Chinese Perspective on Representation Duty in Blockchain-Based Insurance

As a distributed database or ledger shared among the nodes of a computer network, blockchain is best known for its crucial role in cryptocurrency systems where it maintains a secure and decentralized record of transactions. However, its applications extend beyond cryptocurrency. In China, the term “Blockchain+Insurance” typically refers to the use of blockchain technology by insurance firms to optimize efficiency and security, a concept known as blockchain-based insurance. Because of the transparency that blockchain offers, transactions recorded on it are permanent and no data can be modified once written. One of the most common applications is in anti-fraud. Additionally, Chinese insurance firms hope using blockchain for all stages, from the pre-contract stage to post-contract stage. Since 2018, a few Chinese firms have collaborated to develop a health insurance which is the world’s first to require all insurance obligations to be performed on blockchain. It is easy to imagine that the representation of a consumer would be an essential issue. For consumers, blockchain that is expected and developed by insurance firms to reduce their legal risks, is being a new situation that they have to encounter when making representations. How should this new situation be considered? How might it significantly impact existing law? How can the interests between insurers and policyholders be rebalanced in the pre-contract stage with the implementation of blockchain? These are the questions this article tries to answer.

As for the representation duty in Chinese law, the main legal rule is Article 16 of the Insurance Law of the People’s Republic of China 2015 (the 2015 Act), including the definition, the breach of the duty, the insurers’ remedies and the applicants’ defenses. How do Chinese judges apply these rules in practice? By visiting Chinese local courts and reviewing the Chinese PKU Law database, the author has collected 494 samples of appeal and retrial cases in which consumers made a misrepresentation. Unexpectedly, insurers had a minority of chance of winning which is about 20% because many Judges used the judicial discretion to support consumers. These cases indicate that Chinese insurance firms are facing significant legal risks, which also explains their eagerness to adopt blockchain technology.

From a positive perspective, using blockchain can reduce the number of lawsuits related to misrepresentations. Insurance firms may be able to verify whether misrepresentations exist on the blockchain and refuse to underwrite at the first place. Thus many lawsuits focuses on misrepresentation would never happen. However, blockchain may not be beneficial to solving all problem particularly when the root cause lies in legislative deficiencies.

Besides existing problems, new legal issues will emerge in blockchain-based insurance, A typical example is individualized insurance products based on blockchain. By collaborating with social media platforms, insurance firms can get almost all material facts of potential clients, reducing reliance on their representations. It would be unnecessary for applicants to make representations. They may simply check and confirm if there is a mistake on proposal forms. This may lead to a new trend where the representation duty would be replaced by others such as the confirmation duty in blockchain-based insurance. Under what circumstances can be exempted from the duty of representation need to be strictly defined, to better rebalance the interests of two parties. In future, insurance applicants will require greater protection when acting on blockchain.

As one of the most promising technologies in the world, blockchain is expected to optimize the efficiency, security and transparency of insurance industry. When talking about “Blockchain+Insurance” in China, it usually refers that insurance firms use this technology to optimize the efficiency and security which is exactly called blockchain-based insurance. There have been more and more insurance firms, such as Ping An in China, Dynamis in the UK, AXA in France and Lemonade in the US, using it to deal with problems mainly in payment, reinsurance and risk management. One of most common use cases is anti-fraud. Because of the transparency blockchain can offer, transactions done on it are permanent and no data can be modified once written. It is noteworthy that a few Chinese firms has been providing blockchain-based insurance and everything from pre-contract stage to after-contract stage can be done on blockchain. It is believed that it may become one of the most popular use cases for “Blockchain+Insurance” in future. ¹ Typically, the first step for applicants is to make representations on blockchain when entering a contract. This is what insurance firms aim to achieve, as pre-contract information from the insured is crucial. With the help of blockchain, insurers believe they can significantly reduce potential legal risks.

Before analyzing the impact of the technology on the duty of representation, it is necessary to outline the current legislation in China. The primary legal rule is Article 16 of Insurance Law of the People’s Republic of China 2015 (the 2015 Act), which includes three key provisions:

First, applicants must answer questions honestly, which is like the rules in many other countries. According to Article. 16(1) of the 2015 Act, the applicant is required to represent only regarding the information specifically requested by the insurer on the proposal form. Even if the applicant fails to disclose material information, the insurer may not rescind the contract if such information is beyond the scope of the questions raised in the proposal form.

Second, how is a breach of the duty defined, and what constitutes a qualifying misrepresentation? When an applicant is deliberate, it is a qualifying misrepresentation as long as their answers are untrue or misleading. In cases of gross negligence, a misrepresentation is considered qualifying only if the untrue or misleading answer is related to the claim. For example, a man with a liver problem get a liver cancer. In response to a misrepresentation, an insurer’s remedy is to rescind the contract. Article 16 (2) states: “The insurer shall have the right to rescind the insurance contract where the applicant fails to fulfil the duty of representation deliberately or by gross negligence so that the failure of misrepresentation shall sufficiently influence the insurer’s decision on whether he will accept the insurance or raise the premium rate.” Article 16 (4) specifies: “When the applicant makes the misrepresentation deliberately, the insurer shall not be liable for losses that occur prior to the rescission of the contract and shall not refund the premium.” Article 16 (5) further states: “When the applicant makes the misrepresentation by gross negligence, the insurer is not liable for losses that occurred prior to the rescission of the contract if the fact misrepresented materially impacts the occurrence of the insured events, but the insurer must refund the premium.”

Third, applicants are afforded legal defenses when insurers seek to rescind the contract. Article 16 (3) states: “The right to rescind an insurance contract as prescribed in the preceding paragraph shall be annulled after the lapse of 30 days or more from the day when the insurers know the cause of rescission. After the lapse of two years or more from the day when an insurance contract is entered into, the insurer cannot rescind the contract; where an insured incident occurs, the insurers shall be liable for paying indemnity or insurance benefits.” Article 16(6) specifies: “Where the insurer knows the truth which the applicant fails to represent when they enter into an insurance contract, the insurer shall not rescind the contract, and if an insured incident occurs, the insurer shall pay indemnity or insurance benefits.”

How does Chinese judicial practice operate when Judges apply these rules? There are 494 samples of cases in which consumers made misrepresentations from 2017 to 2023. As shown in Table 3.1, insurers lost in 396 cases, accounting for 80.2 %. Regarding these 396 cases, there are primarily two judicial decisions. One is there is no qualifying representation, related to Article 16 (3) and 16 (6). The other is, the insurer cannot rescind the contract even though there is a qualifying misrepresentation, related to Article 16 (4) and 16 (5). When applying these rules, insurers have a minority chance of winning, reflecting that Chinese insurance firms are facing great legal risks and explaining why they are eagerly seeking to use blockchain.

Will blockchain be helpful to insurers? The answer may be positive when applying Article 16 (3) and 16 (6).

Article 16 (3) allows an insurer to rescind an insurance contract within a certain period as a remedy against the misrepresentation of an applicant. The other side of the coin is that insurers will lose the right of remedy once they do not rescind the contract within such a period. It is known as the incontestable provision.

The purpose of the article is to urge insurers to exercise their rights as soon as possible. If they do not find the misrepresentation in time, they are supposed to be liable for the payment. However, many Chinese insurers have been unable to exercise this right effectively because of the incontestable provision. And in many cases, it is too late for them to find incorrect pre-contract information from consumers. Among cases with high loss rates for insurers, 54 were attributed to the incontestable provision in Article 16 (3), accounting for 10.8 % of cases. ² Although insurers have realized the problem, it may always be difficult to be aware of it in time. Taking health and life insurance as an example, it is too costly for insurers to check applicants’ representations after entering the contract because of a huge number of applicants. As a result, insurers usually fail to identify misrepresentations within the two-year period and are compelled to make payments even when applicants act dishonestly.

It may be expected that blockchain can break down the information barrier. By collaborating with relevant institutions or platforms, insurers can get insured’s pre-contract information more easily. The earliest attempt in Chinese market was the service of “Health Recommendation” launched by Sunshine Insurance Group in 2018. ³ With the client’s consent, the insurer can directly correct information from medical examination centers. In other words, the insurer can detect a misrepresentation promptly and refuse to enter into a contract. With the advent of blockchain-based insurance products, insurers can pursue more effective remedies against applicants’ misrepresentation, reducing the likelihood of missing critical legal deadlines.

In addition to offering more effective remedies for insurers, blockchain could also reduce legal risks caused by representatives of insurers. According to Article 16 (6), any representation made to the representative is deemed to be known to the insurer.

It is common in the Chinese market for representatives to proceed with an insurance contract even after identifying a misrepresentation. What’s worse is that the representative may even collude with the applicant. However, the insurer is still required to provide coverage, as they are legally deemed to be aware of the misrepresentation, despite lacking actual knowledge. Table 3.1 indicates that there are 50 cases focusing on Article 16 (6), accounting for about 10.1 percent. ⁴ In these cases, the insurer lost because the representative had known the misrepresentation when entering the contract. In the Chinese market, this issue is considered nearly as problematic as that of the incontestable clause, although this kind of cases account for a smaller proportion in Table 3.1. Although the insurer has been aware of it for a long time, there are few legal provisions directly for regulating representatives because legislators believe that it should belong to internal management of an insurance firm. ⁵ However, insurance firm fails to effectively monitor its representatives, usually only must penalize them after the claim occurs, when they may have resigned. ⁶

Blockchain appears capable of addressing this problem immediately. Based on the above “Health Recommendation” service, Sunshine Insurance Group has been providing coverage for female-specific diseases. Before entering into an insurance contract, consumers should demonstrate health and eligibility based on data from medical examination center. It’s evident that the consumer’s data can be directly collected by the insurer, bypassing any intermediary representative. Both the consumer and the representative have limited capacity to conceal information, because the insurer can find it promptly and will not take the risk. Therefore, the representative, who is exactly only a service assistant on behalf of the insurer, is unable to help the consumer to make a misrepresentation. In this way, insurers can more effectively monitor their representatives in blockchain-based insurance.

The above functions of blockchain may become particularly advantageous in some high-risk insurance sectors. Not only does it mitigate the legal risks of misrepresentations, but it is also considered to be able to efficiently promote some high-risk insurance business. In Chinese market, verifying pre-contract information for insured parties has been particularly challenging, especially within agriculture insurance. Taking the poultry husbandry as an example. There are so many unpredictable risks such as a plague that can cause huge losses to farmers. Authorities have been urging insurance firms to provide coverage. ⁷ Therefore, it is a huge challenge for insurers to meet the needs of farmers. The crux is the difficulty of checking the actual situation of the poultry. Due to such a large amount and a short feeding procedure, it would not be easy to exactly confirm the insured quantity in pre-contract stage. The cost of settling claims is too high. Moreover, a lot of high-cost investigations may bring new risks to epidemic prevention. Evidently, significant uncertainties persist at every stage of poultry husbandry insurance. Therefore, less than 3% of farmers can have the coverage for their poultry in some provinces including Shandong. It is usual that most farmers are rejected by insurance firms because of the excessive and uncertain risks.

Now the situation is being solved in blockchain-based insurance. A notable milestone in China was the launch of the “Blockchain-based Insurance of Duck Farming” (BIDF) in 2018 by AnHua Agricultural Insurance Company Ltd. Specifically, the insurer builds a blockchain system and set up smart claim settlements on it. The applicant should be a farmer who would supply ducks to be slaughtered to a local leading enterprise under a contract. As the party placing the ordering and carrying out slaughtering and sales, the leading enterprise implement standardized management in the whole process. Prior to underwriting, the leading enterprise who is liable for collecting a part of material facts from the farmer, should also sign the insurance contract to ensure the authenticity of the data. Records on blockchain should include the number of deaths, feed consumption, vaccination records, and other relevant details provided by the farmer and the number of ducklings supplied by the leading enterprise. When it is time for the ducks to be slaughtered, the slaughterhouse of the leading enterprise also records the relevant information. When a claim is filed, the data of each group from different parties is calculated to verify the truth including the number of deaths per day. Consequently, the data processing results can be trustful and serves as the basis for payment decision. The excessive and uncertain risks that insurers worried about are believed to be significantly mitigated.

Unlike previous practices that only required farmer to provide pre-contract information, the leading enterprise, who should also responsible for recording crucial data, rarely produces incorrect records. In addition to being bound by the agreement with the insurer, as the ordering party, the leading enterprise would prefer there is no misrepresentation. With the help of blockchain, data from the two parties can be analyzed to verify the truth. Therefore, insurers can more readily detect any misrepresentation within the data processing results and exercise the remedy right. It would significantly support the insurer in developing this high-risk business. Currently, an increasing number of similar products, such as coverage for chicken and goose farming, are being explored in the Chinese market. ⁸ This trend suggests that agriculture can become a huge emerging market for blockchain-based insurance.

Will blockchain be helpful to insurers when applying Article 16 (3) and 16 (6)? The response to this question may not be entirely affirmative. As shown in Table 3.1, there are 390 cases focusing on Article 16 (4) or (5) are telling that the insurer may be also in a disadvantageous position during trial even if the applicant made a misrepresentation without any defenses. Insurers lost in 292 cases, significantly contributing to their high loss rate. It indicates that so many insurers remain at a disadvantage although they are not at fault in many cases. Furthermore, it is essential to further analyze the underlying reason for this judicial phenomenon, as illustrated in Table 3.2. Article 16 (2) states that the insurer shall have the right to rescind the insurance contract where the applicant breaches the duty of representation deliberately or by gross negligence. Pre-contract information required from the applicant is often referred to as ‘material fact’. ⁹ Article 16 (4), (5) provide remedies for qualifying misrepresentations. In brief, there are four situations that will lead to different decisions for misrepresentations.

First, for deliberate misrepresentations, the insurer can rescind the contract and should be exempted from payment for the loss of the insured accident whether or not there is no causal connection between the occurrence of the insured event and the misrepresent fact.

Second, in cases of grossly negligent misrepresentation, the insurer can rescind the contract and should be exempted from payment for the loss of the insured event if there is causal connection between the occurrence of the insured event and the misrepresent fact, although the premium must be refunded.

Three, for misrepresentations by gross negligence, the insurer cannot rescind the contract and should be liable for the loss of the insured event if there is no causal connection between the occurrence of the insured event and the misrepresent fact.

Four, for innocent misrepresentations, the insurer cannot rescind the contract and should be liable for the loss of the insured event.

Table 3.2 presents six types of cases with different main views of Judges. It is necessary to consider the first three type, which are the most numerous and controversial. In the first type, 52 cases show judge’s ruling that the applicant deliberately made a misrepresentation, but not regarding a material fact, resulting in a lost for the insurer lost, accounting for 13.3%. ¹⁰ It seems that the judge consider the false information that the applicant represent as non-material fact, so it is not a qualifying misrepresentation though the insured is deliberate. ¹¹ However, the definition of a material fact that would sufficiently influence the insurer’s decision to accept the insurance or adjust the premium rate, may usually depends on the insurer’s judgment. Most questions that insurers require applicants to answer are material facts. This suggests that the applicant should be deemed to have misrepresented the material fact if they deliberately give an incorrect answer on the proposal form. However, Judges believe they can decide what should be a material fact. For example, some chronic diseases such as diabetes and heart disease those insurers think would affect their decisions and specifically ask the applicant to represent are ruled as non-material facts by a lot of Judges. Similar issues arise in the second type of cases. In 84 cases, representing 21.5%, judges are inclined to deny the causal connection between the occurrence of the insured event and the misrepresent fact although when such a connection is readily apparent from both common sense and professional knowledge. ¹² Common examples include thyroid nodules and thyroid tumors, ¹³ renal insufficiency and uremia. ¹⁴ And in many cases where applicants are clearly deliberate, judges often classify their actions as gross negligence. ¹⁵ As for the third type in which there are 134 cases, applicants often argue that insurers are also at fault when it is difficult to find good reasons for their dishonesty. ¹⁶ Although these claims are often unreasonable – such as requiring insurers to ask questions both orally and in writing ¹⁷ – they are frequently upheld by judges. In some instances, judges insist that insurers should verify the authenticity of representations and would be liable if inaccuracies are present. ¹⁸ The third type accounts for 34.5 percent, which occupies more proportion than either the first or second type. The total number of these three types of cases amount to 270, constituting 69.3% as shown in Table 3.2. This may indicate that many judges are subjected to using the judicial discretion to protect the insured.

What will happen to this judicial issue when blockchain-based insurance comes? Some insurance firms believe that blockchain may provide a solution. This is because the judicial problem appears to be in fact-finding rather than applying provisions. As observed in the controversial cases, many judges usually draw conclusions unfavorable to insurers at the fact-finding stage. When applying the law, they strictly adhere to the provisions and made no inconsistent interpretation at all. It is conceivable that all relevant facts will be presented very clearly for the judge because all records are immutable and traceable as electronic evidence. The causal connection between hepatitis and liver cancer, for example, can easily be found on blockchain. Thus, Judges seem to be better positioned to address these issues because they may only need to consider how to apply laws before making a decision. This is indeed another prominent use case in which blockchain is helping courts handle electronic evidence. ¹⁹ Insurers expect that their disadvantageous position in judicial practice will gradually improve.

However, blockchain cannot fundamentally solve the judicial problem. Because the root of the problem lies in the legislation rather than in fact-finding. Why do so many judges use judicial discretion to protect applicants? The 2015 Act imposes severe penalties on applicants once they are found to have made misrepresentations, namely, contract rescission, no matter how much impact the misrepresentation has had on the insurer. In other words, applicants would lose their coverage even for gross negligence, despite the insurer potentially entering the insurance contract under different terms or at higher premiums. The judge in a case knows there would be only two results, either a complete loss of coverage for the consumer or full payment by the insurer. This is indeed a choice of win or lose all, making it difficult to balance the interests between the two parties even when the conflict is not particularly intense. Judges in many cases hope for more flexible solutions according to different situations. Current law only asks judges to make such a difficult choice of win or lose everything. As a result, judge often exercise judicial discretion to protect the insured rather than the insurer. It can be concluded that the root of such a judicial problem may come from current legislation. In this way, blockchain fails to address the root of the problem. This technology may be able to present the facts of the case clearly, but it cannot solve the problem of conflict caused by existing legislation.

Moreover, blockchain may exacerbate the problem. Furthermore, conflicts of interest between parties would be more exposed in blockchain-based insurance. Since all immutable and traceable information in it can serve as evidence showing what has happened in pre-contract stage, both the intention and behavior of the applicant will be clearer at a glance. Similarly, insurers believe that an applicant who makes a qualifying misrepresentation can hardly have a good reason to deny it. And it is more difficult for judges who are inclined to protect applicants during fact-finding to exercise judicial discretion. As evident in other similar problems in Chinese insurance law, it is foreseeable that judges will have to exercise judicial discretion in applying the law, which diverges from what the insurer expected, requiring them to interpret provisions inconsistently with their stipulated meanings. Therefore, the existing judicial problems may be aggravated in blockchain-based insurance because the legal effect of stipulated articles may be weakened. The problem of the legislation itself, which would be highlighted in blockchain, still requires improvements in the legal system and cannot be solved by technological development alone.

As for the representation duty, some Chinese scholars have proposed improvements to it since 2015, ²⁰ and it would be extremely urgent when the wave of blockchain comes. Where should the focus of reform lie? As mentioned above, the key point of the problem is the remedy of the insurer in cases of qualifying misrepresentations under Article 16. Chinese insurers usually have only one option, that is to rescind the contract, even if they would have agreed to the contract under different terms or at a higher premium. Meanwhile, applicants’ misrepresentations may not be serious enough to warrant rescission, but they still risk losing coverage entirely. A lot of conflicts between the insurer and the applicant, could have been addressed through a series of compromise plans. Therefore, offering a variety of remedies for the insurer would be of vital essence to reconciling this conflict in the future.

According to laws in many countries, including the UK, Germany, Italy and Switzerland, it has been popular to expand remedial options for insurers. The insurer’s remedy is typically determined by what action it would have taken if the applicants had complied with their duty in cases of careless qualifying misrepresentation. In addition to rescinding the contract, there are compromises that keep the insurance contract valid without causing undue losses to the insurer, if the insurer would have entered into the contract. They include treating the contract as if it had been entered into under different terms specified by the insurer under the terms the insurer would have set (excluding terms relating to the premium) ²¹ and proportionately reducing the amount to be paid on a claim if the insurer would have charged a higher premium. ²² For China, the first step could be to introduce the proportionate reduction in payment under Article 16 of the 2015 Act. Specifically, the insurer may proportionately reduce the amount to be paid on a claim if the insurer would have entered the insurance contract but at a higher premium, as it may be the most feasible approach. Apart from the UK, this rule has been implemented in many other countries such as Germany, ²³ France, ²⁴ Italy. ²⁵ Another important reason is that there is a proportionate reduction in payment under Chinese law. Article 32 of the 2015 Act allows the insurer to reduce the amount proportionately only when the misrepresentation of the insured’s age does not substantially affect the validity of the contract. However, this claim by the insurer is not easily supported in judicial practice because many judges think that it conflicts with Article 16. There is not much room for applying this article because people’s age information is often open in China. ²⁶ Nevertheless, it is of great meaning as a good basis on which the rule of proportionate reduction in payment to be more widely applied. With the existing problem that is going to aggravate in blockchain-based insurance, this necessary reform would be particularly urgent.

What should be more concerned is a series of new issues caused by technology.

Blockchain-based insurance also benefits clients with the development of individualized service. As one of the most promising products in blockchain, the individualized insurance products is becoming a popular choice for applicants. When entering into an insurance contract, applicants may not need to represent material information because the insurer has processed their personal information on blockchain. ²⁷ A typical example is Hongfu Health Insurance (HHI) in China. It is the world’s first blockchain-based insurance product, in which every step from entering into a policy to reinsurance can be completed on the blockchain. Now that the insurer, who can collect a large amount of personal information in advance, does not rely on representations by applicants. It may not be necessary for applicants to make representations. Could they be exempted from this duty under these new circumstances? Current legislation in world is nearly absent on this question. In terms of the legal purpose, the duty was designed to enable insurers to efficiently gather material facts they need to know. When the blockchain technology is fully capable of solving the information asymmetry between parties, applicants’ burden could be eased, especially for consumers who may become more vulnerable in the new market. New rules on blockchain-based insurance are necessary to deal with such a new situation, including when and how the applicants can be exempted from the duty.

What will happen next? Will any new pre-contract duty replace the representation? Like HHI, the insurer may ask the applicants to correct and confirm material facts when entering into the contract. It seems that this confirmation, currently a business practice, could potentially become a new duty. Future laws ought to answer a series of new questions focusing on the new duty if its legal status is established. For example, how to handle the problem that the applicants fail to point out incorrect information when confirming it? The applicants who act deliberately should be punished and the insurer should have remedies such as rescinding the contract. As for reckless and careless confirmation, it may be considered unfair to punish the more vulnerable consumers especially given that reasonable care requirements are lower, as mentioned above. Could the insurer rescind the contract? Further legal discussion in the future will be required to balance the new conflicts of parties according to the development of the market. How to regulate data controller who always play a vital role in blockchain-based insurance? They should be regulated by both insurance and data laws, and how these laws should cooperate with each other must be considered. Individualized insurance will probably reconstruct the legal relationship between insurers and applicants at the pre-contract stage and blockchain-based insurance may be regarded as a new type of insurance contract.

Representation in blockchain-based insurance is likely to become a new issue in the future. It must be noted that these issues are only part of legal reforms in the future. More new issues of the representation duty will probably emerge with the growth of this evolving market. It will reflect a legislative process from sporadic articles to systematic laws. China’s insurance law should urgently settle existing issues caused by current regulations before starting to think about new legislation. From this point of view, blockchain-based insurance is not only a serious challenge, but also a great opportunity for legal reform and improvement. Moreover, the contrast between powerful insurers and vulnerable consumers will be more highlighted on blockchain, completely different from the era of “utmost good faith” based on Marine Insurance Act 1906 in UK. With the use of blockchain technology, insurers may become exceedingly powerful. For example, they would not only hold an overwhelmingly dominant position in the insurance contract but also serve as controllers or processors of personal data. Should they be regulated strictly to meet the standard of “utmost good faith”? Will a new era of “utmost good faith” emerge?