On the 15th of May of this year, law firm Clyde & Co launched an off-the-shelf connected parametric insurance contract for use by insurers. In this episode, Walid catches up with Lee Bacon, partner at Clyde & Co and co-founder of Clyde Code.
Lee makes a repeat appearance to discuss connected contracts and Clyde Code, which is a consultancy unit focused on blockchain and smart contracts within Clyde & Co. Lee highlights that insurance is a core focus of Clyde & Co and together with other partners at the firm, he began exploring blockchain in late 2015.
What is blockchain?
From a non-technical perspective, blockchain is a form of distributed ledger technology (DLT) which depending on its guises can be either a public permission-based system or for enterprises as a private kind of ring-fence system. It’s an enabling technology which enables parties to have access to the same data at the same time with an element of trust that the data is of the type and format that all parties can take comfort that they have the same information at the same time.
What is a connected contract?
“A smart contract is neither smart nor is it a contract, but it can be both.”
Lee highlights that the phrase “connected contracts” has been borrowed from Clause.io. A connected contract consists of a smart contract linked to a legal contract. A smart contract requires a trigger to execute a set of actions. In the case of connected contracts, the smart contract executes depending on trigger values defined in the legal contract.
Can smart contracts become law?
Lee points out that legal contracts and law are not the same – legal contracts are subject to the law. Just as legal contracts are subject to law, smart contracts are subject to the same law. He believes that smart contracts are capable of being legally binding.
Partnership with clause.io
Lee explains that connected contracts fall under the umbrella of smart contracts. Specifically, connected contracts offered by Clyde & Co are built on the clause.io platform since these contracts appear as a human readable contract instead of code.
Clause.io permits user input in words and transcribes these words into code for a machine to execute. Further, clause.io allows smart contracts to be connected to legal contracts.
The use-case explored was parametric insurance for a solar plant. This plant was under contractual obligation to supply a certain amount of energy per quarter – failure to do so would invite financial penalty. Thus, this solar plant purchased (parametric) insurance cover to insure against adverse weather.
The claims trigger was more than 10 days of “adverse” weather conditions (per quarter) to generate electricity i.e. more than 10 such days per quarter would trigger a payment. A precise definition of “adverse” was provided in the supporting legal contract. This example illustrates how a connected contract (smart contract + legal contract) operates.
Further information regarding this use-case may be found here.
A note regarding parametric insurance in the UK
Lee points out that there is a fine line between parametric insurance and derivative contracts – the differentiator is that in the UK, the former requires an insurable interest in the asset/event of interest. Under English laws, a contract of parametric insurance does not require the insured or insurer to demonstrate the actual loss. Instead, a “valued loss” (i.e. predetermined sum assured) can be decided upon at the contract outset and this mutually agreed value is paid out as a claim.
In other geographies, parametric insurance is not recognized as an insurance contract. It should be noted that in the UK, the insurer must only establish that a loss has occurred for the claim to be paid out under a parametric insurance contract. You can read more on the subject here.
The importance of connected contracts for Clyde & Co
According to Lee, law firms such as Clyde & Co have traditionally provided legal consulting services. However, the connected contracts offering marks a shift into the “product” domain. This project has been funded entirely by the firm (hence, represents a product with IP owned by Clyde & Co). Special emphasis has been placed on the legal framework and contract terms; matters such as risk pricing have been left to client firms who avail of the connected contract product.
Is blockchain required?
As with many projects, blockchain is not required to facilitate the connected contract product. However, blockchain is useful since it provides a single source of truth along with transparency and audit trail.
Initially the use of blockchain will provide efficiency and cost savings through replacement of paper-based process and reduction of reconciliation activities. In the medium to long term, dynamic pricing agreements and contingent events could be built into connected contracts to add value.
The next steps
Parties want to enter into a transaction and not a contract.
Lee emphasizes that connected contracts will provide a digital environment with several features of legal contract at a lower cost which may be an attractive proposition for several clients. He points out that common standards are required for industry-wide implementation, hence, Clyde & Co has adopted the Accord project. Although this project has involved Clause Co, the offering is platform agnostic.
Clyde & Co will explore the application of connected contracts within the marine supply chain; specifically, around financing activities associated with loading and unloading marine freight.
Furthermore, as suggest by Lee, another area of interest is industry loss warranties (ILW’s) – these contracts are a form of (re)insurance derivatives which pay-out the insured party a specified sum of money in the event of the entire industry suffering a specified loss. ILWs are similar to treaty insurance cover and could potentially see a parametric-style implementation in the future.
Thank you, Lee, for speaking with us regarding connected contracts and how technology is linking the changing worlds of legal consulting and insurance. If you liked this episode, please do review it on iTunes. If you have any comments or suggestions on how we could improve, please don’t hesitate to add a comment below. If you’d like to ask Lee a question, feel free to add a comment below and we’ll get him over to our site to answer your questions.