Interview: James Croome, Head of Fine Art & Specie, Arch Insurance Company

What are the actual risks considered for Digital Assets from an insurance perspective?

The specific risk considerations will differ depending on the type of insurance a carrier is offering. A Tech E&O underwriter, for example, will have a different set of concerns and considerations to a D&O underwriter.

That said, there are some common themes that carriers in this space are concerned with, and they can be broadly separated into three areas: The potential abuse of digitals assets for financial crime and money laundering; the differing regulation (or lack thereof) present in different territories; and the quality of the insured.

The final point is largely self-evident, but it does provide a thread around which carriers can start to explore and expand their product offering. Appetites for different products will differ from carrier to carrier and the risk profile presented by one insured may not induce a given carrier to offer their full gamut of products to that insured. But, generally speaking, the more engaged the insured is in the underwriting process, the more efficient and eloquent they are answering questions and explaining their business and the risk they are presenting, the more likely it is that a carrier will seek to expand their relationship with the insured and provide the coverage that the insured really wants and needs.

What is a specie policy, and how does this differ from other types of insurance, such as a crime market policy?

The specie market has historically focused on a broad range of high value commodities. The subject matter of our policies can range from diamonds to fine art paintings, from hard currency to vintage wines & spirits; essentially if an asset is appealing to a light-fingered would-be thief, then it will likely find an insurance home in the specie market.

Theft is not the only peril the specie market focuses on, however, as coverage is typically provided on an “all risks of physical loss or damage” basis. This means coverage is ordinarily only limited by the exclusions within the wording. Fire, flood, natural catastrophes, accidental damage, unexplained or mysterious disappearance are all common place perils covered on a traditional specie policy.

Given the potential for a specie policy to cover the theft of high value assets there is naturally some potential crossover with the crime market. The specie and crime markets will, from time to time, participate on the same tiered placements for certain risks. The crime markets will often write a smaller monetary limit, broader coverage, primary layer, while the specie markets will provide a larger monetary limit, narrower coverage, excess layer sitting on top of the crime market’s primary coverage. Not all perils covered by the crime market will be covered by the specie policy, but for those perils that are, if the exposure is too great for the crime policy to fully indemnify an insured in the event of a loss, then the specie market has the capacity to help provide the monetary limits our insureds need.

And how do Digital Assets fit into this?

When looking specifically at digital assets the specie market has taken a slightly different approach to the traditional coverage detailed above. Given the relatively immature nature of the digital assets industry, specie underwriters are not prepared to extend their usual “all risks” coverage to these assets.

The concern over unknown or unforeseen loss scenarios is simply too great; we don’t know what we don’t know and there is simply not enough data on the types, frequency or severity of potential losses to limit coverage via exclusionary language only. The wordings created by the specie market have therefore been based on a “named perils” basis. Coverage is only provided for those perils specifically outlined within the insurance contract language and in the event of a claim the insured will have to demonstrate to insurers which peril they are claiming coverage under, and how the loss was caused by that peril. As with an all-risks policy named perils policies still benefit from additional exclusionary language to help clarify the coverage and ensure that all parties are clear on precisely what is, and what is not, covered.

Before discussing precisely which named perils are insured on a specie digital asset insurance policy it is important to understand that, due to their decentralised nature, digital assets are not actually the subject matter of a digital assets specie policy. In order to provide a more specific focal point for the insurance policy it is the private keys, or key shares, that are needed to propagate a transaction of the associated digital asset on a corresponding blockchain that are the true interest of a specie digital assets insurance policy.

These private keys, or key shares, are typically insured against three named perils: Their irrevocable loss or destruction, including any backups or copies; their theft or copying as a consequence of the collusion and infidelity of the employees of an insured, or agent of the insured, who are specifically tasked by the insured with their safe custody; their theft or copying by a third party, not employed by the insured or agent of the insured.

For both the second and third perils for the insured to have suffered an indemnifiable loss the theft and or copying of private keys or key shares must result in the insured being permanently deprived of the associated digital assets following their transfer to a blockchain public address outside of the insured’s control. It is also very important to note that for the third party theft peril the third party cannot commit their nefarious act remotely. The assailant must have direct physical access to hardware used to store the private keys, key shares or backups, or direct physical access to the insured’s designated premises from which they conduct their business.

Tokenized real-world items are becoming more common (perhaps all assets will be digital in some way in the future). If an NFT confirms the ownership of a physical asset, such as a 2015 Domaine Leroy Musigny Grand Cru, and the NFT is burned (sent to a faulty wallet address and therefore lost), what happens to the insurance coverage? What if the wine bottle smashes, and I still have the NFT – what’s covered?

This is a very nuanced question, and the answer will differ depending on a number of factors, principally the basis of valuation for the NFT and how the physical asset is custodied.

 If the owner of the NFT also physically possesses the bottle of wine with which the NFT is associated and they accidently burn their NFT, the physical asset to which the NFT denotes ownership has not been lost or damaged in anyway, and if the value of the NFT is solely derived from the value of the physical asset there is no indemnifiable loss.

However, if the bottle of wine was in the custody of a third party, such as a bonded warehouse or wine merchant, and the party that has come into possession of the NFT (either nefariously or by accident) is able to use the NFT to induce the third party to ship the wine to them, or to another party, then the original owner of the NFT (and wine) will have suffered and financial loss and the NFT policy can be called upon to respond (subject to the policy terms and conditions of the contract).

Similarly, if the value of the NFT is not derived solely from the value of the physical asset, or if the value of the physical asset can be reasonably argued to have diminished by the loss of the NFT, then there could also be a potential to claim under the NFT policy. This is a complicated subject, however, as qualifying the value of an NFT that does not derive its value solely from a physical asset with its own readily obtainable market value requires very specific expertise. The complex nature of these valuations is why NFT insurance products are sold on an “agreed value” basis with an ongoing necessity to revalue the NFT, via the services on a pre-agreed third-party expert, throughout the duration of the insurance period.

What options are available right now?

Specie policy insurance for NFTs is relatively limited at this time but depending on what the NFT is denoting title to, and what cover the insured is seeking, there are various options open to potential insureds.

If the NFT is for digital artwork it is possible to purchase an insurance product that will protect against the loss or theft of the NFT private keys. But, the policy only covers the NFT as evidence of title, there is no cover for the digital artwork. However, due to the highly volatile nature of the NFT valuations associated with digital artworks self-custody is not insurable. The insured would need to utilise the services of an acceptable professional custodian who would not present the same moral hazard to insurers as the individual that both owns and possess the NFT private keys. The simplest way to achieve the above is to utilise a hard wallet to secure the NFT private keys and for the custodian to store the hard wallet in their safe or vault. If the NFT denotes title to  physical asset it is possible to purchase insurance for both the NFT and the physical asset at the same time but depending upon whether or not the insured physically possesses the physical asset will dictate the exact coverage that is available and how the two policies would need to interact with one another.