Climate Resilience: Parametric Insurance and Blockchain (Part II) 

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Regulatory challenges 

Despite the benefits of parametric insurance, there exist some legal and regulatory challenges. In many jurisdictions, such as the UK, the insured must have an ‘insurable interest’ for an insurance policy to be legally valid. In other words, the party taking out the policy must be affected by the subject matter of the insurance, benefiting from its preservation or suffering if it were damaged.6 Yet, parametric insurance does not require an insurable interest, allowing the insured to be indemnified regardless of whether they had an interest in the subject matter or whether they suffered a loss. Particularly in situations where no loss is suffered, there is a potential that parametric policies could be classified as derivatives rather than insurance.  

In the absence of uniform international standards governing smart contracts, insurers also face the difficulty of needing to assess regulatory considerations in each jurisdiction such contracts are used. Limited judicial precedent on smart contracts, especially when applied to parametric insurance, proves it challenging to determine how these contracts should be structured to adapt to different jurisdictions and how to determine the preferred governing law. 

Another issue that could arise is potential disputes in parametric insurance powered by smart contracts. Identifying the choice of law and jurisdiction would dictate where the claims can be heard and what law must be applied to the disputes. However, as mentioned in the previous paragraph, this option might not be as easy and straightforward in the context of smart contracts. Therefore, arbitration could be the better option, and this is split into ‘off-chain’ and ‘on-chain’ arbitration. The former could entail the addition of an arbitration clause in the code of smart contracts that directs parties to traditional arbitration rules, such as those produced by UNCITRAL. The main benefit of this method is that these rules are tried and tested; the drawback is that its general application does not specifically target the unique challenges that arise in smart contract disputes. However, with the introduction of dedicated digital arbitration rules, such as Digital Dispute Resolution Rules published by the UK Jurisdiction Taskforce,7 ‘off-chain’ arbitration could become a favoured option to resolve this type of disputes.  

The second type of arbitration is ‘on-chain’ arbitration, where a third party is permitted to make changes to a blockchain directly without the need for enforcement of a decision in the ‘real world.’8 Essentially, this ‘third party’ is another set of smart contracts that can initiate and conduct arbitral proceedings, as well as enforce the result.9 An example of an ‘on-chain’ arbitration initiative is Kleros, which is a decentralised arbitration service that uses blockchain and crowdsourcing to adjudicate disputes.10 Whilst the concept of using one ecosystem of blockchain and decentralised network to resolve disputes arising from another, the concept is still relatively new and dynamic, with much room for development. 

Looking forward 

Where traditional insurance falls short in keeping up with the rapidly changing risk environment, parametric insurance boasts characteristics that can fill in those gaps. The use of blockchain in the underwriting process can also improve efficiency and costs. 

The adoption of blockchain in parametric insurance policies has already begun to appear in the market. Insurtech company, Arbol, for instance, offers crop insurance policies using smart contracts.11 With adequate regulatory framework and guidance, blockchain-powered parametric insurance could become a powerful and indispensable tool in building climate resilience in the future. 

Claudia Wai Lam Chan (RO(III)4) 

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