Smart contract-enabled insurance holds promise, but can it be scaled?

A new insurance world is coming where smart contracts replace insurance documents, blockchain “oracles” supplant claim adjusters, and decentralized autonomous organizations (DAOs) take over traditional insurance carriers. Millions of poor farmers in Africa and Asia will be eligible for coverages like crop insurance too, whereas before, they were too poor and too dispersed to justify the cost of underwriting.

That is the vision, anyway, on display in the recent Smartcon 2022, a two-day conference that sought to provide “exclusive insights into the next generation of Web3 innovation.”

Subsistence farms, where families basically live off what they grow and almost nothing is left over, account for as much as two-thirds of the developing world’s three billion rural people, according to the United Nations. They almost never qualify for insurance coverage and most probably wouldn’t know what to do if it were offered.

“In sub-Saharan Africa, for example, where I grew up in Kenya, insurance is basically unavailable. 3% have access to it, but nobody buys it, basically,” Lemonade Foundation’s Roy Confino explained at the two-day New York City event.

The Lemonade Foundation, a nonprofit founded by United States insurer Lemonade, is behind the recent formation of the Lemonade Crypto Climate Coalition, a group that believes “blockchain has the potential to pool that risk together” and “basically solve the core problem that has inhibited the scale of insurance in the developing world for profit services and that is cost,” said Confino at Smartcon 2022. Founding members also include Hanover Re, Avalanche, Chainlink, DAOstack, Etherisc, Pula and Tomorrow.io.

Insurance is problematic in poor nations for many reasons. It can’t be easily distributed because there are hardly any local insurance agents or brokers, and historically insurance is “sold,” not “bought.” Also, insurance claims can’t be validated without great expense because, typically, there aren’t any claims adjusters on the scene to make damage assessments. This renders underwriting un-economic.

But, it need not necessarily remain that way. Parametric insurance models can potentially cut producer costs by automating many traditional insurance processes, making it profitable to underwrite those previously deemed uninsurable. Sometimes called “index insurance,” these models insure a policyholder against a specific event by paying a set amount based on an event’s magnitude rather than the losses incurred.

For example, if rain hasn’t fallen in a certain predetermined region in Kenya for three weeks, a blockchain “oracle” — it could be a local weather station — automatically sends a message to a smart contract that remotely triggers a payout to the policyholding farmer's smartphone. It bypasses the claims adjustment process entirely. It doesn’t matter whether an individual farmer’s field is damaged. All policyholders in the area are paid. 

Crop insurance is a good use case for parametric models because many of the forces that can damage crops can be objectively measured, such as rainfall, wind speeds, temperatures and others.

Self-executing smart contracts also ensure that payouts for weather disasters and the like are almost immediate, noted Sid Jha, founder and CEO at Arbol — a parametric insurance provider — and this is especially important in the developing world where many farmers live hand to mouth. “You don’t have customers waiting weeks, months who in many cases can go bankrupt waiting for an insurance check,” he said, speaking at a separate Smartcon 2022 session.

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Parametric insurance isn’t entirely new; it has been around for several decades. But, blockchain-enabled parametric insurance has just emerged in the last few years. Most, if not all, its use cases are still in the pilot stage. The Coalition, for instance, isn’t expecting to scale up its programs until next year.

Many believe that legacy insurance systems could stand some substantial improvement. “Traditional indemnity insurance has many disadvantages: it is slow, bureaucratic, constrained to home damages, and comes with significant uncertainty,” wrote Wharton School associate professor Susanna Berkouwer recently. She described a parametric hurricane insurance product that employs blockchain technology in the Commonwealth of Dominica. NASA-generated hurricane alerts touch off automated international bank transfers to policyholders’ bank accounts. Projects like these are worthy of further study in Berkouwer’s view.

Hindrances remain: Will farmers sign up?

Supplying the world’s subsistence farmers with affordable crop insurance and possibly other protections via chain-based parametric insurance faces some daunting obstacles, however. One is educating farmers in the complexities of insurance. There is really no way at present that this can be done easily by technology or automation alone. 

Tinka Koster and her colleagues at the Netherlands’ Wageningen University, for example, recently completed a review of the World Bank Group’s Global Index Insurance Facility's (GIIF) engagement in Kenya. To increase index insurance take-up rates among African subsistence farmers, GIIF and others would need to boost “awareness, knowledge and understanding by the farmers about the insurance,” said Koster.

“The last-mile outreach is a key challenge for many services to smallholder farmers, including index insurance,” Koster told Cointelegraph in emailed responses coordinated with team colleagues Marcel van Asseldonk, Cor Wattel and Haki Pamuk. “Technology can help bridge part of this gap, but technology alone is insufficient.”

“Sales and product understanding are huge costs in often remote and difficult to reach places,” Leigh Johnson, assistant professor in the department of geography at the University of Oregon, told Cointelegraph. “Renewal rates are notoriously bad.”

“Many farmers need to see that insurance is a tool for managing risk and not for gambling on a certain outcome,” said Jha, who agreed that educating farmers on the need for risk management tools like insurance is critical. As Jha told Cointelegraph:

“When farmers are able to get access to some type of subsidized insurance provided by the government or an NGO, they become much more familiar and comfortable with the concept, and that education process becomes easier in terms of providing specialized coverage products that meet the unique needs of farmers.”

In GIIF’s Bima Pima product for Kenyan farmers, the World Bank Group program used village-based advisors (VBAs) to help distribute the insurance product — essentially taking the place of traditional insurance agents. The VBAs were paid monthly for their efforts. According to the Wageningen report, these advisers were “happy with the SMS messages and the direct premium payment. But they find it hard to convince farmers and are uncertain about the insurance pay-out because the product is so new.”

Does parametric insurance even need DLT technology?

If parametric insurance is going to succeed in emerging markets, does it even need blockchain technology? The World Bank Group’s GIIF parametric insurance projects in Africa, for instance, did not use blockchain technology. What exactly does index insurance lose if it doesn’t employ a decentralized digital ledger? 

“Blockchain is simply a tool,” Jha told Cointelegraph, and one can use many tools to get the same outcome. Still, the digital ledger’s immutability and auditability can build credibility for the program:

“What DLT’s do provide is trust in areas that generally tend to lack trust, and allow for possibly a more efficient micro payment system than what currently exists in some of these countries in terms of disbursing and collecting funds.” 

Johnson, on the other hand, comes down “squarely on the ‘no smart contracts’ camp, precisely because parametric contracts go wrong so often, and there is an important case for correcting these retroactively” in the interests of fairness and equity. 

In a 2021 article, Johnson noted that environmental estimates made by parametric market devices used to commodify risk “are frequently wrong, sometimes grossly so.” In the first season of R4’s Ethiopian program, “one of the most globally renowned programs insuring smallholder farmers against weather risk using parametric indices,” wrote Johnson, R4 made an ex gratia “voluntary donation” to teff farmers “following rain shortfalls that did not trigger the contract.” Such transfers later became “fairly routine.”

“I’m not sure how much information farmers would require re smart contracts/blockchain at the time of enrollment,” Johnson told Cointelegraph, “but one can imagine them being extremely skeptical of unknown monetary technologies and firms.”

If blockchain technology could raise farmers’ awareness and knowledge about insurance, added Koster, “then it would also help for further upscaling the index [parametric] insurance in African context.”

Still, this all might take some time. Jha was asked how long it might be before agricultural insurance can achieve widespread usage among subsistence farmers in the developing world in places like Southeast Asia or Africa — two years? Five years? Ten years?

“Probably ten years,” Jha told Cointelegraph, citing the challenges of education, cost and lack of data, i.e., “everything from a lack of weather stations, crop yield history, and lack of data on farming practices.”

Many farmers need to see that insurance is a viable tool for managing risk, and this is where self-executing smart contracts could provide a powerful example. If farmers see their neighbors being reimbursed immediately during an extreme weather event, they might consider purchasing an index policy themselves.

Government subsidies could help. “There is a lot of work that is needed in terms of making insurance more affordable so that underserved stakeholders who need these tools can access them,” said Jha, while Johnson added, “I think the best progress will come from wider state adoption of safety net programs using parametric solutions — that’s how you get coverage at scale.”

In terms of scaling, the World Bank’s GIIF has already made some progress. “The milestone of one million farmers insured has already been reached in Zambia, with the index insurance bundled with the subsidized fertilizer programme,” Koster said, while in Senegal, GIIF is currently reaching half a million farmers, with a similar number in Kenya with a government-supported program.

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“This shows that it is possible to reach significant numbers of smallholder farmers,” Koster told Cointelegraph, “but not without significant government support.” 

In sum, while parametric insurance models might enable insurance underwriters to pool risks, making it profitable to insure the previously uninsurable, and blockchain-enabled smart contracts can ensure that cash-strapped farmers received payouts during disasters almost immediately, much work still needs to be done in convincing financially unsophisticated and often distrustful farmers to sign up for such programs. Technology alone won’t do the trick, and state entities may need to get involved.