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Insuring the future

Insuring the future

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Chip Reed from Willis Towers Watson provides a comprehensive guide on how blockchain could change the world of marine insurance.

If you’ve been working in the marine insurance industry lately, you will have heard about blockchain at some point; it is the electronic, distributed ledger, notoriously known for enabling the use of cryptocurrencies such as Bitcoin and Ether. But the blockchain technology’s utility goes beyond cryptocurrencies, potentially offering creative ways to solve other real-world problems.

Within blockchain ledgers, the use of ‘smart’ contracts essentially converts contractual obligations into lines of computer protocols, which facilitate, verify, or enforce its performance.

Much has already been written about how this technology could impact the financial services and transportation industries, including container shipping’s problems with non-delivered cargo. The emerging technology also has potential applications in marine insurance.

As its applications beyond cryptocurrencies are just emerging from the develop­mental phase, relatively few companies have implemented blockchain technology on a large scale. That will not be the case for long.

The marine insurance use case

Marine insurance is generally accepted as being the oldest form of commercial insurance; this has enabled the sector’s customs, practices and policy terms to standardise and codify. This standardisation of policy language and customs potentially allows marine insurance to reap the benefits from automation, particularly from the use of a blockchain ledger and smart contracts.

Brokerage

In fields of insurance with well-established policy provisions, where underlying terms and conditions seldom change, a corporate risk manager typically purchases a standard policy from the insurer directly or through a broker. The risk manager can request specific policy provisions beyond the standard contract, either before inception or by endorsement later. These are standard practices.

However, performing and recording these tasks on a blockchain, and having the policy represented in a smart contract, could simplify the purchasing process and increase transparency among the parties.

Conceivably, the purchasing process would no longer require a financial intermediary; it could be performed by the purchaser and all activities related to quoting and binding coverage visible to all stakeholders. The payment of the premium would be immediate and direct to the insurer, and the policy would be available upon confirmation of the exchange of funds. Using a binder to hold coverage in place while an insurer builds and delivers the policy could become obsolete.

In this scenario, disputes would be more easily resolved, as there would be an immutable record of all transactions permanently recorded on the blockchain ledger. The public ledger can be made available to all participants, building transparency and trust among the parties.

Anonymity could be maintained by assigning non-descriptive keys to each party, or by making the blockchain private to those involved. The process would significantly reduce any perceptions of wrongdoing — as well as errors and omissions — because all parties could verify each transaction, in permanent perpetuity.

Other menial tasks typically performed by brokers and insurers also could be automated; since the policy specifications are already hosted on the database, a certificate of insurance summarizing coverage could be quickly produced through a simple query and made available to any party with permissions to view the policy on the ledger.

Marine claims adjusting

Perhaps the most significant impact blockchain could have on insurance practices relates to claims adjusting and payment.

In the complex field of marine insurance, goods travel around the world with insurance attached to them for the entire voyage, or only a small portion of it. While in transit, they are exposed to any number of perils, and title to those goods often transfers several times during the voyage.

Tracking the source of loss or damage and following the chain of insurable interest entails the difficult process of chasing the associated paperwork around the globe. Hosting this information on a publicly shared blockchain ledger would empower adjusters to make informed decisions sooner, reducing the amount of time required to indemnify the client.

Smart contracts could be designed to pay immediately upon notification and verification of a loss, especially in cases of a total loss of goods. Where there is a total loss that is easily verifiable, funds could be transferred based on pre-set criteria that trigger payment.

For example, when a ship sinks it is an easily proven and well-documented event. Payment of the vessel’s agreed value could be performed based solely on a few lines of code, responding only when specific criteria are entered into the blockchain.

In the case of cargo losses, smart contracts can also be designed to pay losses immediately based on predetermined triggers.

Pharmaceutical goods or food-grade products contaminated or thawed prema­turely may constitute a total loss, depending on the underlying policy. If the temperature of a refrigerated container exceeds a specific threshold, a total loss can easily be declared and verified by a surveyor report or other trade document showing the violation. Funds would be transferred immediately for the loss through a smart contract.

Similar transactions can be equally shared by all parties with a financial interest in the voyage, in line with the legal principle in maritime law known as ‘general average’. Informing the blockchain database of an instance of general average could allow immediate posting of an average bond, reducing the time it takes to release cargo.

Admittedly, there are intricacies of the claims process that would need to be further developed, and agreed upon by the insured and insurer prior to entering into a contract.

For example, the salvage value of goods — and the responsibility of the insured to mitigate losses even in cases of total loss — must be clearly understood and enforceable. Smart contracts could be designed to immediately transfer the title and rights of recovery to the insurer, though the insurer typically refuses aband­onment of goods: this maintains an incentive for the insured to mitigate the loss when they still retain title to the damaged goods.

These intricacies of the insurance contract may not be easily captured by a smart contract, but the terms and conditions of the policy would provide guidance.

Marine mutual insurance: P&I Clubs and beyond

In personal lines of insurance, there has been a proliferation of companies adopting the blockchain technology beyond when compared to commercial lines. Blockchain-based insurance companies using the peer-to-peer (P2P) model have emerged globally over the past few years, while commercial insurers are cautiously testing the waters.

One group that is structurally ripe for adopting the blockchain and smart contract technologies using a P2P model is P&I Clubs, or mutual insurance associations of vessel owners, typically based offshore, which insure liabilities of their members.

Many of the advantages of this technology are closely aligned with the practice of P&I clubs. Automatic collection of advance, supplementary, or release calls could be captured by ‘coded’ smart contract. Loss reserves could be established based on user input as soon as claims are reported.

Most other aspects of the club rules, or insuring agreements and conditions of insurance, could be captured in smart contract programming language, and automatically performed.

The process of managing the club could be reduced to a decentralized autonomous organization (DAO) of vessel owners, with the decentralized and public nature of the blockchain removing the need for trust among potential business partners.

Consultants can be hired as part-time trustees — appointed to update club rules and the underlying code — and claims payment could be based on a system of “voting” based on survey reports (when not completely captured by smart contracts).

This hybrid method of automatic payment in qualified circumstances — and voting in instances of partial loss — may enable a more just and adaptable method of adjusting and paying claims.

There are few barriers to implementing this type of DAO: the code is open source, and with the technical knowledge to update the code and a broker to bring them together to get the system in place, the concept is not far fetched.

An intermediary could be used to place risks into the P&I club; alternatively, new risks could be voted in by every other member, and pre-established underwriting guidelines could prevent any “bad risk” from entering the club, or increase the premium. A final vote among the current club members could be used for any risks acceptable by the underwriting guidance.

Vessel owners aren’t the only group that could benefit from application of blockchain technology in mutual associations; similar agreements, or DAOs, could be established among cargo owners, with each mutually insuring the others’ cargo losses. These types of organizations — consisting of potential business rivals — can benefit from pooling risk while simultaneously using a system that does not rely on trust among parties to resolve claims.

Details of implementation

A current obstacle to implementation is accounting for the customs and practices that exist in the marine-insurance marketplace and distilling these into program­ming language to guide smart contracts.

In those cases, when the static nature of computer logic can’t act independently, voting among disinterested members can substitute. Ambiguous situations become the responsibility of the other, disinterested parties to reconcile.

Insurance companies rely on their claim adjusters to make fair assessments of facts pertaining to loss; these facts can be ambiguous and less-than-forthcoming, and may instead be the opinions of a surveyor.

As with present practices, insurers and their adjusters must continue to vigilantly guard against moral hazard, which may seem difficult when the process is outsourced to computer code that pays a claim when criteria are entered into the database.

There needs to be a clear set of rules for payment in these cases, outlined in the underlying policy and understood by all parties. Also, surveyors may still be needed to act as independent third parties to serve as impartial judges of losses, placing automatic payment out of control of the insured.

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