At Microinsurance, we are exploring the use of blockchain technology and smart contracts in the insurance industry. We believe that smart contracts can revolutionize insurance because at its core, insurance is a contract that promises to pay if certain events occur in the future and are covered by the contract.
Currently, insurance contracts are often complex, wordy, and filled with fine print. They can be ambiguous and require legal experts and administrators to navigate through the various escape routes they contain. Introducing smart contracts into the insurance process requires technological advancements and investments, which the insurance industry has been slow to adopt.
Ideally, insurance contracts should be simple, ensuring that both parties are treated fairly and receive what they expect. However, there are cases where insurance companies dispute claims and delay payments. This is where smart contracts can be valuable. Smart contracts eliminate the chance for interpretations, providing clarity and efficiency in insurance processes.
The use of smart contracts is closely tied to the rise of blockchain technology, which is still in its early stages for many companies, particularly in the insurance industry. Blockchain has the potential to bring significant advantages to insurers and brokers, such as streamlined processing and transparency. Smart contracts will eventually be utilized in sharing economy, gig economy, IoT, and platform insurance, making the process more transactional.
The key idea behind smart contracts is to utilize technology coding to automatically determine and enforce obligations between parties. These contracts enable the exchange of money, property, shares, or any valuable asset in a transparent and conflict-free manner. They are built on trust, especially when combined with decentralized blockchain networks. This holds great power for the insurance industry, particularly in parametric and transactional insurance, as it eliminates ambiguity and enhances speed and volume.
While the term “smart contract” is commonly associated with Ethereum and IBM, it is possible to create smart contracts on other blockchain platforms. Ethereum smart contracts are currently the most popular.
A US Senate report in 2018 stated, “While smart contracts might sound new, the concept is rooted in basic contract law. Usually, contractual disputes are handled and terms enforced by the judicial system. However, it is also common to use arbitration methods, especially for international transactions. With smart contracts, the contractual terms are enforced by a program embedded in the code.”
Another form of smart contracts relevant to the insurance industry is Ricardian contracts. A Ricardian contract is a digital contract that defines the terms and conditions of an interaction between multiple parties. It is cryptographically signed, verifiable, and readable by both humans and machines. This type of contract proves useful in insurance, where both parties may need to access the contract periodically.
A Ricardian contract connects a legally valid document to a specific object or value in a digital format that can be executed by software. It combines a legal agreement and a protocol, offering a high level of security through cryptographic identification.
Using a smart contract, it is possible to encode an insurance policy for hurricanes on the blockchain with specific rules. In the event of a hurricane, the smart contract can automatically transfer the claim money to the beneficiary. The insurer may include additional constraints, such as only enabling the transfer if the hurricane reaches a certain intensity and tracks within specified parameters.
Since smart contracts rely on data stored in the blockchain, they can utilize external services, known as “oracles,” to gather data from the real world. For example, an oracle can examine the track and intensity of a hurricane to determine if the insured party is eligible for a payout. The oracle can also instantly verify claims materials on the blockchain, such as invoices or records, triggering immediate automatic payment.
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