The complex types of insurance, such as parametric insurance policies can be digitalized and verified through blockchain and oracle. Parametric insurance is a form of insurance, where the payouts are identified not through a claims adjuster surveying the damage, but based on objective measures, i.e. the magnitude of a weather event.
It is most often used for insurance of natural catastrophes, such as tornadoes or hurricanes, where individualized policies, based on specific damage, would be difficult and costly to administer but a standardized proxy-based payout, such as the severity of the storm, would suffice. Parametric insurance is preferable to other forms of insurance when a quick payout is necessary, such as when a country suffers a hurricane and needs to quickly obtain money to begin rebuilding and pay emergency workers. Parametric insurance can lower the time of payment from months to two weeks, which can help jumpstart the rebuilding process.
The major base of parametric insurance is defining the objective indicators to be used as an effective proxy for the type of loss being covered. The advantage of defining the effective proxies lies in the fact that complex insurance policies that otherwise would have been needed to be adjusted qualitatively could instead be simplified into “if-then” logical statements. The bright example is when you rely upon such objective markers as storm intensity, wind speed, or amount of rain, therefore, the need for individualized adjustments of claims becomes obsolete.
After a hurricane damages an area, an independent validator: oracle can extract data from a third-party site, i.e. National Weather Service. The latter allows oracle to identify objective measures, such as the strength of the storm, and then on the basis of that data make the respective payment. Although individual losses might exceed or be less compared to the specified payment amount, nevertheless, the insurer is granted certainty in loss forecasting and the policyholder gets the opportunity to make faster payment. Consequently, both parties are in a win-win situation due to the automation of the process and the reduction in frictional costs.
Parametrization of current insurance forms on the basis of proxies for loss and programming these policies into Blockchain-based smart contracts can substantially change the nature of insurance offerings. The latter will result in the following advantages:
- Reduction of transactional expenses as a result of simpler policies enabling for lower-premium policies to be profitably managed,
- Broadening horizons for insurance products to enter into new markets, since local claims adjusters or other trusted agents would no longer be enough to efficiently manage the policy.
Although some costs are difficult to manage, studies have found that management and contract administration are the most important components of cost variation for property and casualty insurance. According to a study by Mckinsey & Company, for property and casualty insurance over 80% of the cost variance was associated with management factors. In addition, the same research indicates that improvement of IT efforts alone might decrease costs by 20-40%, while business complexity and performance management are the remaining large components of cost variation.
The parametric blockchain-based smart contracts offer multiple benefits of IT improvement, simplification of business complexity, efficient management of performance, increased transparency and trust. Blockchain technology can be implemented in parallel and as a complementary solution along with existing IT systems. Several cloud service providers, such as Microsoft Azure already provide commercial blockchain platforms.
Finally, blockchain-based smart contracts can be validated through oracles and monitored in real-time through analytic software checking the permanent blockchain record of transactions and loss occurrences. The use of oracles would reduce the number of local agents and could substitute the need to rely on the reports of adjusters on the ground.
The reduction of frictional costs will increase the profitability of those policies that were previously unprofitable because of low margins resulting from low premiums or high administration costs.
Digitalization of parametric insurance policies through Zap oracle marketplace
On the Zap oracle marketplace, anyone from an individual to large corporations can create or access oracles on their own terms. Decentralized application developers will be able to create a new generation of Dapps capable of integrating “real-world” data. What follows is a short outline of how existing markets can make use of Zap marketplace.
“Zap turns to the free market to source the best data feeds so that a decentralized community can choose among multiple and competing oracle data feeds”.
Zap oracle marketplace believes that the insurance industry will benefit greatly from smart contracts. The ZAP store’s data marketplace will provide insurance companies with an opportunity to provide self-actuating insurance, that automatically pays customers eligible for a payout. With smart contracts, insurance payouts can be predetermined, streamlining the process for insurers and consumers alike. For example, doctors in a decentralized insurance network would use their private key to sign the smart contract, releasing the funds in order to pay for their service. This is an example of humans acting as oracles.
In conclusion, by using the benefits of newly-developed technology, parametric, blockchain-based smart contracts are both an opportunity for digitalization of existing insurance products, the realization of efficiencies and are also opening up an access to potentially un-tackled markets for insurance products.