In my view, embedded insurance is everything that is wrong with the startup approach to insurance.

Rather than look at things from the consumer’s perspective and ask how it helps them, embedded looks at things from the insurer’s perspective: How can we sell something to people that they may not need?

So, it might seem that embedded insurance is good for insurers. In fact, it’s a bad idea for insurers also.

Before I get on the soapbox about both, let’s define what embedded insurance is. This is just a new term for, when you buy some other product, the seller tries to get you (or even forces you!) to buy insurance, too.

This may remind many of you of the extended warranty pitch when you buy a car or TV or when the rental car agent tries to badger you into buying insurance. In other words, these are things most people don’t want, but some pushy salesperson tries to convince you that you need so they can make a commission.

Today, you may think of it as Tesla selling insurance to its customers. But, in many ways, that is an outlier. The embedded insurance movement is more about insurers trying to get other companies to sell insurance for them, rather than a retailer starting its own insurance arm.

The idea is that customers don’t realize they need insurance, or perhaps they realize it but want the convenience of buying it automatically rather than having to shop separately.

There are some applications where this could make sense. Let’s say you’re climbing Mt. Everest; it might be nice if the sherpa included some life insurance in the travel package!

But more often than not, embedded insurance is like when toy makers used to sell electronics with batteries included. A lot of the times the batteries didn’t work as well as the ones you could buy yourself, yet they cost more because you were forced to buy them.

Recycling Old Ideas

Some of you may read this and say, isn’t embedded like when the auto dealer tried to sell you insurance on the lot? Yep, that’s exactly what it is.

Or isn’t it like when Sears used to sell Allstate policies in its stores? Right, that too.

Or when the Circuit City salesperson would talk you into a new stereo only to tell you at checkout, “You know, this is a piece of crap and will break in a year, so you really should get the extended warranty?” Yeah, that was embedded, too.

So, you can think of embedded like all those ’70s TV shows they’ve brought back with new actors that nobody was asking to be rebooted. Nobody is quite sure why the network agreed to make them. That’s embedded insurance!

The Lazy Consumer

The core premise of embedded is that the buyer is too lazy to buy their own batteries or, perhaps, that they don’t know the difference between AA and AAA, so they need to have the decision made for them.

Almost every type of insurance being offered as “embedded” could easily be bought separately. We are not talking about creating new types of insurance for novel risks. It is mostly auto, pet, comp and warranty.

The main reason they are being repackaged as “embedded” is because the insurers realized they are bad at selling them on their own. The hope is by using a middleman, they can catch you in a weak moment where you might buy pet insurance from the pet store that just sold you the puppy.

It’s emotional manipulation rather than truly addressing a need.

Nudge vs. Manipulate

What this really comes down to is what you think about the sophistication of your customer. If you think they want to do the right thing but need it made easy for them, then behavioral finance would suggest you can “nudge” them to the optimal outcome.

However, often companies think their customers are dumb and can be taken advantage of. Think about how they put the candy bars at the checkout to try to get you to make an impulse buy that you didn’t really want.

So, is embedded insurance the checkout candy bar or a helpful nudge?

Let’s start by examining the business case for embedded insurance. Every paper I have read advocating for embedded highlights how it’s good for the insurance company (they sell more policies), good for the distributor (they get fee income for the referrals), and good for investors (embedded insurance can be overpriced due to the inability to comparison shop).

Rarely, does it address whether it is good for the buyer. So, we certainly seem to be in manipulation territory.

We also know impulse purchases tend to be overpriced because they take advantage of your emotional state. Even if done logically, we know captive products tend to sell at higher price points, so it is unlikely to be a good deal for the buyer.

There is usually some discussion about addressing the “insurance gap.” This would fit the nudge narrative. As someone who is building a business around fixing the home insurance coverage gap, I am very receptive to this concept!

(Read CM’s profile of author Ian Gutterman and his startup Informed Insurance in the article, “InsurTech Tackles Underserved Homeowners Market: Uninformed Buyers“)

Mind the Gap

However, the way to address the gap is to convince customers of the value of your product. It isn’t to trick them by positioning it as an impulse purchase, including it in the product without clearly disclosing it, or putting on pressure sales tactics to twist someone’s arm into buying something they wouldn’t have otherwise.

I’m not saying all embedded insurance uses one of these tactics. There are fine examples of addressing the coverage gap, but more often than not, the motivation is what is good for the corporate interests rather than the consumer.

Most people have learned not to buy the rental insurance or the extended warranty. So, why are we trying new versions of this tactic when the old ones were clearly anti-consumer?

What embedded insurers are really doing is trying to make the insurance buying process less efficient by using the cover of “making it easy” to make it harder to understand what you actually bought and whether it’s appropriate—all while charging you a higher price.

That doesn’t sound like innovation. That sounds like a new way of doing what insurance companies have done for hundreds of years—ignoring what the customer wants.

The Value Test

If an embedded insurer is truly bringing value to the customer, it will need to accomplish three things:

• Better coverage than available in traditional channels.
• Lower price than in alternative channels.
• Easier buying process with clear explanation of why it’s a good price and offers better coverage.

If a company has found a way to do all three of those, then it has created a good experience by embedding. If all it’s doing is selling overpriced products or insurance to people who don’t need it, then it shouldn’t exist.

The Great Irony: Insurer = Dumb Capacity

But there’s one other consideration: Is selling a product to an unaware buyer actually good for the insurer? In my view, the insurer is losing, too.

Why? Because you are doomed to be a commodity provider.

What’s the worst area of insurance to be in over a cycle? Reinsurance. Why? Because (with rare exceptions) you are nothing more than capacity to your client.

You have little pricing power, no meaningful brand and limited ability to set terms. You are a price taker. You observe where the market clears and choose whether you want in or out at those terms.

Conversely, the best place to be is a primary brand with wide name recognition and a good reputation that leads to high retention and less price sensitivity. While some of these companies may spend too much, and thus have low returns, their brands are impossible to replicate and have significant franchise value.

When you choose to be an embedded insurer, you are acting more or less like a reinsurer. You are a nameless, faceless entity. The customer doesn’t care who you are. They attribute all the value they perceive from the transaction to the retail brand that you partnered with. That brand gets all the goodwill.

You are nothing more than dumb capacity. Sure, there are some isolated cases where you have some technology strength that would prevent other insurers from replacing you easily, but more often than not, the retail partner could care less if another insurer stood in your shoes.

Bargaining Power

If your distribution partner holds all the cards, what does that mean for your economics? It’s quite simple. It means they won’t be good. You, dear embedded insurer, need your partner way more than they need you.

If they stop selling your product, they lose some ancillary fees. Whoopty-doo. Maybe somebody’s bonus will be a little lower, but their business will do just fine.

On the other hand, you as the insurer, lose everything. You will do anything in your power to maintain that relationship.

You don’t have to be a game theory expert to understand how this will end. Distribution partners will demand bigger and bigger pieces of the pie. If you don’t cut them another slice, they will drop you for another partner.

You will also be expected to meet high service standards so you don’t provide a bad experience that hurts the partner’s brand. That is an expensive requirement.

Margins will be worse than reinsurance! Primary insurers need to keep buying reinsurance each year. Maybe they buy less if they don’t like the terms, but they still have to buy. Retailers don’t have to be in the insurance distribution business. It is the definition of non-core.

It will be a very low ROE business, if it’s even a positive ROE business.

Adverse Selection

The partner will want to sell your product to every customer since that is incremental fee revenue for them, even the ones with a high likelihood of a claim or willingness to commit fraud. Unless you demand they receive a healthy chunk of their payment as profit based contingent commissions, they won’t care about your loss ratio.

Given we’ve established the partner has all the bargaining power, the likelihood of insurers being able to tie distribution fees to underwriting profit is somewhere between slim and none.

Now, if the end customer is truly seeking insurance protection and you are providing a better solution than they can get elsewhere, this may not be much of a concern. But if they are being pressured into a sale by a customer service rep or being pushed something online that they don’t understand, the odds are fairly high that most of the buyers will be those who suspect they have a high probability of a loss.

Poor Valuation

Given everything I just laid out, what would an investor pay for an insurance business with no franchise value, no name recognition, no pricing power, no leverage with its distribution and a high possibility of adverse selection?

I wouldn’t pay more than book, if that. It’s a terrible business model. Reinsurers at least provide a service to their clients—they are smoothing volatility, which reduces the primary’s cost of capital. That means reinsurers with strong balance sheets and better ratings will be able to ask for bigger allocations and have some influence over terms.

Why would a distribution partner choose one insurer over another besides price? Maybe some service or technology capability that provides a better experience? Possible, but that comes with a higher expense structure, so your overall returns are no better.

Embedded will be the ultimate commodity industry. It’s like store brand credit cards. Shoppers care about the name of the store on the card, not whether Chase or Citi provides the funding.

A Matter of Expediency

So, why did so many startups decide to go in this direction (besides the cynical answer that it was easy to raise capital for the flavor of the day)? Because InsurTechs still focus too much on top-line growth and ignore long-term economics. Sure, you can grow quickly doing an embedded deal. But you’re not going to grow profitably or have an exit multiple you’re going to be happy with.

It’s the easy button. Going direct was too hard. Building a true specialty distribution capability takes too long. Selling through agencies might work for a while, but you have to burn your way in through pricing and you’ll get book rolled anytime you raise price.

With that set of choices, embedded looked like the one way out of the maze—if your goal was to grow top line in order to raise the next round.

If, on the other hand, you’re trying to build a lasting business, being completely beholden to your distribution partner is nothing more than a dead end.