Edward Koral, BDO
The growth of the sharing economy asks profound questions of the insurance industry, in many cases rendering its traditional methods of calculating and pricing risk redundant. But captives, which have historically served as a laboratory for underwriting new and emerging risks, could be a solution to this problem, says Edward Koral of Deloitte Consulting.
We have all seen, and probably participated in, the rapidly growing sharing economy. We use ride-sharing services and rent cars by the hour; we may use hot desk office spaces rather than permanently leased premises; on vacations, we rent unused apartments or houses instead of hotel rooms; the local food vendor may crowd-source delivering our dinner to the front door; even our teenagers rent upscale prom outfits instead of purchasing them for a one-time wearing.
“In the sharing economy, a key challenge lies in confirming that commercial activity and its participants are protected by insurance, despite the altered roles of the players and technology.”
The sharing economy has been defined many ways, but there are some important common elements. In a sharing economy, people and businesses earn money by increasing the use of an underused asset. That asset might be a parked car, a spare bedroom, an empty office, a pair of idle hands, or an evening dress. When an online platform or handheld app is used to connect the user and the idle asset, allowing the asset to be rented out for use by a third party, that transaction becomes a service in the sharing economy.
According to a 2016 study conducted by Pew Research Center, 72 percent of American consumers have used some form of shared or on-demand online service. Studies differ on the speed of growth of this sector, but nearly all agree that it will continue to grow rapidly, and will exceed $100 billion within a few years.
Imaginative and creative entrepreneurs are now using digital platforms to lend or borrow a wide variety of assets: photography and video equipment, landscaping tools, parking spots, boats, bicycles, and the like, and in many cases, they are turning to an increasingly fluid population of “gig workers” to facilitate delivery of these assets.
As with any new business opportunity, there are challenges and risks accompanying the potential rewards. Buyers and sellers may be reluctant to use peer-to-peer trading platforms to arrange bookings or make purchases if they perceive an unacceptable risk.
Let’s begin with a few questions:
- Who is liable if something goes wrong: the individual providing the good or service, or the company that arranged the match? Or both? And will anybody’s insurance respond?
- Is the person who delivered your dinner an employee of the restaurant that prepared it? Or does s/he work for the service that delivered it? Or is s/he an independent contractor?
- What happens if you are injured? Who is responsible for your medical bills? What if the gig worker is injured? Does workers’ compensation apply? What if others are injured?
The answers to these questions are not always straightforward, consistent (depending on jurisdiction), or even available. The roles and responsibilities of people and organisations change as they migrate to the sharing economy, creating many situations for which traditional insurance policies do not provide coverage.
Many online trading platform operators proclaim that they assume no liability for property loss or damage, or bodily injury, suffered by buyers, sellers, lenders, borrowers, or other third parties; they insist that they merely operate the peer-to-peer trading platform, with no further involvement.
Despite this vacuum of responsibility, the loss incidents—vehicle accidents, property theft, damage and destruction, and bodily injuries—do occur. Worse still, many of the players in the sharing economy are operating under the mistaken impression that they have valid insurance for their activity, even though their policies exclude coverage for it.
Standard insurance policies do not reliably fit or respond to the risks we have described here. The policies either provide insufficient coverage, leaving open important coverage gaps, or they are an overkill, providing coverage more suited to a full-time scaled-up business when the user needs only occasional protection for a part-time endeavour.
A typical personal lines automobile liability policy will not provide coverage when the insured drives for commercial purposes. But what if you’re driving for that service only in your spare time, and don’t want or need a full livery car policy? Other examples abound: do you need to buy a commercial lines insurance policy if all you want to do is rent out your lawn mower?
Amid this uncertainty and disruption, let’s tally the lines of insurance affected by our discussion so far: we have touched on automobile liability, property insurance, commercial inland marine, general liability, crime insurance, food product liability, completed operations, workers’ compensation, employers’ liability, employment practices liability, cyber liability, and disability, for starters.
The role of gig workers
The most commonly cited examples relate to the ambiguous role played by the gig worker, who is a key component of the sharing economy. Is s/he an employee? The employment landscape continues to evolve, but its transformation shifted into high gear in September 2019, when California’s governor Gavin Newsom signed into law Assembly Bill 5 (AB5), which will go into effect on January 1, 2020.
Under the new law, workers will be deemed employees if a company exerts control over how they perform their tasks, or if their work is part of that company’s regular business. The law provides that Californian workers can generally be viewed as independent contractors only if the work they perform is outside the usual course of a company’s business.
The California AB5 law, which has provoked strong opposition in many quarters, has far-reaching implications for companies employing gig workers who are currently classified as “independent contractors”. This stretches across the old economy and the new—from office cleaning contractors to ride-sharing companies.
Some of these companies seek to avoid classifying gig workers as employees, since having employees implies responsibilities such as federal and state tax withholding, healthcare and pension obligations, unemployment insurance protection and, notably, workers’ compensation insurance.
Proponents of the new AB5 law argue that these companies are abusing the system by misclassifying their workers as independent contractors. They contend that these companies are freeloading on the system, seeking to avoid paying their fair share of benefits and taxes, and denying their workers basic rights that are required to be afforded to employees.
AB5 may not survive in its current form, but there will undoubtedly be changes in the way gig workers are treated for insurance, tax, and benefits purposes.
There is a chicken and egg dilemma arising from the traditional means used by insurers to underwrite risks. These risks will be highly specialised and uncertain, particularly at the start. Insurers need data as a prerequisite to offering dedicated insurance products for the sharing economy, but there is not enough historical data for underwriters to be able to reliably and fairly price the new coverages.
This has led to much frustration from entrepreneurs unable to launch their sharing economy ventures. A sharing economy executive was quoted in a 2015 Casualty Actuarial Society paper, venting his frustration in starting up a car-sharing enterprise:
“When we were trying to launch the company, one insurance carrier strung us along for six months and then said: ‘we really want to write this policy but we just need some data, so why don’t you come back after six months of operations and we’d be happy to take a look at it’.
“For us, that was not helpful at all and they should have told us that six months ago. How are we supposed to get the data if we can’t operate without insurance? We didn’t go back to them. If you don’t take a chance you lose the business.”
Even if insurers do want to write the business at the onset, they will want to add a risk premium to compensate them for underwriting based on limited information.
The captives answer
Part of the answer can be found in a sector that has historically served as a laboratory for underwriting new and emerging risks that are not well understood by the commercial insurance market: the captive insurance industry.
While captive insurers are often used as vehicles for retaining the risk of their parent owners, for years a sizeable number of them have underwritten unusual third-party risks in support of their parents’ core businesses. Frequently these are risks faced by customers, distributors, franchisees or other business partners.
Hoteliers, tour operators, shipping companies, franchisors, and manufacturers of consumer products have long used their captive subsidiaries to provide insurance to customers who may be reluctant to commit to a purchase because they are worried about the inherent risk of the purchase.
Coverages provided include trip cancellation, marine cargo, specialised casualty coverages, and extended warranty/replacement coverage. In each case, the parent’s ability to confirm the availability of insurance coverage (supported by the captive’s ability to take on these risks) strengthened customer confidence, and enhanced the parent’s value-add and sales capability.
In those captive reinsurance programmes, the parent works with a commercial insurance company to design an insurance programme with terms and conditions customised to the unique risks of the parent’s business with its customers. The insurance is then offered to the customer at the point of sale, possibly by checking a box with a mouse-click, for a small additional premium.
A portion of that premium is retroceded by the insurer to a reinsurance captive owned by the parent, which assumes most or all the risk.
If business owners in the shared economy believe that they need to take risk to keep the business, then reinsurance captives are an important ingredient to its success. They provide relatively easy entry into the insurance risk-taking business, and create a partnership between licensed insurers and operators in the shared economy.
In this regard, new transformed insurance products operating under subscription or usage-based models—automobile insurance rated by the mile, for example—will become increasingly important.
The partners are waiting. Willis Towers Watson reported in October 2019 that, through the first three quarters of 2019, investment capital flowing into insurtech totalled $4.36 billion, a 5 percent increase from the total amount of investment in all of 2018. While insurers are reluctant to take on risk whose parameters and history are not well-known and defined, they are more likely do so if they are partnering with a business that has “skin in the game”, and can invest in the learning curve of the risk.
In the sharing economy, a key challenge lies in confirming that commercial activity and its participants are protected by insurance, despite the altered roles of the players and technology. Most of the ingredients to make this happen are all already in place: risk capital, large commercial insurers working hard to get into this space, new insurtech companies innovating on product design and delivery, and peer-to-peer operators realising that uncertainty about insurance impedes the growth of their businesses.
Captive insurers, demonstrating their parent owners’ willingness to invest in the risk of their new businesses, could be an important final ingredient.
Edward Koral is a specialist leader in Deloitte Consulting’s actuarial and insurance solutions group in New York. He can be contacted at: firstname.lastname@example.org
Deloitte, Captive, Insurance, Sharing economy, Edward Koral, North America