Digitalization and Social Networks as Drivers of Innovation in the Insurance Industry – the Case of “Friendsurance”

• High percentage of fraud in insurance cases (10 % according to GfK estimate)

• Optimization potential lies in opportunities offered by digitalization and social networks

• Insurance for small-scale damages available in social networks via “Friendsurance”

• Insurers can reduce their administrative costs and outsource moral hazard

• Insurance holders save money – the lower the damages in a given group, the higher the return on premiums

The start-up “Friendsurance” offers insurance products that are based on digital social networks: Friends can buy insurance together and regulate damages up to a certain sum within the circle of friends. If the damages exceed this limit, the classic insurance policy kicks in. The model provides advantages to both customers and insurers. In damage-free years, customers will receive back a large portion of their insurance premiums. Insurers, on the other hand, can outsource moral hazard to circles of friends, thereby reducing the cases of minor damages they have to regulate as well as their administrative costs.

One of the classic challenges in the insurance industry is the so-called “moral hazard”. This refers to the case when an individual’s rational behavior is not in the interests of the collective, while simultaneously this individual’s rational behavior is only possible due to the existence of the collective. In the context of the insurance industry, this case occurs when an insured person acts in an incautious manner precisely because he is insured, such as the driver who drives dangerously precisely because he has comprehensive collision insurance. In addition to this moral hazard, a further challenge in the insurance business lies in the fact that supposedly smaller types of fraud are often regarded as a minor or gentleman’s offense. However, that which is marginal and insignificant as a singular case becomes a problem for the collective when many individuals engage in such behavior.

One solution for both of these problems – moral hazard and fraud – consists of making anonymity impossible within the collective by limiting membership to a small number of people. This is precisely the path chosen by “Friendsurance”, and it does so by operationalizing online social networks.

Via “Friendsurance”, users can buy insurance together with their contacts and friends in social networks. Part of the insurance premium of each group goes to a classic insurance company while the rest of the premium goes into a (virtual) pot managed by “Friendsurance”. The money in this pot is used to pay for small-scale damages. The insurance companies in the background only step in in the case of larger damage amounts. From the perspective of the insurance companies, this model increases the co-payments by insurance holders, allowing premiums to be significantly reduced.

If any money is left in the pot at the end of the year, it is paid out to the group. Each damage claim reduces the sum paid back at the end. Thus in the case of fraud and damages that derive from carelessness, the insurance holders directly affect their friends. Research shows that moral hazard and fraud can be significantly reduced with such a model. As a result, the insurance premium can be lowered, a fact that appeals to customers’ price sensitivity and that is used as a key selling proposition towards customers.

The business model of “Friendsurance” combines the functions of an online insurance broker with product optimization based on the aforementioned group tariffs. As an insurance broker, “Friendsurance” works with traditional insurance companies and recives a commission from them for the contracts it procures. The products on offer include liability insurance, household insurance, mobile phone insurance, and legal protection insurance. The special group tariffs are applied to these insurance products.

The goal is to reinstall the basic principle of insurance and simultaneously to lower the costs for moral hazard, fraud, and administration. The last element in particular is not to be underestimated. The administrative costs of an insurance company include the processing of damage claims. The costs for claims processing are (theoretically) dependent on the amount of the damages. In the case of small-scale damages, the relative share of processing costs is therefore higher than for larger damages. As a result, assuming that the level of damages is the same, the processing of many small-scale claims is more expensive than the processing of a few larger claims. As insurance customers are price sensitive, the insurers are under pressure to lower their costs. The “Friendsurance” model reduces the number of claims to be processed, thereby generating cost advantages for insurance companies.

The innovation of “Friendsurance” lies in the use of digital networks to solve classic problems of insurance providers. In place of an anonymous collective that socializes private risks, “Friendsurance” creates the opportunity to spread risks across private networks, thereby reducing problems such as moral hazard. Insurance through small networks is not new per se. Rather, it is a return to the roots of insurance companies, which began as small insurance associations based on reciprocity. One can still find this practice today in many agricultural or village communities. What is new in this case is that the advantages of these closed networks can be provided to an urban customer base thanks to the digital nature of social networks, which are not bound to a specific geographical location. In doing so, the innovation of “Friendsurance” does not compete with the products of classic insurance companies. Rather, “Friendsurance” is engaging in a symbiotic relationship with established insurance companies, to the benefit of both sides.

Friendsurance
http://www.friendsurance.de

Financial Times Deutschland
http://www.ftd.de/karriere/gruendung/:friendsurance-geld-sparen-mit-facebook-freunden/70023285.html

Gesamtverband der deutschen Versicherungswirtschaft e.V. (GdV)
http://www.gdv.de/versicherungsbetrug/zahlen-und-fakten/