Private-investor-backed insurance allows third-party investment capital to pay or backstop claims expenses in exchange for investment return. For example, a private investor, in theory, could agree to receive premium payments from a basket of insureds in exchange for the obligation to pay claims when they arise. In this model, the private investor (or group of private investors) essentially steps into the financial shoes of the insurer, accepting a stream of certain cash flows in exchange for an uncertain future liability (which could exceed those cash flows). The facilitator of such a marketplace would likely take some fees in exchange for customer acquisition, administration, securing reinsurance and performing the functions of an insurer other than providing risk capital.
There are a handful of benefits we think the private-investor-backed model offers participants in the insurance relationship.
First, if certain types of insurance risk can be effectively securitized, those securities would (theoretically) offer professional or retail investors diversification through an instrument that is not highly correlated with the general market (low beta). Some investors already have exposure to insurance through reinsurance contracts and catastrophe bonds, but securitized insurance could offer broader access to more familiar risks with different payoff profiles.
Secondly, similar to what Lending Club and Prosper were able to accomplish in personal and small business lending, a private-investor-backed insurance model might offer price-competitive options to customers who have difficulty securing traditional insurance. For example, today, customers who are unable to secure insurance from conventional insurers (standard market) use excess and surplus (E&S) markets to address their insurance needs. If private investors are willing to take on these E&S risks—whether due to the presence of unique underwriting criteria or higher risk appetites—they could create new competitive dynamics in the E&S market and ultimately improve options for buyers.
As a side note, we often hear people combining the notions of P2P and private-investor-backed insurance. In our minds, they are related and can work together but are separate concepts. Private investor backing is not a prerequisite to building a P2P model — a pure P2P model could employ a variety of strategies to guarantee liquidity and solvency. For example, P2P insurers could leverage reinsurance to cover large or aggregate claims beyond the pool balance, eliminating the need for private investment capital. The P2P insurers might also use traditional fronting arrangements to ensure solvency. By comparison, a pure private-investor-backed model doesn’t need P2P features to function. Instead, it might offer investors financial products that look similar to reinsurance contracts without making any changes to risk pooling or centralization of control.