From Lloyd's Coffeehouse to Polymarket: Prediction Markets Are Reshaping the Insurance Industry

From Lloyd’s Coffeehouse to Polymarket: Prediction Markets Are Reshaping the Insurance Industry

By Dongcha Beating

Reprinted from Mars Finance

In 2023, a letter was sent to the mailboxes of 100,000 households in Florida, USA.

The letter came from Farmers Insurance, a century-old insurance company. The message was brief and brutal: 100,000 policies, covering everything from homes to cars, are canceled effective immediately.

A written promise, turned to waste paper overnight. Angry policyholders flooded social media, questioning a company they had trusted for decades. But all they received was a cold announcement: “We need to more effectively manage our risk exposure.”

In California, the situation is even worse. Insurance giants like State Farm and Allstate have stopped accepting new home insurance applications, and over 2.8 million existing policies have been denied renewal.

An unprecedented “insurance retreat” is unfolding across the United States. Once a social stabilizer, promising to back everyone, the insurance industry itself is falling into turmoil.

Why? Let’s look at some data.

Hurricane Helen caused damages in North Carolina that may exceed $53 billion; Hurricane Milton, according to Goldman Sachs, could result in insurance losses over $25 billion; and a major fire in Los Angeles has an estimated total economic loss between $250 billion and $275 billion, with insurance payouts estimated between $35 billion and $45 billion by CoreLogic.

Insurers are discovering that they are approaching their capacity limits for payouts. So, who can replace the traditional insurance industry?

The Gamble in the Café

The story begins over three centuries ago in London.

In 1688, by the Thames River, in a café called Lloyd’s, sailors, merchants, and shipowners were all under the same shadow. Cargo-laden ships set sail from London to distant America or Asia. If they returned safely, it meant great wealth; if they encountered storms, pirates, or ran aground, they would lose everything.

Risk, like an ever-present dark cloud, hung over every sailor’s mind.

The café owner, Edward Lloyd, was a shrewd businessman. He realized that these captains and shipowners needed more than just coffee—they needed a place to share and spread risk. So, he began encouraging a kind of “betting game.”

A captain would write details about the ship and cargo on a piece of paper and post it on the café wall. Anyone willing to assume part of the risk could sign their name and specify how much they would insure. If the ship returned safely, they would share in the reward paid by the captain (the premium) proportionally; if the ship was lost, they would compensate the captain’s losses proportionally.

If the ship returned, everyone was happy; if it sank, losses were shared.

This was the embryonic form of modern insurance. It had no complex actuarial models—only simple business wisdom: dispersing a large individual risk among a group of people.

In 1774, 79 underwriters united to establish Lloyd’s Association, moving from the café to the Royal Exchange. A trillion-dollar modern financial industry was born.

For over three centuries, the essence of insurance has remained unchanged: it is a business of managing risk. By actuarial calculations, it estimates the probability of various risks, prices them, and sells coverage to those seeking protection.

But today, this ancient business model faces unprecedented challenges.

When hurricanes, floods, and wildfires occur with frequency and severity far beyond historical data and actuarial predictions, insurers find that their measuring tools can no longer gauge the world’s increasing uncertainty.

They have only two options: significantly raise premiums or retreat, as seen in Florida and California.

A more elegant solution: risk hedging

When the insurance industry is caught in a dilemma of “uncertain calculations, unpayable claims, and inability to insure,” we might step outside the insurance framework and look to another ancient industry for answers: finance.

In 1983, McDonald’s planned to launch a revolutionary product: McNuggets. But a management problem arose—chicken prices fluctuated wildly. Locking in menu prices meant that if chicken prices soared, the company would face huge losses.

The tricky part was, at the time, there was no chicken futures market to hedge the risk.

Ray Dalio, then a commodities trader, proposed a genius solution.

He told McDonald’s chicken suppliers: “Isn’t the cost of a chicken just small chickens, corn, and soybean meal? The prices of small chickens are relatively stable; the real volatility is in corn and soybean meal. You can buy futures contracts for corn and soybean meal to lock in production costs, thus providing McDonald’s with a fixed price for chicken.”

This “synthetic futures” idea, which seems obvious today, was revolutionary at the time. It not only helped McDonald’s successfully launch McNuggets but also laid the groundwork for Ray Dalio’s later founding of the world’s largest hedge fund—Bridgewater.

Another classic example comes from Southwest Airlines.

In 1993, CFO Gary Kelly began developing a fuel hedging strategy. From 1998 to 2008, this strategy saved Southwest about $3.5 billion in fuel costs, accounting for roughly 83% of the company’s profits during that period.

During the 2008 financial crisis, when oil prices soared to $130 per barrel, Southwest used futures contracts to lock in fuel at $51 per barrel for 70% of its needs. This made it the only major U.S. airline able to maintain its “free checked bags” policy at that time.

Whether it’s McDonald’s chicken or Southwest’s fuel, they reveal a simple business wisdom: using financial markets to turn future uncertainty into today’s certainty.

This is hedging. It shares the same goal as insurance but with a fundamentally different logic.

Insurance is risk transfer—you transfer risk (like accidents or illness) to an insurer and pay premiums; hedging is risk offsetting.

If you have a spot position (say, need to buy fuel), you establish an opposite position in futures (buy fuel futures). When spot prices rise, the profit from futures offsets the loss in the spot market.

Insurance is a relatively closed system, dominated by insurers and actuaries; hedging is an open system, jointly priced by market participants.

So, if hedging is so elegant and efficient, why can’t we use it to solve today’s insurance problems? Why can’t a Florida resident hedge against hurricane landfall like Southwest Airlines?

The answer is simple: because there is no such market.

Until a young entrepreneur, starting in his bathroom, brought it to us.

From “Risk Transfer” to “Risk Trading”

22-year-old Shayne Coplan founded Polymarket in his bathroom. This blockchain-based prediction market gained fame in 2024 with the U.S. presidential election, with annual trading volume surpassing $9 billion.

Besides political bets, Polymarket hosts some interesting markets. For example, will Houston’s high temperature exceed 105°F in August? Will California’s nitrogen dioxide levels be above average this week?

An anonymous trader named Neobrother has made over $20,000 trading weather contracts on Polymarket. He and his followers are called “Weather Hunters.”

When insurers fled Florida due to unpredictable weather, a group of mysterious players was actively trading on temperature differences as small as 0.1°C.

Prediction markets are essentially platforms where “everything can be futures-ized.” They extend the functions of traditional futures markets—from standardized commodities (oil, corn, forex) to any publicly verifiable event.

This offers a new way to address the insurance industry’s dilemma.

First, it replaces expert arrogance with collective wisdom.

Traditional insurance pricing relies on actuarial models. But as the world becomes more unpredictable, models based on historical data fail.

Prediction market prices are determined by thousands of participants “voting” with real money. They reflect the market’s collective assessment of the probability of an event. A contract on “Will a hurricane land in Florida in May?”’s price fluctuations are the most sensitive and real-time indicators of risk.

Second, it replaces helpless acceptance with trading freedom.

A Florida resident worried about their house being destroyed by a hurricane no longer only has “buy insurance.” They can buy a “hurricane landfall” contract on the prediction market. If the hurricane hits, their profit on the contract can help cover damages.

This is essentially personalized risk hedging.

More importantly, they can sell the contract at any time, locking in profits or cutting losses. Risk is no longer a burdensome, bundled, one-time transfer but a tradable asset that can be sliced, bought, and sold at will. The risk taker becomes a risk trader.

This is not just a technological upgrade but a shift in mindset. It liberates risk pricing from a few elite institutions and returns it to everyone.

Is the end of insurance the beginning of something new?

Will prediction markets replace insurance?

On one hand, prediction markets are eroding the foundation of traditional insurance with a kind of “cutting the roots.”

The core of traditional insurance is information asymmetry. Insurers have actuaries and large data models; they need to understand risks better than you do to price coverage. But when risk pricing is replaced by a transparent, crowdsourced market driven by collective intelligence and insider info, insurers’ informational advantage disappears.

Florida residents no longer need to blindly trust insurance quotes; they can look at the prices of hurricane contracts on Polymarket to gauge the market’s real assessment of risk.

More critically, traditional insurance is a “heavy model”—sales, underwriting, claims, and settlement, all full of labor costs and friction; prediction markets are an “ultra-light model,” with only trading and settlement, almost zero middlemen.

But on the other hand, prediction markets are not omnipotent. They cannot fully replace insurance.

They can only hedge objectively definable and publicly verifiable risks (like weather or election outcomes). For more complex and subjective risks (like accidents caused by driving behavior or personal health), they fall short.

You can’t open a contract on Polymarket asking the world to predict “Will I have a car accident next year?”

Personalized risk assessment and management remain the core strengths of traditional insurance.

The future landscape may not be a “who replaces whom” extermination but a new, intricate symbiosis.

Prediction markets will become the infrastructure for risk pricing—like today’s Bloomberg Terminal or Reuters, providing the fundamental data anchors for finance. Insurers may also become deep participants in prediction markets, calibrating their models with market prices or hedging catastrophic risks they cannot absorb.

And insurers will return to their core role of service.

When pricing advantages diminish, insurers must rethink their value. Their core competitiveness will shift from information asymmetry to deep engagement in personalized, long-term risk management areas like health, retirement planning, and wealth transfer.

The old giants are learning the new dance. And explorers of the new world need to find routes back to the old continent.

Epilogue

Over three centuries ago, in a London café, a group of merchants invented a risk-sharing mechanism with primitive wisdom.

Now, in the digital world, players are reshaping how we coexist with risk.

History often completes its cycles unnoticed.

From forced trust to voluntary trading—perhaps this is another exciting chapter in financial history. Each of us will evolve from passive risk recipients to active risk managers.

And this is not just about insurance; it’s about how each of us can better survive in a world full of uncertainties.