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In most jurisdictions around the world, the banks provides some kind of insurance protection, usually against theft, for its clients’ fiat money in the bank. Although there is a maximum limit for the sum insured for each customer (in the US, it is $250,000 under the FDIC insurance and in the other jurisdictions it is much lesser than that), it does give some relief to the bank’s customers.
Additionally, if you are running a business, you would have access to
a) Money Insurance (which is usually written on “all risks” basis for fiat money kept at the business premises or in transit and
b) Fidelity Guarantee Insurance for loss of fiat money through employee embezzlement.
But should you, whether as an individual or an organization, keep cryptocurrencies with a crypto custodian or an exchange, in most cases you are your own insurer, since most of them do not provide any insurance protection for their customers’ cryptocurrencies kept in their wallets and those who do provide do so with limited coverage. Besides, for businesses handling crypto neither money insurance nor fidelity guarantee insurance is readily available to cover loss of their cryptocurrencies. This, inter alia, is an impediment to the growth and wider adoption of cryptocurrencies and blockchain backed businesses.
Across the world, central banks are reportedly thinking about and researching on how Central Bank Digital Currencies (CBDC) could replace traditional fiat money. Although they are researching into it, a survey by the Bank for International Settlements shows their work is primarily conceptual and only a few of the central banks intend to issue CBDC in the short to medium term. When they do issue CBDC, we can possibly expect them to extend FDIC type of insurance to be extended to cover the CBDC held by the banks in their respective jurisdictions. If and when they do, it is unlikely that such FDIC type of insurance would extend to cover cryptocurrencies issued by private enterprises and kept by the banks as custodians.
Bear in mind that even if the banks do extend their FDIC type insurance for cryptocurrencies, the coverage and the limit is unlikely to surpass the current coverage for Fiat currencies, which at $250,000 per customer or lower, is bound to prove inadequate for many. Such limited coverage is unlikely to impress any business dealing in crypto and certainly not crypto exchanges or crypto custodians.
In the event of the bank going into receivership or eventual liquidation, the situation can be much bleaker. Despite legislation providing some kind of relief for the creditors in such an eventuality, in most jurisdiction the creditors should consider themselves lucky if they can finally get 50% of initial deposit and that too after several years of wait.
Although, Banks’ customers are the first to receive a safety net (albeit a limited one) from their governments, central banks and insurance companies, businesses and individuals who hold digital currencies in the exchanges or with the custodians or in their private wallets, do not get any such reprieve because of the lack of meaningful crypto insurance market for businesses and individuals.
We do hear of crypto insurances arranged by businesses such as bitgo.com, curv.co, coinbase.com, kingdomtrust.com, nexo.io, BC Group, anchorage.com, gemini.com, and a few others. These are few and far between considering the huge number of businesses and individuals in the crypto industry. Besides the coverage provided is limited and is not anywhere near the “all risks” basis as is available for fiat currencies, as discussed above. '
Reasons for slow response from insurance industry
We explore below the reasons for the insurance industry’s slow response to crypto risks.
1. Technology is still being developed and fine-tuned
The main technology that powers the cryptocurrencies, the DLT, is a new technology that is being fine-tuned and/or augmented with as we speak. Issues relating to scaling, privacy, interoperability, security and many others are being addressed and being improved upon on a continual basis. Innovative technologies like lightning network, atomic swaps, zero knowledge proofs, layer 0 protocol and many others have been or are being developed, tested or deployed. In a sense, we can say that the technologies powering the cryptocurrencies have not fully matured. Hence the issues relating to scaling, privacy, interoperability, security and others remain hot issues, which makes the insurance market naturally apprehensive and slow to react.
2. Without reinsurance protection, there will be no insurance
Reinsurance is relatively an unknown concept to many.
If insurance companies cover risks businesses and individuals are exposed to, then reinsurance companies cover risks the insurance companies are exposed to. When insurance companies insure the risks of the individuals and businesses, those risks of the individuals and companies are contractually transferred to the insurers. The financial capacity of insurance companies are limited by their paid-up capital and reserves. A claim under a single policy could technically wipe out this capacity. Hence, these insurance companies have to manage the risks they have contractually accepted (via the insurance policies they have issued) by reinsuring a part (usually a large part) of these risks with specialist insurance companies known as reinsurance companies. Reinsurance companies specialize in insuring only the risks borne by insurance companies.
Without these reinsurance companies, insurance companies will not be in a position to underwrite many of the risks they insure. In most cases insurance companies reinsure more than 90% of the risks they underwrite retaining 10% or less for their account. In some large cases involving values (sum insureds) in hundreds of millions or billions of dollars, their retention could go as low as 1% or lower.
Naturally, if there is no reinsurance market for a specific type of risk, then the capacity of insurance companies to underwrite such risks will be hamstrung. This has been the case for crypto based risks for some time in the past. Only recently some of the reinsurance market participants have been warming up to crypto risks. But the number of reinsurers with appetite for crypto risks is still small. Faced with a new type of complex and ever changing technology-based risk, and with little historical data to go by, they are being abundantly prudent in their crypto risk portfolio by accepting only risks they understand well and not accepting extremely large values (sum insureds) to protect their balance sheet.
The key to enticing reinsurance companies to accept crypto insurance lies in making sure that they have a deep understanding of crypto risks. Reinsurers need to understand the technologies involved, the risks that these technologies carry or resolve, details of the risks events that the industry has witnessed to-date and what could have prevented those risks events from happening again. Those proposing insurance (exchanges, custodians and others) should ensure that such information is made available to the insurance broker and explained clearly in writing and records of such communication kept for later reference.
It needs emphasize here that insurance contracts are deemed to be contracts of uberima fidei (a Latin term which means ‘utmost good faith’). It simply means there is an obligation on the person proposing the insurance to provide the insurance company all the information that are considered material enough for the insurer to either reject or accept the risk and if he accept the risks, the terms and conditions that he would impose including the amount of premium he would charge. The insurance proposer has this strict obligation even if the insurer does not request for such information. Failure to provide such information, entitles the insurance company to reject claims for breach and keep the premium paid. For this reason alone we cannot emphasize more the importance of putting every communication in writing and verbal communication to be followed up with written confirmations and keeping a record of the same for later reference.
3. Lack of technical knowledge and experience among underwriters
Reinsurers and insurers who wish to underwrite crypto risks probably already have IT and blockchain specialist on their staff. Even if they do have such staff, these staff are likely to be new to the insurance industry and will need time to learn the principles and market practices of the insurance industry, such as principles of reinsurance and insurance, risk assessment, risk management, and underwriting. Besides they need to have a thorough knowledge of the present developments in the crypto industry itself.
The insurance proposer need to be mindful of these limiting factors and assist the insurance company to understand the risk in whatever way they can.
4. Regulatory Hurdles
Insurance companies and reinsurance companies operate in highly regulated environment. They are required to have operating licenses and are subject to strict supervision by the regulatory authorities in their respective countries. They are required to comply with the AML and CFT legislation in their respective jurisdictions. These jurisdictions impose heavy penalties on the insurance companies and reinsurance companies for failure to comply with the regulations. In addition, the chief executive officer and senior management staff are often held criminally liable for breaches with heavy fines and in some cases imprisonment. In the worst case scenario, their licenses to operate could be revoked or severely restricted.
Insurance and reinsurance companies are therefore extremely careful not to take risks they don’t understand fully or be in anyway linked with any businesses not in compliance with or seemingly not in compliance with AML and CFT legislation.
Such stringent regulations stand in the way of insurance for crypto-based risks because many insurance companies have understandably a limited understanding of crypto risks and because cryptocurrencies by their very nature could easily be used for terrorism financing, money laundering or other nefarious activities.
Things crypto businesses need to know as an insurance proposer
Insurance brokers are insurance intermediaries who broker the insurance on your behalf as your agent with the insurer and the reinsurers. They are considered as professionals in the eyes of law, just like a doctor, engineer or a lawyer. Hence, if they are negligent in the performance of their work resulting in your claim being declined by the insurance company, you have a right of action against the broker for professional negligence for your losses. To protect them against such professional negligence risk, in most jurisdictions, brokers are required by law to procure Professional Indemnity policies. Since these brokers often negotiate and secure insurances with sum insureds running into millions and sometimes billions of dollars, their potential liability for professional negligence could run into hundreds of millions of dollars.
The mandatory legal requirement to procure a Professional Indemnity policy could be satisfied in most jurisdiction with a minimal coverage of say, even, $1 million per occurrence. Unfortunately, some brokers do procure just enough coverage to meet the minimum legal requirement and not their real risk exposure. Some of these brokers have been known to resort to contractual exclusions to escape their professional liability to their client (i.e. the insured party). These contractual exclusions usually appear in their correspondence with you. If you are not legally trained or legally trained but unfamiliar with insurance law, you are likely to pass over these clauses as something not unusual in the industry.
Allow us to repeat our earlier statement that insurance brokers are insurance intermediaries who broker the insurance on your behalf as your agent with the insurer and the reinsurers. This has legal consequences. One of which is that if your broker fails or neglects to forward any of your communications (instructions, information etc.) to the insurer (or reinsurer) or communicates it with errors (this can easily happen if you give verbal instructions), and if such information is material information then you are deemed to have failed in your duty to provide material information to the insurer. You would then be in breach of the terms of the policy and your claim, if any, will not be paid. There is little you can do in such circumstances except to sue the broker.
In a similar situation with a life insurance agent the results are just the opposite because, at law, the life insurance agent is considered to be the agent of the insurer and is deemed to be negotiating the insurance on behalf of the life insurer. Thus for example, if you had communicated to the life insurance agent a material information about, say, your health and if the life insurance agent failed to communicate it to the insurer, then you will not be faulted for the failure. The life insurance company is deemed to know of the material information you provided to the agent because the agent is the insurance company’s agent and negotiated the contract on their behalf. Of course, you will have to prove your communication to the life insurance agent with, preferably, written records (such as a letter or email), failing which you could still be unsuccessful in your claim.
If you need us to cover any other area of insurance you may make a request with details in the comments section. We will be happy to look into it and endeavor to publish articles later covering the said issues.
The information here is provided strictly on a without prejudice basis. It is provided soley for educational purposes only and under no circumstances should be considered as professional advice.