Peer-to-Peer Insurance: How Blockchain is challenging the traditional insurance model
In my last article, I talked about a fairly new concept of On-Demand Life Insurance, which raised a lot of questions from the insurance experts. This week, I am back with another topic that would surely offer food for thought. If it does invoke curiosity, the purpose of the article is served.
Peer-to-Peer (P2P) insurance has attracted a lot of attention recently. Whilst it turns traditional insurance on its head, the idea is not fundamentally different from mutual insurance concept. In this article, I would compare and contrast traditional insurance and P2P insurance and share my thoughts on how the use of Blockchain makes it more transparent and cost-efficient.
How does traditional insurance works?
Policyholders pay the premium to the insurer to cover themselves against financial losses. If the insured event doesn’t occur, the insurer keeps all the premiums. In case of an insured event, the insurer pays the claim. While this looks good in theory, the model incentivizes the insurer to not pay claims. This is more applicable to the insurers with the short-term horizon.
How is P2P insurance different?
P2P insurance also works on the fundamental of pooling of risks. P2P insurers form a group of people with similar insurance needs and each member contributes to cover themselves against the potential financial loss. In case of claims, the contribution is directed to the affected set of people. The remaining money after the payouts, expenses and fees is returned to the group or passed on to a charity.
Clearly, in this arrangement, the organization running P2P insurance has no incentive to decline the claim as their fees are either a fixed percentage of contributions or a fixed percentage of claims paid!
How is Blockchain taking it to the next level?
The efficiency brought by Blockchain results into lesser premiums. Once the premium has been set, the members put the money into an escrow account. In case of a claim event, which is generally approved by voting mechanism, the amount is paid to the claimant. Any remaining money is re-distributed to the members or passed on to a charity. The following diagram summarizes the claim process of Blockchain powered P2P insurance arrangement
The P2P insurers make money either by charging a flat percentage of the premium/contribution or the claim amount and hence are NOT disincentivized to payout claims!
Since the entire arrangement is managed by peer group and automated with the help of technology, the cost is lesser which translates to lower premiums. The transparency comes from the approval mechanism wherein the members of peer group approve/reject claim through voting!
Those thinking about the extreme scenarios wherein the number of claims is large and the total claim amount exceeds the contribution, the P2P insurers get themselves covered with the help of reinsurance. And of course, some part of premium/contribution is shared with reinsurers!
In case you have any questions, do write to us at hello@fidentiaX or reach out to me on Twitter when you can #AskTheActuary directly! I am live next on 17th September at 8 PM SGT!
Disclaimer: The article has been written with an aim to broadly explain an otherwise complicated and technical topic for readers with little or no insurance background. Hence, it doesn’t have finer details but is still broadly correct. The readers are recommended to take advise from their respective financial advisers before taking any financial decision.
About the writer: Mr Sumit Ramani is the Chief Actuary of fidentiaX. He is a qualified Life actuary and a computer science engineer with over a decade of experience in (re)insurance business with focus on modelling of life and health products, peer review and business analysis.