What does the LendingClub scandal mean for peer-to-peer insurance?
For weeks we’ve been hearing about the steady demise of LendingClub, one of the largest peer-to-peer (P2P) online lending platforms in the states, after its founder and Chief Executive Renaud Laplanche was removed from his post after being implicated in allegations of fraud and non-disclosure.
But what does this mean for the fledgling P2P insurance market?
First, it’s worth taking a look at why.
Up until the beginning of 2016, LendingClub had huge success among both borrowers and lenders, in the last quarter of last year acquiring over $2 billion in loans. LendingClub was at the forefront of an emerging industry, but despite the hype surrounding the company, success hasn’t lasted.
From early 2016 the P2P lending site started to struggle to attract investors. Through increased defaulting on loans and tightening regulations, investors were quickly becoming wary of the P2P lending platform, and investment decreased. The pressure was mounting for executives to meet growth targets and keep loan volume up.
In April 2016 LendingClub commissioned an external firm to investigate reports that dates had been altered on around $US3 million worth of the companies loans. The investigation uncovered multiple issues, including that the P2P firm had sold a $22 million portfolio of loans to a major investor, Jefferies, under false credentials, and CEO Laplanche had failed to disclose partial ownership of an investment fund that was a customer of LendingClub and which he also pushed for the company to invest in.
LeadingClub’s founder and chief executive, Renaud Laplanche, and three of the firm's other executives stood down as a result of the problematic loans, and in the month following, LendingClub’s stock prices fell by 39 percent as a result of the scandal.
As peer-to-peer investments aren't typically as protected by any government guarantee or regulation, like tradition financial institutions are, there is a high amount of trust and honesty involved in the P2P lending process.
Through the fall of P2P’s poster child, this trust has been damaged. Investors worst fears were confirmed, and although regulation had started being introduced into the peer-to-peer world, many are now calling upon stricter measures and third party oversight to gain increased transparency of the sector. But with this increase in regulations comes an increase in costs for all parties involved.
Interestingly for insurers, in the wake of this crisis, it’s clear that P2P insurance faces similar challenges.
Some of the more prominent P2P insurers follow a model where social groups share each other's exposure to excess. Put simply, all members of the group pay the same amount into a deposit account to buy units of protection, the more units of protection a person has the higher their cover is. Members then draw on the joint deposit when they claim insurance.
Through this model comes the problem of moral hazard, where someone takes more risk because another person bears the cost. This relates back to the challenges faced in peer-to-peer lending, where there is a certain element of trust required for the transaction to run smoothly and fairly.
There are also regulatory issues that come with P2P insurance. This industry has such a high level of regulation surrounding it that it could be difficult for P2P insurance companies to develop and grow, and difficult for regulators to know what to do with them.
Stepping back from all the challenges and issues that come with the peer-to-peer sector, it’s worth acknowledging that P2P services could still hold a crucial role in the future development and growth of both the investing and insurance industries.
The financial industries have struggled to keep up with consumer expectations. There has been very little change in decades, yet the rest of the world has advanced enormously. The P2P sector can create a dynamic for change that is essential for the success of both industries. Banks would be able to cut costs and offer better interests rates to both borrowers and investors and insurers would be able to lower premiums and offer potentially fairer and more transparent insurance for all.
The question is: will P2P insurance really take off and become a disruptor like some predict, or is it just another flash in the pan held back by regulation and an unstable business model?
Companies that can tap directly into the complex wealth of the human marketplace will be able to scale and adapt well beyond what we’ve already seen. But this is a model that relies heavily on trust, something that, as proven by LendingClub, can be hard to come by these days.