Distributed Insurance: Tokenization of Risk and Reward Allocation

Abstract

It is fairly common in developed economies that a small set of insurers with large capitalization often account for the majority of their insurance markets. While tight regulations of the insurance industry are well-intended to protect the interests of policyholders and ensure market stability, the legal compliance and capital requirements create prohibitively high barriers that prevent retail investors or small companies from entering the market, further exacerbating the consolidation of the market. The advancement of distributed ledger technology has enabled new models to transfer risks from policyholders to crypto capital market. There has been little to no previous study on the underpinning theory of such new mechanisms. We propose a new theoretical framework for distributed insurance, where risks and rewards can be spread in a large distributed network of retail investors, as opposed to the traditional practice of risk concentrations on insurers. Our findings show that distributed risk sharing can significantly reduce the cost of coverage, improve capital efficiency while meeting the needs for limited liabilities and common investment principles for retail investors.

Keywords: distributed insurance; decentralized insurance; peer-to-peer insurance; risk sharing; tokenomics

JEL Classification: G22; O31