This is the second in a series of posts that breaks down our article, “Smart After All: Blockchain, Smart Contracts, Parametric Insurance, and Smart Energy Grids,” recently published in the Georgetown Law Technology Review. We previously discussed the enforceability of blockchain-based smart contracts under ESIGN and UETA and will now look at the application of blockchain-based smart contracts for simple insurance contracts. You can read the full article here.
Even though basic insurance contracts can often be boiled down to an agreement to make payment upon the occurrence of a discrete event, administration can quickly become complex. Claims adjusters are needed to assess a claim and its validity and disagreements can arise if parties later disagree about the interpretation of the terms or relied on representations outside of the policy. In addition, parties are often mistrustful of one another because of the potential for fraud, abuse, or denial of claims. In either event, insurance companies incur costs administering even the simplest of contracts, and those costs are often passed along to consumers in the form of higher premiums. However, reducing basic insurance contracts to “if-then” statements and digitizing administration would reduce the cost of administering these products and help overcome challenges of trust and transparency.
Efficiency Gains in Current Insurance Contracts: Life Insurance and Final Expense Policies
Some of the simplest “if-then” types of insurance policies are individual life insurance and final expense policies. Life insurance contracts pay out upon the policyholder’s death. Although this process is normally easy for the survivors to carry out problems can arise in multiple ways. For example, the policyholder may hold multiple life insurance policies, the beneficiary may not know about the policy, or the beneficiary may misplace the paperwork for the policy. As a result, inefficiencies and increased administration costs can arise without any malfeasance or ill-will from any party.
Blockchain-based smart contracts can remedy many of these problems. For example, rather than maintaining only a written insurance contract, a blockchain-based smart contract is digitally instantiated and recorded to the blockchain’s immutable ledger. Rather than relying upon the policyholder to retain the policy (making the policy subject to loss through misplacement or destruction by fire, flood, or similar occurrences), the policy would be recorded on the blockchain and its terms would be available at any time for the insurer, the policyholder, and the beneficiary to review. Rather than relying upon a beneficiary to notify the insurance company, a blockchain-based smart contract can be constructed to rely on oracles set to monitor specific sources of information about individual deaths. The transparency of the blockchain and the fact that its rules are not administered by any single participant in the process can allow purchasers to rely on digital instantiation and administration.
Digitization has already enabled portions of this process. The United States government maintains the Social Security Death Master File, which tracks when a person with a Social Security number dies. Although this is not a perfect record and has in many instances been subject to legitimate criticism for its accuracy, an oracle could monitor this file for policyholders, and upon the death of a policyholder trigger contract execution. Currently, the Master File is only updated once a week and a person’s death must be reported to the Social Security Administration for it to be filed. For that reason, oracles could also monitor other digitally-available sources of information, such as social media, in order to provide further assurances before the final execution of the contract. Indeed, some organizations are already experimenting with peer-to-peer unemployment insurance smart contracts based on LinkedIn data.
A similar application for blockchain-based smart contracts in insurance is final expenses insurance. Final expenses insurance is a form of insurance where a fixed sum is paid out upon a person’s death to help cover funeral costs. For some cultures, it is essential to have a proper funeral or perform funeral traditions. However, families are often unable to pay for an unexpected funeral or even the funeral of an elderly family member. A blockchain-based smart contract could be set up using the same sources as a life insurance smart contract and perform the same function. Indeed, contracts could even be purchased by family members in other countries, with agreed-upon oracles and specified mechanisms of digital payment, such as direct payment to funeral providers, rather than reliance upon local reporting and paper checks.
Smart Contracts, Insurance, UETA, and ESIGN
In our last post, we argued that blockchain-based smart contracts are enforceable under UETA and ESIGN. Specifically with respect to insurance contracts, however, these types of digital contracts are also the exact types of contracts that Congress wanted to protect under ESIGN. Insurance contracts are specifically included in the statute (6 15 U.S.C. § 7001(i)-(j)). ESIGN, as part of its consumer protection provisions, prohibits the cancellation of life insurance policies through electronic means. This protection reflects the special status of life insurance as providing for one’s family after death, which has led states to protect life insurance proceeds in other ways. UETA does not have a similar protection, but many states have implemented similar exemptions (e.g., N.C. GEN. STAT. § 66-313(e)(3)). These limitations restrict the kinds of smart contracts that can be created for insurance products.
In order to take advantage of UETA and ESIGN, a blockchain-based smart contract for life insurance would not be able to cancel a policyholder’s policy upon non-payment of the premium. Instead, the cancellation notice would need to be sent via physical form. Cancellation of blockchain-based smart contract-driven life insurance policies for non-payment may be an area for further development of legal guidance under UETA and ESIGN. In addition, smart contracts need to be worded carefully to ensure that policyholders do not use them as a substitute for a will, as ESIGN and UETA would not ensure that they are valid.