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28 November 2018Analysis

The top of the blockchain

As captive insurance domiciles race to become the go-to hub for blockchain, cryptocurrencies and digital assets, the Cayman Islands has been taking a number of steps to become a leader in this space.

Bermuda, Malta, and Gibraltar have already passed laws to help facilitate more blockchain and cryptocurrency business in their respective jurisdictions, and others such as Liechtenstein and the Bahamas are not far behind.

Bermuda and Malta have issued initial coin offering (ICO) specific legislation, and the Bahamas has already announced it is exploring the use of a state-backed cryptocurrency, and was among the first in the Caribbean to have a bitcoin automated teller machine.

“There is need for a multi-pronged approach for any jurisdiction working to establish itself as a blockchain hub,” says Melanie Snyman, director in PwC Cayman Islands’ insurance practice.

“It’s more of a journey than a destination. Locations that are able to balance the speed of industry demands with the requirements of legislation that will maintain a long-term edge.”

Getting engaged

While the Cayman Islands does not yet have blockchain or cryptocurrency-specific regulations, it is actively engaged with blockchain, cryptocurrencies and digital assets.

Initiatives such as Tech City Cayman, a technology-centric special economic zone by Cayman Enterprise City, help to attract companies to establish a physical presence in the jurisdiction. So far it has helped to attract more than 40 blockchain and cryptocurrency-related companies.

Concurrently, Cayman Finance, which represents the jurisdiction’s financial services industry, is working on a certified digital ID (CDID) platform that chief executive officer Jude Scott believes will act as a catalyst to creating digital industries in the Cayman Islands.

These include fully anti-money laundering-know your customer (AML-KYC) compliant digital exchanges trading cryptocurrencies, smart contracts and other financial products; high quality ICOs; initial token offerings (ITOs); and security token offerings (STOs) with robust AML-KYC procedures.

“When this comes to fruition, Cayman Islands funds will be able to issue digital tokens in addition to shares, units, or partnership interests. These tokens can be listed and traded on digital exchanges, investment managers will be excited to have stickier capital, and investors will be excited to have a more liquid investment.”

Cayman Finance has been particularly active in this space, having formed a working group tasked with developing ways in which fintech can be embraced by the financial services industry while aligning with regulation and creating transparency.

Scott adds: “All domiciles are fighting to gain dominance, and while some jurisdictions are getting recognition, the Cayman Islands has been a silent leader in this space and is poised for continued development.”

Progress with captives

Blockchain is increasingly being embraced by many parts of the insurance industry, although it still faces a somewhat uphill battle against insurers’ scepticism.

The 2018 PwC Global Blockchain Survey of 600 executives noted that the major drawbacks to blockchain adoption relate to regulatory uncertainty (48 percent); lack of trust among users (45 percent); and the ability to network together (44 percent).

Cryptocurrencies—which are possible only because of blockchain technology—perhaps face more a challenge as there are concerns over their volatility and how they are regulated.

Isabel Gumeyi, senior manager–technology, risk assurance and advisory services at PwC Cayman Islands, says there have not been any captives within Cayman directly holding cryptocurrency to date.

She believes it is unclear from a regulatory perspective whether an investment in cryptocurrency would be a permitted asset of a licensed insurance company in the Cayman Islands.

“Licensed insurers are required to have their investment policies approved by the regulator and any risky/illiquid assets, which could jeopardise the payment of claims on timely basis, would generally not be permitted, unless the insurer can clearly demonstrate that it has more than sufficient funds to pay out its insurance liabilities and these assets are effectively backing shareholder funds only,” says Gumeyi.

“In the event the captive elects to invest in cryptocurrencies via a regulated exchange, this would have to be evaluated in light of existing regulation.”

The overall lack of consensus globally as to the classification of cryptocurrency investments—for example, as cash, equity securities or commodities—from an accounting, tax and regulatory perspective creates challenges when captives are owned by entities or individuals in different jurisdictions, Gumeyi notes.

Cayman Islands law has yet to recognise digital currencies as legal tender, and this remains one of the key hurdles for cryptocurrencies.

Scott says that when this happens, any entity will be enabled to transact with a digital currency in lieu of a fiat currency such as dollars, sterling or euros. Until that happens, however, the uses are limited mostly as an investment play within captives or commercial insurance companies.

“As this is still a new area, there remain concerns about the volatility of the currencies and further, due to the rapid pace of innovation, not all currencies will ultimately survive as the market gravitates toward those that serve it best,” he says.

“Any invested in will have a much higher likelihood of losing the majority of its value. There is also difficulty in performing AML-KYC on the incoming funds. This will be reduced with the coming to fruition of the previously mentioned CDID platform.”

Scott believes the Cayman Islands is in a unique position to establish itself as a leader in digital transactions—as long as Cayman’s lawmakers are able to react fast enough.

“For example, new cryptocurrencies (stable coins) are being developed which are backed one-to-one by a fiat currency or a commodity of value such as precious metals,” he says.

“Some of the most recent stable coins are seeking to be fully regulated. The intention is to reduce the volatility experienced in cryptocurrencies such as bitcoin and therefore make them a more feasible currency for transacting with.”

Blockchain and cryptocurrency uses

The benefits of distributed ledger technology are many, and a number of companies in the insurance and captive insurance markets are developing business models that incorporate cryptocurrency and blockchain in some way.

In 2017, Allianz Global Corporate & Specialty successfully implemented a blockchain prototype that looks at three common process flows in the captive insurance cycle: annual policy renewals, premium payments and claims submission and settlement. It translated these processes into the distributed ledger environment, decreasing the time from start to policy, policy to premium and claim to settlement.

Shipping giant Maersk uses its Denmark-based captive Maersk Insurance to provide comprehensive insurance coverage for its fleet of ships, and in 2018 started using blockchain platform Insurwave for its marine hull portfolio.

Distributed ledgers such as these can be used in conjunction with real-time data to track the movement of physical marine assets such as ships and containers, and provide a record of real-time changes.

Cayman insurers have started using drones to capture real-time evidence of incidents, which Snyman says provides more detailed, accurate, timely and almost irrefutable evidence that feeds into the claims review process.

“With this level of electronic evidence already available in real time, there is opportunity for sharing data at similar speeds with all parties involved in the claims process, in real time. It can be argued that distributed ledger technology opens the door for this level of efficient collaboration along with the internet of things and artificial intelligence.

“It is not surprising that some companies are exploring the blockchain use cases to create a whole revenue stream by either targeting a different type of investor or automating existing service lines,” she explains.

She also notes that some captives reinsure other insurance companies that use blockchain technology in insuring customers for travel insurance (using smartphones to log claims on a real-time basis).

In terms of cryptocurrency, Gumeyi provides interesting uses cases that have the consumer experience as the focus.

One such example is flight delay insurance, where customers signs up for a policy via an app on their smartphones. The insurance terms and conditions are recorded on a smart contract, and then can trigger payment to the policyholder via the blockchain based on an external feed from the airline of a flight delay.

“Some utilise the Ethereum blockchain, so payments are made in Ethereum’s cryptocurrency (ETH) but could be expanded to other cryptocurrencies; others however, make payouts directly to the policyholder’s bank account,” says Gumeyi.

“As some airlines already accept bitcoin, there could also be opportunity even for the insurer of the airline to receive premiums in the same cryptocurrency.”

Another area Gumeyi suggests is crowdfunding for mortgage lending, where loans are tokenised and recorded on the blockchain. Loans are insured and passed on to a reinsurer, both of which have access to the ledger—the token can then be exchanged for other crypto-based assets.

Beyond these use cases, Snyman suggests there are potential investment and and capital benefits for captives that use cryptocurrencies.

“Outside of traditional investment securities, captives have traditionally invested in vehicles such as mutual funds and hedge funds,” she says.

“With the advent of investment vehicles linked to crypto/blockchain-related businesses including in the exchange traded funds (ETFs) space, captives could consider exploring these instruments when offered by regulated entities.

“This would be best conducted after evaluating the company offering the products (eg, governance structure, geographical location as well as applicable laws and regulations, fees, etc) and reviewing the market to determine the funds to be allocated and to effectively manage the associated risk.

“The benefit would be the potential to gain from cryptocurrency growth from a basket of stock, while minimising the risk of investing in individual stocks.”

If regulatory acceptance is achieved, Snyman says, there could also be a role for cryptocurrencies to raise capital for non-traditional risk facing vehicles. She warns that there is a cost associated with developing the infrastructure that would support crypto-based transactions, and that publicly available platforms have their own set of risks and exposures.

“If captive insurance companies take the use of this emerging technology as a slow evolution as opposed to an overnight revolution, they will be better able to design business case strategies that are more aligned to their strategic goals,” says Snyman.