All markets have two sides (or more), but the two-sidedness of some markets is their distinguishing feature. Economists refer to such markets as matching markets, e.g., Marriage ‘markets’ (one-to-one); university places and students (one-to-many); employers and employees.
Matching markets are characterized by:
- Search – (customers search for insurers and vice versa), involving cost, time, and inconvenience.
- Risk – Matching requires at least one side of the market to reveal private, sensitive information and trust between buyers and sellers.
- Asymmetric information – often requires screening or signaling, or even regulation.
- Unstable allocations – frequent switching, high switching costs, perverse incentives, etc.
Insurance Market Dynamics
A buyers’ valuation of an insurance product increases with an increase in their risk profile. The sellers’ costs = Claims + Tax + Administration + Distribution (‘CAC’). Of these, Claims (expected underwriting loss) and Tax also increase with buyers’ risk type, so overall unit costs do the same. Therefore the average cost curve, which reflects the sellers’ costs of production, is downward sloping.
The insurance price (PAS) and quantity (QAS) sold are given by the intersection of the demand and average cost curves. Adverse selection occurs because high-risk buyers are selected by traditional insurers’ go-to-market methods, while low-risk people ‘self-insure’ choose not to buy insurance or buy minimal coverage. As a result, the cost of insuring low-risk customers is higher than their willingness to pay; therefore, expected claims from insuring low-risk customers are small – CAC accounts for most of the cost for these customers.
Salty leverages its Embedded Insurance® to generate a frictionless match between the customer and the insurer to reduce customer acquisition costs (CAC). Because of the ability to seamlessly reach all types of customers at the point of purchase, this enables a 78% reduction in CAC. The decrease in cost shifts the supply curve down. Salty adds a pool of lower-risk customers, mitigating adverse selection, lowering underwriting risk, and benefiting high-risk and low-risk customers.
Search costs incurred by customers are estimated to be up to 28% of premium. Customers also incur non-search costs, e.g., psychological costs related to making decisions. Salty can provide customers with the greatest convenience: they don’t need to search for insurance policies by themselves or inform themselves on the market so they can make an effective comparison. By integrating at the point of sale, Salty also maximizes the salience of insurance, increasing the differential between the customer’s valuation of the policy and its cost. Elimination of these customer costs and increasing the salience of coverage shift up the demand curve.
Customers who previously had very low valuations of a policy are now willing to buy insurance. Moreover, with even lower-risk customers joining the pool, the average cost decreases further, driving the price even lower in a virtuous cycle that creates an economic moat.