simplicity and has immediate benefits.

· It now allows individual clients to identify with a recognized charity. Clients may now feel even more engaged as a charity donor any may be more motivated to start badgering friends and family to also donate via buying insurance.

· It may encourage clients to perhaps purchase more insurance for items which are not usually insured; such as extended warranty for electronics, pet insurance, bike insurance, loss of cellular phone, travel insurance etc.. Clients may now think that even if there is no insurance claim a donation will be made to a charitable cause, so why not shell out a few bucks on some insurance. Presently Lemonade offers a limited range of Insurance products.. but it`s only just getting started.

· It may reduce fraudulent or excess claim values, since claimants are aware that this will reduce the funds going to a worthy do-good cause.

Why does Lemonade ask to record a video during the claims process?

Making a claim via Lemonade could not be simpler? It only takes a minute to shoot a video of yourself explaining in your own words what happened. No paperwork, hassle free and Lemonade`s objective is to authorize your claim even before Usain Bolt breaks the 100m World Record. They have allegedly once paid a claim in a world breaking record 3 seconds.

Sounds pretty cool right? But what does making a video have to do with Behavioral Finance? Dan Ariely is the Chief Behavioral Officer at Lemonade and he`s also the best selling author of the The Honest Truth About Dishonesty. It has not been said publicly, but I am speculating that the videos are using facial micro-expressions to try to profile dishonest claimants; these may require a more detailed analysis of the claim submitted. Studies have found that our faces often reveal hidden sentiments that are intentionally concealed. For the vast majority of honest claimants it will be a speedy process and happy experience that they are likely to share with friends and family and hence drum up even more business for Lemonade. Lemonade does not use brokers to place business. Word of mouth recommendations is their sales strategy.

The diversity of diversity

I am guessing that when the first cellular phones were launched, the telephone companies scoured the best engineering universities to hire the worlds` best telecom PhDs. Apple`s iPhone was a collaborative result of creating a diverse team that probably included the best marketing executives, designers, DJs, book editors, photographers, calligraphers and yes.. telecom engineers. And we all know how that story ended.

Lemonade has incorporated the diverse services of Behavioral Economists (guru Dan Ariely leads the team), High tech teams (Maya the interactive chatbot that replicates a virtual customer service experience is extremely cutting edge — only invented in 2016), Philanthropists, Private Equity experts and yes… some insurance & reinsurance guys. This meeting of minds has the potential to create a truly new insurance product offering and thinking out of the box.

Making Lemonade from Lemons. Claims as a business

Rubbernecking at the scene of a traffic accident. Why do we do this? Everyone loves a good train wreck. We are enamored by ruin. Carl Jung made a similar argument. He maintained that our mental health depends on our shadow, that part of our psyche that harbors our darkest energies. And after seeing a tragic accident, we are more inclined to drive more cautiously, we temporarily stop driving and texting etc.. After we read about a terrible plane crash, for a few days we are somewhat reluctant to fly and grow a little more concerned when we experience sporadic turbulence. Behavioral Economics considers this to be totally irrational behavior since our new cautionary sensitivity will definitely not reduce the risk of having an accident.

It`s only actuaries that think about insurance 24/7, most normal people really don`t ponder thoughts about their insurance coverages or lack thereof. Might it not be the most opportune time to pitch for a sale of a new insurance policy when the client is filling out an insurance claim for reimbursement? When he/she is more sensitive to the benefit of insurance.

Of course there are different categories of claims. Claimants who have just undergone open heart surgeries are probably not a good target for up-selling additional life or health insurance. However minor surgeries (e.g. appendicitis, minor accidents) can qualify to be targeted to be sold new or enhanced policies that have more coverages or higher limits. The concept is to automatically filter claimants using predictive modelling into categories such as:

· eligible for simplified issue for new insurance coverage

· we need more detailed information/questions before offering new insurances and

· not eligible for new insurance

This concept has the following paradigm changing benefits for the insurance industry:

· Insurance companies can include some additional underwriting/medical additional questions on the existing claim form that will `update` the state of health of the client (weight, medical issues etc). Usually health information about clients are only known by the insurer at time of policy issue.

· The head of Claims will now have a `new business premium` target. The claims managers will now be motivated to pay claims more efficiently since a happy client is likely to be more receptive to receiving an offer to buy more insurance. Indeed the concept is truly making lemonade from lemons.

This `Claims as a Business` concept is not related to Lemonade insurance model. It is presently being tested in selected markets by traditional insurance companies and the results look extremely promising.

Conclusion

A target demographic group for the Insurance disruptors are the millennials who are ignored by brokers/agents and are woefully under-insured. The most successful disruptors can be successful because the incumbent is busy improving its products and services only for its existing customer base. Typically, an incumbent business works to service only those customers that provide its main source of revenue and profit. This leaves un-served segments of the market — gaps that a new and more nimble entrant can focus on.

The millennials are also not that loyal to the brand of traditional insurance carriers (the majority of leading insurers were established before computers were invented), they are more open to buy insurance from a `new` brand like Lemonade. However new insurance products will have to be created to suit the millennials` lifestyles and aspirations.

Albert Einstein is credited with saying “The definition of insanity is doing the same thing over and over again, but expecting different results”. The most exciting aspect of the application of Behavioral Finance to Insurance is that it`s certainly not business as usual.

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