What Makes or Breaks Startups in the Sharing Economy? Insurance Rates

Alexandra Liss rarely uses her car, so first-time renter Kathleen Wernigg picks it up in Nob Hill. Photo: Gus Powell

As recently as last year, it wasn't clear that RelayRides' business made financial sense. The company, which lets strangers rent one another's cars, was growing — acquiring rivals like Wheelz and expanding into new markets. It was charging its users a healthy vigorish; car owners paid the company 25% of every rental fee, while renters kicked in an additional 15%. (Most digital marketplaces only take a total of 10-20% of every transaction.) And yet, the company was still losing money on every transaction. The culprit? Insurance.

"We were paying punitively high rates," says CEO Andre Haddad. "They had to come down, otherwise we never would have been able to operate properly."

Insurance represents both the lifeblood and the biggest threat to the sharing economy. As I explore in this month's WIRED cover story, companies like RelayRides — or Airbnb, Lyft, or any other sharing company — depend upon its customers' willingness to trust one another. These businesses have devised numerous mechanisms to engineer that trust, but perhaps no one feature has been as important as insurance.

That's because our decision to trust someone else boils down to a fairly simple equation: If the potential benefit outweighs the perceived risk, we trust. In the early days of eBay, when strangers were sending one another cashier's checks in exchange for Beanie Babies, the risk was relatively low. The most they could lose was the amount written on the check. But sharing-economy companies expose customers to much higher potential risk — their homes could get trashed, their car wrecked, their safety compromised. The potential losses are limitless.

Airbnb learned this lesson the hard way during 2011′s infamous ransackgate incident. The debacle suddenly made potential Airbnb hosts very aware of all they might be risking by listing their home. Airbnb responded by introducing its own insurance policy, guaranteeing to cover damages of up to $50,000 — a figure later upped to $1 million and underwritten by Lloyd's of London — essentially reducing the financial risk back to zero. Now, that $1 million figure has become something of an industry standard. Dogvacay, Lyft, Relayrides, and Feastly all cover their customers for damage up to at least that amount. (Some critics — including taxi-industry trade organizations and the California insurance commissioner — argue that even this coverage can be insufficient and leave gaps.)

But to some degree, this isn't solving a problem as much as shifting it onto the companies' own balance sheets. That's because offering $1 million in insurance to every one of your customers can be a brutally expensive affair — especially when you're building an entirely new business model without a track record that underwriters can use to calculate how much they'll charge.

Scott Weiss, a partner at Andreessen Horowitz who led the firm's investment in Lyft, told me that the ride-sharing company is overpaying for insurance today — though he expects those rates to come down over time. "They're going to get the claims data that will show the insurance companies: 'Oh, these are really good drivers, they're not having accidents,'" he says. "But because it's new, it takes a while for that data to spit out. So, in the interim, they'll have to pay more speculative rates."

That puts companies in the position of doing everything within their power to ensure that their members treat one another well — not only for their customers' sake, but to minimize payouts and convince insurers to lower their rates. RelayRides' Haddad says that his underwriters calculate premiums by looking at the previous year's payouts and adding a 25 percent margin. "So everything we do to protect our marketplace from bad drivers — to make sure that as close to 100 percent as possible of transactions run completely smoothly — lowers our payouts and our premiums." To that end, RelayRides has instituted mechanisms to weed out unsafe drivers — including getting realtime DMV data to screen potential renters, at an average cost of $13 per driver. (The fee varies widely by state). As a result, Haddad says, between 15 and 20 percent of RelayRides applicants get turned down.

"That creates friction, obviously," Haddad says. "Sometimes we lose legitimate people that way. But at this point we've taken the approach of being a bit on the harsh side to lower our insurance premiums, which otherwise would have killed the business."

Haddad says that caution is paying off. Today, he says, RelayRides has brought rates down dramatically. "We can now see how this could be a solidly profitable business over time," he says. "We're still not covering fixed costs, but at least every transaction contributes positively to the bottom line."

So now the company just has to scale — while continuing to patrol its borders and protect its hard-earned low premiums. It's a delicate negotiation for any sharing company. Open your marketplace to everyone and your insurance premiums will kill the company. Restrict your user base too aggressively and you won't pull in enough customers to stay alive. The best solution, of course, is to figure out some way to ensure that the maximum number of users treat one another, and their property, with care and respect. But that's no easy task.

Jason Tanz is executive editor of WIRED. Over the next few weeks, he will be exploring ways that sharing-economy companies negotiate the tricky business of building trust.