How Blockchain and Smart Contracts will Change the Face of Insurance in the U.S.

Theodore (Ted) J. Mlynar andRobert M. Fettman | Hogan Lovells | May 23, 2019

In the last several years, we have seen a new crop of digital products and services enter the lexicon of the insurance industry. And with these, inevitably comes a myriad array of insurance regulatory issues. Usage-based insurance, peer-to-peer insurance, machine-learning algorithms, robo-advisory insurance processes, blockchain-based insurance, and the Internet of Things present many challenges. Insurtech has permeated virtually every aspect of the insurance industry.

Regulators, technology providers and insurance companies are frequently grappling with questions like:

  • Do digital marketing and advertising activities trigger insurance producer licensing requirements?
  • Does the provision of value-added services violate state anti-rebating laws?
  • How can insurance referrals be compensated without triggering insurance regulations?

The ability of AI and machine-learning to analyse data at very granular levels has regulators concerned about consumer protection.

Algorithms that utilize geographical data or other individualized information may effectively create proxies for sensitive characteristics such as race, religion, gender, etc. prohibited from consideration by insurance law.

On the one hand, the application of machine-learning to price risk could help insurers reduce moral hazard and adverse selection inherent in selling insurance broadly.

On the other hand, the narrow tailoring of risk and the creation of highly customized policies reflecting unique characteristics of an insured could undermine the risk-pooling function of insurance and lead to groups or categories of risk becoming uninsurable in the private insurance marketplace.

Insurtech firms involved in underwriting and pricing functions must appreciate the regulatory landscape governing insurance product development or risk running afoul of multiple insurance regulations.

For example, a company providing a model that impacts rate filings may be acting as an advisory or rating organization that requires licensure under state law.

And, even where state law may be unclear how far licensing requirements extend, regulators nevertheless may insist on some degree of oversight as a condition to approving an insurer’s rate filings.

Regulators are scrutinizing the potential anticompetitive effects of Insurtech vendors that supply similar data and models to multiple insurers serving a particular market. There is a concern also that non-traditional information sources may provide proxies for prohibited discriminatory factors.

In parallel, the National Association of Insurance Commissioners (NAIC) is compiling best practices for regulators to use in reviewing insurance company filings containing predictive models. And such “best” practices may not be the “most streamlined.”

One draft under consideration identified 16 best practices to apply and 92 pieces of information a regulator should consider.

The insurance actuarial modelling world is also benefiting from new forms of data collection and analysis, including data-mining, statistical modelling, and machine-learning. It has become increasingly challenging for insurance regulators to evaluate filed rate plans that incorporate sophisticated technology-based predictive models.

To address these issues, insurance regulators are considering methods of field-testing the new technologies in controlled environments similar to the FinTech “sandbox” concepts implemented in the UK and other countries.

Insurers and Insurtech firms that communicate with regulators early in the development of their offerings will be the ones most likely to achieve compliant success.


Many see tremendous potential for blockchain technology in the insurance industry, especially the ability to bring efficiencies and cost savings to existing insurance processes.

Data management and claims administration are ripe for significant improvement.

While there may be some ambiguity in the application of state insurance laws to aspects of blockchain technology, there are also opportunities for innovative legal and technical solutions.

Of course, policy information and personal customer data residing on a blockchain will need to comply with existing privacy and data protection regulations. State insurance laws generally require an insurer’s books and records to be maintained in state and be available to the state regulator for inspection and audit.

It is easy to imagine encrypted blockchain technology that is designed to provide such compliant storage.

But even more interesting (and perhaps unsettling to some) is the possibility of significantly streamlining compliance efforts by allowing a state regulator to directly monitor transactions in real-time via a node on the insurer’s blockchain.

Smart contracts

Smart contracts implemented in connection with a blockchain offer even more potential benefits to the insurance industry.

For insureds, the implementation of smart contracts could remove key pain points in the claims filing process while reducing claims handling expenses for insurers.

A good example of smart contracts’ potential is in connection with parametric flight delay insurance policies that run on a blockchain.

The insurance process can be fully automated with a smart contract both determining whether customers are eligible for indemnification and managing the payments.

Customers on a substantially delayed flight would benefit from automatically receiving their payout when they (finally) arrive at their destination. No claim need be filed.

The claims-free, guaranteed-payout features achievable with smart contracts certainly add value for insureds and may provide opportunities for premium pricing for insurers.

As smart contracts and blockchain technology reduce administrative, compliance and claims-handling costs, certain traditionally uneconomic insurance products, such as microinsurance, may become realistically viable.

However, the fundamental nature of smart contracts presents a number of regulatory and compliance hurdles under existing insurance laws.

At the threshold, a determination, on a case by-case basis, is needed whether smart contracts with insurance-like features are actually subject to regulation as “insurance” contracts under state law, or are they derivative contracts subject to other regulatory regimes.

If it is a regulated “insurance” product, are automated payments via smart contract allowed, particularly if funds are to be escrowed?

And, can those payments be made in a cryptocurrency? Will the answer change if that cryptocurrency is pegged to, or floats against, the U.S. dollar currency used to pay the insurance premiums?

State laws prescribing claims-handling procedures will also need to be considered carefully. Much like other algorithmic approaches, a smart contract’s automated claim denial may be challenged as a substantive design flaw or as an inadvertent programming error.

Similarly, the immutable and irreversible nature of smart contracts poses an interesting challenge in the context of insurance delinquency proceedings.


The implementation of Insurtech, AI, machine-learning, blockchain technology and smart contracts in insurance is growing. New products, new markets, and new efficiencies are within sight, if not already within grasp. Insurers and regulators will be wrestling with state laws, and looking for ways to collaborate with each other, as each innovation tests the boundaries of existing regulatory regimes.

Next steps

You can find out more about other recent developements in the insurance industry in our Insurance Horizons 2019 brochure, which also covers topics such as insurance business transfers in the U.S., data protection after the GDPR and preparing for Brexit and international initiatives on sustainability and climate change.

“Rip-and-Tear Damages” In Construction: A Roadmap For Coverage Where None Existed?

Ashley Veitenheimer | Kane Russell Coleman Logan | May 22, 2019

The insuring agreement in most commercial general liability policies states that the carrier “will pay those sums that the insured becomes legally obligated to pay as damages because of…’property damage’ to which this insurance applies.” In addition, most policies exclude coverage for the defective work of the named insured. Questions have arisen, however, as to whether and when there is coverage for damages commonly known as “rip-and-tear,” which are those damages caused to other property by the necessity of removing, replacing, and correcting defective work.

Prior to 2015, Texas law held that rip-and-tear damages were covered if there was underlying covered property damage in the first instance. See Lennar Corp. v. Markel Amer. Ins. Co., 413 S.W.3d 750 (Tex. 2013). That all changed with U.S. Metals v. Liberty Mutual Ins. Group, Inc., 490 S.W.3d 20, 22 (Tex. 2015). In U.S. Metals, the Court appears to hold that damages are covered even when they are not “because of” property damage, leading to vexing issues for the insurance carrier regarding when the duty to defend is triggered and whether rip-and-tear costs are covered when they are not “because of” property damage.

In U.S. Metals, U.S. Metals sold ExxonMobil 350 flanges for use in constructing diesel units. When ExxonMobil conducted post-installation testing, it discovered that several flanges leaked and did not meet industry standards such that it was necessary to replace them to avoid the risk of explosion. For each flange, this process involved stripping the temperature coating and insulation (which were destroyed in the process); cutting the flange out of the pipe; removing the gaskets (which were also destroyed in the process); grinding the pipe surfaces smooth for re-welding; replacing the flange and gaskets; welding the new flange to the pipes; and replacing the temperature coating and insulation. 

After ExxonMobil sued U.S. Metals and the parties settled, U.S. Metals sought indemnification from its insurer. On appeal, the parties disputed whether the installation of the faulty flanges physically injured the diesel units.  The Court noted that “the installation of the leaky flanges…can certainly be said to have injured – harmed or damaged – the diesel units by increasing the risk of danger from their operation and thus reducing their value.” However, no physical injury resulted because ExxonMobil replaced the flanges in order to avoid the risk of such injury.

The Court concluded that the diesel units were physically injured in the process of replacing the flanges because the flanges were welded to the pipes, and the removal process “necessitated injury to tangible property, and the injury was unquestionably physical.”  That tangible property was the original welds, coating, insulation, and gaskets. Because the diesel units were restored by replacing the flanges, they were impaired property to which Exclusion M applied.[1] Id. But it also concluded that the insulation and gaskets were destroyed in the process and replaced such that Exclusion M did not apply. Therefore, the Court held that these rip-and-tear costs, were covered because the items were physically injured and constituted “property damage.”

After U.S. Metals was decided, the Western District of Texas issued an opinion illustrating the problems the holding created. In Travelers Lloyds Ins. Co. v. Cruz Contracting of Texas, LLC, the Western District relied on the U.S. Metals holding to conclude that rip-and-tear damages were covered. 2017 WL 5202891 (W.D. Tex. Sept. 7, 2017). There, Cruz, the subcontractor, was hired by D & D to install utility systems, which were later discovered to be faulty. D & D alleged that, in order to replace the sewer system installed by Cruz, it had to tear out and redo roadways, curbs, and parkways.

Based on U.S. Metals, the court found that D & D suffered property damage in the form of rip-and-tear damages “to access faulty equipment installed by an insured…”. The problem with this conclusion is that no damages “because of” property damage existed prior to the rip-and-tear process being undertaken. Rather, as the court concedes, the adjoining utility work was “not physically disturbed by Cruz’s defective work” but was “rendered useless by the defective work.” Consequently, the court apparently relied upon the loss of use as the trigger for the insurer’s duty to defend.

This, in turn, raises the pivotal issue of when the alleged property damage actually occurs. In other words, since there was no “property damage” prior to the tear-out and replacement of Cruz’s work – there was merely faulty work (which is typically excluded from coverage) – when did the “covered” property damage occur? The court’s opinion states that the property damage “occurred when the utility systems installed by Cruz failed testing, rendering them inoperable and unusable.”. Although the court relies upon Don’s Buildingfor this proposition, this is a rather questionable conclusion because there was no property damage prior to the damage caused in accessing the faulty work.[2]

Take as an example pipe work that is performed before pouring a concrete floor. No damage exists at the time the pipes are installed; however, there is later discovered a leak in one of the connections that requires replacement. If suit is filed merely alleging that the pipe was faulty and that the concrete needed to be torn out, is this sufficient to trigger a duty to defend in Texas because the rip-and-tear is in itself property damage? And, if so, does the insurer for the connection supplier owe a duty to defend the entire lawsuit when the concrete flooring, pipes, and other building components are damaged in an effort to repair and replace the connection? If that is the case, almost every suit for construction defects may plead a covered claim because it will involve rip-and-tear costs.

Equally confounding it the issue of “when is the occurrence.” If the rip-and-tear is itself the “property damage,” then can an insured create its own trigger for defense by alleging that the installation was improperly performed and required the rip-and-tear damages to replace the faulty connection? These are the questions created by the holding in U.S. Metals that have yet to be answered, but the Cruz holding certainly got this issue wrong. That is because U.S. Metals clearly identifies when the occurrence is:

We have further held that, for purposes of a duty to defend under an occurrence-based policy period, damage due to faulty workmanship “occurs” not at the time the damage manifests (when it is discovered or discoverable) nor when the plaintiff is exposed to the agent that will eventually cause the damage (when it is installed, presumably). Rather, under a straightforward reading of the policy, we concluded that “[o]ccurred means when damage occurred, not when discovery occurred.” Since a defective product that causes damage is not an occurrence until the damage actually happens, it would be inconsistent to now find that a defective product that does notcause damage is nevertheless an occurrence at the time of incorporation.

Cruz, however, held that the “occurrence” happened when the utility systems failed testing without any related property damage. This is one example of the myriad of questions created by the U.S. Metalsholding, relied upon by the Cruz court, and the lower courts’ application of the ruling, which may create the potential for a huge shift in coverage law as to when the duty to defend is triggered.


[1] Exclusion M denies coverage for damages to impaired property, which is defined as property that can be “restored to use by the…replacement” of the faulty flanges. Id.

[2] Interestingly, the Southern District relied upon U.S. Metals to conclude that rip-and-tear damages are covered when the utility of component parts is destroyed “[a]s a consequence of their having been encased in bad concrete.” See Lauger Cos., Inc. v. Mid-Continent Cas. Co., 2017 WL 8677353 (S.D. Tex. Aug. 2, 2017). This creates the same problems as Cruz and gives rise to the same concerns of when the duty to defend is actually triggered.

What Insurer Conduct Is Prohibited and Considered Unfair Under California Law? A Quick Guide to Holding an Insurer Accountable

Victor Jacobellis | Property Insurance Coverage Law Blog | May 24, 2019

The California Fair Claims Settlement Practices Act outlines specific insurer conduct prohibited and considered unfair to insureds. Identifying prohibited insurer conduct and effectively communicating to a carrier it committed prohibited acts will lead to better claim results.

This a better practice than just merely accusing an insurer of bad faith. This often will not get a carrier’s attention because it may think you are arguing bad faith instead of presenting information supporting coverage. The careful identification of prohibited conduct, however, projects an understanding of the insurer’s claim duties and puts the carrier on notice that its acts are evidence of poor conduct and may be evidence of bad faith.

An effective way to communicate an insurer’s prohibited conduct is state that the insurer has violated the California Insurance Code and treated its insured unfairly. An efficient way to state this is to identify the specific conduct and identify the California Insurance Code provision that prohibits such conduct. Specific prohibited acts are identified and summarized below.

  • An insurer has a duty to disclose all policy benefits, coverage, time limits and all other policy provision applicable to a claim. Cal. Ins. Code § 2695.4(a). Always ask an insurer in writing to disclose all this required information.
  • If an insurer is unable to accept or deny a claim, it should provide a written explanation of why it cannot come to a claim decision and describe what additional information it needs. Cal. Ins. Code § 2695.7(b). Demanding an insurer explain what information it needs or why it cannot determine coverage will help you to better understand what is needed to resolve the claim.
  • An insurer must state in writing all legal and factual bases for denying a first party claim.Cal. Ins. Code § 2695.7. A mere statement that a claim is not covered is not acceptable and a more thorough statement should always be demanded.
  • Any adjustment for betterment or depreciation shall reflect a measurable difference in market value attributable to the condition and age of the property and apply only to property normally subject to repair and replacement during the useful life of the property. The basis for any adjustment shall be fully explained to the claimant in writing. Cal. Ins. Code § 2695.9(f).
  • When a loss requires replacement of items and the replaced items do not match in quality, color or size, the insurer shall replace all items in the damaged area so as to conform to a reasonably uniform appearance. Cal. Ins. Code § 2695.9(a)(2).
  • An insurer cannot require a first-party claimant to give notification of claim or proof of claim within a specified time. Cal. Ins. Code § 2695.4(d).
  • An insurer cannot require an insured to have property repaired by a specific vendor. Cal. Ins. Code § 2695.9(b).
  • An insurer cannot recommend a repair vendor unless: (1) the insured expressly requeststhe referral or (2) the insured is informed in writing that the insured has the right to select a vendor of its choice. If an insured selects the insurer’s preferred vendor, the carrier must insure the damaged property is repaired to its pre-loss condition. Cal. Ins. Code § 2695.9(c).
  • An insurer can only request information that is material to a claim. Cal. Ins. Code § 2695.7(d).
  • An insurer must provide notice of the deadline to a file a lawsuit at least 60 days before the deadline. Cal. Ins. Code § 2695.7(f).
  • A claim settlement cannot be conditioned on an insured not submitting a claim to the California Department of Insurance. Cal. Ins. Code § 2695.7(0).

Georgia Federal Court Says Fact Questions Exist As To Whether Nitrogen Is An “Irritant” or “Contaminant” As Used in Pollution Exclusion

Lawrence J. Bracken II, Michael S. Levine and Alexander D. Russo | Hunton Andrews Kurth | April 15, 2019

The Southern District of Georgia recently ruled that Evanston Insurance Company is not entitled to summary judgment on whether its policies’ pollution exclusion bars coverage for the release of nitrogen into a warehouse. The case stems from an incident at Xytex Tissue Services, LLC’s warehouse, where Xytex stored biological material at low temperatures. Xytex used an on-site “liquid nitrogen delivery system” to keep the material properly cooled. This system releases liquid nitrogen, which would vaporize into nitrogen gas and cool the biological material. On February 5, 2017, a Xytex employee, Deputy Greg Meagher, entered the warehouse to investigate activated motion detectors and burglar alarms. Deputy Meagher was overcome by nitrogen gas and died as a result. Following Deputy Meagher’s death, his heirs filed suit against Xytex and other defendants. Evanston denied coverage based on the pollution exclusion in its policy. Evanston then brought a declaratory judgment action to confirm its coverage position.

In denying Evanston’s summary judgment motion, the Southern District of Georgia reasoned that the type of injury sustained is essential in analyzing whether the pollution exclusion applies. Specifically, Xytex argued, and the court agreed, that the underlying lawsuit alleged that the bodily injury was caused by a lack of oxygen, not exposure to nitrogen. The court also distinguished prior decisions, explaining that injury caused by a lack of oxygen is not a contamination or irritation of the body in the same way as injury resulting from exposure to carbon monoxide or lead. The court also found that Xytex “reasonably expected that liability related to a nitrogen leak would be insured.”

The Xytex decision clarifies that, under Georgia law, when analyzing pollution exclusions, courts will pay careful attention to the specific cause of the bodily injury. Here, although liquid nitrogen arguably played a role in causing the events that led to the injury, it was alleged that the lack of oxygen was the actual cause of death. Accordingly, insurers and policyholders should carefully analyze facts surrounding potential contamination events and evaluate how those facts fit within Georgia’s decisions interpreting pollution exclusion language.

Fire Consultants Cannot Base Opinions on Speculation

Christopher Konzelmann | The Subrogation Strategist | April 3, 2019

Larsen v. 401 Main St. Inc., 302 Neb. 454 (2019), involved a fire originating in the basement of the Quart House Pub (Pub) in Plattsmouth, Nebraska that spread to and damaged Plattsmouth Chiropractic Center, Inc., a neighboring business. Fire investigators could not enter the building because the structure was unsafe and demolished. The chiropractic center nevertheless sued the Pub alleging that its failure to maintain and replace basement mechanical equipment caused ignition.

To prove its claim, the plaintiff retained a mechanical engineer who reviewed documents and concluded that the fire “originated from a failure of one of the items of mechanical equipment located in the area of the [basement] boiler.” Importantly, however, the consultant could not determine the root cause of the fire, could not eliminate the possibility that the fire originated in a compressor, and could not rule out the building’s electrical service as the ignition source because it was outside his area of expertise. The consultant nevertheless found that the fire most likely would not have occurred if the Pub had regularly serviced and replaced the equipment when needed.

The trial judge granted the Pub’s motion to strike the consultant’s opinion and dismissed the complaint. The court found that while the consultant was a qualified mechanical engineer, his testimony failed to satisfy the standard established in Daubert v. Merrell Dow Pharmaceuticals, Inc., 509 U.S. 579 (1993) and the state’s equivalent evidentiary rule, Neb. R. Evid. 702, because “the methodology could not be properly applied to the facts at issue.” Further, the consultant could not state that a mechanical failure caused the fire and it was mere speculation that regular inspections and maintenance would have prevented ignition.

The Nebraska Supreme Court, addressing both preclusion of the expert testimony and the grant of summary judgment, affirmed the trial court’s decision. The court found that the trial court did not abuse its discretion in excluding the expert’s testimony because the consultant could not form an opinion on which piece of equipment failed and caused the fire. The consultant, likewise, could not establish that the fire would not have occurred had the Pub performed inspections and maintenance. The Supreme Court found that the trial court properly granted summary judgment because there was insufficient proof, without engaging in “guess, speculation, conjecture, or choice of possibilities [sic], that a negligent failure to adequately maintain equipment caused the fire and resulting damage.”

Proving a fire loss claim premised on ignition, as opposed to spread or delayed detection, requires proof by a qualified consultant of origin and cause. A consultant’s inability to inspect a fire scene and evaluate relevant evidence because of dangerous conditions makes origin and cause determination tasks much more challenging and sometimes impossible. The Nebraska Supreme Court’s holding was a predictable result given the facts presented.