Decentralized Insurance: Technical Foundation of Business Models

Description

The book offers an introduction to the technical foundation of decentralized insurance models, for advanced undergraduate students, graduate students and practitioners. The book is self-contained and anyone with a basic knowledge of probability and statistics should be able to follow through the entire book. It adopts a minimalist approach to describe the essential elements and first principles so that readers can get a gist of these models without being overwhelmed with too much technicality. It can be used as a reference for business model designs. The inclusion of exercises and practical examples makes the book suitable for advanced courses on decentralized insurance and risk sharing. There is a mix of industry practices and academic models presented in this book. The exposition starts with an overview of historic and current business practices and preliminaries on the mathematics and economics of risk and insurance.  A bird's-eye view of traditional insurance is provided as a benchmark for various topics to be used in contrast with decentralized insurance. The book then continues with decentralized insurance practices around the world, including online mutual aid originated in China, takaful from the Islamic world, peer-to-peer insurance in the West, catastrophe risk pooling for Carribean countries, etc. Theories of aggregate risk pooling and peer-to-peer risk exchanges are provided for readers to appreciate the mathematical foundation of risk sharing. A unified framework of decentralized insurance is presented to show a structured approach to the economic design of decentralized business models. The book ends with a technical review of blockchain and decentralized finance (DeFi) insurance applications. Foreword by Marco Mirabella Foreword by Michel Denuit and Christian-Yann Robert Preface Acknowledgements Contents About the Author 1 Introduction 1.1 Primitive Risk Sharing 1.1.1 Babylonian Laws 1.1.2 Roman Burial Society 1.1.3 Middle East Blood Money Systems 1.1.4 Granary Reserve in Ancient China 1.1.5 Migrant Caravans in the Pakistan-India War 1.2 Centralized Insurance 1.2.1 Centralized Models 1.2.2 Pros and Cons 1.3 Insurance Ecosystem 1.3.1 Distribution 1.3.2 Underwriting 1.3.3 Pricing 1.3.4 Asset and Liability Management 1.3.5 Claims 1.3.6 Governance 1.3.7 Regulation 1.4 Decentralized Insurance 1.4.1 Rise of Sharing Economy 1.4.2 Decentralized Models 1.4.3 Why Decentralized Insurance? 1.4.4 Structure of the Book 1.4.5 Closing Remarks 2 Risk Assessment and Measures 2.1 Univariate Modeling 2.1.1 Loss Distribution 2.1.2 Quantile Functions 2.2 Risk Measures 2.2.1 Value-at-Risk 2.2.2 Tail-Value-at-Risk 2.2.3 Coherent Risk Measure 2.3 Ordering of Risks 2.3.1 Stochastic Order 2.3.2 Convex Order 2.4 Multivariate Modeling 2.4.1 Multivariate Distribution 2.4.2 Conditional Distribution 2.4.3 Multivariate Normal Distribution 2.4.4 Comonotonicity 2.4.5 Counter-Monotonicity 2.5 Dependence Measures 2.5.1 Pearson Correlation Coefficient 3 Economics of Risk and Insurance 3.1 Basics of Risk Management 3.1.1 Risk Avoidance 3.1.2 Risk Transfer 3.1.3 Risk Retention 3.1.4 Risk Mitigation 3.2 Basics of Insurance 3.2.1 Elements of Risk Management 3.3 Economics of Risk and Insurance 3.3.1 Utility 3.3.2 Risk Aversion 3.3.3 Optimal Risk Transfer—Non-proportional Insurance 3.3.4 Optimal Risk Transfer—Proportional Insurance 3.4 Pareto Optimality 3.4.1 Marginal Rate of Substitution 3.4.2 Pareto Efficiency 3.4.3 Risk Allocation 3.4.4 Multi- to Single-Objective 4 Traditional Insurance 4.1 Pricing 4.1.1 Equivalence Premium Principle 4.1.2 Portfolio Percentile Principle 4.1.3 Utility-Based Premium Principles 4.2 Reserve and Capital 4.2.1 Accounting 4.2.2 Reserves 4.2.3 Capital 4.2.4 Stochastic Reserving and Capital Requirements 4.3 Risk Aggregation 4.3.1 An Illustration 4.3.2 Variance-Covariance Approach 4.4 Capital Allocation 4.4.1 Pro Rata Principles 4.4.2 Euler's Principle 4.4.3 Holistic Principle 5 Decentralized Insurance 5.1 Background 5.2 Online Mutual Aid 5.3 Peer-to-Peer Insurance 5.4 Takaful 5.4.1 Mudarabah 5.4.2 Wakalah 5.4.3 Hybrid 5.4.4 Surplus Distribution 5.5 Catastrophe Risk Pooling 5.6 Other Decentralized Models 5.6.1 Health Share 5.6.2 Multinational Pooling 5.6.3 Tontines 6 Aggregate Risk Pooling 6.1 Non-olet 6.2 Utility-Based Risk Sharing 6.2.1 Unconstrained Cases 6.2.2 Constrained Cases 6.3 Risk-Measure-Based Risk Sharing 6.4 Conditional Mean Risk Sharing 6.5 Visualization in Cake-Cutting 7 P2P Risk Exchange 7.1 P2P Risk Exchange 7.2 Least Squares P2P Risk Exchange 7.3 Minimum Variance Risk Exchange 7.3.1 Pareto Optimal Quota-Share 7.3.2 Fair Pareto Risk Exchange 7.3.3 Pareto in the Class of Fair Risk Exchanges 7.4 Altruistic Risk Exchange Appendix 7.A Least Squares Risk Sharing Appendix 7.B Pareto Optimal Quota-Share Risk Exchange Appendix 7.C Pareto in the Class of Fair Risk Exchanges Problems 8 Unified Framework 8.1 Two-Step Process 8.1.1 Risk Sharing (Mutualization) 8.1.2 Risk Transfer to Third Party 8.1.3 Decentralized Insurance Scheme 8.2 Ordering of Decentralized Insurance Schemes 8.2.1 Risk Diversification by Mutualization 8.2.2 Risk Reduction by Transfer 8.3 Decentralized Insurance for Heterogeneous Risks 8.3.1 P2P Insurance 8.3.2 Takaful 8.4 Composite Decentralized Insurance Schemes 8.4.1 Mudarabah-Wakalah Composite 8.4.2 CAT-Mudarabah Composite 8.4.3 Cantor Risk Sharing 8.4.4 General CAT Risk Pooling 8.5 Case Study: Xianghubao 9 DeFi Insurance 9.1 Elements of Blockchain Technology 9.1.1 Promise of Smart Contracts 9.1.2 Asymmetric Key Cryptography 9.1.3 Hash and Merkel Tree 9.1.4 Structure of a Blockchain 9.2 DeFi Ecosystem 9.2.1 Stablecoins 9.2.2 Decentralized Exchanges 9.2.3 Decentralized Lending 9.2.4 Other Protocols 9.2.5 DeFi Risks 9.3 DeFi Insurance 9.3.1 Underwriting 9.3.2 Pricing 9.3.3 Capital Management 9.3.4 Asset Management 9.3.5 Claims 9.3.6 Governance 9.3.7 Tokenomics 9.3.8 Risk Sharing 9.4 Departing Words Appendix References Index