Future Insurance – Digital Domiciles

Prophecy is for lunatics and heralds. Futurists fall somewhere in between, tending toward lunacy with a dash of megalomania. Insurance is part and parcel of the economy and has been around since the advent of trade. Roman soldiers created a proto life insurance policy for fallen soldiers by passing around an offering helmet for the dead to be distributed to the decedent’s next of kin. Pirates developed a de facto workers compensation program by providing six pieces of eight for any pirate who lost use of his right arm in battle. There is nothing new about insurance. So long as there is risk, there shall be insurance.

Given that governments regulate insurance, the future of insurance is linked with the evolution of government. Due to the relatively high costs of starting new governments (bloodshed, societal upheaval, flag design), new governments are a relatively rare phenomenon. However, technology has opened the door for a new form of government operating pursuant to rules and algorithms. Digital governments are possible. Regulators of the future will be composed of bits and bytes. Trends indicate that the fracturing of power seen in finance (bitcoin) and intellectual property (YouTube and Spotify) shall spread to the state.

For example, a handful of billionaires are designing floating cities as breakaway city-states. These autonomous units floating in the sea will be able to police themselves, raise their own food, and will be outside the reach of the civil authority of any current state. In addition, the government of Honduras recently granted the right to Roatan to operate as a de facto autonomous libertarian paradise capable of drafting its own civil laws. Thus, we see the seeds planted for new, micro-governments. So, how does a government of the future regulate the insurance industry?

Insurance companies require a license. Only governments may issue valid insurance licenses. As new governments enter the insurance space, there is an opportunity to drag insurance regulation into the 21st century. Regulations are one of the key drivers of insurance costs as compliance slows filing approval, creates additional costs passed on to the insureds, and generally slows the pace of the economy. Moreover, many regulatory bodies are rent-seeking and frequently craft regulations to serve the established few at the expense of providing a pathway for new entrants into the market.

But what really needs to be regulated? And how many people does it really take to run an insurance department? If the creators of a new regulator use automated processes to reduce labor and regulatory slow down, then the laws should be narrowly focused to address only the bear minimum necessary to ensure a free and healthy market. Insurance regulators are principally responsible for five mandates.

First, the government needs to know what entities are licensed or registered within a jurisdiction. Governments serve the people and part of this mandate requires the government to police entities within its jurisdiction. This power requires full disclosure of the regulated entity and the ultimate beneficial owners of the company. For fines and penalties to have any meaning, the ultimate beneficial owners should be actual humans and not holding companies. Otherwise, disreputable businesses practices can hide behind the corporate veil. Licensing and registration should be conducted through a website portal for immediate distribution of government licenses.

Second, the government should enforce its rules and regulations. Fines and penalties can be assessed via automated processes when the regulated entity commits an infraction. Given that most international insurance carrier owners do not reside within the domicile, police action for fraud is generally unrealistic. Rather, the imposition of fines and penalties coupled with the stripping of the insurance license is all that is necessary to enforce the law. With proper reporting standard, most fines and penalties can be automated with notification distributed from a database. In the event of fraud, Interpol is better equipped to hunt down criminals than a small government.

Speaking of criminals, the best law enforcement screens out potential criminals on the front end. The third function of government is to conduct background checks on all prospective insurance carrier owners from reputable independent parties. Software can screen the background reports for red flags and deny based off credit issues, criminal background, or unreasonable debt to income ratios.

Fourth, the government should establish minimum standards of capitalization. Insurance companies pay claims. Thus, they require money to get up and running. A simple ratio of premium to surplus capital should provide investors and potential insureds as to the viability of the insurance company.

Fifth, the government should mandate third party, independent audits of insurance companies within the domicile to ensure basic record keeping and transparency of transactions.

Beyond that, there is nothing else that a government really needs to do. Most of these mandates can be automated via machine learning with a sophisticated website for the beneficial owners to interact with. In a sense, most of an insurance department can operate as a distributed autonomous organization with records held in a blockchain for security and the daily operations conducted via bots.

Programs can review financial statements. Rather than submitting financial records produced by a firm’s CFO, have the CFO produce the financial documents in the government’s website to allow for immediate solvency calculations and capital review. Audits that are prepared and submitted to the government can be scanned by a bot with natural language processing that will be able to quickly identify any areas of concern for the regulators which can then be discussed with the owner of the insurance company.

Interestingly, the concept of new regulators entering the field is not a novel concept for one area of insurance. Captive insurance regulation is far from universally accepted. The states of California and Washington famously lack any captive insurance legislation. On occasion, new regulators enter the market as a new state adds captive insurance laws to the state’s code. This inevitably creates a wave of marketing by the state to attract captive promoters to incorporate within the new domicile rather than with one of the established players. Consequently, states’ annual fees for captives are relatively low and regulations are generally lighter than with admitted carriers. Governmental competition is the consumer’s best friend.

Thus, there is already a functioning model in the captive marketplace showing that governments do, in fact, compete for business. As new forms of governments sweep across the globe, the concept of a government being tied to a particular geography will fade away. Digital governments open the door to a digital jurisdiction wherein the regulators will be programmed bots operating pursuant to the best practices established by a handful of humans.

Under the U.S. Constitution, insureds have the right to procure insurance from any carrier they like. That right extends to alien, non-admitted insurance carriers. Thus, procuring insurance from a carrier domiciled within a digital jurisdiction is perfectly fine under current U.S. law. This paradigm shift will result in much faster regulatory action, lower frictional costs of doing business, and an abundance of new players entering the market as the barriers to entry fall across the globe.

The best part of all is that there is nothing the government can do to stop this. If a consumer logs into a website and private purchases insurance, all the laws in the world will not stop the payment of premiums and distribution of claims. Individuals currently have the technology to purchase insurance from carriers domiciled in a global, digital jurisdiction beyond the regulatory authority of any state regulator.

Global insurance regulatory regimes will open the door to larger markets. Larger markets will distribute risk across greater pools of insureds. This will result in lower rates for consumers. Digital governments are the future and in this future the consumer is the winner.

About J. Matthew Queen

Insurance Executive with a history of working in captive insurance & specialty risks. Skilled professional well-versed in risk financing, tax consulting, insurance brokering, and corporate governance.

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