What is Smart Contract Based Insurance?

Technological innovations are happening every day. Many times, these innovations have the power to change the way society functions in specific areas. The advent of blockchain technology and smart contracts may have the potential to fundamentally change the insurance industry and how policies are implemented.

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What is Blockchain Technology?

Blockchain technology was first created to implement cryptocurrency transactions. However, since its creation, many have seen potential uses of blockchain technology for various other aspects of business, including insurance. Essentially, blockchain is a digital and decentralized public ledger of transactions. Digital “blocks” are continually created to represent the latest transactions. The blocks are recorded in chronological order, allowing for the tracking of transactions without centralized record keeping.

What is a Smart Contract?

Smart contracts utilize blockchain technology's decentralized ledger to create legal contracts which are automatically executed. The contracts are converted into code and stored on the system, while being supervised by the computer network which runs the blockchain. This helps to reduce transaction costs associated with forming and executing contracts, including insurance policies which are essentially just legal contracts. The use of smart contracts in the insurance industry is aimed at making processing insurance claims faster and less costly for the insurer and ultimately, the insured.

How do Smart Contracts Work with Insurance Policies?

In order to understand how smart contracts work with insurance, it is important to understand exactly what an insurance policy is. An insurance policy is basically a legal contract between the insured and the insurer. The policy governs the claims which the insurer must pay to the insured, known as the policyholder.

Essentially the insurance policy is a contract which says, “if this happens, then that will happen.” Determining whether or not an event which occurs has actually caused a loss to the policyholder usually requires significant human intervention and labor, adding costs to implementing an insurance claim for the insurer, while causing an administrative headache for the policyholder. Using artificial intelligence, a smart contract eliminates the need for human interaction in processing an insurance claim by automatically checking for predetermined conditions which would trigger a payout directly to a policyholder's bank account. The artificial intelligence would examine various factors to determine the size of payouts required in accordance with the terms of the smart contract.

Smart Contracts Provide Transparency for Insurance

Transparency was a key impetus for creating blockchain for cryptocurrencies and it is also an important aspect of using smart contracts for the insurance industry. Smart contracts and blockchain allow policyholders, as well as other stakeholders, to obtain unprecedented access to data relating to premiums and claims.

Also, this higher level of transparency can be helpful for government agencies that are in charge of regulating the insurance industry. The regulators can more easily look at the information publicly stored on the blockchain in order to determine whether or not the insurer has been fulfilling on its promises to its customers. This will incentivize insurers to be even more vigilant and thorough than they have been before, while ensuring a higher level of protection for consumers.

Current Uses of Smart Contracts for Insurance Claims

Although using artificial intelligence to process claims of a digitized insurance policy seems like a thing of the future, it is already beginning to be utilized in the insurance industry today. For instance, a French airline has begun to utilize smart contract technology for their flight insurance policies. In this case, if the policyholder's flight is late by two hours or more, the policyholder would be notified with options for payout. Once choosing a compensation option, the money will be sent directly to the insured's account.

Another insurance company which specializes in farmer's crop insurance is also beginning to utilize smart contracts to process claims. The company insures farmers against the possibility of catastrophic weather conditions, such as droughts, which can destroy a farm's entire crop. The insurance company uses specified parameters based upon weather data or an index measuring rainfall in order to determine the veracity of a policyholder's claims. This eliminates the need for examining a policyholder's actions, which can be susceptible to fraud and are also expensive to monitor.

This type of insurance can be quite useful in many places in Africa where a large proportion of farm crops are watered via rain, making droughts especially devastating. For instance, a farmer in Rwanda may become approved for an insurance claim if during the growing season a rainfall index observes less than a certain amount of rainfall during that specified period of time. In this case, the payment for the claim can be made automatically with the money going directly into the policyholder's account.

Smart Contracts Are the Future of Insurance

Despite being a newer technology, smart contracts and blockchain are already being integrated into the insurance industry. Many believe smart contracts are the future of insurance. Therefore, it may be a good idea to stay up-to-date on the latest innovations in this area, especially if you are in the insurance industry or if you are looking to obtain insurance coverage in the future.