The use of smart contracts in insurance opens up all sorts of opportunities. And they sound clever and exciting, but they also raise questions. How will they influence the trust that consumers have in insurance?
Let’s define a couple of terms first. Smart contracts are small programmes running on a blockchain that come together and initiative certain actions when predefined conditions are met. A blockchain is a distributed register that stores records and transactions without central coordination, instead using consensus based mechanisms to check their validity.
A lot of the discussion about smart contacts in insurance dives into their flexibility, stability and security, and those technical nuts and bolts are pretty impressive. Yet what I want to explore here is less the mechanics of smart contracts and more the implications that they might have for insurance underwriting.
Smart contracts are an important link in the personalisation trend in insurance. Personalisation has three core elements at the moment. Risks being underwritten on an individual basis. Prices being set according to what we’re each prepared to pay. And telematics and the Internet of Things putting pressure on the notion of annual periods of cover. Soon smart contracts in insurance will introduce a fourth element: the atomisation of the cover itself.
Gone will be the concept of a household policy. In its place will be personalised cover, assembled for you in micro-seconds and tailored to what the data tells the insurer about you. It will bring together a myriad of risks into one place. And these will be all about you, rather than about just that house, this holiday or that pet.
You can see just how well this sits with price optimisation: less about risk, more about you. Yet price optimisation is also less about insurance and more about willingness to pay. Will smart contracts in insurance be the same? They have that capacity.
Smart contracts allow the insurer to draw together a multitude of micro-covers and weave them into one ‘all about you’ policy. And it is here that you need to forget the cleverness of ‘how’ and focus on the ethics of ‘what’ and ‘who’. What micro-covers will make up this ‘you’ policy and how decides on them?
It will only ever be the insurer controlling that process of course, and to a certain extent, that’s no different to the present. Yet the present also has commoditised policies that the public have some hope of understanding, and it also has intermediaries to represent your interests. With smart contracts, both of those go out the window.
The chief executive of the Financial Ombudsman Bureau told me a few years ago that there was no such thing as a bad insurance policy. The problems lay in their design and distribution. And the example she gave for bad design were some travel policies: full of micro-covers that tended to mask the really important elements of cover, like medical expenses and repatriation. The travel policies that the FOS had difficulty with were those that reduced those expensive core covers while emphasising the frill covers that rarely produced worrying claims. Will smart contracts exacerbate this problem?
Smart contracts in insurance are going to reduce trust in the market because they will increase information asymmetry. They will make it more difficult for consumers to be sure that their interests are being represented. And they will create policies that are more difficult to understand. No wonder then that a recent survey by PwC found that 72% of insurance chief executives thought that it would be harder to sustain trust in a digitised market. And 28% were “extremely concerned” that trust will affect their firm’s growth. At least it’s good that the problem is gaining recognition.
Let’s think long term. Smart contracts are bound in the long run to lead to covers that are more in the manufacturer’s interests and less in the consumer’s interests. That’s how markets work. And into that gap will come all sorts of ‘risk services’, designed to help the consumer manage their risks and to look after themselves in the event of a loss. How much will actually end up being insurance though? And by this I mean the stuff of good old risk transfer. Less and less I expect. More frills for the ombudsman to unpick then.
Smart contracts, and the blockchain that underpins it, are indeed innovative. Yet every innovation, from the wheel to the internet, sits in a social, economic and political context. As smart contracts complete the chain of personalisation of insurance, the market needs to recognise the questions it raises. Yes, be excited about the revolution that insurance is starting to undergo. But take it from someone with a degree in the nature of scientific innovation: be sure to recognise the questions that are being raised, for society will be wanting to hear your answers.
And remember: don’t be tempted to answer those questions yourself: the only reliable answers will come from your customers. Go on: ask them.
Duncan is the founder of the Ethics and Insurance blog and the author of its many posts. He's a Chartered Insurance Practitioner, having worked 18 years in the UK market. As an adviser to many firms on ethics issues, as well as a regular conference speaker, he is one of the leading voices on ethics and insurance.