The global insurance industry is exploring the use of so-called smart contracts, and for good reasons. This digital innovation, which uses distributed ledger technology, also known as blockchain, offers potentially revolutionary advantages in transacting insurance.
Blockchain technology and smart contracts offer the potential to create and maintain living policy documents that are securely stored on multiple, decentralized ledgers, making them impossible to misplace or alter without permission, and at the same time convenient to amend and share among multiple parties. Depending on how smart contracts are structured, they can automatically execute payments when certain parameters are met. That is a particularly interesting innovation in the realm of insurance claims tied to specific metrics, such as weather events. Even though blockchain technology supports publicly visible transactions, such as those using Bitcoin, it is possible to create encrypted, permissioned access on distributed ledgers.
Despite the potential benefits for insurers and reinsurers, there are still many unanswered questions about using smart contracts. For starters, data privacy laws in the United States and European Union are stringent, such as the General Data Protection Regulation (GDPR). Accordingly, one challenge for insurers is to ensure that any smart contracts involving individuals are compliant with privacy regulations.
Other questions arise from the fragmented regulatory environment for insurance, particularly in the US. Jurisdictions differ on rate and form filing, which may pose a hurdle for changing smart contracts. Virtually all insurance laws and regulations assume a paper-based world, whereas blockchain is entirely digital. Insurers and professionals must be mindful of applicable document retention laws and regulations, and in some cases those laws and regulations may need to change.
Still another area in question is the nature of disputes between insureds and carriers, or cedents and reinsurers. While smart contracts are intended to automate certain aspects of contract performance, issues of interpretation will remain that require adjudication or settlement. The decentralized nature of blockchains and the lack of any one party with custody of the information stored solely on the blockchain raise issues of jurisdiction, evidence preservation and the scope of discovery.
Clyde & Co has anticipated the emergence of smart contracts in global insurance, which is why the firm launched Clyde Code, a first-of-its-kind consultancy to advise insurers and reinsurers on how to implement smart contracts to attain the benefits while complying with all relevant regulations and legal requirements.
There are many questions on how insurers can effectively use smart contracts, and the advice of expert counsel is valuable. Careful drafting of contract terms and wordings and consultation with programmers to create smart contracts will be increasingly important as this innovation continues to develop.
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