by Stephan Karpischek, Co-Founder of Etherisc

I gave a short talk about risk pool tokens (RPTs) at D1Conf in Cancun, Mexico. I wanted to let attendees know how these tokens can provide capital for opportunities within the emerging category of parametric insurance.

We published our views about the concept of risk pool tokens about a year ago. We have not yet implemented the concept, mostly because of existing regulatory concerns. But we think the concept remains valid and exciting.

What are risk pool tokens?

Risk pool tokens, as their name implies, are a class of tokens that address the problem of capitalizing risk pools. We faced this problem when we capitalized the risk pool for the first iteration of our Flight Delay dapp by ourselves, for example.

Clearly, things do not scale if you attempt to finance an ongoing parametric insurance company by yourself. So you need to find a way to get money into these insurance contracts.

The concept is simple. You buy these tokens to provide the capital for the pool, and cover the long-tail risk. The traditional way to mitigate this risk is to sell it to reinsurance companies; you can use tokens for this same purpose.

The buyers of these tokens thus take on some risk, and get compensated for it. The tokens, therefore, function as securities, insurance-linked securities are a well-established concept.

Outlining a Simple Process

To provide a clear understanding, here are the steps in a simple RPT process:

Smart contracts are deployed, tokens are issued Investors buy tokens, risk pool starts to fill When risk pool is sufficiently full, smart contract starts selling insurance

(for a limited period of time, e.g. one month) Every new policy underwritten adds to the total risk exposure Every policy expiring reduces the total risk exposure Every premium adds to the risk pool Every payout diminishes risk pool If total risk exposure is higher than the balance of the risk pool, the smart contract won’t underwrite new policies When last policy expired or paid out, tokens are bought back with any profits or losses shared among all token holders

Challenges and considerations

It seems easy enough to understand that just as every policy that is written increases the risk exposure, every policy that expires reduces the risk pool again. We can set a threshold to avoid having the exposure higher than what’s in the risk pool, simply by not underwriting new policies at that point. After claims are automatically paid out, a certain amount of money is left, ideally to be paid out to investors.

Yet we face many challenges in executing the concept of risk pool tokens. Examples include:

High capital costs

Who can sell and buy Insurance Linked Securities?

In which jurisdictions?

Total risk exposure vs. expected payouts

Solvency II requirements vs. 100%+ collateralization

Premium/payouts for customers vs. capital gains for token holders

Can we create an efficient market in which RPTs are created and sold as new risk enters the system and bought back and burned when policies expire?

We are still in the early days of parametric insurance, so we’re able to test our hypotheses and models. We are convinced in any case that risk pool tokens are a valid concept, and we welcome any and all input and collaboration on this issue!

Resources

Watch the video of my short presentation

My slides are also available here