The Human Story Behind Insurance

From the trailer: Lloyd’s of London the love story that shook an empire! A magnificent masterpiece of motion picture achievement! Truly… one of the great entertainment spectacles of all time! Never before had screen drama risen to such emotional heights! The critics say you must not miss it! You will shout agreement to their praise! Lloyds’s of London.

Ok bear with me this is relevant to understanding what hyperlocal insurance is but first you’ve got to be willing to be touched by such a poignant scene:

Mr. Angerstein (25m 45s)

“news honestly acquired and honestly shared is the foundation of this business.”

Mr. Angerstein (26m 44s)

“Lloyd’s is founded on two great pillars, news and honest dealing. If either fails we fail and with us the whole of the British merchant marine. Lloyd’s isn’t merely a business of profit and loss, it’s the lifeblood of British commerce, nothing to deprecate … ships and cargo are protected by our honesty. A mighty commerce built on faith.”

Jonathan (27m 55s)

“from this hour Sir I’ll do me best to be what you said, honest with Lloyds and England”

- Lloyds of london 1936

This scene is so touching. Like Jonathan, I also feel like vowing to “do me best” to live up to such principles. Unfortunately that’s not how the world works right now.

Large Insurance Companies Distrust Policyholders And Policyholders Distrust Large Insurance Companies

Soft insurance fraud occurs when a policyholder purposely overstates a legitimate claim — generally to make the payout larger. One common way this happens is when a policyholder exaggerates the damage to his or her car during a wreck, usually to cover the cost of the deductible. According to the Insurance Information Institute, soft fraud costs insurers roughly $32 billion a year comprising nearly 80% of all non-healthcare related insurance fraud.

A recent survey by consulting company Accenture found that 38 percent of U.S. consumers overstated the value of their losses on their last home insurance claims, and 20 percent overstated the values on their last auto insurance claims. According to the Accenture report, 43 percent of U.S. consumers who admitted to claims padding said they did it because they received poor customer service.

Meanwhile in the healthcare marketplace patients with chronic illnesses are reporting that their insurance is worthless when their providers withhold coverage of essential treatments prescribed by a doctor.

Quite a departure from the pillars of news and honest dealings uttered by Mr. Angerstein. He said that if either of these fails then Lloyd’s would fail. Have you ever stopped to consider that maybe it (the insurance market) already has? Maybe what we know as ‘insurance’ today is a completely failed system that simply overcompensates for a lack of honesty between the participants.

How is Blockchain Supposed to ‘Fix’ This Problem?

The problem is trust. People don’t trust each other. Obviously parties to an insurance contract don’t know each other so how in the world could they possibly trust each other. Do you know who underwrote your auto insurance policy? Do you know who is approving or denying your healthcare insurance claims? We get our services from institutions not people. Seems like a great opportunity for people to harm one another indirectly without ever having to lie directly to someone’s face. In today’s insurance world all the policyholders are member ID #s and all the providers are faceless corporations. That’s the problem we are trying to solve in insurance. To solve it we need a better way for small communities to pool their resources without relying on a trusted third party to assist them. The trusted third party is the problem because insurance companies, dominated by large carriers, have made purchasing insurance as personal as purchasing coke from a vending machine. Insurance relies on trust and trust requires building relationships.

Blockchain technology isn’t some sort of techno wizardry that magically makes problems disappear. We need public blockchains to hold money that belongs to the community. Tandas, Huis, Cundinas, susus, stokvels, tanomoshikos, and chamas are informal lending clubs. These groups are ways people distribute money among themselves without a centralized institution or trusted third party. With blockchains those structures get an upgrade. Now we can hold money without a centralized institution or trusted third party. Blockchain technology allows the creation of lending clubs on steroids and that upgrade enables true peer to peer insurance.

We Were Told Oracles Would Enable Insurance

First most of my readers may not know what an oracle is. The following article by Doug von Kohorn about oracles and blockchain is helpful:

Using an oracle means receiving data from outside of a blockchain. Said another way, an oracle provides a connection between real world events and a blockchain … transparently representing real-world events in precise digital terms is a challenge. If this is a smart contract for an insurance agency, then its oracle ‘information court’ will try to resolve the question ‘did the house burn down?’ according to the agency’s definition. All of us depend on truth because when honesty is lacking, we suffer, and society suffers. With improved tools for scaling trust and truth, we will do better.

An oracle is a way for a blockchain to know the true state of events in the real world. Oracles are data feeds. These data fees could be websites such as flightstats.com reporting on which flights were delayed or cancelled or espn.com reporting on who won the superbowl. In some cases we trust the oracle because they have a good reputation of past honest reporting (Etherisc). In other cases we need a way to verify the state of events that provide rewards for honest answers and penalties for dishonest answers (Augur). Either way oracles allow the blockchain to incorporate real world events into its record so that contracts can determine if they should pay a flight insurance claim or award a prediction market sports bet.

I used to believe that an oracle could be invented for any type of contract and this would include insurance contracts. Now I can tell you that oracles are not the best way to have blockchain contracts determine if they should award an insurance claim. The only exception to this rule is parametric insurance which is a very special type of insurance that doesn’t measure or consider damage to an individual policy holders insured property. An example of parametric insurance is crop insurance which makes payments based on weather events such as temperature or rainfall regardless of their actual effects on a farmers crop. Most types of insurance people purchase are not of this category (business, health, auto, life, home, property, injury).

The Obvious Solution is Far More Personal

Blockchains hold money. People make judgements. When people hold money we have counterparty risk. When blockchains make judgements we have science fiction. I don’t like counterparty risk and I don’t like science fiction. Perfect oracles for insurance contracts could theoretically solve amazing problems and make blockchains fantastic beasts but there’s a few issues to consider:

They don’t exist yet. No one can say for sure if they will ever exist. They don’t solve the underlying problem of trust. People don’t trust each other because they don’t know each other. Moving from faceless institutions to faceless decentralized applications isn’t helping.

Even if you had a perfect oracle to determine the value of an underwritten insurance loss its not going to help solve the problem of trust the right way. The right way to solve the problem is by remembering that insurance is people! Oracles for complex types of insurance products must rely human judgements. Do you want these judgements to come from outside of your community of peers or within your community of peers? If you don’t believe this then I suppose you could believe in an AI dystopia where the blockchain uses people rather than people using the blockchain. The blockchain is borg, the blockchain is hungry, we will all be assimilated.

Hyperlocality is Another Word for Community

Lending clubs are hyperlocal structures but the thought is that this wouldn’t work for insurance because with so few people you would have liquidity issues. Bancor fixes this problem. It allows you to run an insurance pool with extremely low liquidity. Using Unity architecture policyholders have strong guarantees that all claims are treated equally.

With hyperlocal architecture all the participants know one another and everything is face to face. Blockchains hold the funds and people make the judgements. Policyholders should be able to trust the blockchain to hold funds safely. Policyholders should also be able trust that their community can make fair judgements about their insurance losses. If you can’t trust your community to make these judgements then go find a community you can trust. But don’t hope that blockchain can provide you with insurance services sans community.

Here’s a fun slide deck to help you put these concepts together: