Smart contracts: a new model for the insurance industry

Investment in blockchain-based technologies in the insurance industry has mostly concentrated on enhancing processes like record-keeping, managing claims and other administrative procedures. However, interest in the potential of blockchain applications for insurance has gained significant traction.

One potential application of the blockchain for the insurance industry is the smart contract – software technology that could have a transformative impact on the sector.

A smart contract is basically a software programme into which the contract conditions are set, and the contract can then self-execute once the pre-set conditions are met. A smart contract is not reliant on a human third party or central operator. The performance of a smart contract is media­ted by technology, and actions defining the contract provisions are enabled automatically and are irrevocable. Once initiated, the outcomes for which a smart contract is encoded to perform cannot be stopped, unless one of the contract conditions is not met.

A key feature of smart contracts is that they are particularly well-suited to contract conditions that may be expressed as an ‘if-this-then-that’ function. For ex­ample, if the price reaches €2, then sell. In contrast, smart contracts are not well suited to cases where the consequences of a contract are not straightforward, or require subjective analysis.

Why is the insurance industry particularly well suited to implement smart contracts in its day-to-day operations?

Insurance policies are generally based on logical ‘if-this-then-that’ scenarios where if the insured event takes place, then the insurance claim is triggered. An example could be an insurance contract against flight delays, with a claim payable immediately if a flight is delayed by more than three hours.

Once a three-hour delay passes, the insurance policy could immediately self-execute and pay out to the insured party.

Such small, simple contracts are particularly amendable to leverage the automation, the security and the transparency provided by the blockchain on which such smart contracts are based.

The benefits of smart contracts in insurance are clear, and in theory should reduce insurer costs, not least claims administration costs. Insurers could then pass on the saving in lower pre­miums for policyholders, or offer increasingly refined insurance cover for small events that would not make sense in a manual claim processing workflow. Policy adjust­ments could be made automatically in response to certain pre-determined events or inputted information.

Policies are generally based on logical ‘if-this-then-that’ scenarios

Automated claims payments would also mean that policyholders would get paid more quickly in comparison to today’s environment in which claims take weeks to be paid.

All these factors will greatly im­prove the customer’s experience. With blockchain’s key features of transparency, immutability and security, smart contracts should also reduce the risk of fraudulent insurance claims.

The difficulty in smart contract coding lies in actions that depend on parties upholding contract terms. In insurance, this drawback is increased by insurance-specific contractual nuances, such as pre-contractual disclosure obligations or force-majeure exclusions. Moreover, decisions of underwriters and regulators are often made out-of-contract, as well as human subjective analysis such as the claim surveyor in instances of damage.

The highly regulated nature of the industry increases the concerns. Insurance companies adop­ting smart contracts need to satisfy their legal and regulatory objectives – their contracts need to be legally binding and enforceable.

Will the smart contract purport to constitute or to merely perform aspects of a contract?

A not insignificant obstacle to the deployment of smart contracts by insurers is sufficient human and financial resources for their development. As smart contracts represent more of a re­volution than an evolution in the way business is transacted, they will require significant strategic long-term resources committed to their development.

Smart contracts are not yet used by insurers in Malta, but blockchain-based contracts have generated much interest among several local industries, established businesses and start-ups.

The government of Malta is well on its way to become a global pioneer and to set up and implement a regulatory structure that addresses key legal issues of block­chain solutions across industry sectors. It is doing so with the collaboration of a number of im­portant regulatory institutions, including the Malta Gaming Authority, the Malta Information Technology Agency and the Malta Financial Services Authority.

With the government’s vision for Malta to become a European hub for the development of blockchain technology, players in the insurance industry are encouraged to be part of this future, and start taking an active role in exploring the possibilities of this new technology, which promises to revolutionise the way business is done, ultimately, with lucrative benefits.

This could be initially done, perhaps, by trying hybrid smart contracts, automating some contract fundamentals like payments, in short-term and low-risk situations where the potential for disputes is low and the management of claims uncomplicated.

Steve Muscat Azzopardi is head of corporate & financial services at Chetcuti Cauchi Advocates.

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