Smart contracts
Emerging technologies such as distributed ledgers have been identified as a way to enable “smart contracts” i.e. computer programs which run automatically (in whole or in part) without the need for human intervention. As such, smart contracts can be used to record and perform the obligations of a legally binding contract in which some or all of the terms are recorded in or performed by code on a distributed ledger (like blockchain). This may take the form of: (i) a natural language contract where performance is automated by computer code; (ii) a hybrid contract consisting of natural language and coded terms; or (iii) a contract which is written wholly in code. Smart contracts are expected to increase efficiency and certainty in business and reduce the need for contracting parties to have to trust each other; the theory being that the trust resides instead in the code.
However, despite the opportunities offered by this new technology, questions remain about the circumstances in which a smart contract will be legally binding, how smart contracts are to be interpreted, how vitiating factors such as mistakes can apply to smart contracts, and the remedies available where the smart contract does not perform as intended.
In the UK, this has culminated in the Law Commission issuing a Call for Evidence in December 2020, the results of which are due later on this year.
What does this mean for the insurance sector?
Smart contracts bring with them many potential benefits for insurance. Automated claims processes linked to smart contract technologies are already in use and should mean policyholders will get paid more quickly and reduce claims administration costs due to increased efficiencies (not to mention the reduction in fraudulent claim risk). Mid-term policy adjustments could also be handled using data fed into such technologies in response to certain predetermined events or information received.
Whilst the use of smart contracts is likely to initially develop in the commercial parametric insurance market, particularly covering environmental risks in response to physical triggers (such as wind speed or location and magnitude of earthquake); with the rise of the Internet of Things (and the data collected from individuals’ devices), consumer insurance may follow swiftly thereafter.
That being said, such innovation does not come without risk. Code used to create a smart contract may execute in an unforeseen way due to a malfunctioning oracle (an independent data source which the parties to the smart contract agree should provide the required data for the smart contract), a system failure on the platform on which the code is deployed or there may be interference by malware. In addition, parties will need to grapple with disputes arising in the context of smart contracts and the remedies applied. This may be particularly critical where third parties are used to ‘translate’ the agreement into code, which may not reflect the common intention of the insurer and the insured.
In the UK, the pre-contractual disclosure obligations required for a fair presentation of the risk become more challenging because of the remedies for breach under the UK Insurance Act 2015 which include avoidance, non-payment of claims, and alterations to both contract terms and premium payable.
In addition, as part of a closely regulated market, the regulators are likely to push for transparency of process particularly in relation to consumer outcomes.
Therefore, a key question for the insurance industry looking to adopt smart contract technology is if and how legal and regulatory obligations can be met. From whether or not the insurance contract in question constitutes an enforceable binding contract; to if the smart contract can meet transparency and fairness requirements.
What else is happening in InsurTech?
Artificial Intelligence (AI) remains top of the agenda, with EU Commission’s recent announcement of its proposals for a regulation on “artificial intelligence systems” described as the first ever legal framework for AI (which is likely to capture most (if not all) of the participants in the insurance distribution chain).
In the UK, the recent publication of the independent FinTech Report: ‘The Kalifa Review’ commissioned by the government, has also identified that the use of AI and machine learning models by financial services institutions and FinTechs offers potential efficiency gains and may improve the quality of decision-making (e.g. through use of better data). However, there can also be significant risks where AI models are involved in making decisions about consumers, including concerns regarding bias, discrimination, or lack of fairness. In many cases, there may be insufficient understanding of the impact of these models, which in turn could lead to inadequate management and oversight of these issues.
In April, the Law Commission in the UK also published a call for evidence on digital assets, designed to seek views about, and evidence of, the ways in which digital assets are being used, treated and dealt with by market participants. This includes the proposed approach to the possession of crypto/intangible assets and any wider impact on their use in smart contracts.
In short, there is plenty happening in the InsurTech sphere in 2021, including the continued attempts to address the tension between encouraging innovation and protecting the rights of consumers.
Authored by John Salmon and Clare Douglas.
