Over the last year, a number of the captive conferences, in breakout sessions, have focused on captives and the sharing economy. At the 2016 Cayman Captive Forum, a presentation by Pinnacle Actuarial Resources, Inc., and York Risk Services Group, "Insuring the Shared Economy," looked at the insurance needs of this new business model and the actuarial issues it presents. Similarly, a presentation at the 2017 Captive Insurance Companies Association (CICA) International Conference, "The Sharing Economy: Growth, Challenges, and the Need for Alternatives," from Lyft, Marsh Captive Solutions, and Oliver Wyman Actuarial Consulting, Inc., explored how one business in the sharing economy was using a captive insurer to help underwrite the risks associated with its operations. Obviously, there is a role for captives to play in this new economy. We'll explore what the sharing economy is and how it presents a unique opportunity for captives to participate as it expands over the next decade.
A Basic Definition
Wikipedia defines "sharing economy" as follows.
Sharing economy is an umbrella term with a range of meanings, often used to describe economic and social activity involving online transactions. Originally growing out of the open-source community to refer to peer-to-peer based sharing of access to goods and services, the term is now sometimes used in a broader sense to describe any sales transactions that are done via online market places, even ones that are business to business (B2B), rather than peer-to-peer. (Source: Wikipedia contributors, "Sharing economy," Wikipedia, The Free Encyclopedia, https://en.wikipedia.org/w/index.php?title=Sharing_economy&oldid=773726841 (accessed April 17, 2017).)
The presentation at the 2017 CICA International Conference offered a more condensed definition, as follows: "optimization of resources through the mutualization of excess capacity in goods and services using information technology." Some may argue that in many ways today's sharing economy is an outgrowth of the bartering system, which predates the introduction of any monetary system. However you choose to define this new segment of the market, one attribute stands out. Its growth rate has been substantial, and indications are growth will continue to accelerate. PricewaterhouseCoopers (PwC), in The Sharing Economy Consumer Intelligence Series, estimated that revenue derived from the five key sectors of the sharing economy—travel, car-sharing, finance, staffing, and music/video streaming—will reach $335 billion by 2025, up from roughly $15 billion when the study was done in 2014. And, while PwC identifies five major sectors, the industry potential is much greater. Examples of areas that some pundits believe may be served by the sharing economy in the future include recreational vehicles, sports equipment, other types of recreational items, clothing, educational services, professional services, and home cleaning and maintenance services.
Implications for Property-Casualty Insurers
As this new business model evolves, the implications for traditional property-casualty insurers are substantial. Cognizant, an information technology, consulting, and business processing outsourcing firm, in its white paper The Sharing Economy: Implications for Property & Casualty Insurers describes the change as follows.
The sharing economy is growing at a staggering pace … bringing with it new types of business models and risks that property and casualty (P&C) insurance carriers have not previously considered, such as the use of personal property for commercial purposes at certain times; high-frequency transactions (assuming that each transaction has to be underwritten and priced individually); low premium amounts per transaction; less control over how assets are used with a degree of variance between transactions; plus significant reliance on external data for underwriting, pricing and claims.
IRMI, Captive.com's parent company, has published an article on IRMI.com looking solely at management liability issues associated with these new business operations: "The Sharing Economy: A New Frontier in Management Liability?" The article points out sharing economy businesses replace the typical two-party relationships that property-casualty insurers understand with multiple parties, all with different rights, obligations, and expectations. As a result, there is a blurring of the long-established lines between which policy responds, for whom, and when.
A quick look at Uber and Lyft, often referred to as "transportation network companies (TNCs)," shows how these policy questions can become blurred. When a driver for either of these entities is off duty, his or her personal auto policy is responsible for any accidents in which the driver and vehicle are involved. However, as soon as the driver activates the app, policy coverage becomes more commercial in nature since the driver is now operating like a taxi service. Almost all personal auto policies exclude coverage for "livery services," and most state regulations require higher liability limits for commercial vehicles. The National Association of Insurance Commissioners (NAIC) published a white paper in March 2015, Transportation Network Company Insurance Principles for Legislators and
Regulators, exploring these risks in detail. Today, the NAIC has an established working group dedicated to sharing economy risks. For a discussion of the issues around insuring TNC drivers, see "Uber and Lyft: Insuring the Drivers," also on IRMI.com.
Looking at the sharing economy from an actuarial perspective provides further examples of why traditional P&C companies are leery about underwriting these risks. Pricing actuaries rely on a three-tiered approach to determining how to develop a rate, as follows.
- Classification—are results predictable, and what constitutes good results? This allows for setting deductible amounts and overall limits of insurance.
- Risk characteristics—defining the risk characteristics allows for the creation of underwriting rules and the use of schedule rating debits and credits.
- Loss experience—are losses credible based on the amount of claims, size of the exposure base, and time?
Unsurprisingly, the sharing economy presents actuaries with problems in all three areas. Covered activities are harder to define, leading to an inability to develop predictable results and allowing for specific definition of risk characteristics. Independent contractors are not a homogeneous group, creating risk control issues and potential moral hazards. How well can you measure exposures, and are measures comparable between the traditional economy and the sharing economy? Are contractors more transient, meaning historical exposures are not indicative of future exposures? And, finally, the limited amount of loss data makes any experience rating model difficult to construct. All of these problems have led the traditional P&C market to be wary about underwriting these risks.
A Role for Captives
Captive insurers initially evolved because the traditional property-casualty markets were unwilling or unable to offer the coverages required at rates that buyers considered to be competitive. The risks embedded within the sharing economy are creating new exposures and, given the growth rates for these business models, increasing quickly. As we noted above, traditional P&C capacity is limited, and pricing is likely to be higher given the actuarial problems discussed. This opens the door to the use of captive insurers to fulfill the insurance needs of sharing economy companies.
In the CICA presentation mentioned above, Marsh identified five main benefits that sharing economy companies can derive from employing a captive insurer, as follows.
- Funding of retained risk within the captive may provide leverage when negotiating with commercial insurance markets.
- Captives may improve the overall economics of the costs of insurance through increased flexibility.
- Captives can craft unique coverage documents with manuscript wording.
- Independent contractors working for these companies may be more receptive to association or managing general agent (MGA) type captive programs.
- Captives provide direct access to reinsurance markets that may be more willing to underwrite certain risks.
Lastly, the sharing economy companies are extremely technology savvy and, as entrepreneurs, more willing to accept risk. Both attributes help make a captive insurer a natural fit.