Micro-insurance hasn't worked; Can blockchain fix it?

  • Andrew W. Singer, Principal at Singer Publications

  • 08.01.2019 11:15 am
  • undisclosed

Micro-insurance (i.e., small-premium insurance for low-income people) hasn't really caught on in the developing world. But two new initiatives will soon be offering micro-insurance (MI) with a twist: MI with blockchain and smart contracts Both involve crop insurance. When an extreme weather event strikes -- drought or a typhoon, say -- the small maize farmer in Kenya or the rice paddy farmer in Sri Lanka do not even need to submit a claim. Nor does the insurer send a claims adjuster. A claims payment is triggered automatically by a blockchain-enabled smart contract.

Micro-insurance programs typically struggle to enroll farmers. Take-up rates in India, where the government subsidizescrop insurance, are estimated at less than 5% of eligible small farmers. One reason is distrust of the process. Small farmers don’t believe they’ll really be paid when the monsoon destroys their crop -- or  if they are paid, the benefits will reach them too late.

A partnership among Aon plc, an insurance provider; Oxfam, a charitable organization; and Etherisc, an InsureTech firm; is working to bring crop insurance to 3,000 small, rice-paddy farmers in Sri Lanka. The pilot program uses a weather data index as a trigger for smart contracts that are built atop an Ethereum public blockchain. If wind speeds in a certain locale ever reach 75 miles per hour during the growing season, for example -- typhoon force winds -- a payment is triggered automatically. Eventually, the program may be extended to 800,000 Sri Lankan farmers.

These type of coverages are called parametric insurance because they do not indemnify the pure loss, but agree to make a payment if a pre-defined event parameter is met or exceeded.

This event could be a natural disaster like an earthquake, tropical cyclone, or flood where the parameter or index is the magnitude, wind speed or precipitation, respectively, but it could also be something more mundane like an airline flight delay, where a flight delay insurance payout could be triggered by a delay of more than two hours. 

The beauty of parametric coverages are that there are no disputes, notes Etherisc CEO Stephan Karpischek. It is easy enough to verify wind speeds by an agreed-upon “oracle,” or source of truth, like a local weather station report. No claims adjusters or insurance underwriters are required. Software, not human beings, triggers the claims payout. 

[Note: A blockchainis just a distributed, tamper-free, digital ledger, and a smart contractis a set of conditions recorded on the blockchain so that transactions (e.g., a claims payout) trigger when certain of those conditions are met.]

Delay in claims payouts is an impediment to the "take up" of crop insurance in the developing world. In India, "delays in claims settlement, have led to 95 million farmer households not being covered, despite significant government subsidy," according to one report. Another notes that large numbers of Indian farmers "did not receive any claim amount even when they faced crop loss." 

It can take traditional insurance companies as long as one year to settle some crop insurance claims, says Christopher Sheehan, CEO of WorldCover, another firm that is building a blockchain-enabled crop insurance product. The insurer has to send someone to assess the claim, there’s an audit, the insurance company may submit a claim to a reinsurance company, money may have to be sent across borders, and so on. 

WorldCover is targeting small farmers in Africa where drought is a persistent worry. A maize farmer in Ghana, for example, might become eligible for a claim if less than 200 millimeters of rainfall is observed during the growing season. Once the rainfall is measured, a claim payment would be instantly sent via a mobile money service like M-PESA.

Simplicity of product is critical in such programs, Sheehan adds. You can’t send small rice farmers a 20-page document with an insurance offer. Someone has to explain the product face-to-face, e.g.,  “If you go seven days without rain, you’ll get this payout….”  His firm uses machine learning algorithms to customize its offerings to farmers. Premiums could be as little as 5 to 10 dollars annually with payouts of $100 to $200 (though this could be scaled up). When the smart contract is triggered, a simple text message might appear on the farmer’s mobile phone: “It hasn’t rained for seven days. Your claim has been triggered. You’ll be paid in 24 hours.” 

Finding trustworthy “oracles” for parametric insurance cases is a challenge, says Sheehan. The National Weather Service might be a a good “source of truth” when confirming a hurricane event in the U.S., but determining drought conditions in Ghana could be more problematic. Can you really trust the local weather station using rain gauges as an “oracle”?  Or do you go instead with a meteorological and environment-monitoring satellite service that measures soil moisture from outer space -- but which may be more expensive? 

Historically, it has not made sense for a commercial insurance company to write a crop insurance policy for just a few dollars (premium) a year, notes Karpischek. It’s just not worth the insurer’s time and expense. Parameterizing crop insurance policies could drastically reduce business complexity, though, and with blockchain-based smart contracts insurers would need fewer local agents, with “oracles” replacing adjusters on the ground.

Parametric coverages are still relatively rare in the insurance world, but their number is growing."I'm very keen on parametric insurance," says John Lucker, Principal – Deloitte Advisory, Deloitte & Touche LLP.  It allows for better frequency-severity modeling. It’s analogous to a casino's vigorish, or “vig.”  First the break-even odds are computed, then several basis points are added for the house, the "vig." This becomes the casino's--or insurance underwriter’s--profit margin. "It takes out a lot of the uncertainty" that is typically associated with insurance, says Lucker. 

Traditional insurance suffers from an inherent conflict of interest, adds Karpischek. The same entity that manages the claims payout -- i.e., the insurance company -- stands to profit by denying (or delaying) payouts. This, arguably, goes to the root of farmers’ distrust of insurance.

If, however, you were to have software in the form of smart contracts take over this critical process, the trust deficit in the developing world might fall.

Mukherjee, Subhankar & Pal, Parthapratim. (2017). Impediments to the Spread of Crop Insurance in India. Economic and political weekly. 52. 

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