‘There’s An Inherent Conflict Of Interest At The Heart Of The Insurance Business Model’

Matt Wong, Senior Research Analyst, CB Insights: Great. Thank you, Anand. I’m personally excited to kick things off, the day with insurance tech. In many ways, insurance represents some of the new, next frontier of fintech. There’s a new breed of entrepreneurs determined to reinvent the entire insurance value chain, some of whom are joining the conference today. For those unaware, CB Insights have been putting out a weekly newsletter, a research blog covering the insurance tech landscape. Please find me later if you’d like to chat more about that.

Before we get started, just a few housekeeping rules. Join the conversation @cbinsights again and #futurefintech within the conference mobile app. Feel free to ask questions and we’ll get to those at the end of the panel discussion.

Let’s kick things off with some data. In some ways, it was almost inevitable that startups would target the insurance industry and the multi-trillion dollar premium price that it holds, specifically $4.1 trillion in non-life and life premiums. This breaks down in various ways. Cyber-insurance premiums are set to reach $7.5 billion in 2020, small commercial insurance representing about $100 billion in premiums in 2013.

And the major opportunity here within the insurance tech landscape is really to create a new set of digital-first insurance brands that consumers actually love. So insurance, historically, has been among the most frustrating consumer experiences digitally, ranking just ahead of telco and cable. And today, we’re seeing an influx of new insurance distribution startups creating next-generation brokerages, managing general agents and even carriers. You’ll hear from Oscar tomorrow in a fireside chat.

We’re also seeing a wave of opportunity from ancillary tech trends like the Internet of Things. So over the past few years, we’ve seen a wave of partnerships across wearables, smart home sensors, connected car technologies, and that’s also now translating over to a wave of strategic investments by carriers. Here, you see one of Helium’s card-size sensors which measures temperature, pressure, light, and humility. And they recently took an investment from Hartford Steam Boiler. I believe I saw Excel innovate this morning. They just made an investment in a startup called Notion also providing sensor technologies. And we’re also seeing a host of insurers look to apply drones to the claims and process. You see a PrecisionHawk drone here, which recently partnered with Munich Re to improve post-catastrophe assessment. And another opportunity, obviously, is some of the new risk pools. So technology-enabling start formation across new areas of insurance.

So the incumbents in insurance firms are aware of this. This is a quote from Brian Duperrault of Hamilton Insurance Group, previously at Ace and Marsh. “While we continue to resist change, venture capital companies are looking to our industry and seeing dollar signs. So the clock is ticking. If insurance as we’ve known it was an ecosystem, a large section of it would be on the endangered species list.” By “venture capital companies,” he means startups here. But there has been a lot of chatter by venture capital investors over time. So here, you see just a number of the firms who have publicly blogged about or add commentary on sort of coming change in the insurance industry, and you see a wave of the firms, some of whom today will be here with us at the conference, including firms like Andreessen Horowitz and Bain Capital Ventures. And here, you see just a small portion of the growing landscape of startups in this space. Ranging from areas like life insurance, to auto, to small commercial, and other areas.

So obviously, that’s resulting in an influx of deal flow. I think the orange line here is what’s most important to pay attention to. That’s the deal trend. Over time, you see new highs being hit in Q1 in the insurance tech landscape for venture investment and deal activity. And insurers are also not sitting on the sidelines. So here, you see the wave of new venture arms in insurance as well as direct insurers who are also making direct investments in tech startups. And you see just the influx of continued insurers who are starting up these arms, the latest being Liberty Mutual, which just announced a $150 million commitment in a recent investment.

So what are some of the areas that are buzzing within this space or what are people talking about? One is this notion of coverage on-demand, so startups that are unbundling policy time and coverage. On bringing new mobile-first purchasing experiences to insurance. You see there, a screenshot from a startup called Trove, which just launched a swipe-to-insure app in Australia around electronics. I believe we have Wayne from Sure here, another startup in this space presenting on our startup track.

This idea of re-imagining mutualization [SP], so new peer-to-peer models that are looking to leverage digital networks, promising more transparency as well as other benefits. And here, we’ll talk a little bit more and you’ll hear from Lemonade and Daniel Schreiber on the panel right after this.

The idea of blockchain, we’ve seen a wave of strategic investments by insurance firms into firms like Digital Currency Group, which is actually an investor in a host of block chain startups itself. So you see that exploratory view into this space. And then applications in areas like insurance fraud. Here, you see a slide from Everledger, which is a startup working to use blockchain in the diamond fraud space.

And then this idea of…the risk to reinsurance, value chain being disrupted. Here’s a quote from Swiss Re about being able to allocate capital efficiently and getting to those risks more directly and not waiting for intermediaries like direct insurers and brokers to get disintermediated [SP] sooner rather than later. You see, this is also a topic of discussion within the insurance tech landscape.

So some questions that we were thinking about and also will be addressed on the panel. “What will areas like life insurance, small commercial insurance buying look like in the next five to ten years?” “What will will Internet giants…” if you think about where consumers, especially millennials, are spending the majority of their time, how will they plan to what they see within insurance distribution in other areas? And then, what are some of the approaches we’ll see, eventually, that will result in big winners in this space? Will startups like Oscar take the full-stack approach? Will we see winners in alternative approaches? You see some of the biggest exits here, but still very little in terms of big venture-backed exits in the insurance tech landscape.

So with that, I just want to introduce our panel. We have a great panel moderated by Ian Carr today, who reports on blockchain, fintech, and Snapchat for courts. We have Daniel Schreiber who’s CEO and co-founder of Lemonade. Earlier billed itself as the first peer-to-peer insurance carrier and raised $13 million in seed funding from Sequoia Capital on the left to do that. Dan Reed, the Managing Director of American Family Ventures, the direct venture arm of American Family Insurance. Investing in early stage companies focused on insurance, connectivity, and analytics. And then Kevin Kerridge who’s in his 20th year at Hiscox and brings a wealth of experience in the online, property, and casualty insurance space, and initially started in the UK and bringing to replicate sort of the online direct SMB buying experience here in the U.S.

So with that, I want to bring Ian and the panel on to chat about insurance tech. Thank you.

Ian Kar, Reporter, Quartz: Hey, everyone, thanks for being here. We have a very exciting panel up ahead, so this is Dan from Lemonade, another Dan from American Family, and Kevin from Hiscox.

Kevin Kerridge, Small Business Direct and Partnerships, Hiscox: Sorry, go ahead.

Ian: Yeah, I think we have a couple of extra seats. All right-y. We’ve got a lot of questions up on board, so let’s just get started, I guess, if that’s alright with you guys?

Kevin: Sounds good.

Ian: So let’s start with Daniel. When you launched Lemonade, Sequoia’s seed investment of $13 million, your press release that the goal was to “reinvent the insurance industry business model and make insurance a delightful experience, and alter the current industry’s bureaucracy and structure in ways not available to legacy insurance carriers.” So can you expand on that? A bit more detail on the major weaknesses in the insurance space and how you guys are going to try to solve it?

 Daniel Schreiber, CEO, Lemonade: Good morning, everyone. You shouldn’t believe what you read in press releases. I think it’s almost self-evident that there’s something profoundly broken in the world of insurance. There’s plenty of evidence, but as I say, it’s almost self-evident. There’s a reservoir of ill will towards insurance companies. In the U.S., most Americans perceive insurance as a necessary evil rather than a social good, which is kind of shocking because it could be the ultimate social good. It’s a community taking care of people in distress. But no, that’s not the perception at all. Twenty five percent of Americans, when surveyed, say it’s okay to defraud insurance companies. The other 75% were brought up better than to admit that kind of thing to strangers. You’ve got an industry which is one of the most disliked sectors out there. I think as I say, the notion that there’s something profoundly broken is almost not up for debate. The question comes what are the root causes? And that’s really the key to how do you resolve them.

And from our perspective, there are two structural issues in insurance today, and that’s really why Lemonade is rebuilding itself as an insurance carrier, because we don’t think that you can simply parachute down some kind of technological solution on an existing infrastructure when the problems are structural. And I’ll try and touch on them briefly.

But the first and the easiest one to chat through is the legacy. In the U.S., almost 10% of the Fortune 500 is insurance companies; 40-something companies out of the 500. Their average age is 95 years old. Nothing wrong with that, but what you’re talking about is a corporate structure that is really the byproduct of the Industrial Revolution. These are companies that were best practices, no doubt, at the time of their establishment, but those practices are no longer true today in the era of the sharing economy and the Internet. And it’s incredibly difficult to reinvent yourself when the seas change.

State Farm has 18,000 brokers. What do you do? How do you invent yourself as a direct-to-consumer when you’ve got that kind of albatross around your neck? I think the first one is simply the corporate structure, and it’s the general, broad, innovator’s dilemma of how do you adjust behemoth, huge institutions with tens of thousands of employees? How do you adjust them when the winds change as dramatically as they have? That’s the first structural issue. The second one is, I think, more subtle and more insidious. And that is the business model. And this is really a big part of what we’re trying to take a run at.

So at the risk of being a little bit provocative, hyperbolic, or facetious, insurance makes money by denying claims. There is a profound conflict of interest at the very core of the insurance business model. If I’m the insurance company and you’re making a claim, every dollar that I pay you is a dollar less to my bottom line. Conflict of interests don’t get more entrenched than that. And I think that that is something that spirals.

So I have a profound financial incentive not to pay you. You sense that, even if you don’t understand the business model, which is why 25% of Americans say what they say and you start embellishing your claim. Which then justifies my treating you as a criminal and putting heavy-handed claims processes in place. Which pisses you off and makes you behave even worse. Where you get this spiral area of today, where people don’t like insurance, don’t trust it, and most Americans say they do not believe the insurance company will pay them when the day comes.

So you end up with the situation where you’ve got corporate structures that have been around for 100 years and are very hard to change, genuinely hard to change when the winds change. And you’ve got a business model which has a conflict of interest at its very heart.

Ian: It’s kind of the combination of both of those two problems.

Daniel: Yeah.

Ian: So what do you guys, Kevin and Dan, you guys are already in this space. Corporate VC, investing in insurance. You’re an established player in this space. What do you guys think about Daniel’s answer and what do you guys think about that are the major weaknesses in this industry?

Kevin: The first comment is around the model. I mean, the thing that persuaded me to come the U.S., and my interest is in small business insurance, is just how far the U.S. is behind other parts of the globe. My direct comparison is the UK, where I think we’re at least five years behind here in terms of how we deliver small business insurance to customers.

And the thing that’s holding it back are not consumers. Customers are asking for a more contemporary, modern way to deal with their business insurance like they do with everything else in life; from banking, to booking holidays, to buying stuff from Amazon. It’s the industry that’s holding it back.

So I remember, I came over here in 2010. And the year after, I spoke at an insurance executives conference in Manhattan. And I remember looking out from the stage, and…conservative, middle aged white dudes would be a good summary of the audience. And I think it’s a cultural thing in our industry, which is it’s very conservative and it’s very looking in the rear-view mirror. Then you come to an event like this and you see the talent and the technology entrepreneurship that is just crying out to change the landscape. So I’m absolutely with you on that, Daniel.

Ian: Dan, what about you?

Dan Reed, Managing Direct, American Family Ventures: I have the perspective of sitting, really, in both camps. I work for American Family Insurance, which is the eighth largest property and casualty carrier in the U.S., and it sits somewhere in the Fortune 332. Maybe right at the 332.

I certainly have the perspective of the carrier side of this story. And if you talk to a carrier, you would say, “While it’s true that this isn’t the most innovative industry, it’s one that is built for stability.” And that’s, in a sense, what you want from your insurance carrier. On the other hand, you have startups saying, “But the customer experience is antiquated and there’s a lot we can do to update it,” and I believe both sides of it.

What I try to do is facilitate the connections between innovative startups, like what Daniel’s creating, and the legacy, regulatory, compliance, and ability to execute insurance which has all sorts of competitive moats around it. The complexity of it, the capital required. And not insignificantly, it’s a very low consideration category.

So one of the things that we think about is provocative and really, the reason behind what I do and what my team does, is we can help facilitate the connection between large enterprise and the resources associated with an 89-year-old insurance company, and the nimble and customer-forward focus of the startups that are emerging in this space.

Ian: You’re literally sitting right in the middle, so it makes a lot of sense. But you touched on something really interesting. I think, that you said, the customer experience is a little antiquated. I have never purchased an insurance product; I’m on my parents’ healthcare plan. So I’m not looking forward to leaving that yet, but that’s a separate conversation.

I guess this is for anyone. It seems like a lot of insurance companies are kind of struggling to develop new ways to reach younger customers. Trying to get that core, key millennial demographic. So starting with Kevin and anyone else who wants to chime in, how, I guess from an established player point of view, how are you guys trying to attract younger people to sign up for insurance products? And going beyond just web and mobile, and what other strategies are you guys using?

Kevin: That’s a great question. I have a hidden advantage…if you look at Hiscox in the U.S., I think I’m one of the oldest employees. Our employee base are mostly millennials, which really helps with our thinking.

So when we launched back in 2010, we were the first insurance company in the U.S. to enable small businesses to quote and buy through the web and through mobile. And I think that gives us an immediate advantage. When you look at the millennial generation, which is starting and running these new economy businesses, they go to Main Street insurance agents anymore. They’ll go to Google and the web. So the fact that we have assets to play to that is a really good step up for us at an initial cut.

And then looking beyond that sort of deeper thing about engagement with millennials…I remember in our first year, one of our strategic challenges was nobody had heard of Hiscox before when we started here. So I said to the marketing team, “Go out and find me a big idea. And that idea needs to be something that no insurance company on planet Earth will ever do. It needs to scare me.” And the thing they came back with was to film a web TV series. And it was scary, and we did it, and it was all around, actually, engaging with the millennial audience.

So we did two series of ten episodes using real actors and engaging with people with Guy Kawasaki and Gary Vaynerchuk, and the Young Entrepreneur Council. And we got 6 million views of episodes of those two seasons. So we really try hard to not think like an insurance business, and think like a marketing business and a retailer to engage that millennial audience.

Ian: Interesting. You said it was also on Hulu and all these kind of different platforms…

Kevin: Yeah, through Hulu.

Ian:…and people are watching TV nowadays. Do you guys have anything to add on the millennial aspect?

 Daniel: One thing I’d say is I always find it curious, and Dan spoke about this. Insurance, you want to be able to trust the brand. You typically go into any town, the tallest building belongs to the insurance company. It’s part of a demonstration of prowess and “You can trust us,” and “We’re very rich.” But the problem is that trust doesn’t necessarily correlate with balance sheet, because your concern with the insurance company isn’t that they won’t have the wherewithal to pay the money, it’s that they won’t have the willpower to pay you the money.

And you find it an interesting thing; this is true of millennials, this is true of many other people, I was struck. Just an aside, when the Snowden story broke, and suddenly, we found out that the U.S. government is monitoring much more than we thought they were monitoring. The outcry was global and dramatic. And at the same time, Google knows about me so much more than the NSA ever will. Because my friend calls through Google Voice and all my e-mail is Google, and they read my e-mails and target ads at me, and I’m okay with that.

So I think that getting to a better place in insurance requires that trust. It’s a cultural change. Trust isn’t borne of the fact that you have the tallest skyscraper. It’s got to be borne of a very different kind of approach. And ultimately, if you want a fabulous insurance experience where you make a purchase on Amazon and you’re apropos engagement and low engagement, your ad pops up and says, “Oh, Daniel, congratulations on the new watch. We’ve just added it to your policy.” You’ve got to trust your insurer to tap into your e-mail stream the way you trust Google to do that. We’re a long way away from that.

Ian: So let’s talk a little bit about corporate VCs. I think there’s an interesting movement in insurance. Dan, you are a big part of that. I think that when it comes to corporate venture into the insurance space, it seems to be a little bit more incremental rather than, I guess, ambitious. So I think that a lot of the startups focus on…or rather, the investments focus on strategic partnerships between startups rather than looking for the next Uber of the insurance industry.

I guess a two-part question. First, what are you looking for now? And two, do you worry about potentially missing out on the next big behemoth tech startups that’s coming for the insurance industry as a venture capitalist?

Dan: Yes, I’d say that’s probably the number one thing that I worry about. As any investor in the room would say, you want to hit the big winners, right? What we focus on is, really, it’s mission-driven. It’s a thematic focus for not just what matters to our business, but what we feel like differentiates us from other sources of capital. So for us, we focus on insurance. That’s the first of three themes. And we feel like when it comes to insurance, a startup that’s trying something new in that industry can use the expertise that we have…maybe not necessarily on my five-person team, but within our large enterprise. There’s a lot that we can bring to the table that I think is particularly helpful and differentiated versus just a pure financial investor.

We invest in what we call “connectivity,” it’s really IoT. And IoT as it applies to the coverages that we offer. We’ve gotten particularly deep in home automation. I think we’re one of, if not the most active insurance VC when it comes to home automation solutions. And part of our thesis there is what we bring to the table to a startup is an alternative distribution channel, and one that is economically aligned with our interests, such that we may subsidize the deployment of some new systems if they have the effect of mitigating the risks that we cover.

And that can be pretty helpful for a company that’s just post-traction to have access to our customer base and be able to move it through. And there’s a couple good examples that, if we had more time, I would talk about. And then finally, analytics is important for us as well.

So I would say that we do invest for strategic purposes. But we happen to be investing in three very hot themes. And we’re offering something along with our investment that I think is differentiating.

Ian: Gotcha. So next question is for Daniel. I’ve been covering Lemonade since the big Sequoia investment. And I think there’s a couple of really unique aspects to the company. I think one of them is P2P, the idea of peer to peer and how it plays into insurance. Another one is that you guys recently became a public benefit corporation. So I think if you can talk a little bit about the risks of the P2P model and how you guys are trying to solve that. And what was the incentive behind…and maybe if you can run through what a public benefit corporation is, because it’s a different kind of strategy. I think you’re the first insurance company to do that. And what the incentive behind it was.

Daniel: Sure. I spoke earlier about two structural issues, one of them being a conflict of interest. And we’re very privileged to have, as our chief behavioral officer, our professor Dan Ariely, who’s really one of the luminaries in the field of behavioral economics, and he recently wrote a New York Times bestseller called “The Honest Truth About Dishonesty.” I plug the book shamelessly; it’s well worth reading.

And Dan’s work in the whole field of behavioral economics has done a spectacular job of mapping out what it is that brings out the very best and very worst in humanity. And Dan’s conclusion actually was that if you set out with the intent of creating a system to bring out the worst in humanity, it would look remarkably similar to a modern insurance company.

The problem with insurance fraud isn’t the Russian mafia; it’s the people in this room. It’s us. And people who consider themselves to be law-abiding, upright citizens will abide by laws except for they’ll exceed the speed limit and they will defraud their insurance company, and they’ll feel just fine about it. And the insurance industry spends a lot of money on adverts saying, “Insurance fraud is not a victimless crime,” and they’re missing the plot. People think it’s a righteous act.

So I think that this comes back to that core structural problem that I spoke about. Wikipedia quotes studies saying that 38% of the money in the system is consumed by fraud and fraud mitigation. And that understates the problem, because the true problem isn’t simply numeric. It makes for a product that sucks. It makes for an experience that’s adversarial, distrustful, bureaucratic. It’s really poisonous.

So then you scratch your head and you say, “Well, how would I do it differently?” And here, I have the advantage of being a newbie. I’ve been in insurance for one year. This is something very new to me. And you say, “Well, with a whiteboard and if you had no legacy, and you didn’t have to solve a problem for an existing company, how would you construct things?”

And without going into too much of the specifics of what we’re doing in Lemonade, there are a few elements that become clear straight away. One of them is you cannot be in conflict within your customer. You cannot make money by denying their claims. You cannot take their residual money to yourself because it means that there is a profound conflict of interest which will express itself, no matter what you do.

And for us, part of the public benefit corporation, which is a fairly new concept. It enables for-profit companies to have a broader mission. Part of that for us is saying, “How can we use social impact and social causes, and maybe earmark that money towards something that your community cares about?” And that changes incentives in profound ways. It means that I don’t make money by denying your claim. And it means that when you think about embellishing your claim, you’re not hurting some anonymous insurance company whom you’re resentful of in the first place and distrustful of in the first place, but maybe you’re hurting your community or your friends, or something that you care about.

And it changes…it modifies behavior…there’s a lot of science about this. It modifies behaviors in profound ways. So we call it “partnering on purpose,” which is to say, “Can you partner with purpose-driven organizations, non-profits, seed a lot of your profit to them?” But in so doing, it’s not a pure act of altruism. It’s enlightened self-interest. It’s about realigning incentives and creating a new kind of point of equilibrium where every player in the system behaves better. And if that happens, then you end up with a product that is delightful and instantaneous and un-conflicted and all those things that you read out at the beginning. I hope that gives you some kind of insight.

Ian: Yeah. Maybe if you can go into the P2P aspect a little bit and maybe explain some risks and how you’re trying to solve those a little bit more?

Daniel: Sure so there was a slight…beforehand which did a reasonably good job of just laying it out. Lemonade, and I apologize for this, is still pre-launch in terms of our product and still finalizing our regulations, so we’re a little bit coy about specifics.

But in a sense, this is…as so much of the sharing economy is, this is the oldest new idea. And whether you view Lemonade as being radically innovative or as old as the hills, it’s simply a question of perspective. Lloyd’s of London started with a guy called Lloyd who had a coffee shop on the East Docks of London and when captains were going off to the new world, they recognized that not all of the ships in their fleet would come back. And they’d sit round the table and they’d look in each other’s eyes and they’d say, “Let’s pool our risk.” And I’d write my name on a piece of paper and I’d hand it over to you, and you’d write “Ian” under “Daniel,” and that’s where underwriting comes from. You’d write your name under mine. And insurance used to be a social construct where a community was taking care of its own. People who trusted each other pooling their risk, and it was a social good in the most profound sense of the word.

In the late 1800s, with urbanization and big institutions, not by chance, that’s when the big insurance companies come in. Because suddenly, you come into the big city. Everybody is alienated from one another, they’re anonymous, and then you get these big monolithic corporations saying, “Don’t worry about any of that, I’m going to take care of you,” and that’s where modern insurance comes from.

But for us, like so much like Uber and like Airbnb and like so much in the sharing economy, the new modes of communication and technology enable you to reconstruct notions of community and bring back products that once existed into a different guise, but that the basic underlying psychology and incentives could be reconstructed through technology. And that’s where how we see peer-to-peer. Whether you call it “peer-to-peer” or “community” or “sharing economy…” I’m not sure what term best describes it. But that’s the pathos, if you’d like, behind Lemonade.

Ian: That’s pretty interesting. I think that a lot of developing countries, it still operates a lot like it did back in the day.

Daniel: Absolutely.

Ian: Dan, I think you guys….you touched on behavioral and how that plays into insurance. That’s another big area as big data. And I think you guys have been investing in that space a little bit. Can you explain a little bit more about how big data is being used by the bigger, more established insurance companies, and what they’re looking for in terms of big data? And if you have any examples offhand, that’d be really helpful, too.

Daniel: Sure. Well, Matthew hit on a few use cases in the overview at the start. I guess a couple that I would add is like a lot of large enterprises, we use big data techniques for audience identification…marketing, really. Our marketing department…not to talk about our book too much, but works with one of our portfolio companies called Network Insights, which has a partnership with Twitter on the supply side and with WPP on the distribution side. It helps us really learn about our customers in a broad way.

So marketing is important, certainly on re-analysis of the claims that we’ve paid out. We have large unstructured text, data sets called “claims notes” going back decades. The four claims that we’ve paid out that are full of jargon and require some natural language processing…work that we’ve been doing.

We talk about…I think an interesting product development inside of big data is this move toward not just affinity-type pooling, but towards individualized risk assessment, and a more contextual-type insurance, more behavioral-type insurance. So that the usage-based insurance is the name for this concept in the automotive context. Which is, in many cases, second by second; accelerometer, GPS driving behavior data, which is, you would think, a strong predictor of the risk. But it creates a large data problem. We’re moving that automotive concept into the home as well to understand how people use their home, and what specific risks that starts to surface for pricing, for risk mitigation opportunities.

We’ve seen across the big data…use cases across the entire value chain as well as in the development of new products.

Ian: Got ya. So the next question is for Kevin. I think an interesting aspect that Matt touched on in his presentation is the amount of venture capital money going into insurance tech companies. I think the question that I’ve been wondering is that is it just enough to be a tech-driven platform in insurance? Or is there other…is this more than just a technology problem? There are regulatory concerns and things like that to deal with as well. So what are your thoughts on that?

Kevin: Yeah, I think it’s much wider than what you said. So we were talking earlier about how conservative the insurance industry is in terms of our culture…for people like me that have been here for decades. And then on the other side of the coin, the entrepreneurial community, the technology community. We have conversations every week with people who look at our industry and say, “That’s fat and inefficient. It’s ripe for disruption. We’re going to come in and change it.”

And what they miss is something…one of you guys were talking about, about the depth of the ecosystem around things like the regulatory framework. Just how complex an industry is. And I think both parties, both communities, need to work with each other to solve some of these customer-facing challenges we have.

And the other thing I just wanted to point out is that I think…Daniel and Lemonade, that’s an amazing example of disruptive innovation. But if you look beyond that, there’s so much value in just basic incremental innovation in the established industry. Just to take customer experience to a level of, as I said earlier, everything else in life. That the value in that in the short and medium term for the industry is huge. Without having to jump to that level of disruption that brands like Lemonade are driving. And I think that’s something we miss as an industry.

Ian: How is it working with entrepreneurs? Especially in the insurance space. I feel like it’s so heavily regulated. Does it kind of come as a shock to them?

Kevin: No, I love it. Dan and I have been working with this company, Bunker, who announced yesterday…who are looking to revolutionize 1099 contract insurance. And the thing I love is it’s that blend of the insurance talent with the technology talent. And when you get a business like that with a good idea and great people, it’s very exciting to be part of that.

Ian: And you see partnerships developing all over fintech. And it’s interesting that in the insurance space, it started off developing in partnerships in a lot of ways, too. So next question is for Daniel. You guys have been making a lot of big hires in the behavioral science space. I think it’s really interesting because I don’t think a lot of people…I think there’s an interesting idea of big data being really, really important and finding new ways of finding that data. But from a behavioral aspect, what makes insurance really compelling? And how does figuring out how humans behave impact insurance and underwriting, and risk models, and things like that?

Daniel: Sure, I think…

Ian: You go through your hires, too, that’d be great, too.

Daniel: Yeah, because I mentioned our chief behavioral officer, professor Dan Ariely, who really is the lead in our behavior side, but a lot of people in the insurance industry understand and acknowledge that behavior is phenomenally important. One executive said to me that they only recently understood that they’re not insuring property, they’re insuring people. So the soft skills, the psychology, the incentives are phenomenally important.

And when you look at some of the statistics I said that law-abiding people like the people in this room, presumably, let their demons loose when it comes to insurance. You go there and say, “Well, there’s something then at the behavioral level.” And this is costly in the order of hundreds of billions of dollars. Distrust is eroding the product and it’s costing staggering sums of money. And it means that you don’t know that your insurance…your claim is going to get paid, etc., etc.

I’ll give you one example of an experiment that Dan did, but there’s so many of them, and it’s just kind of interesting to get a sense of the impact. Is that okay? I’ll digress for two seconds.

Ian: Absolutely.

Daniel: So one is an experiment known as the public goods game. People are probably familiar with the prisoners’ dilemma. This is a variant of that kind of experiment. And the experiment goes like this; I’ve got ten people round the table. I say to each of them, “Listen, guys, you can put up to $10 into the secret envelope. I, as the moderator, am going to take all the money in the pool, I’m going to double it, and divide it by the number of participants.” So sure enough, everybody puts in $10, I take it, I have $100, I double it, I now have $200, I divide it ten ways, I give everybody back $20, everybody’s smiling.

I say, “Okay, guys, we’re going to play the same game again.” Nothing changes. Everybody puts in $10, the cycle repeats, they make $20, everyone’s winning. On cycle three, one smart aleck…we’ll call him “Ian,” decides that he’s not going to put his $10 in, because he’s a smart aleck and he figured out that if he doesn’t put his $10 in, he actually beats the system. And what happens then is that there’s $90. I double it to $180, I divide it by ten, I give everybody $18 back. But you’ve got $10 still in your pocket because you didn’t put it in; you’re $28 up. You’re happy.

The problem is that when round four comes around, Dan and Kevin don’t put their $10 in either because they don’t want to be those suckers. And by round five, there’s no money in the kitty. And you find that the point of equilibrium in the system is zero, even though if there was trust in the system, the point of equilibrium would be everybody making $20 every time.

And that is a simplified game theory kind of experiment, which I think is…I’m simplifying, but is illustrative of what’s happening in insurance. Because of the behavioral dynamics, you end up with a system that becomes prohibitively expensive, incredibly cumbersome, and these things are structural and they’re built into the human psychology because trust is missing, and that drives behavior in the way that I just described.

Ian: So without the trust, you have a bigger incentive to pursue less than ideal behavioral aspects? I guess, endeavors, right?

Daniel: Yeah. And you get people embellishing their claims, you get the tit for tat, and you get a vicious cycle which, as I say, corrodes the experience, erodes trust, and adds cost and complexity into the system. So to our way of thinking, technology is absolutely just one piece of the puzzle. Much more profound and much harder to change are the psychological dynamics.

But it’s doable. Micro-lending in the developing world is a phenomenal business. So you’ve got places like in rural India where these micro-financing…Grameen Bank has loaned out billions of dollars in microfinance. Their repayment rate is 99%. No FICO scores, no enforceable contracts, no legal systems, no collateral. Ninety-nine percent repayment rates. And you take people with the same DNA and you stick them in America with legal systems and claims assessors and FICO scores, and 38% of the money goes out of the window through fraud.

So thinking thoughtfully about these kind of behavioral dynamics can be transformative.

Ian: You’ve given me a lot to think about. We’re going to go to the Q&A soon, but last question…this is for everyone, and we’re going to start with Kevin and move our way over here. What’s the single biggest impact technology is going to have on the insurance industry over the next five years? Kevin, your thoughts?

Kevin: For me and my world, it’s just transforming the customer experience.

Dan: Yeah. Within our insurance theme, one of our core theses is that insurance will start to become an incidental sale through some adjacent customer experience. Kyle Nagasuchi [SP] from our team has written about this on the CB Insights blog, I believe. I think we’ll see insurance carriers partner with companies that offer some predictably digital experience that’s not in insurance, but just adjacent to insurance. Which will then monetize through an insurance sale.

So companies that can help and get to the point where they can support distribution through that channel, I think, will be a provocative source of growth.

Daniel: I’d go with Kevin. I think that a simple user experience is really where you have to get to. It belies the complexity that lies beneath, because all the systems behind there have to be changed, and it’s incredibly difficult when you’ve got legacy. But I think the conclusion is the right conclusion.

Ian: Great, I think we have some questions coming up. If, I think, Matt Wong is going to be handling that.

Matt: Yeah, we have some questions that are coming in from the live stream. This question is for Kevin. “Given the rise of venture-backed startups in the small commercial insurance space, what’s it going to take for a big, valuable company to emerge? Is it just a enough to be a tech-enabled broker?”

Kevin: Yes, it’s a great question. I remember when I came here in 2009 to actually just scout the opportunity. And I went back to London saying, “I must be missing something, because small business insurance is so far behind everything else in life in the U.S. And what am I missing?”

And the big conclusion that we came to was that it’s just all about general conflict. All the big, incumbent insurers have got so many billions of dollars of premium tied up in agents, traditional agents. That for one of them to actually break ranks and saying, “We’re launching an online, direct-to-consumer business” would be a huge deal.

I think that’s the thing that’s holding it back at the moment. We are seeing some signs. Berkshire Hathaway launched a business this year, direct-to-consumer. We’re seeing a lot of activity in the online agent space.

But we really hope for at Hiscox is one of the really big, small commercial brands to start going for small commercial in a big way. Because all those marketing dollars that they’ll spend will benefit brands like us, because it will help change consumer behavior to actually…for those that are open to it, to actually go to the web, rather than go through traditional channels.

But I think the other thing on that is there’s a lot of talk about insurance agents going the way of the dodo. That ain’t happening. Insurance agents are here for the long term. And I think it’s more about what those agents look like, and how they will be enabled by technology, rather than wet signatures and paper apps.

Ian: Bank tellers, everyone thought they were going to go away, but they’re still sticking around. It seems like they’re, you know, becoming more and more important. Especially because when you do go to a bank, you’re only going when you really, really need help, I think.

Kevin: Yeah. People need people. I love…I think it was Esurance had this line on their TV advertising. “Technology when you need it, people when you don’t.” And even with our business, 48% of sales we make every day go straight through the machine without touching a human. But 52% of people still want to do stuff online, but then speak to a human. So the people element is absolutely critical in an online business.

Dan: That’s consistent with our experience as well. There’s still a small majority of people who say that they’ll never buy insurance, except through an agent. Now, there’s a growing number…and I suppose at some point, it’ll cross. But we will see small…fewer agencies and larger ones.

Ian: Gotcha. Matt?

Matt: This is going to be the last question from the live stream. This is for Dan from Ampham [SP]. “Five years from now, how do you expect the rise of corporate VCs in insurance to shake out? Who will be left standing? How many will leave, and why?”

Dan: I think one of the things that’s unique to corporate VCs, that you’re subject to leadership changes in the organization because you have a single funder and it’s not a traditional LP-type model. So I think one of the main reasons why some corporate VCs will cease operations is the strategies and the leadership at their companies will change.

The other thing that I think is important for the success of a CVC is that they need to make sure that they align every aspect of their process to market standards. That has to do with the speed of execution. It has to do with the diligence process, and who you need to get involved and who you don’t. And then what type of contractual expectations you have beyond what the financial investor would expect.

And in our case, we really don’t take any. For us, that’s been a source of some of our…I don’t know if we can say “success” yet, but some of our focus has really been “Make sure we can execute quickly. Make sure we’re not expecting rights of first refusal, exclusivity-type provisions that are more aligned with the corporate mindsets than with the startup mindset.”

Ian: It seems like we have six more minutes left. I guess I can keep asking a couple of more questions that I have. One of them is about the bigger tech companies and how they’re thinking about insurance. I think it was Citibank put out a research note a couple months ago. Essentially saying that it would make sense for Google to potentially acquire AIG. And I thought that sounded bizarre to me.

But the more I kept thinking about it, the more I was like, “Huh, this actually doesn’t make sense. Google works really, really well with big data sets. Big data is really, really important in the insurance space.” This is a question for all of you guys. Which big tech company, do you think, is going to interested in the insurance space? And do you think that we’re…it’s a highly regulated area, so do you even think that it’s going to be something that we can see in the foreseeable future? Or do you think it’s something that they’re going to try to maybe do partnerships or something like that instead? I’d love to hear your thoughts on the bigger…the Facebooks and the Googles and the Apples, and how they’re thinking. What you guys think that their involvement in insurance will be.

Dan: I can start. Google was…we’re in a company called CoverHound, which is a comparison shopping site for auto, home, and small commercial insurance. And until very recently, they were what we thought of as the last mile partner for closing business that came through Google compares…comparison experience.

Google pulled back from that. I don’t think the story is necessarily over with Google’s interest in this space. But I think one of the challenges that we saw in why CoverHound was an investment for us is that there is definitely some trepidation at the carrier level for working with some of these tech giants. And CoverHound was able to build integrations with carriers that was taking Google a bit longer than perhaps they expected.

Ian: Kevin, do you have any thoughts?

Kevin: Yeah, I think you have to separate customer experience and distribution from risk taking. I think generally, if you think about Facebook or a Google, you can see how they have a big part to play in changing user experience and distribution of products. But not many of these big companies will be willing to have insurance on their balance sheet.

Ian: Right.

Kevin: Because it’s a different business. So I think distribution, customer experience is where that game is in the medium term. Long term, maybe there is…it does stray into risk taking. But I don’t think that’s anytime soon.

Ian: You can kind of see that in the payments world, where Apple and Google and these companies developed the front end user experience, while the existing payment really stays the same. Daniel, I’d love to hear if you have any thoughts on the big tech companies in insurance.

Daniel: I don’t have any real insights. It’s been curious to see that…I think as you just said, they’ve generally stayed away from heavily regulated industries in general. So Google does experimental stuff in medical, but doesn’t actually bring product to market. It’s dabbled in insurance, but it hasn’t come to market…

Ian: They shut that down, I think.

Daniel: Yeah. It would be a change in strategy. I wouldn’t rule it out. I do think for reasons that I touched on earlier, that they would have some tremendous advantages relative to the incumbents. But I think to Kevin’s point, whether they have the appetite for that in the business model and where it would be good for their multiples and those kinds of considerations, I don’t know.

Ian: Great. Well, thank you guys so much for joining us today, and thank you to the CB Insights team for having us discuss the insurance space. It’s been a great chat. I really appreciate it.

Daniel: Wonderful.

Dan: Thanks.

Kevin: Thank you.

Ian: Thanks.