“the financialization of law will be an important vector in the next decade(s) #FinLegalTech.
The core of the thesis centres on two drivers, process improvement (removal of frictions) and characterizing the pricing of exotic forms of risks. (specialty risks).
The later driver – Pricing exotic risks is an area, that I have been looking at closely over the last few months as there exist a potential opportunity for me, specifically as it relates to liability that may arise from the proliferation of embedded devices. As with other fields being disrupted by technology, the Insurance field is moving from personal liability to mostly product liability. The future of auto Insurance is being shaped by technology, like the concept of usage-based insurance (UBI). In a usage-based insurance model, data points that were previously taken into consideration when insuring a vehicle, such as age, gender, car model, zip code is being weighted at a lower rating, while objective assessments based on the risk profile of the driver, and other real-time data points (telematics) provide for a more objective premium. The adoption of UBI has skyrocketed over the last 5 years. According to statistica.com, In 2013, only about 5.5 million policies were in force globally, and as of this year, that number has reach 107 Million.
Table 1: Number of usage-based insurance users worldwide in 2013 and 2018 (in millions)
Another segment of speciality risks is the Internet of Things (IOT) or connected hardware/software segment which continues to proliferate the home, health and automotive sectors. How might we offer competitive insurance products that correctly ascribes liability where it belongs and how do we price risks appropriately?
While there seem to have been an uptick in adoption, legal challenges facing UBI include risks associated with the collection, use and disclosure of personal data gathered, especially in light of new data regimes such as the GDPR. Other factors include the “black box” syndrome with algorithms potential for indirect discrimination.
Liability conundrum
Ponder this scenario, a faulty nest thermostat overheats the home to 180 degrees F, causing the connected refrigerator to overheat which ultimately starts a fire, leading to the death of the house pet. The home also had an Alexa device which should have received signals from the nest system to dial 911. The complexity of the interdependencies of hardware, software and operational flow of these connected devices like will make for a complicated legal argument by even the most technology savvy litigator, was it the code driving the operating system that was faulty, or was it a mechanical failure from the hardware sensor manufacturer?
The existing product liability framework does not fully address losses that may arise as a result of failure of IOT devices. The Consumer Product Safety Commission(CPSC) was recently made aware of the “always on” flaw in Samsung TV’s, Alexa and other household IOT devices. As a result of the current Economic loss doctrine which does not allow for recovery of monetary damages that do not arise from physical injury to a person or property – private data that may have been captured by the company before the notification was made is not in scope for the product liability framework.
Data is king, and while most IOT devices offer some convenience, the real trade-off is that consumers give off their privacy with the expectation of security. If trends are anything to go by, there will be more cybersecurity breaches, with private data made available publicly, or worse still a hack into home, auto or health embedded device with malicious intent and grave financial and physical consequences.
For insurers, lawyers and those in the fintech space, pricing risk is of utmost importance. The automation of actuarial services and a code driven risk management process means even more “black box” type scenario where algorithms are not only decision makers but are a competitive advantage.
Those charged with providing legal counsel now have to understand in great detail the technology that drives the IOT device and the interplay between hardware, software and operational aspects of owning such devices such as updating the software if auto-update is turned off. As we watch the evolution of law and admonish the legal system to adopt finance and Insurance’s ability to predict, price and manage risks, these two sectors are also experiencing some disruption with how to best address pricing risks.