Source: Smith + Crown
Ethrisc is developing a decentralized insurance protocol intended to support the emergence of a wide range of specialized insurance products across a variety of markets. The distributed, smart contract-based system is conceived of as a platform dApps can build on and extend with smart contract libraries and risk models that enable products like flight insurance or localized weather insurance. The aim is for the products
to be less expensive and less subjective than products from traditional insurance companies, while also being more transparent and responsive. Several insurance products are being launched on Etherisc, and a live MVP insurance product insuring against flight delays has issued ETH payouts to several policy holders. The DIP token functions as a staking requirement for anyone collecting fees on the platform.
What the Decentralized Insurance Protocol Intends to Accomplish
The modern insurance industry is built around three core elements:
- Calculated expected value of the risk: refers to the anticipated amount to be paid out over an identified time frame. If crops are being insured against failure, what do historical records and statistical tables indicate will be the expected number of failures in a given season or year? This informs premiums charged by the insurer.
- Capital cost (or reinsurance) for long tail risks: effectively are a reserve in the event that a 100 year drought sends crop failures out to multiples of anticipated amounts. Does the system have the capital reserves to cover this eventuality as well?
- Transaction costs: are the incidental costs associated with normal business operations, and are also related to the complexity and customization required per product.
If the above represent the core elements of an insurance operation, in practice, most of the world interacts with a system where two additional elements have become commonplace:
- Administration: refers to the general overhead of the large insurance companies that are required to operate their system, the costs of which must be built into the premiums individuals and businesses pay for coverage.
- Shareholder return: must be factored into premiums and decisions regarding payouts, at least to the extent that insurance companies have shareholders expecting a return on their own capital.
Etherisc proposes a decentralized protocol upon which anyone can launch smart-contract based insurance products. They contend that a blockchain-based platform has the potential to decrease transaction costs, administration costs, and remove the pressures of shareholder return, while at the same time enabling new parties to contribute both models for calculating the expected value of risk and capital for long-tail risks. Smart contracts can automate premium collection and payouts, while also making obligations more transparent. A protocol that standardizes how insurance products are presented, structured, and managed creates additional opportunities to reduce inefficiencies and administrative overhead on a corporate level, enabling the further reduction premiums. Beyond this, creating a protocol-based system, where token holders effectively replace shareholders, will remove the need to provide a return to capital, allowing a further reduction of financial obligations that filters back to premiums.
This approach lends itself in particular to a focus on parametric insurance markets, where outcomes are generally quantitative ones that are informed by sensors or other automated means that are able to communicate with smart contracts. An example can be seen in the hurricane insurance program, where payouts are based solely on recorded wind speeds, in flight insurance programs that measure delays, or in crop insurance projects based entirely upon rainfall amounts. This type of insurance generally relies on objective indicators and has payouts not determined by estimated loss, leaving insurance companies less room to fight payouts. Etherisc also argues that traditional insurance against loss will nonetheless benefit from a system that at the very least, reduces the administrative costs of managing capital.
In addition, compared to typical insurance companies that often work to avoid or reduce customer payments, the more transparent nature of a smart-contract based system should reduce both time spent disputing and disappointment with insurance policies, due to less opaque obligations. The overall result is imagined as a new type of insurance company that will be able to honor justified claims and rapidly settle outstanding issues, all while dedicating a considerably smaller percentage of premiums to administration and overhead. When Etherisc claims that a blockchain-based insurance system could be operated for an order-of-magnitude less than a traditional insurance company, the scale of the opportunity can be appreciated.
The system involves an array of on-chain actors that have direct counterparts in the traditional insurance industry.
Keepers: keepers package and offer insurance products based on smart contracts. Etherisc imagines these could be entrepreneurs, data scientists with new risk models, or traditional insurance providers offering new products. Keepers determine the premium and payouts of their products. They are also responsible for determining whether policyholders are allowed to buy policies e.g. farmers must actually plant crops to qualify for crop insurance.
They are also considered responsible for recruiting an array of other service providers as needed, discussed below. Keepers can fully integrate these functions or rely on partners.
- Underwriters: Underwriter evaluate risk models for pricing policies, determining the premiums and payouts to keep policies solvent.
- Oracles: Verify off-chain conditions that should trigger payouts. In cases of parametric insurance, systems like sensor networks or information sources could serve as oracles, or trusted third-parties could serve as final verifiers of payouts.
- License Providers: Keepers ultimately choose whether to operate with a license. Etherisc imagines that established insurance companies could earn fees for ‘renting’ or allowing others to operate under their license(s) in a particular jurisdiction. As with keepers, fees are established by the provider, encouraging competition between providers.
- Claims Adjusters: In cases where loss needs to be estimated, claims adjusters would be responsible for providing the necessary adjustments to payouts.
Risk Capital: Keepers may collateralize the product with their own capital, or acquire additional backing for their product either through collateralizing a risk pool and selling tokenized fractions of it, or acquire reinsurance through a licensed reinsurer.
Relayers: Relayers are responsible for connecting users and the products that Keepers bring to the market. These website would advertise insurance, likely from multiple Keepers. Relayers are imagined as helping police against bad products by choosing not to list them, for example, by choosing to only list products with insurance licenses, though Relayers can list any product they want. Keepers can also establish themselves as their own Relayers, offering a website on which people can sign up for policies. Flightrisk, operating today, is example of a product choosing to advertise on its own site, though presumably eventually consumers will need insurance product aggregators to discover and compare insurance products. Relayers establish their own fees for listing insurance products.
Etherisc is structured around what it calls a ‘Two-Fold Approach,’ reflecting the structure of the ‘Decentralized Insurance Foundation’ and the multiple for-profit commercial entities unique to a jurisdiction that form companies such as Ethereisc Holding AG, Etherisc US, or Etherisc MT. These jurisdictionally specific entities are in turn controlled by the Decentralized Insurance Foundation. The jurisdiction-based entities serve as the local repository of contracts and provider of platform services, allowing and encouraging new projects to join to access the smart contracts and services within the protocol. This structure should allow localization of insurance products, which are usually heavily regulated by jurisdiction.
New projects joining the protocol will in turn create a ready market for other elements of the broader Etherisc ecosystem, whether they be oracle providers, KYC services, licensed insurance companies who legally ‘rent’ their licenses by allowing firms to piggyback on their own licences, relayers, data scientists with unique risk models to cover entirely and yet-uninsurable forms of risk, or claims adjusters qualified to serve as trusted authorities for traditional insurance. As the network grows, additional capital should be attracted by the opportunity to pledge funds to the risk pools functioning as reinsurance pools within the network, standing ready to insure the larger tail-risk scenarios that might require excess capital beyond the immediate capacity of a small insurance dApp.
A Platform for New Insurance Products
This design is intended to support the emergence of new insurance products while also enabling forms of insurance recognizable today. For example, insurance products for smart contracts or cryptoassets could emerge if entities like OpenZeppelin could step in as underwriters to assess smart contract vulnerability, cryptoasset holders stepped in with risk capital, and developers and cryptoasset users purchased policies. Etherisc imagines the protocol as a potential platform for anyone to monetize an ability to develop better risk models than those that exist today or more specialized risk models in niche markets, for example, rainfall in certain specific geographic areas.
DIP tokens are used by all service providers throughout the system–any entity earning fees will be required to stake tokens in a proportion between 15-25% of their monthly income on the platform. Users are not required to use DIP to pay for insurance products or receive it as payouts. Given that premiums are collected on-chain and fee structures should be written into the insurance product smart contracts, this monthly income should be easily calculable, though the method of enforcement and potential punishment for noncollateralized activity is still being determined. If the requirement can be seamlessly enforced, DIPs value should track both overall adoption of the platform, as it is a ratio of realized revenue for all participants on the platform, and the on-chain fee structure of the participants.
For example, if $120 billion were purchased in insurance products, with an average total aggregate service provider fee of 10% resulting in $1 billion in collected monthly fees between Keepers, Relayers, and other service providers, then at least $150 million to…