Author: Jay Jiyuan

The best way to know is to read my thoughts on the blog site: Ideabins.blog. I have been a managerial consultant for 10 years and then college teaching for 12 years. Entrepreneur in heart, interested in financial leteracy

Liabilities Insurance

Do You Know What Is “Silent Cyber?”

Post author By Jay Jiyuan
Post date February 20, 2023

The Takeaways:

Colonial Pipeline ransomware attack was one of the best known cyber insecurity incidents in the US. It potentially cost the firm multiple millions on ransom and disruption of operation for days with the largest fuel pipeline system.
Cyber security threats range from phishing, ransomware, malware, Distributed Denial of Service, Advanced Persistent Threats, Zero-day exploit, social engineer, insider threat and Internet of Things (IoT) threat.
The best approach to dealing with cyber security is to do both risk management and risk transfer.
Risk management covers fields of identifying vulnerabilities (knowing where weaknesses are), prioritizing risks (knowing which risk brings bigger loss), developing risk mitigation strategies (firewalls, access control, incidence response plans and regular testing), monitoring for threat (staying up to date with the latest threat) and continuing improvement (regular review, invest in new technologies).
Risk transfer means purchasing cyber insurance, which helps companies hedge against the potentially devastating effects of cybercrimes such as malware, ransomware, distributed denial-of-service (DDoS) attacks, or any other method used to compromise a network and sensitive data. It cover the costs associated with a cyberattack, including loss of business income due to the attack and additional direct costs such as forensic expenses. In some cases, policies can even cover losses from an attack on a third-party such as a vendor or partner. It can also incentivize companies to implement stronger cybersecurity measures as many insurance policies require businesses to meet certain security standards in order to be eligible for coverage.
It’s worth noting that traditional insurance policies like property liability, general liability, or directors and officers insurance, may not cover some of the consequences of a cyber-attack. This concept is known as “Silent Cyber,” where traditional insurance policies are silent on whether they will cover cyber-related losses.
Cyber insurance is designed to protect companies from these primary risks through four distinct insuring agreements: first-party coverage, third-party coverage, crime coverage, and cyber terrorism coverage.

The Cyber Insecurity Story

On May 13, 2021, Colonial Pipeline, the largest fuel pipeline system in the United States, allegedly paid an unknown amount to a ransomware group named DarkSide, despite FBI’s advice for not paying it.

For those not familiar with ransomware attack, it is an attack of criminal groups holding data hostage until the victim pays a certain amount of money as they demanded. In this case, the demanded sum was nearly $5 million, and the CEO of Colonial Pipeline said he authorized a ransom payment of $4.4 million.

The attack resulted in the company shutting down its operations of 5,500 miles of pipeline, carrying 45 percent of the East Coast’s fuel supplies for several days, which caused fuel shortages and price increases in many parts of the country, a move that has led to panic buying and massive lines at gas pumps.

As New York Times pointed out, “In recent months, officials note, the frequency and sophistication of ransomware attacks have soared, crippling victims as varied as the District of Columbia police department, hospitals treating coronavirus patients and manufacturers, which frequently try to hide the attacks out of embarrassment that their systems were pierced.”

Turns out that paying ransom in cryptocurrencies is a bad idea as it’s harder to trace perpetrators and exacerbated attacks “’hitting soft targets like hospitals and municipalities, where losing access has real-world consequences and makes victims more likely to pay,’ said Ulf Lindqvist, a director at SRI International who specializes in threats to industrial systems. ‘We are talking about the risk of injury or death, not just losing your email.’”

Cybersecurity Top Threats

A CNN Report tells us that “CISA and the FBI confirmed that DarkSide was used as a ‘ransomware-as-a-service,’ in which developers of the ransomware receive a share of the proceeds from the cybercriminal actors who deploy it, known as ‘affiliates.’” In other words, people are now calling themselves ransomware professionals offering specialized “services” for any clients with such a need.

Now is the good time to look at the top cybersecurity threats. ChatGPT lists the major types, to which I did addition search to add more details to each:

Phishing: This is a type of cyber-attack that can target both individuals and businesses. Phishing starts by an attacker sending fraudulent emails, text messages, or other electronic communications that appear to be from a legitimate source in order to trick the recipient into providing sensitive information such as login credentials, credit card numbers, or other personal data.

Phishing is also one of the most common cybersecurity threats. According to a report by Verizon, 36% of data breaches involve phishing. It is also relatively easy to execute through email, social media, SMS, or phone calls.

Ransomware (like in the Colonial Pipeline case): This is a type of malware that encrypts a victim’s files and demands a ransom payment in exchange for the decryption key.

Ransomware is a type of malware that has become increasingly common in recent years. According to a report by Cybersecurity Ventures, ransomware damages will cost the world $20 billion in 2021, up from $11.5 billion in 2019. The report also estimates that a business will fall victim to a ransomware attack every 11 seconds in 2021, up from every 14 seconds in 2019.

In addition, ransomware attacks have become more sophisticated and can now target specific organizations and industries.

It is important for individuals and organizations to take steps to protect themselves against ransomware, including regularly backing up important data, using strong passwords, and implementing security software and practices that can help prevent and detect attacks.

Malware, to which ransomware is one type, is any software that is designed to harm, disrupt, or gain unauthorized access to a computer system. It can include viruses, worms, Trojans, spyware, and adware.

Malware is a significant threat to individuals, businesses, and governments and can cause a wide range of problems, including theft of sensitive data, disruption of critical systems, financial losses, and damage to an organization’s reputation.

I should know because I have been hit by malware myself. It’s not a big deal but it switched my search engine from Google Chrome to Yahoo — without my knowledge. I finally called Microsoft supports and they had to use a tool to access my computer screens and after 2 hours they still cannot change the machine back to Chrome. In the end, I had to set up another new login account to move everything over in order to be able to use Chrome again.

Malware can lead to legal liabilities and compliance violations, as well as loss of customer trust. According to a report by AV-TEST, there were over 700 million malware instances in 2020, a significant increase from previous years and highlights the growing threat of malware.

In addition, the report notes that the majority of malware is designed to steal data or gain unauthorized access to systems, making it a serious threat to organizations of all sizes.

Distributed Denial of Service (DDoS) attacks are designed to overwhelm a target system with traffic, making it unavailable to its intended users. An attacker floods a website, server, or network with a large amount of traffic, overwhelming its ability to respond to legitimate requests.

Imagine you are a Prime member of Amazon and one day you want to log onto your account to order something there. DDoS however could make the website appearing too busy to allow your access to the account.

A DDoS attack is typically carried out by a network of compromised devices, known as a botnet, that are controlled by the attacker. These devices can include computers, servers, routers, and even IoT devices. The attacker can use various methods to gain control of these devices, such as exploiting vulnerabilities or using social engineering tactics.

Needless to say, DDoS attacks can have serious consequences for businesses and organizations, such as loss of revenue, damage to reputation, and legal liabilities. In addition, DDoS attacks are often used as a distraction or smokescreen for other types of attacks, such as data theft or malware installation.

Zero-day exploits are a funny name because they are vulnerabilities in software or hardware that are unknown to the legitimate owners and are exploited by attackers before a patch or update is released. “Zero day” means threat discovered before the vendor or programmer is made aware of it.

In recent news, Apple released updates to its operating systems and Safari browser to fix a zero-day vulnerability in its WebKit browser engine that was actively being exploited.

Hackers like zero-day exploits as they can provide a way to gain access to sensitive data, systems, or networks without being detected. Because there is no patch or fix for the vulnerability, organizations may not be aware of the threat until it has already been exploited.

Keep in mind that it is always a game of time to see who moves faster than others.

Insider threats are threats that come from within an organization, such as employees or contractors who have access to sensitive information and use it for malicious purposes.

Social engineering is a technique used by attackers to manipulate people into revealing sensitive information or performing an action that is against their best interests. This type of attack usually involves psychological manipulation or deception rather than exploiting technical vulnerabilities.

Cloud securities are becoming more complex, such as data breaches, insecure APIs, and unauthorized access as the use of cloud service increases.

Internet of Things (IoT) securities are vulnerable to attacks due to their limited security features and the lack of standardization in IoT security protocols.

How Risk Management Helps Reduce Cyber Risk

Risk management is a process that helps entities and individuals identify, assess, and prioritize risks, and then implement strategies to mitigate those risks. Risk management is a key component of an effective cybersecurity strategy and can help reduce cyber risk in several ways:

Identifying vulnerabilities: Through risk assessments, entities and individuals can identify potential vulnerabilities in their systems, networks, and processes that could be exploited by cyber-attackers. By knowing these vulnerabilities, they can take steps to address them, such as implementing stronger passwords, regularly updating software, and conducting employee training.
Prioritizing risks: Not all risks are created equal, and risk management can help entities and individuals prioritize which risks addressing first. This ensures that resources are used most effectively to mitigate the most significant risks.
Developing risk mitigation strategies: Once risks have been identified and prioritized, entities and individuals can develop strategies to mitigate those risks. This may include implementing technical controls such as firewalls and intrusion detection systems, implementing policies and procedures such as access controls and incident response plans, and regularly testing and reviewing those controls.
Monitoring for threats: Risk management also involves ongoing monitoring for new threats and vulnerabilities. This allows entities and individuals to stay up-to-date with the latest threats and adjust their risk management strategies accordingly.
Continual improvement: Risk management is an ongoing process, and it requires continual improvement to stay effective. Entities and individuals should regularly review and update their risk management strategies to ensure they are keeping up with evolving threats and new technologies.

Why Firms and Individuals Need Cybersecurity Insurance

Cybersecurity insurance, also known as cyber insurance or cyber liability insurance, can help entities and individuals in several ways:

Financial protection: Cybersecurity insurance can provide financial protection in the event of a cyber-attack. It can cover the costs associated with data breaches, such as legal fees, forensic investigation expenses, and notification costs. It may also cover costs related to business interruption, lost income, and damage to computer systems.
Risk management: Cybersecurity insurance can also help entities and individuals manage risk by providing resources and tools to prevent cyber-attacks from occurring in the first place. Many policies offer risk assessments, cybersecurity training, and access to cybersecurity experts to help organizations better understand their risks and mitigate them.
Reputation protection: Cybersecurity insurance can help entities and individuals protect their reputation in the event of a cyber-attack. Some policies may cover the costs of public relations and crisis management, helping to minimize the damage to an organization’s reputation.
Compliance: Many industries have regulations and compliance requirements around data protection, and cybersecurity insurance can help ensure compliance by covering the costs of regulatory fines and penalties.
Peace of mind: Cyber-attacks can be complex and costly, and cybersecurity insurance can provide peace of mind knowing that there is a plan in place to help mitigate the damages should an attack occur. It can also help organizations and individuals feel more confident in their cybersecurity strategies and risk management plans.

What Does Cyber Insurance Cover?

Cyber insurance works similarly to other types of insurance. Entities or individuals purchase a policy from an insurance provider, pay a premium, and in the event of a covered cyber-attack, the insurance company provides financial assistance to help mitigate the damages.

The specific details of cyber insurance policies can vary depending on the insurance provider and the policy purchased, but there are a few key elements that are common to most policies:

Network security and privacy liability – this coverage can include both first party (i.e., yourself as the policyholder, such as costs related to data breaches, such as legal expenses, notification costs, and credit monitoring services) and third-party (i.e., someone else) who suffers losses due to damages covered by the policy.
Network business interruption – this coverage can protect a company from lost income due to a cyber-attack that disrupts business operations. This is first party protection for yourself.
Media liability – this coverage can protect a company from claims of copyright infringement, defamation, or other types of media-related liability arising from the company’s website or social media activities. Again this is first party protection.

Errors and omissions – this coverage can protect a company from claims related to errors or omissions in the services or advice provided to customers in the course of doing business.

Tags Colonial pipeline, Cyber insurance, Distributed denial of service, Insider threat, IoT threat, Phishing, Ransomware attack, Silent Cyber, social engineering, zero-day exploit

Did You Know?

When a State Has 80% Homeowners Lawsuits in the Country, How Can We Do Better in Risk Management?

Post author By Jay Jiyuan
Post date February 18, 2023

The Takeaways:

Risks are inevitable, losses don’t have to be — if we do risk management right.
One-way attorney fees and assignment of benefits (AOB) are the two big legal loopholes pushing up insurance cost and lowering down private insurance affordability and availability in Florida.
Four technological platforms or tools are very useful in risk management: ChatGPT, Smart Contract, Internet of Things (IoT) & Tango. Together they have the potential to revolutionize insurance business by significantly reducing insurance costs and increasing fare & efficient insurance coverage.
ChatGPT will be trained to read and explain lengthy and complicated legal documents such that ordinary citizens can quickly understand the gist of a 200-page contract. This will significantly reduce the currently indispensable role of human attorneys (they may be needed to proof check the ChatGPT answer but that should not take very long.)
Another ChatGPT development is customized, always on, mobile and industry- or even firm-specific ChatGPT. The program will be locally pre-trained by records of past risks and past losses, and then provide intelligent and insightful answers to inquiries of all employees in dealing with new but similar problems.
Smart contract associated with blockchain will effectively reduce the problem of legal system abuse, over-crowed or jammed court rooms, long waiting lists of scheduled litigations — by drafting really smarter contracts that are filled with very detailed, context specific “what if” terms and conditions (ChatGPT can help draft and interpret the document), taking into account all relevant historical cases and eliminating extra spaces for misinterpretation and post hoc litigation, while keeping the feature of automatic execution of a predetermined agreement.
Internet of Things (IoT) will establish a field monitoring network at critical junctions of business operation to record objective evidence admissible to the court of law, deterring frivolous lawsuits and prevent predatory practices of trial attorneys.
Tango is the easiest and most intuitive training tool for employees by providing step by step guides with intuitive screenshots every step of the way that everyone can understand and easy to follow. In the future new employee orientations will be mostly done by watching Tango generated PDF files. Numerous risk management field guides can be developed with context specific Tango flowcharts to reduce the chances of misbehavior and mishandling.

This is a more detailed (and longer) version of my proposal for the “In2Risk23” Conference to be held on October 5-7 in Washington D.C. by the CPCU Society of the Insurance Information Institute or the Triple-I as it is called.

Bad & Then Good News from Florida

Don’t get me wrong, I only have California state insurance (and financial) license so what happens in Florida does not really concern me. Yet insurance everywhere bears similarities, and it doesn’t hurt to learn from the mistakes in another big state like Florida.

The Insurance Information Institute (Triple I), one of my favorite sources of insurance related information, has recently issued a two page news brief on Florida Property /Casualty (P/C) Insurance crisis. It tells us the bad news first, and then some good news.

Perhaps the best way to start a story is by providing some quick statistics: “Florida accounts for nearly 80% of the nation’s homeowners’ insurance lawsuits, but only 9% of all U.S. homeowners’ insurance claims are filed.”

Wow, there are disproportionally way more insurance lawsuits than other states adding together! As a result of excessive or runaway lawsuits, it “costs every Florida household more than $5,000, and the state more than 173,000 jobs annually,” according to the American Tort Reform Foundation’s “Judicial Hellhole” report.

So what’s going on here?

“Legal system abuse and misuse of assignment of benefits ‘are creating a lose-lose, contributing enormously to the net underwriting losses for the few remaining insurers in the state,’ said the Triple-I CEO Sean Kevelighan.”

The CEO only talked about assignment of benefit or AOB problem in Florida, another is “One-way attorney fees” to be discussed later in more detail.

The good news is that, as the above briefing points out, “Reforms put in place in the closing weeks of 2022 and proposed in the first quarter of 2023 suggest Florida is now quite serious about fixing the fraud and legal system abuse that have contributed to the state’s insurance crisis.”

The Underwriting Losses in Florida

Let’s look at another shocking figure from Florida:

“Florida’s homeowners insurers cumulatively incurred net underwriting losses of more than $1 billion in both 2020 and 2021 and expect larger losses for 2022 when year-end results are tabulated.”

The figure of $1 billion loss in Florida has to be placed in the context of national figures to make more sense. According to this report, “In 2021, the insurance industry experienced a $3.8 billion net underwriting loss, after a $5.2 billion underwriting gain in 2020.” In other words, the entire country had a gain in 2020 when Florida had a loss, and of the national loss of $3.8 billion in 2021, Floridan contributed $1 billion, more than 25% of it.

One crucial term in the above news is “underwriting losses.” According to ChatGPT, “Underwriting loss is the financial loss incurred by an insurance company as a result of the claims paid out to policyholders being greater than the premiums collected from those policyholders. In other words, underwriting loss occurs when an insurance company pays out more in claims than it receives in premiums.”

Simply put, underwriting losses happen when insurance companies have to pay out more money for insurance claims than they received from policyholders’ premiums. You don’t have to be a genius to figure out that is not good.

To be sure, insurance companies make money in several ways, not just from premium. Therefore, underwriting losses are not the only factor to determine the company’s overall financial health. Investment income is another major source of revenue.

When an investment company receive policyholder’s premium payment, they won’t let the money sit there collecting dust. Instead, they invest the premiums to security market to generate additional income.

In addition, operating expenses such as salaries, rent, and marketing costs can also affect an insurer’s bottom line. If an insurer has high operating expenses, it may be more challenging to achieve profitability even if its underwriting results are strong.

Still, other things equal, having an underwriting loss is definitely not a good news.

Trouble with Assignment of Benefit AOB

Assignment of Benefits or AOB is common primarily in property & casualty insurance but also in others like healthcare insurance. it is a legal agreement that involves the transfer of insurance benefits from the policyholder to a third party, such as a contractor or healthcare provider.

It seems to be a harmless arrangement. For example, say you have some illness and your physician successfully treated you. If that illness is covered by healthcare insurance, you know you will be reimbursed. So instead of you paying the physician and then get reimbursed from your insurance, you can choose to assign your physician to get all the insurance payment because he did all the job and earned it, right?

The answer is not that simple. While AOBs can be useful in certain situations, they are generally not recommended because they can lead to a variety of problems for both the insured and especially the insurer (i.e., the insurance company).

A main problem is insurance fraud. In some cases, contractors or healthcare providers may exaggerate the cost of their services to get paid for work they never did. Or they can perform unnecessary work in order to increase their profits, sometimes charging the patients with free medicines they received from marketer, for example.

I know this happens a lot in China, where hospitals over-examine patients because those imported medical equipment (e.g., an MRI scanner) cost a lot of money and hospitals don’t want the machine sitting there collecting dust. Doctors ask most if not all patients to have a medical imaging done first, even though it is clearly not necessary for some, and the procedure sometimes costs enough to send a family back to poverty!

Another issue with AOBs is to make it difficult for insurance companies to manage their claims because there is a third party involved in the claims process. The insurance company have to verify the work that was done and to ensure that the costs are reasonable. Delays and higher costs become common.

The bad news is that ultimately it is the insured person will bear the extra cost due to AOB. If the third party performs work that is not covered by the insurance policy, the insured person may be responsible for the additional costs.

Problems with One-way Attorney Fee

Another major problem in Florida that reduces insurance affordability and availability is the so called “One-way Attorney Fees,” also called “fee shifting.” This determines who is responsible for the litigation cost and to pay the attorney(s) involved in the case.

One-way attorney fees are meant to shield policyholders from legal bills if they need to sue an insurer, but critics say attorneys and contractors exploit the law to file unnecessary suits with the goal of collecting attorney fees.

The Triple-I briefing has this to say: “Before the reform, state law required insurers to pay the fees of policyholders who successfully sued over claims, while shielding policyholders from paying insurers’ attorney fees when the policyholders lose.”

Here is how one way attorney fees work: Policyholder can sue their insurer at limited risk for legal fees. If they win the case, insurance company will pay for their attorney fees; but if they lose, they will only pay their own attorney fees and let insurance company pay their own.

Honestly, the name “One way attorney fees” may have created the impression that win or lose the policyholders won’t have to pay for any legal cost, and insurer will take care of that. That is not true. A better way is to call it “asymmetric attorney fees,” where the asymmetry exists in demanding for more financial responsibility from insurance company such that if they lose the case, they will have to pay for attorneys for both sides. But if they win, they cannot ask policyholder to do the same for their legal cost — although policyholder still must pay for their own lawyer(s).

Such a legal arrangement is not out of line but rather reasonable. After all, insurance companies have a deeper pocket than an insured.

But perhaps this is one of the things where the rule looks fine on paper but not so in practice. The reality is that there are way too many lawsuits filed by policyholders against insurance companies. As a result, several private insurance companies either had closed down or packed up to leave Florida.

What are the problems? There are several:

Increased Litigation against insurance companies, caused by the asymmetric (i.e., lower) financial responsibility for policyholders than for insurance companies. We have marginal or meritless legal dispute that people just hope to extract a favorable settlement from the insurance company.
Difficulty in estimating claims costs, a relatively minor problem: One-way attorney fees can make it difficult for insurance companies to estimate the total costs of a claim, as it is challenging to predict the outcome of a lawsuit, which determines whether the insurance company will have to pay the plaintiff’s attorney fees.
Higher Settlements: One-way attorney fees can push up settlement amounts for claims. This is because insurance companies may be more willing to settle claims, even if they have a good chance of winning in court, to avoid the possibility of having to pay the plaintiff’s attorney fees in the event of a loss. This means settlement is better than attorney fees.

Going from Florida to the Nation

Florida insurance crises are basically supply sided problems. I mean look at how many private insurance companies left or shut down there. But if we look around the entire country, you’ll find insurance losses across lines but especially in Property & Casualty.

Prove to yourself by entering the search phrase “News about insurance underwriter loss” and you will see many headline pieces. For example, “Private U.S. property/casualty insurers saw a $5.6 billion net underwriting loss in the first nine months of 2021,” according to this report on February 15, 2022.

State Farm provides another example, as its main auto unit generated $8.6 billion in underwriting losses through the first nine months of 2022.

One obvious solution is to raise insurance rates. This USA Today report tells us that auto insurance rate will go up this year. “Drivers nationally are spending an average of 2.93% of their income on car insurance this year, based on an average annual premium of $2,014 for full coverage insurance.” and “car insurance rates increased by nearly 14% between 2022 and 2023, compared with an overall rise in yearly inflation of 6.5% in December.”

What about California? “Progressive recently received approval for a 19% rate increase for those renewing their policies or buying new ones.”

Risk Transfer & Risk Management

In insurance business, there is a familiar saying that risk is inevitable, loss does not have to be — if we do risk management right.

Compared with raising price, risk management is a more efficient, sustainable and proactive way of lowering insurance cost and ensuring just and fair coverage for losses.

ChatGPT says the following: “Risk management and risk transfer are two different approaches to managing risks, and each has its own advantages and disadvantages. However, risk management is generally considered a better approach than risk transfer for several reasons:

Retaining Control: Risk management allows an organization to retain control over the risks it faces. By implementing risk management strategies, an organization can identify and assess potential risks and take steps to mitigate or avoid them. In contrast, risk transfer involves passing the risk to another party, which means giving up control over how the risk is managed.
Cost Effectiveness: While risk transfer can be a quick solution, it can be more costly in the long run. Risk transfer often involves paying premiums to an insurer, which can add up over time. Risk management, on the other hand, can involve implementing cost-effective measures to reduce the likelihood and impact of a risk.
Tailored Approach: Risk management allows an organization to tailor its risk management strategies to its specific needs and circumstances. This can result in more effective risk management than a one-size-fits-all approach, which is often the case with risk transfer.
Reputation: In some cases, risk transfer can damage an organization’s reputation, particularly if the transfer is seen as an attempt to avoid responsibility. In contrast, implementing effective risk management strategies can enhance an organization’s reputation by demonstrating a commitment to responsible and proactive management.”

The above answer provides a good overview of why risk management is better than risk transfer (i.e., insurance). However, the best approach is to do both risk management AND risk transfer. We cannot bet entirely on risk management because there are things out of our control. But we can do everything in our power of control to reduce and/or control risks. I propose the followings along that line:

The key to risk management is to empower employees and/or clients to quickly and easily learn the right and crucial things to improve risk reduction. The term “risk management” sounds like only managers are the stakeholder but that’s not the case. The best risk management is to mobilize all employees and clients to get the job done. Reaching that goal requires first and foremost modern technological tools.
ChatGPT, Smart contract, Internet of Things (IoT) & Tango are the four most important technologies for risk management with the potential to revolutionize insurance business by proactively and significantly reducing insurance cost and making insurance sustainable. Of the four, ChatGPT is likely to play the most important role because it is approachable by ordinary employees and clients. All we need to do is to expand its functionality to make it useful to professionals.
ChatGPT will not just give everyday texts for fun but will be trained professionally to understand, and then to explain, complicated legal documents such that even ordinary citizens can comprehend the gist of a 200 page legal document. This will significantly reduce the currently indispensable role of human attorneys (they may be needed to proof check the ChatGPT answer but that should not take very long.) The key is to reduce our reliance on the middlemen like attorneys by empowering the end users.
Another ChatGPT development is customized, always on, mobile and industry- or even firm-specific ChatGPT. The program will be locally pre-trained by records of past risks and past losses, and then provide intelligent and insightful answers to inquiries of all employees in dealing with new but similar problems. Localized and customized ChatGPT can do many things faster, better and cheaper.
Smart contract associated with blockchain will effectively reduce the problem of legal system abuse, over-crowed or jammed court rooms, long waiting lists of scheduled litigations — by drafting nothing less than really “smarter” contracts that are filled with very detailed, context specific “what if” terms and conditions (ChatGPT can help draft and interpret the document), taking into account all relevant historical cases and eliminating extra spaces for misinterpretation and post hoc litigation, while keeping the feature of automatic execution of a predetermined agreement. The idea is to work with a better beginning to save time and energy toward the end.
Internet of Things (IoT) will establish a field surveillance network at critical junctions of business operation to record objective evidence admissible to the court of law, deterring frivolous lawsuits and prevent predatory practices of trial attorneys. Even with caseload remaining the same as before, having historical field evidence will still speed up the litigation process.
Tango is the easiest and most intuitive training tool for employees by providing step by step guides with intuitive screenshots every step of the way that everyone can understand and easy to follow. In the future new employee orientations will be mostly done by watching Tango generated PDF files. Numerous risk management field guides can be developed with context specific Tango flowcharts to reduce the chances of misbehavior and mishandling.

Tags Assignment of benefit, Blockchain, ChatGPT, Empowerment, Florida, Internet of Things, Middlemen, One-way attorney fees, Risk management, Smart contract, Tango

Health Insurance

A Mississippi Physician Received Five Years for Hospice Fraud, What You Need to Know About Error & Omission Insurance?

Post author By Jay Jiyuan
Post date February 17, 2023

The Takeaways:

There have been repeated healthcare fraud cases related to hospice for financial gain, lack of oversight, complexity of hospice care and pressure to meet targets.
E&O insurance, also known as professional liability insurance, provides coverage for professionals who make errors or omissions while performing their duties, such as medical professionals.
Medical professionals, like physicians, should carry E&O insurance to protect themselves in case of claims of negligence or malpractice. In this case, if the physician had E&O insurance, they may have been able to use the coverage to pay for legal fees and damages awarded to the victims.
E&O insurance, however, does not cover intentional acts of wrongdoing such as fraud like in this case.

Repeated Offenses in Hospice Fraud

According to Fox News on February 9, a Mississippi physician named Nelson has been sentenced to five years in prison plus $15 million in restitution for healthcare fraud connected to hospice operations.

Evidence showed the physician referred numerous patients to hospices even though they were not terminally ill. A quick background information: To qualify for hospice care, doctors must certify a patient has six months or less left to live to receive Medicare coverage. In case the patient improves with increased life expectancy, the hospice is forced to discharge them from their care — otherwise it is considered hospice fraud.

In the above Mississippi fraud case, some patients were able to testify at the trial almost 10 years after Nelson put them on hospice care. You can imagine how bad the system misuse is.

Unfortunately, the case is far from being alone.

According to this report of December 2, 2021, two doctors who helped a local hospice agency scam Medicare were sentenced to a combined 23 years in prison. This case in 2017 also for hospice fraud. Another in 2020 the same. Still another in Texas in 2020.

What Is Hospice Fraud

According to this article, Hospice fraud revolves around hospice care and hospice patients. “It happens when caregivers, facilities, or organizations commit fraud against hospice patients or the public health systems responsible for covering hospice costs.”

The four major types are false claims (the most observed type that defrauds government-funded healthcare programs like Medicare or Medicaid, or charging patients for unnecessary services), kickbacks (incentives hospice providers give to nursing homes for patient referrals), false diagnosis (like in the Mississippi case), and improperly delivered services or products.

Hospices do not always provide needed or adequate care to their patients. These improper cares are called “deficiencies,” which is also a type of fraud. A recent study by the Office of Inspector General at the US Department of Health and Human Services found that over 80% of the hospices they reviewed had at least one deficiency.

Why Hospice Fraud So Popular

Several reasons explain for the frequent fraud related to hospice care:

Picking Uncle Sam’s pocket: Hospice care is often funded by government programs like Medicare and Medicaid, which can create easy target for fraudulent activities. A common case is overbilling for services or charging for services that were never provided.
Lack of oversight: The hospice industry is largely self-regulated, which means there may be a lack of oversight and enforcement of rules and regulations.

Complexity of hospice care: Hospice care can be complex and difficult to navigate, which can create confusion and opportunities for fraud. Patients and families may not fully understand the services they are entitled to, and providers may take advantage of this confusion.
Lack of education and training: Some hospice providers may not be properly trained in the regulations and laws surrounding hospice care, which can lead to unintentional violations or fraud.

If you ask me, I’d say anything related to seniors in this country is always vulnerable to crime, as many criminals specifically target this subpopulation. Similarly anything related to Uncle Sam is also crime or abuse prone. Hospice care happens to sit at the crossroad of both seniors and government. Fraud is almost inevitable.

What Is Error & Omissions Insurance

Error & Omissions Insurance can help — at least to a certain extent. But first, what is E&O insurance?

E&O is really just professional liability insurance, and is designed to protect professionals and businesses from financial losses that may arise from claims of negligence or mistakes in the services they provide.

Examples of professionals and businesses that may need E&O insurance include:

Doctors, dentists, and other healthcare professionals
Lawyers and legal professionals
Accountants and financial advisors
Architects and engineers
IT consultants and software developers
Real estate agents and brokers
Insurance agents and brokers
Advertising and marketing professionals
Event planners and organizers
Any business that provides professional services, advice, or expertise to clients.

It seems fair to say that most fields covered by E&O insurance are “brainy businesses.”

Ways E&O Can Help

Here are some ways in which E&O insurance can help professionals:

Legal costs: If a professional is sued by a client or customer for an alleged error or omission in their work, E&O insurance can help cover the legal costs associated with defending against the claim. In the Mississippi case, the physician could use his E&O to cover the legal costs.
Damages and settlements: If a professional is found liable for a client or customer’s financial losses due to an error or omission, E&O insurance can help cover the damages or settlements awarded to the plaintiff. Importantly, E&O does not provide coverage for intentional acts of wrongdoing like fraud. So this guy will be out of luck and would have to pay from his own pocket for the $15 million in restitution that the judge ordered.
Reputation protection: A professional’s reputation can be seriously damaged by a claim of professional negligence or error. E&O insurance can help cover the costs of hiring a public relations firm or marketing professional to restore their reputation. Again, intentional act of fraud does not deserve the protection of reputation.
Peace of mind: Knowing that they are protected by E&O insurance can give professionals peace of mind, allowing them to focus on their work and serve their clients without worrying about the potential financial consequences of a mistake or error. Again, physicians committed fraud cannot and should not maintain peace of mind from E&O insurance.

In sum, E&O is not designed for fraud but before you are convicted, E&O can certainly help you out. Do not take this benefit lightly. Hiring a top criminal defense attorney can help improve your outcome if you’ve been accused of hospice fraud. Hospice fraud accusations require expert legal assistance and time to clear the charges. These cases involve thorough investigations by multiple agencies. You need an experienced attorney for the best defense.

Tags Error & Omission Insurance, Hospice fraud

Life insurance

Is Annuity a Good Idea with Inflation?

Post author By Jay Jiyuan
Post date February 16, 2023

The Takeaways:

Investing in a time of inflation is essentially buying the best physical and financial products to preserve the value or the purchasing power of your money. The goal is to invest so that your rate of return on investment will beat the inflation rate.
An annuity is mostly a retirement product offered by insurance companies to provide protected, reliable income for life after retirement. It can help bridge the income gap between the savings you’ve accumulated over time, traditional sources of retirement income, like Social Security and the goal of living a comfortable retirement life.
The chain of reactions: Inflation entices fed to raise interest rates, which in turn push bond yield high, and potentially lead to higher annuity income. Bond yield is the rate of return earned by an investor who buys a bond and holds it until maturity (i.e., Annual Interest Payment / Face Value x 100.).
The higher the interest rate, the more money you earn on your annuity. When you’re ready to retire, you’ll have more wealth in your account as a result of earning higher interest, also with regular payment that is inflation adjusted to keep the same purchasing power for your retirement money.

A Common Question People Ask

I’m not sure about you but in my experience one of the most common questions people have asked is what the best investment is today. We can be curious for different reasons — sometimes just for the sake of striking a conversation, other times deadly serious about investing and making money.

Of course, you do not need me to tell you that one of the biggest concerns for today is inflation. Thus, the above question becomes what investment tool we should choose that can beat inflation.

Let’s find out first what ChatGPT has to say. Below is the heavily edited answer, as the original version was too “plain vanilla” for lacking a better word. My hope is to make the explanation easier and livelier.

Inflation means price hikes for goods (e.g., gas, eggs, meat) and/or services (e.g., ridesharing price), which lowers down how much goods you can buy with the same amount of money (e.g., $10).

Sometimes people ignored the fact that inflation must be sustainable for a period of time rather than a short-term phenomenon. You may also hear people saying inflation is “general” price hike, although inflation can be “sectorized,” meaning different sectors of an economy can receive different impacts rather than all sectors move together.

In a farming economy, food price can be a major driver of inflation, but in an energy or natural resource centered economy like Russia, oil price change plays a big role.

A simple, hypothetic example is $1 buys 3 eggs now, compared with 4 eggs before inflation. The value of your $1 decreased and it took one egg away from you (or 25% of its original value was “eaten” by inflation.)

Formally, we say the value of your money decreases, even though a $10 bill will always be $10 on the face value, no matter how long it sits in your wallet. Another way to say the same thing is consumer’s “purchasing power” goes down when inflation goes up. Note value of money comes from its purchasing power, in addition to other factors like its intrinsic value (e.g., gold or silver), acceptance, scarcity, stability, government backing.

General Principle of Investment During Inflation

Regarding what investment is the best for inflation, the idea is this: During inflation most if not all goods are getting more expensive or priced higher. This is the time to ask yourself what specific goods you should buy so that not only your initial investment will not be washed away or severely reduced by inflation, but you make money beyond the invested money — despite inflation.

Let me use an example to illustrate the point. If you believe the price of pork will be significantly higher one year from today, it will be a good idea for you to buy piglets and raise them so that one year later you can not only get your investment money back but with a large profit margin.

The pig example involves physical property. Another example of physical property is real estate. For those not know yet, real estate is known for its value in fighting inflation because housing price and rental income both tend to go up during inflation.

They are like boats: When the water level is up, boats go up with that.

As you can see from the above example, the key to fight inflation is to compare two rates. The first is inflation rate, typically measured by Consumer Price Index (CPI). The CPI is a measure of the average change in the prices paid by urban consumers for a basket of goods and services over time.

The second is your rate of return on investment. Say one year later the inflation rate hits 5%, but selling pigs gets you 10% of return, you win because your return is twice the inflation rate. On the other hand, with the same 5% inflation rate but your pig sales only offered you 4% of return, you know your real return is actually 4% – 5% = -1% or negative 1%, because real return must be adjusted against inflation.

Note sometimes you hear people mixing up “rate of return on investment” and “profit margin.” They are related but not the same. Briefly, profit margin focuses on measuring the efficiency of a company’s operations, while the rate of return on investment is on evaluating the performance of a particular investment, although both are percentage figures.

Investing in Financial Products

Investing in physical properties (pigs, real estate) sometimes is not the most convenient thing to do to earn a high return. To raise pigs you will need the piglets, the feed, the pig farm, the labor and the veterinary, to name just a few. To invest in rental income you must do a good job in maintaining the properties and also in dealing with dishonest renters.

Is there anything else that allows profit but is easy and fast to operate?

You bet. They have a special name “financial products” to differentiate from physical property. The former possess ideal features and should be among your first consideration for investing.

Speaking of investable financial products, in the old days gold came first but not anymore, as there are financial products that do better nowadays. I won’t get into the list of all the investment portfolio options for inflation purpose here. Let’s just consider one financial product that will benefit from inflation: annuity.

A Sideline Story of Eggs

Before proceeding, let me tell you a side story to lighten up the reading a little bit.

Assuming my previous hypothetic example of egg price in inflation is real, does it mean we should all stop buying eggs because their prices are so high and $1 now only gets you 3 eggs instead of 4?

I actually asked ChatGPT this egg question just for fun. Interestingly, although the database of ChatGPT does not cover the latest news, WebChatGPT, a free Google Chrome extension, does that. Every time you ask a question, the app will search three pieces of latest news related to the inquiry and then ask ChatGPT to present a conversational answer drawing from these reference.

Perhaps you already know the answer but formally, no, we don’t want to stop buying eggs if they are important to us. WebChatGPT also correctly points out that “the increase in egg prices is not directly caused by inflation, but rather as a result of various market factors.”

We need to separate consumption from investment, as well as separating segments of consumers. For some people eating eggs is a daily necessity and eggs are their staple food that nothing else can substitute. Others however will be happy to explore alternative sources of protein that are more affordable, such as beans, lentils, and canned fish.

Now let’s switch to the topic of “Annuity and Inflation.”

Nature of Annuity

Let’s begin from ChatGPT again. The following is an edited version of the answer.

An annuity is a financial product that provides regular payments to the owner over a certain period, often for the rest of their life. This means you won’t be too far off if you link annuities to retirement, as they are frequently retirement related investments products.

I say “not far off” because some annuity like immediate annuity provides regular income payments right away for a set period of time or for life, and you don’t have to wait until retirement. Instead, you can begin receiving payments immediately after purchasing the annuity with deposited fund.

Similarly with deferred annuity you may or may not have to wait until retirement — as long as you wait long enough to enter annuity’s “annuitization” phase (i.e., time to receive annuity payment).

You may hear some people calling annuity “annuity insurance” but that is not exactly right — even though annuity is a type of insurance contracts between insurance company and the person receiving annuity payment, or “annuitant” as they are called.

For one thing, insurance, especially life insurance, is designed to benefit one’s loved ones (i.e., spouse or children or any designated party), while annuities are mostly for oneself.

Secondly, annuities usually do not need a particular “trigger event” to start the payout, as long as enough money has been accumulated to pay. Life insurance however always requires that (most likely death but also terminal or chronical illness) to start the payout. In other words, you can’t start receiving insurance payment just because you feel like it. You must convince the insurance company that it’s time for them to pay you according to terms of the insurance policy. Annuity does not need you to do anything in particular, as everything is in the contract and is predetermined.

Finally, most annuity features regular payouts over a fixed interval, while life insurance can have a lump-sum payment to the beneficiaries.

Parties in the Annuity Contract

The typical parties listed on an annuity contract are:

Annuity owner: The person who buy the annuity either in a lump sum payment or more typically through a series of regular contributions in order to receive regular payments either immediately or wait for a period of accumulation.
Annuity issuer: The company or institution that issues the annuity and is responsible for making the payments to the annuity owner. This is generally an insurance carrier but can also include other financial service firms.
Annuitant: The person whose life expectancy is used to calculate the annuity payments. The annuitant can be the same person as the annuity owner or a different person. This is why I say annuity is mostly designed to protect oneself.
Beneficiary: The person or persons who will receive any remaining funds in the annuity upon the death of the annuity owner or annuitant. However, unlike a life insurance policy there is no guarantee for annuity beneficiary to receive money. It all depends on whether there is fund left in the annuity account when the annuitant died.

Let’s use a hypothetic example to show how annuity works on the high end. I made the human characters up, but the rest of story is reasonably realistic.

Owning a Luxurious Shipboard Condo

Beth is in her 50s and has never married with no child. As a company executive, her personal assets are in the millions. One day she received a phone call from her friend Gloria who is also in her 50s and a female executive in another firm. Gloria suggested Beth to check out the sales materials she received and invited Beth to own one of the “private residential yacht” apartment rooms next to her, in the world’s largest residential ship called MS The World with 12 decks, 165 luxurious shipboard condos built 13 years ago and equipped with every possible modern convenience in each apartment, costing from $825,000 to $7.3 million. Beth and Gloria each must prove a net worth of at least $5 million, then add another 10 to 15 percent for annual maintenance and other fees based on your apartment size.

Beth and Gloria have no problem with provable net worth, the concern is with the regular annual payment for maintenance and other fees. They both want to set up a way to take care of the money. Beth has a Farmers insurance agent friend named Tiffany who heard the issue and offered to help. Tiffany told Beth, and through her to Gloria, that since they both will own the shipboard condos after retirement, annuity would make sense for them.

How Annuity Works

The steps are listed below:

You make either a lump sum payment or a series of payments into an annuity account. For Beth and Gloria, a one-time only, lump-sum investment makes sense.
The annuity provider (or issuers, in this case, Farmers insurance) invests money from Beth and Gloria in a portfolio of assets such as stocks, bonds, and other securities.
The investments generate interest, dividends, or capital gains, which accumulate in the annuity account and are tax-deferred until you withdraw them. Here “tax deferred” means taxpayers owe IRS taxes on investments, revenues, or profits but they don’t have to pay now and can be “delayed” or “postponed” to the future. (If you know the concept of “time value of money,” you know $1 today carries more value than $1 next year, so delayed tax payment is a good thing.)
Depending on the type of annuity, you may receive payments immediately — if you made a lump sum investment into the annuity like Gloria and Beth will do, or at a future date, either for a fixed period or for the rest of your life. Most people will choose not to receive a lump sum payment. The whole reason they invest in annuity is to get a stream of regular payments month to month, quarter to quarter and year to year. In that case, the annuity issuer (i.e., Farmers in Beth and Gloria case) will write you a check on a regular basis and it’s worry free.
The amount of the payments depends on several factors, such as the size of the initial payment, the duration of the annuity, and the interest rate or returns generated by the investments.

An important thing to know is that sometimes an annuity can pay you (the annuitant, like Beth and Gloria) more money than you initially invested because the earnings from stock and/or interest rate from bonds are higher than expected.

Beth and Gloria each will invest $500,000, but Beth picks a “Single Premium Immediate Annuity (SPIA)” that provides a guaranteed income stream for life (or a specified period). This annuity is ideal for those who want to convert a lump sum into a guaranteed income stream. It is possible that Beth’s $500,000 may turn out to be $550,000 in the end, due to good marketing performance of the investment by the annuity issuer.

Gloria on the other hand decides to invest in a variable annuity, which is for annuitant with a higher risk tolerance and wants to invest in a range of mutual funds or other investment options within the annuity. Variable annuities can offer potentially higher returns but come with more risk and fees.

Why Is Annuity More Attractive During Inflation?

When price increases during inflation, annuities become a more attractive investment option because it provides a fixed income stream that is immune to inflation. For others without owning annuity, inflation lowers their purchasing power of money. An annuity, however, can provide a guaranteed income stream that is typically linked to inflation, meaning that the income increases along with inflation. This can help protect annuity owners from the negative effects of inflation on their purchasing power.

For example, say an investor (not Beth nor Gloria) purchases an annuity that promises to pay her $1,000 per month and inflation is 3%, the annuity may increase the payout to $1,030 per month to keep up with inflation. This has a special name for it: cost-of-living adjustments (COLAs), which helps her payments keep pace with inflation and keep her purchasing power over time, even if the general cost of living goes up.

Of course, money does not fall from the sky. The reason annuities can afford to pay COLA is because the insurer (or annuity issuer) will invest the annuity premiums in assets that will provide a higher return to offset the impact of inflation. According to this report, “In general, insurance companies earn more in bond yields when the Federal Reserve raises interest rates. As a result, they can offer their customers higher rates.”

Remember the “boat” metaphor I used earlier for real estate? When price level goes up, rental income and housing price goes up as well. This applies to annuity which is guaranteed income to annuitant.

Tags Annuity, Cost of living adjustment, Inflation, Inflation rate, Interest rate, Rate of return on investment

Property Insurance

A 14-year-old Stole 26 Kia and Hyundai in Two Months, What You Need to Know About Comprehensive Auto Insurance Coverage

Post author By Jay Jiyuan
Post date February 14, 2023

The Takeaways:

Design flaws (e.g., lacking electronic engine immobilizers in certain models of Kia & Hyundai) open the product up for theft or other property damages.
Social media could be a fast contagious source of risk exposures and financial losses if coupled with lax regulations and little screening of posts/clips.
Insurers can choose not to cover those models in the future, but existing policyholders of comprehensive coverage will still be covered under the current policy.

Owners can shop around for insurance carriers who do write policy for those models, and you can also find government sponsored insurance.

A Case of Youth Offenders Armed by Bad social media.

According to a February 5 report by Cleveland.com, criminal charges were filed in the week before against two 14-year-old Cleveland boys, one of them stole more than two dozen Kia and Hyundai cars that social media essentially unlocked them last summer.

The age of the suspects is not the only thing shocking, as “the number of insured Kias and Hyundais stolen in Cuyahoga County jumped more than 233% from October to December, when 656 cars were stolen in the county. Cleveland alone saw 459 thefts of the two makes in the final month of 2022.”

“The surge is sparked by a viral TikTok video from the so-called Milwaukee Kia Boys that showed how to steal the cars using a USB cable.”

“The technique works because the manufacturers did not install electronic engine immobilizers in models that require a metal key instead of a push-button start, an anti-theft measure that was ‘standard equipment on nearly all vehicles of that vintage made by other manufacturers,’ according to a September 2022 report from the Highway Loss Data Institute.”

The same HLDI report says stealing these vehicles became a social media trend in 2021 as car thieves began posting videos of their thefts and joyrides and even videos explaining how to steal the cars.

More specifically, HLDI released insurance claims data last September that confirmed that some 2015 through 2019 Hyundai and Kia models are roughly twice as likely to be stolen as other vehicles of similar age. Furthermore, these cars don’t have electronic immobilizers that were standard equipment on 96% of vehicles sold for the 2015-2019 model years.

In Chicago, where only 328 Kias were stolen in 2021, more than 3,500 were stolen last year, CBS Chicago reported.

According to Insurance Information Institute or Triple-I, three anti-crime organizations have asked YouTube to take down all videos that teach people how to steal Kia and Hyundai automobiles. The organizations – the National Insurance Crime Bureau (NICB), the Coalition Against Insurance Fraud, and the International Association of Special Investigation Units (IASIU) – made their request in response to a spike in thefts of these vehicles.

Celeste Dodson, president of IASIU, added, “When a vehicle is stolen, it is often not the end of the crime but the beginning. Vehicle thefts are associated with a multitude of criminal activity, including insurance fraud. The cost of these crimes is then passed on to consumers through higher premiums.”

Legal Ramifications

The story does not stop with those cars already stolen, owners of those makes and models are all affected. The aforementioned report by Cleveland.com says that “Progressive and State Farm, two of the country’s largest auto insurers, said in the last week that they have stopped writing new policies for certain makes and models of Kias and Hyundais. And some existing customers in places like Denver and St. Louis have seen their insurance premiums hiked in recent months, news outlets have reported.”

“A Missouri-based attorney filed a lawsuit in federal court in October that seeks class-action status on behalf of owners of the affected Kia and Hyundai models.

“Seattle on Friday sued the manufacturers after that city saw a jump from 48 of those makes stolen in August to 197 in December.

“Asked whether Cleveland would consider such an action, city spokeswoman Marie Zickefoose said, ‘the law department is evaluating options at this time.’”

How Bad social media can impact insurance.

Spread of misinformation: Social media platforms can spread misinformation about insurance products and services, leading to confusion and mistrust among customers.
Reputation damage: Negative comments and reviews about insurance companies can quickly spread on social media and harm their reputation. This can lead to a loss of trust and business.
Cybersecurity risks: Insurance companies that use social media to collect sensitive information from customers may face cybersecurity risks, such as data breaches and hacking. The cases we are talking about here are of this category.
Regulatory compliance: Insurance companies must comply with strict regulations regarding the use of social media. Misuse of social media, such as making false or misleading statements, can result in legal and financial consequences.
Negative customer experiences: Insurance companies that use social media to process claims or respond to customer complaints may not always provide the level of customer service that customers expect. Negative customer experiences can be amplified on social media and harm the reputation of the insurance company.

Are Kia and Hyundai Owners Out of Luck?

If you’re a current owner of a Kia or Hyundai from those vulnerable model years, don’t worry if you bought a comprehensive coverage for your auto, which typically cover theft of a vehicle, including a Kia or Hyundai model without an electronic engine immobilizer.

Comprehensive insurance is a type of auto insurance coverage that protects against damage to your vehicle that is not caused by a collision. This includes theft, vandalism, fire, and natural disasters.

However, the exact coverage and details of a comprehensive insurance policy can vary depending on the insurance company and policy terms, so it’s important to review your policy documents or speak with your insurance provider to understand what is covered and what is not.

If you recently bought a secondhand Kia or Hyundai of those model years, even though some insurance companies won’t issue policy for your auto, you can still do your research and shop around to find insurance carriers that do provide coverage for your model.

You can also check with your local Kia or Hyundai dealership to see if they have any recommendations for insurance providers that offer coverage for their cars.

Additionally, you may be able to find coverage through a government-sponsored insurance program or a specialty insurance provider.

Tags Comprehensive auto insurance, Electronic engine immobilizer, Kia & Hyundai model theft, Social media, State farm

Liabilities Insurance

Boy Scouts of America Was Bankrupted from Sexual Abuse Lawsuits, What You Need to Know about Commercial Liability Insurance?

Post author By Jay Jiyuan
Post date February 14, 2023

The Takeaways:

The most fundamental commercial insurance is general liability insurance. No business should be doing any business without commercial liability coverage. In my opinion, commercial liability insurance should become mandatory by law, just like nobody should be allowed to drive without auto liability insurance for personal injures and property damages.
Insurance coverage needs to meet the specific nature of business. BSA works exclusively with youth and therefore is exposed to sexual abuse with minors. It is far better to work on risk management to prevent risks from getting escalated and to avoid huge insurance payment.
There will be lawyers trying to leverage the existing lawsuits to make money for themselves by filing unfounded claims. There will also be collusion between organizations and claimants to get insurers to pay. Once again, the best preventative step is to avoid lawsuits preemptively through means of risk management, especially in commercial insurance.
Insurance and lawsuits are closely related. Insurers must pay close attention to legal battles that sometimes can make or break themselves.

The Stories in 2020 & 2023

This insurance journal article did a good job in offering a brief overview of the history of the Boy Scouts of America BSA bankruptcy case and quickly shows where the problem is:

“When it sought bankruptcy protection in February 2020, the BSA had been named in about 275 lawsuits and told insurers it was aware of another 1,400 claims. The huge number of claims filed in the bankruptcy was the result of a nationwide marketing effort by personal injury lawyers working with for-profit claims aggregators to drum up clients, according to plan opponents.”

Guess what the number of claims is today? “More than 80,000 men have filed claims saying they were abused as children by troop leaders around the country… the staggering number of claims, when combined with other factors, suggests that the bankruptcy process was manipulated.”

Even “a plaintiffs’ attorney acknowledged that some 58,000 claims probably could not be pursued in civil lawsuits because of the passage of time.” That is, many or most men in the lawsuits will have little chance of winning any compensation.

Shortly after the bankruptcy in 2020, BSA had announced several plans (like this and this) to settle down its sexual abuse lawsuits with minors.

Why Insurers Want to Reverse the BSA Bankruptcy Reorganization Plan

Under the bankruptcy reorganization plan, which In September was approved by the U.S. Bankruptcy Judge Laurie Selber Silverstein for $2.46 billion, and described by the BSA as a “carefully calibrated compromise,” the BSA itself “would contribute less than 10% of the proposed settlement fund… The bulk of the compensation fund would come from the BSA’s two largest insurers, Century Indemnity and The Hartford, which reached settlements calling for them to contribute $800 million and $787 million, respectively. Other insurers agreed to contribute about $69 million.”

On the other hand, “Insurers opposing the plan argue that the BSA is contractually obligated to assist them in investigating, defending and settling claims, as it did before the bankruptcy. They say that the BSA, desperate to escape bankruptcy, colluded with claimants’ lawyers to inflate both the volume and value of claims in order to pressure insurers for large settlements, then transferred its insurance rights to the settlement trust. The insurers argue that if the BSA transfers its rights under insurance policies to the settlement trustee, it must also transfer its obligations under those policies.”

In other words, the insurance companies are accusing BSA for working under the table with claimants to inflate the value of claims and to shift the financial responsibility of compensating sexual abuse victims to insurers without working with insurers to verify the claims.

Lessons Learned

The bankruptcy of the Boy Scouts of America (BSA) serves as a case study in the importance of adequate insurance coverage.

Lesson 1: The importance of liability insurance. The organization was facing a large number of lawsuits related to the sexual abuse of minors. In the absence of adequate liability insurance, the BSA would have been forced to pay out millions of dollars in damages, potentially putting the organization’s very existence in jeopardy. However, the BSA had liability insurance in place, which allowed it to weather the legal storm and continue its operations.

Lesson 2: The need for insurance coverage to match the nature of the organization. BSA is a youth organization that works with minors, making it particularly vulnerable to sexual abuse lawsuits. Therefore, it was essential that the organization have liability insurance coverage that was adequate for this type of exposure. Organizations that work with minors should take this lesson to heart and ensure that their insurance coverage is sufficient to protect them in the event of similar lawsuits.

Lesson 3: The need for ongoing review of insurance coverage. BSA should have ongoing review of insurance coverage to ensure that insurance coverage remains adequate, as the insurance needs of an organization can change over time. For example, had BSA reviewed its insurance coverage in recent years and discovered that it was insufficient, it could have taken steps to increase its coverage and avoid the financial strain of the lawsuits it faced.

Lesson 4: The best strategy for all insurers is to manage risks and reduce them before they turn into large scale social scandals for policyholders, which will invite opportunists to seek financial gain from the “no risk, pure gain” legal class actions.

Tags Boy Scouts of America, BSA Bankruptcy reorganization plan, General liability insurance, Risk management, Sexual abuse of minors, Unfounded claims

Property Insurance

Earthquakes Killed 17,500+ in Turkiye & Syria, What Lessons Can We Learn?

Post author By Jay Jiyuan
Post date February 13, 2023

The Takeaways:

Insurance matters all the time — oftentimes we don’t see until hit by a catastrophe. In the end, buying insurance could be the best investment you ever make in your life.
Earthquake insurance coverage is not a decoration number to make the insurance book pretty, it can be the difference between life and death.
Coverage must be enforced to save lives and get the places quickly up from disasters.
Reinsurance matters especially for catastrophic events to keep insurance carriers on their feet rather than bankrupted or out of business.
Some governments like China emphasized political mobilization of citizens to stay safe in pandemic, which has its own liability and risk. It is better to have risk management (e.g., massive social lockdown) and risk transfer (i.e., insurance coverage) at the same time.

Earthquake News in the Words of a Financial Rating Agency

According to financial ratings agency Fitch on Thursday February 9, the initial earthquake and numerous aftershocks struck southern and central Turkiye and western Syria on 6 February had claimed more than 17,500 lives so far from a maximum magnitude of at least 7.8, the most severe earthquake in the region since 1999.

The toll is expected to rise as rescuers comb the rubble for survivors. On top of that, insurable losses are hard to estimate as conditions change all the time. At this time “they appear likely to exceed USD2 billion and could reach USD4 billion or more. However, insured losses could be much lower, perhaps around USD1 billion, due to low insurance coverage in the affected regions.”

“The Turkish Catastrophe Insurance Pool (TCIP) was created after the Izmit earthquake of 1999 to cover earthquake damage to residential buildings in urban areas. However, it does not cover human losses, liability claims or indirect losses, such as business interruption. Moreover, earthquake insurance cover is technically mandatory in Turkiye, but is very often not enforced in practice. As a result, many residential properties are not insured, particularly in many of the affected areas, where low household incomes constrain affordability.”

Six Lessons Learned

Importance of insurance coverage: The low insurance coverage in the affected regions highlights the importance of having adequate insurance coverage. It’s crucial to understand the risks that you face and to make sure you have the right coverage in place to protect yourself, your family and your assets.
Risks in underinsured regions: Natural disasters can strike anywhere and perhaps in least expected times. They can result in significant losses for sure. In regions where insurance coverage is low, the economic impact of a disaster can be even more devastating. This highlights the need for governments and insurance companies to work together to increase insurance penetration in these areas.
Preparedness is key: While insurance can help mitigate the financial impact of a disaster, being prepared in advance is crucial. This includes having an emergency plan in place, taking steps to secure your home and property, and staying informed about potential threats. We don’t have detailed information on how well the Turkish people were prepared but judging from the low coverage rate we have reason to suspect a low preparedness this time.
Reinsurance matters by sharing and spreading risk among insurance companies. Major catastrophes almost always rely on reinsurance to save insurers.
The importance of accurate loss estimates: Accurate loss estimates are critical for the insurance industry to respond appropriately to a disaster. Insured losses from a disaster can have a significant impact on the financial stability of insurance companies and the broader economy. It is reasonable to think that preparedness and accurate loss estimates are linked such that when one is low, the other is low as well.
Some places (e.g., China) have emphasized risk management (e.g., massive social lockdown and tests) during pandemic, but doing that without developing a good system of risk transfer (i.e., insurance) has its own risks. What we need is both risk transfer and risk management.

One Knowledge Point: Insurable vs. insured losses

In the above news by Fitch, there is a big gap between insurable loss and insured loss. Below is the highlighted difference between the two.

Insurable losses refer to the potential losses or damages that an individual or business can be covered from an insurance policy. This could include losses due to property damage, liability, theft, natural disasters, and other covered events as outlined in the insurance contract. Insurable losses are the losses that the insurance companies are willing to provide coverage for.

Clearly not all losses are insurable. Uninsurable losses are risks or events that cannot be covered by insurance due to various reasons, such as reputational risk, regulatory risk, trade secret risk, political risk, and pandemic risk. In addition, some risks may also be considered uninsurable due to the absence of adequate data or the difficulty in predicting the likelihood and severity of the losses.

Insured losses, on the other hand, refer to the actual losses that occur and are covered by an insurance policy. When an insurable loss occurs, and if the individual or business has insurance coverage, they can file a claim to receive compensation for the covered losses. The compensation provided is limited to the terms of the insurance policy, including the maximum coverage amount, deductibles, and exclusions.

From the Turkish earthquake we can see sometimes there can be a huge gap ($3 billion) between insurable ($4 billion) and insured losses ($1 billion), due to a low coverage rate and unenforced mandatory insurance in certain jurisdictions.

But Turkiye is not alone. According to this report, the cost of storm damage in an average year results in USD 19 billion in uninsured losses from flooding in the US, compared to USD 5 billion in insured losses. This is due to the fact that only one in six homes in the US has flood insurance, and many risks related to flooding are considered uninsurable.

Reinsurance Matters

From the Fitch news we also learned that the bulk of the insurance cost will be covered by reinsurance and there is no major impact on the rating of the insurance companies.

So what is reinsurance? This article provides a highly readers friendly answer:

“At its most basic level, reinsurance is insurance for insurance companies. If there is a catastrophic event that affects many homeowners, like a hurricane or strong earthquake, those losses can be so staggering that paying claims could cause an insurance company to become insolvent.”

Reinsurance works by allowing insurance companies to purchase insurance policies from other insurers, thus spreading the risk across multiple companies. This helps to reduce the likelihood of large payouts for a claim and allows insurance companies to remain solvent by recovering all or a portion of their losses through the reinsurance process. For example, in a hurricane or strong earthquake that affects many homeowners, the losses can be too high for a single insurer to pay all the claims, causing the insurance company to become insolvent. In such a case, reinsurance allows the insurance company to transfer some of the risk to another insurance company, reducing the potential for insolvency.

Tags Catastrophe, Coverage rate, Earthquake insurance, Fitch ratings, Insurable vs insured losses, Reinsurance, Risk management, Risk transfer, Turkiye & Syria earthquakes, Uninsured & underinsured

Property Insurance

Oh No, a 50-Car Train Derailment in Ohio! What Insurance Covers That?

Post author By Jay Jiyuan
Post date February 7, 2023

The Takeaways:

For train derailments the first thing coming to many minds is “inland marine” insurance, which however may not be true.
Commercial general liability insurance usually covers the most ground.
The cause of the derailment, the ownership of the train and cargo, and the location of the incident, these may all enter the equation.
If the train was carrying hazardous materials, there may also be environmental liability insurance in place to cover any cleanup and remediation costs, although this may not be relevant for trains carrying cars.

The Bad News

According to the AP news on February 4, 2023, “A freight train derailment in Ohio near the Pennsylvania state line left a mangled and charred mass of boxcars and flames Saturday as authorities launched a federal investigation and monitored air quality from the various hazardous chemicals in the train.”

“About 50 cars derailed in East Palestine at about 9 p.m. EST Friday as a train was carrying a variety of products from Madison, Illinois, to Conway, Pennsylvania, rail operator Norfolk Southern said Saturday. There was no immediate information about what caused the derailment. No injuries or damage to structures were reported.”

“20 of the more than 100 cars were classified as carrying hazardous materials — defined as cargo that could pose any kind of danger ‘including flammables, combustibles, or environmental risks.’”

50 Car Train Derailment in Ohio. Source: AP News Drone Image

Now, who is covering the big mess?

A 50-car train derailment can result in significant property damage, environmental harm, and liability for personal injury. The type of insurance that would cover this loss would depend on several factors, including the cause of the derailment, the ownership of the train and cargo, and the location of the incident.

Generally, liability coverage is provided by commercial general liability insurance and railway protective liability insurance. The railway company may also have a self-insured retention or deductible to cover smaller losses. If the train was carrying hazardous materials, there may also be environmental liability insurance in place to cover any cleanup and remediation costs.

In the event of damage to the train and cargo, the railway company and/or the owners of the cargo may have marine cargo insurance or inland marine insurance. If the train was being operated under a lease agreement, the lessee may have rolling stock insurance to cover the dam age to the train.

It’s important to note that insurance coverage for a train derailment can be complex and the actual coverage will depend on the specific policy language and any exclusions that may apply.

As a final note, the news did not tell us details about what caused the accident, who own the train and cargo. Knowing those will allow us to say more about the insurance.

Would inland marine insurance policy cover train derailment?

If you know even a bit of insurance, enough to get you pass the license exam, then you most likely will remember a type of insurance called “inland marine” insurance.

Inland Marine Insurance Covers Stuff in Move

This is a funny name because the term “marine” historically referred to transportation of goods by water or even ocean, but now it also covers transportation of goods by land. The term “inland” distinguishes this type of insurance from “ocean marine” insurance which specifically covers transportation of goods by sea.

Inland marine insurance generally covers goods in transit and other movable property, such as bridges and tunnels, and provides protection against loss or damage from various causes such as theft, fire, and weather events being moved within a country.

In the case of a train derailment, an inland marine insurance policy may provide coverage for the damage to the goods or property being transported by the train. This would depend on the specific policy language, the cause of the derailment, and any exclusions or conditions that may apply.

It’s important to note that while inland marine insurance may provide coverage for goods and property being transported by train, it is not specifically designed to cover train derailments. For that, the railway company and/or the owners of the cargo may have railway protective liability insurance or commercial general liability insurance.

Additionally, if the train was carrying hazardous materials, there may also be environmental liability insurance in place to cover any cleanup and remediation costs.

What is environmental liability insurance?

Environmental liability insurance is a type of insurance coverage that protects individuals and businesses against financial loss and legal liability for damages or injury to the environment, including natural resources and wildlife, as a result of their operations or products. It covers costs associated with cleaning up contaminated sites, compensating affected parties, and defending against legal action related to environmental issues. Environmental liability insurance is often required by law for certain industries and businesses, and is also available to protect against the risks associated with environmental incidents caused by a third party.

Environmental Liability Insurance Covers Hazardous Materials

Tags Commercial insurance, Environmental liability insurance, General liability insurance, Inland Marine Insurance, Property & Casualty Insurance, Train derailment

Cryptocurrencies & NFTs Financial talks at dinner table

Algorithmic Stablecoins Require Right Mindset + Reserve

Post author By Jay Jiyuan
Post date July 11, 2022
3 Comments on Algorithmic Stablecoins Require Right Mindset + Reserve

The Kingstons continued their conversation on stablecoins, especially on algorithmic stablecoins, the purest form of truly decentralized stablecoin that, in its extreme case like TerraUSD, may have nothing tangible to back it up in case of breaking the peg.

Kimberly: We haven’t talked about algorithmic stablecoins yet, and I feel we have to because they are more in troubles these days, like the Terra Luna stablecoin.

Greg: You are right. But first thing first, not all algorithmic stablecoins were born equal. I know many people are talking about TerraUSD and using that as a convenient case against all stablecoins. I recently went to an investment conference and one speaker there brushed away all stablecoins as “failed experiment” citing the Terra case. But Terra, or more accurately “UST” as the stablecoin in the Terra ecosystem is called, is an exception because it relies on smart contract algorithm, very little on full or excess backup reserve.

Kimberly: So does it mean having solid backup reserve is the key for the success of stablecoins?

Greg: I would say so at this early stage of stablecoins, which have yet to establish widely accepted trust or even broad awareness. But reserve matters even with public trust because trust does not fall from the sky but must grow up from the ground. Reserve provides the rich soil for trust to grow. To see it from a crisis prevention perspective, there is an article in Investopedia that says it well: Reserves are an antidote to panic.

Joy: The recent story with Tether proves how important reserve is. According to an article from blockworks.co, after the crash of UST, Tether investors rushed to redeem or to get rid of more than $16.3 billion worth of Tether token or “USDT” as the largest stablecoin is called. They either switched to dollars or to rival stablecoins like the second largest stablecoin USD Coin or “USDC.”

Emily: These names are confusing sometimes. But I guess they all start with USD, which stands for “US dollars”, right?

Joy: Right. The last letter tends to separate them. The “T” in USDT stands for Tether, “C” in USDC means Circle, the issuance entity for the USD Coin or USDC, while “T” in UST stands for Terra. BUSD is an exception because it uses the first letter of “B” to indicate the issuer of Binance.

Greg: The two stablecoin giants, number one ranked USDT by Tether and number two ranked USDC by Circle, clearly understand how important reserve is for getting public trust. After the crash of UST, these two stablecoins both tried to convince the public that they are financially fine with reserves. Circle announced they would publish weekly reserve report from now on, and Tether released an assurance report on its reserves by an auditing company MHA Cayman.

Joy: It’s interesting that Tether could only get a Cayman Island based auditing firm to write the report, not by a US based auditor. Its reserve composition is also less transparent than USDC is. I was worried that USDT would lose its crown as the top stablecoin. But in the end, although it experienced the largest “run” away that forced Tether to “burn” 20% of USDT token, Tether managed to keep its dollar peg and also the title of the largest stablecoin.

Greg: I wasn’t too concerned because USDT is centrally controlled and far better reserved than UST. During times of uncertainty, people always look for things they are familiar with, and having central control and backup reserve are the comforting factors.

Kimberly: Mom says USDT “burned” tokens, what does it mean?

Greg: “Burning” and “minting” are the two basic operations for changing the market supply of digital token or coin. I use “tokens” and “coins” interchangeably because digital coins are nothing but tokens. When they are “burned,” it means to send them to addresses or digital wallets that can only receive — never release or return — the token, as if they were dollar bills burned to ashes. Burned coins have been removed permanently from market circulation and the total coin supply is reduced.

Kimberly: But why do we want to do that? Are we having too many coins in circulation than needed?

Lily: Let me guess: The “law of scarcity” applies. When the USDT price drops below the peg, say one USDT only buys $0.989 instead of $1.00, it signals that the demand for USDT is lower than its supply, as more investors would keep dollars than USDT. Tether must “burn” some USDT tokens to take them out of circulation to push the value of USDT up to $1.00, all because things in short supply have higher value, other things equal.

Joy: And in the opposite scenario Tether must “mint” USDT when its price rises above the peg. Say one USDT coin can sell at $1.015, which means more investors want USDT than dollar. “Minting” USDT then increases the coin supply to push the price down to $1.00 peg.

Lily: So the story says “when USDT price drops, burn, when it rises, mint!”

Greg: To “burn” is to decrease USDT supply or equivalently to increase its scarcity; to “mint” is to increase USDT supply or decrease its scarcity. Think of the price of watermelons: In the summer more watermelons are available, and we can get one for just $4.99 even in the Bay Area. In the winter the supply of watermelons is decreased, so we must pay a higher price like $8.99. Now, if supermarkets want to keep the same price, say $6.99 throughout the year, they will put some watermelons into storage in the summer and release them from storage in the winter — assume a watermelon can be stored for months. Burning USDT is like putting watermelons into storage in the summer to raise its price from $4.99 to $6.99, while minting USDT is like releasing watermelons in the winter to lower its price from $8.99 to $6.99.

Kimberly: That makes sense. Do other stablecoins work the same as Tether’s USDT?

Greg: Yes and no. All stablecoins have the “burn” and “mint” operations but they do that somewhat differently. The two largest stablecoins, Tether’s USDT and Circle’s USDC, are both centrally controlled, which means they rely on a central authority to determine when to “burn” and when to “mint.” Algorithmic stablecoins are smarter as they rely on smart contract to automatically control burning or minting.

Kimberly: Speaking of algorithmic stablecoins, what about the most famous one, the UST? Does it use burning and minting as well?

Greg: Of course but in its own unique way. Basically it played a “seesaw” game using the stablecoin UST and a governance coin called “LUNA.”

Emily: What’s a governance coin?

Greg: It’s a coin that offers voting right to its owner, like stockholders voting for company issues. For our purpose it’s better to think of LUNA as a “sister” or a “utility” coin because it’s used as a tool or incentive to help UST maintain its peg with dollar.

Kimberly: How do the two work out together?

Greg: At the first glance you may think the design is clever. The Terra ecosystem has a special deal for trading between LUNA and UST. It says whenever investors swap LUNA token for UST or sell UST to buy LUNA, they can do that at a guaranteed fixed price of $1 — even though the prices of UST and LUNA are subject to market fluctuation. We can think of LUNA and UST as “identical twins” and if a LUNA owner wants to buy UST, or a UST owner wants to buy LUNA, the price will always be fixed at $1.00. This part of transaction sounds simple. But here is what gets complicated: The prices of LUNA and UST will both vary on the open market. This creates an opportunity for arbitrage.

Kimberly: It’s complicated indeed. Please give an example and explain what arbitrage is.

Greg: Let’s say in the stablecoin open market the UST is currently priced at $1.02, meaning one UST token or coin can sell for $1.02, 2 cents above the $1.00 peg. Meanwhile, say the current price of LUNA token is $0.50. I’m making it up because the real price of LUNA now is around $0.0001. If UST and LUNA were not “identical twins” with a price guarantee, LUNA owner will have to pay $1.02/$0.5 = 2.04 tokens to get 1 UST coin. With the price guarantee, whoever holding LUNA tokens will only pay $1.00/$0.5 = 2 LUNA tokens, not 2.04. Meanwhile everyone else without LUNA token have to pay $1.02 to get one UST coin. The saving of 2 cents is not much but comes risk-free because Terra system sets up that way. In addition, if I own one a lots of LUNA tokens and use them all to buy UST coins, the profit adds up quickly. This is how arbitrage works, which is nothing but legitimate ways to make money by taking advantage of price differences.

Kimberly: So Terra knew there would be price breaking away from the peg and designed the seesaw game to encourage arbitrage as a way to bring UST price back to the peg, right?

Greg: Yes. Now what would happen when investors all rush to get UST using every LUNA token they have? The price of UST will go down while LUNA price will go up. Why? Two ways to understand it. The first is to think about watermelons again: When all supermarkets are flooded with watermelons in the summer, they will lower the price for quick sale. This works the same for UST. When investors are buying UST, the market will be flooded with UST tokens, just like the watermelons in the summer. The UST price will go down. The other way to look at it is to think of the “burning” and “minting” operations. When investors are buying UST, new UST tokens must be minted, and the spent LUNA tokens will be burned. This also leads to a lower price of UST and a higher price of LUNA.

Kimberly: You just described the scenario when UST goes above the $1.00 peg. How about UST price going below the peg, which is more likely to happen as we all know?

Greg: It works the same way as a seesaw game. Say one UST coin only sells at $0.985 rather than $1.00 in the open stablecoin market, but within the Terra system one UST coin can still sell $1.00 worth of LUNA, which is 2 tokens. Guess what investors will do? Everyone will sell UST at $1.00 to buy 2 LUNA tokens, because in the open market one UST coin only gets you the equivalent of $0.985 in LUNA, which is $0.985/$0.5 = 1.97 tokens. From there the watermelon story repeats itself, in the sense that LUNA price goes down and UST price goes up. Again, arbitrage helps bring UST closer to the peg.

Lily: It just came to me that the seesaw game played by UST works much like the central bank: Fed sells government securities to banks to reduce the money supply in order to raise the interest rate; Fed buys government securities from banks to increase money supply in order to lower the interest rate. Fed has a goal of keeping the inflation rate at 2%, just like stablecoins have a goal of $1.00 peg with the dollar. Fed manipulates government securities just like UST relies on arbitrage with LUNA to stay on peg.

Kimberly: If so, why has UST failed so miserably while the Fed has been playing the same seesaw game for decades or centuries and it works fine.

Greg: It goes back to the backup reserve that we’ve been talking about. Fed has the deepest pocket that Terra can never match. Nobody will worry about Fed default because it has all the cash they want to buy securities. Terra on the other hand was severely under-reserved. An article published by Coindesk.com tells us that before its collapse in May 2022, UST had a market capitalization of $18 billion, but its reserve was less than $4 billion.

Joy: The way I see it, we also have a mindset problem. In other words, there is more to stablecoin than scarcity. We need to understand social psychology to be successful in major innovations. Understanding public mindsets allows us to foresee things before price changes or more importantly before crisis hits. The sustainability and value stability of stablecoins demand more than scarcity. Meanwhile, many in the crypto world, from Satoshi to the Terra co-founder Do Kwon, only focus on scarcity. Satoshi and his followers believed controlling the total supply of Bitcoin to 21 million is enough to control inflation. Do Kwon believed playing a seesaw game between two coins of UST and LUNA is enough to keep the value of stablecoin stable. Reality has proven them wrong. Bitcoin has been a lousy “inflation hedge,” while UST had a free fall in value. It’s the willingness to adopt that plays a more important role.

Greg: Sounds interesting. How does the “willingness to adopt” works?

Joy: It’s about convincing as many people as possible, not just the current investors in UST or LUNA. To do that, we have to understand what public hidden concerns are and offer insurance or assurance. I want to cite the example of FDIC for bank deposits. FDIC works its wonder since 1933 not because it sits there waiting for scarcity to show up. Instead, it preemptively offers a signal of assurance to all depositors by promising a coverage of up to $250,000 to boost public confidence.

Emily: What is FDIC?

Joy: Its full name is “Federal Deposit Insurance Corporation”. It’s a great way to ensure the safety and security of funds for all depositors. FDIC was founded in 1933 and ever since then it claims that not a single depositor has lost one penny of the deposited funds under its coverage.

Greg: Good point. I wish the Terra folks understood this before betting everything on UST and LUNA. It’s easy to ignore the big picture and single out scarcity and technicality — it’s easy to be penny smart and pound foolish. Many things done by central banks are not replicable by an entity because behind the Fed is the silent but almighty “Uncle Sam” who holds a unique and exclusive power of collecting taxes from every taxpayer. Fed should always issue a warning before making a policy move that says “Danger, do not try it at home!”

Emily: I want to go back to bank runs. Mom says investors were running away from Tether and redeemed $16 billion USDT for dollars, is that the same as bank runs?

Joy: Running away from a stablecoin is not the same as running away from a bank. The biggest difference still comes down to backup reserve. They also have different business models. With banks nobody can ask them to hold all the deposit, because banks make money by lending the deposits out or by investing the deposits in something else. To ask banks keeping all deposited money in their vaults is asking for bankruptcy.

Emily: Why is that?

Joy: Let’s say Bank of America receives $100 million from depositors in a month, if the Fed asks it to keep 10% of the deposits, Bank of America will lend $90 million out to earn higher interest to keep its door open. The Fed will never ask the bank to keep 100% of deposit.

Kimberly: But what if all depositors rushed to get their money out, no bank can pay them all and will be forced to shut down, right?

Joy: That’s where FDIC comes into play. Also, Tether has limited itself to institutional or large investors as it demands a minimum fiat withdrawal or deposits of $100,000. Clearly it is not for general public.

Kimberly: Now we know how banks make money, what’s the business model for stablecoins? I mean how do they make money?

Greg: There is an article on the website Binzinga.com that talks about that. There are several ways. They can charge issuance and redemption fees. When an investor pays dollar or other collateral to get stablecoin, she’ll be charged “issuance fee.” When the investor wants to get rid of the stablecoin and get dollar or other collateral back, she’ll be charged “redemption fee.”

Joy: Centralized stablecoins makes money mainly through short term lending and investing. One example is Tether loaned $1 billion to Celsius Network in October 2021. The latter would pay Tether an interest rate of 5% to 6% per year, which means Tether received between $50 to $60 million dollars per year.

Kimberly: So this works just like banks.

Joy: Except the required amount in reserve is usually higher — much higher — for stablecoins than for banks because FDIC does not cover stablecoins.

Greg: Lending is not the only way stablecoins make money. The other way is investment. Stablecoins are backed by assets, but not necessarily all by cash. For example, in July 2021, 61% of USDC reserves were in cash or cash equivalents while the rest was invested in a variety of assets such as Certificates of Deposit, corporate bonds, municipal bonds, U.S. Treasuries and commercial paper. They can invest in money market funds like commercial papers and better yet, treasury bill.

Emily: What is treasury bill?

Joy: It’s called “T-bill” for short. It’s short term debt issued by the Treasury Department to borrow money from the public. Its term ranges from 4 to 52 weeks, meaning an investor can buy T-bill today and the Treasury Department will pay her money back no later than the 52^nd week. Because of the short time, T-bill will not pay interest, but investors can buy at a discount price from the par value.

Emily: What’s par value?

Joy: Par value is the face value of the T-bill. It’s the amount of money that the Treasury Department promises to pay the investor back when the bond reaches the maturity date. For example, say I bought a T-bill of $1,000 that is mature in 4 weeks. If the T-bill is discounted at 20%, I will only pay $800 today to receive the bond and after 4 weeks, the Treasury Department will pay me $1,000 to get the bond back.

Greg: Tether is not the only stablecoin doing the lending business. The second largest stablecoin, USDC, also does that. Jason, please check the market caps for top stablecoins from www.coinmarketcap.com.

Jason: It stays USDT ranks number three overall but the largest stablecoin by market cap. Its price is $0.9991. USDC is right behind Tether, with a price of $1.00.

Kimberley: How is USDC doing better than Tether in pegging?

Joy: According to an article by gemini.com, USDC has central control just like Tether does. Also like Tether, USDC is fully backed by reserve. What sets USDC apart is that its reserve is held at regulated US financial institutions, just like commercial banks do in the traditional finance. Furthermore, it’s audited by a U.S. accounting firm that issues monthly report on the reserves backing USDC.

Kimberly: If I remember correctly, Tether holds its reserve to itself, not to outsiders, right?

Joy: That’s right, and that may explain why the article from blockworks.co says only Tether knows what exactly its backup reserve is made up of. This also made it harder for Tether to obtain a creditable auditor willing to issue public reports about its reserve.

Lily: So the real lesson is that people are willing to invest in crypto and use stablecoins as long as (1) they are fully reserved, preferably in stable fiat; and (2) their reserve information is transparent and verifiable.

Joy: I would add another lesson: it’s a good thing that we have different stablecoins at the same time, because it helps speed up the learning process. Think of it, if we only had Tether, we’d have to wait to see how it performs during bad times before trying anything else. Now we can compare different models of stablecoins and pick up the best.

Lily: Following your logic, having price ups and downs is also a good thing, because it provides a good testing environment for different stablecoins.

Greg: The article on blockworks.co has an informative chart showing prices of top four stablecoins since May 1st: Tether or USDT, USD Coin or USDC, Dai and Binance USD or BUSD. We know one thing for sure: the demise of UST or TerraUSD has more negative impact on USDT than on anything else. Binance USD even has price higher than the peg, reaching a peak price of $1.07 on June 19, 2022.

Kimberly: Why is BUSD priced higher in the event of UST crash?

Joy: I wonder to what extent has that been caused by having a governmental agency in New York offering authorization of BUSD stablecoin, not just by fiat backup and auditing report.

Greg: I see what you mean. It also helps that the New York State Department of Financial Services or NYDFS authorized Paxos Trust Company LLC to offer a gold-backed virtual currency, the first such virtual currency. Keep in mind that Paxos is in a partnership with Binance to launch BUSD.

Lily: I find it funny that Crypto is supposed to be a game changer to traditional finance; yet in reality, its creditability and reliability still depend so much on traditional finance, like having fiat backup or setting up account in banks.

Kimberly: I agree. Bitcoin and other cryptocurrencies were designed to be unregulated, and they call for disintermediation; yet having a governmental approval helps Binance USD or BUSD succeed.

Joy: Bear in mind though that stablecoins are designed to be the bridge connecting digital currency with fiat, which means they have a naturally strong tie with traditional finance. Non-stablecoins may not have such a feature. But you are right, stablecoins works much like fiat: The more regulated and the closer the link with fiat, the safer it is perceived and the stabler during the time of uncertainties.

Tags Algorithmic stablecoins, Backup reserve, Bank runs, Business model for stablecoins, Governance coin, Scarcity, Seesaw game, Terry, Tether, USDC, USDT, UST

Blockchain Cryptocurrencies & NFTs Financial talks at dinner table

Some Stablecoins Are Already Digital Money

Post author By Jay Jiyuan
Post date June 20, 2022

The family digs deeper today into stablecoins, focusing on reserve and collateral and how some fiat backed stablecoins like Tether is on its way to qualify for being a digital money.

Kimberly: Last time we were talking about depositing $2,000 worth of Ethereum before anyone can claim $1,000 worth of stablecoin. The ETH collateral is twice the value in stablecoin. I wonder if that is true in general.

Greg: Not really. The key question to ask is what are being used for collateral and how stable they are. For stable assets like many fiat currencies are, a stablecoin can get away without over-depositing or over-collateralization like in the ETH case.

Joy: In other words, to claim you have a stablecoin valued at $1 million, you only need to have $1 million in reserve if the asset is stable. That’s 100% backup or 1:1 reserve. But for unstable assets like cryptocurrencies it’s common to see $1.5 million or even $2 million worth of crypto deposited for $1 million worth of stablecoin.

Kimberly: This prepares for the scenario when the unstable asset suddenly decreases value, right?

Joy: Right. It provides an extra layer of protection to investors, just like insurance company will charge you a higher premium if you have a record of drunk driving or other risky behaviors.

Greg: That’s a good analogy. I want to add that even with over-collateralization those stablecoins are not error-proof. In case a cryptocurrency is completely busted, over-collateralization won’t save the stablecoin.

Lily: How about backing up a stablecoin by a basket of cryptocurrencies, would that help?

Greg: Theoretically it would, except the history of crypto has shown a high correlation among the price movements of most if not all cryptocurrencies. This differs from the mature market of stocks and bonds, where diversification helps reduce non-systematic risk in the traditional financial market. Diversified collateralization by a basket of cryptocurrencies may or may not do the trick.

Lily: Why are the prices of cryptocurrencies closely related?

Greg: One reason is that the crypto market is heavily dominated by two big guys Bitcoin and Ethereum, followed by thousands of small guys. If you check out the site https://coinmarketcap.com you will see that except for Bitcoin, which is more than 40% of the market share, and Ethereum, which is around 15%, plus a few stablecoins, the market share for the others quickly drops to 1-2%.

Lily: So the small guys will have a price movement heavily influenced by Bitcoin and Ethereum, right?

Greg: Right. Another reason is that speculators have low royalty to individual crypto. They are constantly searching for the “next big one.” This makes all cryptocurrencies exposed to the same speculative risk.

Joy: I think future cryptocurrencies should specialize in industries or lines of business to reduce the correlation among them and also to grow quickly. Today’s innovations have focused on different features of the same cryptocurrency, but the future lies in “application specific crypto” or ASCs. Even a decentralized financial market has no space for nearly 20,000 cryptocurrencies. Integration will have to happen for the market to settle down, where many small crypto will be bought off by a few big guys.

Greg: I agree. Another thing to bear in mind is that despite its bad reputation of dramatic price shifting, cryptocurrencies may still be better than some fiat. Crypto price can go down but also go up. This is not the case with some fiat. The Argentina money, where the inflation rate hits 58%, is worse because it’s all inflation, unlikely to have deflation. A Bloomberg report says it right that in Argentina, nobody knows the price of anything.

Emily: What’s deflation?

Joy: That’s when prices of many things go down instead of going up. Deflation is good news for consumers as it offers higher purchasing power. Economists used to worry about deflation a lot as a sign for a weaker economy but not as much today, because lower prices can also mean higher productivity or economy of scale.

Lily: Oh yeah. I’ve read an article that lists 10 things that are cheaper now than 10 years ago, like smart phones, calculators, flat screen TVs, domestic flights.

Greg: In addition to what are used as reserves and how stable they are, it also matters a lot how a stablecoin makes its claims. Regulators will always come after you if they believe you’ve made misleading claims. Sometimes firms make their job easier. Tether, the largest fiat-backed stablecoin, used to claim its value has 100% backup “by the dollar.”

Joy: Yeah, they paid a big price for saying that. A Wikipedia page says Tether is to pay $41 million fine to the Commodity Futures Trading Commission, or CFTC. Now Tether only says its token is fully backed by its “reserves,” not dollars.

Greg: That’s true. Looking at Tether’s transparency page, you will see that “All Tether tokens are pegged at 1-to-1 with a matching fiat currency and are backed 100% by Tether’s reserves.”

Kimberly: Is the new claim accurate? Does Tether now have sufficient reserves to cover its ground?

Greg: Let’s find out. Jason, please go to this webpage https://tether.to/en/transparency/ and we can check the numbers to see if the total assets and liabilities of Tether on USD match.

Jason: Total assets $72,657,372,695.04 or more than $72.6 billion on June 10, 2022, total liabilities $72,494,981,446.98 or $72.5 billion. Looks like they have more assets than liabilities.

Greg: That’s Tether’s account balance for the dollar. Let’s look at the Euro as well.

Jason: Okay… Oh, same story here, total assets are more than total liabilities.

Greg: They do that to have extra room of cushion, which is called “shareholder capital cushion,” and also to impress investors and regulators.

Joy: There is a report by Quartz that tells us more details. Tether defends itself by saying that the findings were from more than two and a half years ago, that they always had enough money in reserve, that the fine only meant the reserves were not all in cash and all in a bank account titled in Tether’s name, at all times.

Lily: Do you think Tether was wrongly charged? I mean stablecoins have been unregulated and suddenly Tether was thrown a huge fine.

Joy: I’m pretty sure the CFTC has a solid legal ground for imposing the fine. If you read the Wikipedia page on Tether, you’ll see many problems associated with Tether, including the misleading statement of dollar reserves, having $31 million token stolen, and price manipulations and lack of auditing.

Greg: At a deeper level, let’s take one step back and ask ourselves why holding sufficient reserve is so crucial for stablecoins. The answer is in two words: “stability” and “liquidity.”

Kimberly: Could you elaborate?

Greg: “Stability” is easy because that’s what all stablecoins are named after, none of them calls itself “unstablecoin,” right? The whole reason for stablecoin to exist is to provide stability of value, which other cryptocurrencies do not have. Liquidity on the other hand means taking precautions to pass a “stress test” under extreme scenarios.

Kimberly: Can we have an example what an extreme scenario looks like in a stress test?

Greg: Say all owners of Tether tokens were to cash out for dollars, will Tether still have enough cash or cash equivalent to allow investors to get their money out in dollars? Having liquidity means Tether can say “Yes” for sure, otherwise it will fail the test.

Lily: I see it now: When it comes to stablecoins, there is no shortcut and no need for getting creative. You just have to keep enough cash or cash equivalent in reserve. That’s the only way for Tether to possess stability and liquidity.

Greg: That’s right. That’s also why I believe Tether’s self-defense is weak. All reserves must be in cash or cash equivalent, and all must belong to Tether, not shared with anyone else.

Joy: It’s interesting that I’ve read an opinion piece that says the future of payment is not in stablecoins. One of the key arguments is that stablecoins tie up liquidity unnecessarily, making those dollars in reserve unavailable to other uses.

Greg: I see their points but ultimately it all comes down to the issue of trust, which does not fall from the sky — you must earn it over time. For now keeping 100% reserve with stable assets is a price stablecoins must pay, given its currently low public and regulators’ trust. Like Lily says there is no other way around that. I would not however rule out future payment possibility for stablecoins. To say stablecoins are not the future of payment is to deny the possibility for stablecoins to establish trust. That goes too far.

Joy: I agree. Commercial banks are not required to keep 100% reserve for issuing loans. In fact, since March 26, 2020, the Fed reduced the reserve requirement ratio to zero. Of course, that is in the traditional or centralized financial world but who is to say in the decentralized financial world things will never change and stablecoins will always be required to keep 100% reserve?

Emily: What’s the reserve requirement ratio?

Joy: That’s the amount of deposits a bank is asked to hold for customers’ withdraw. Let’s say a bank has $100 million in deposits from its customers. Banks make money by lending the deposited money out to earn a higher interest. But can the bank lend out all $100 million to businesses? Normally not, because the central bank will ask it to keep a part of deposited money, and that part is reserve ratio. Say the ratio is 10%, then the bank must keep $10 million and only lend out $90 million. Sometimes however the central bank may allow banks to lend out all the money to stimulate the economy.

Lily: I think the risk for a stablecoin is higher than for a commercial bank. The latter is a part of centralized system. It has less freedom than a stablecoin but also lower risk because the central bank will come to its rescue in case of a major crisis. A decentralized stablecoin has more freedom but higher risk as the central bank may or may not save it from its own trouble.

Greg: That’s true and we should keep the higher risk of stablecoins in mind. The future relationship between central bank and decentralized financial institutions is a very interesting topic. One possibility is that the Fed will keep its direct reign over all membership banks but will make suggestions or recommendations to decentralized finance entities to implement its monetary policies.

Joy: Maybe the Fed will tell future stablecoins that if you follow or coordinate with our monetary policies we’ll add you to our list of “associated members” to offer partial bailout in case of crisis. It’s unlikely for the Fed to order stablecoins to do anything, though — unless the law says otherwise.

Greg: Meanwhile, without central bank rescue stablecoins will have a higher risk of “bank run” unless they keep 100% reserve all the time. Future regulations may ask them to maintain a higher reserve ratio than that for the centrally controlled banks, other things equal.

Emily: What’s bank run?

Joy: A bank run happens when a large group of bank customers all want to withdraw cash from their bank accounts, either because of the bad news in the market or about the bank. You know banks make money by lending money out and they are only required to keep some cash. When many customers all want to get cash at the same time, banks quickly run out of cash and must close the door.

Lily: Let’s go back to Tether. I think it’s good for Tether now to keep more assets than liabilities.

Greg: If you think of it, having extra assets above and beyond liabilities is for Tether’s own good because it relies heavily on money market instruments, which are either unsecured, like commercial papers, or have penalty for early withdrawal, like certificates of deposit. They are cash equivalent but not exactly cash. Those extra assets help mitigate money market risk.

Emily: I meant to ask it before: What’s cash equivalent?

Joy: Let’s use Tether as a handy example. On Tether’s transparency page there is a reserve breakdown. We can see that more than 55% is US Treasury Bills, about 28% is in corporate commercial papers & Certificate of Deposits or CDs. The rest is money market funds and others. Treasury Bills, commercial papers, CDs are all cash equivalent, meaning they can turn into cash quickly if they must.

Emily: I remember commercial papers are short term debts of companies. What are money market funds?

Joy: Those are mutual funds that invest in cash and securities that are due within one year. These assets can all be converted to cash quickly. Again, they can all be converted to cash quickly.

Lily: Back to your comment, dad, on having extra reserve is good for Tether, did you mean some commercial papers may default, but Tether can use the extra reserve to pay investors? Say Tether has a total of $10 million commercial papers and $1 million defaulted. if Tether only had $10 million assets to meet $10 liabilities, it would be $1 million short after the default. But if Tether has additional $1 million extra reserve, it will cover all payments. Am I right?

Greg: Either that or let’s say they must withdraw CDs before the maturity dates, which will incur early withdraw penalty. Let’s say that’s $1 million. In that case Tether can still use its extra reserve to pay all investors in full.

Lily: That’s pretty impressive for Tether to do what it’s doing now.

Greg: That’s not enough, though. Tether also must constantly add cash or cash equivalent to its pool of reserve whenever it issues more tokens to investors. Let’s say Tether has issued another $500,000 tokens to old or new customers last quarter, Tether must add $500,000 to its pool of reserve to cover the new tokens.

Joy: Let’s not forget the dark side of Tether. If you look at Tether’s fee schedule, you’ll see that Tether requires a minimum of $100,000 per transaction of fiat deposit or fiat withdrawal. In other words, you can’t deposit or withdraw $10, $100, $1,000 or even $10,000. Tether also charges for withdrawing the dollar either $1,000 or 0.1%, whichever is greater. If you withdraw exactly $100,000 from Tether, it will charge $1,000 each time. Besides, it also charges $150 for verification of Tether token.

Greg: Tether also has a central control system, not exactly decentralized. I’m sure critics will say something about that. Finally, it does not serve any US residents, only entities established or organized outside of the United States or its territorial or insular possessions; and those having eligible Contract Participants pursuant to U.S. law.

Lily: That’s strange. Who are “eligible contract participants?”

Greg: Its webpage defines a participant as “a corporation that has total assets exceeding $10,000,000 and is incorporated in a jurisdiction outside of the United States or its territories or insular possessions.” Frankly, many if not most entities with more than $10 million total assets tend to have an overseas base outside the US.

Joy: Now the positive news for stablecoins. In January 2021, the Office of the Comptroller of the Currency, or OCC, has told federally controlled banks to treat stablecoins the same as SWIFT or ACH. Furthermore, these banks can participate in the Independent Node Verification Network or INVN, which is nothing but blockchain.

Lily: If that’s the case, how do we explain the recent crash of Terra/Luna stablecoin?

Joy: The OCC acknowledges the value of blockchain, and the role played by stablecoins. But not all stablecoins were born equal and OCC doesn’t or should not endorse everything about stablecoins. There are always bad apples, and the sad thing is that bad news travels fast.

Greg: All in all, I believe stablecoins — not including crypto backed and algorithmic stablecoins — are designed to be digital money because they meet the three money requirements: Store of value, medium of exchange and unit of account.

Emily: Could you tell us more?

Joy: There is a paper written by Federal Reserve Bank of St. Louis that does a good job explaining what money is. Let’s consider the three requirements one by one. A store of value is all about stability of value, meaning the value of money is stable enough for you to keep it for a reasonable period of time without worrying about losing that value significantly or even completely. Stablecoins meet that requirement because their value is stable, as the name suggests — except for algorithmic stablecoins as we have learned.

Kimberly: How long is that “reasonable period of time?”

Joy: It depends on which currency you are talking about. The key point, as the above Fed paper points out, is that money does not have to be perfect store of value because we do have to watch out for inflation, which lowers the value of money from the value before inflation.

Lily: So the now crashed “stablecoin” Terra Luna can’t pass this test.

Joy: No it can’t. The second requirement of money is a “unit of account,” which basically says money can be used to measure value of different things. Without money we’d have to resort to bartering, meaning we trade one thing for another, like one airplane for one million T-shirts. Fiat backed stablecoin meet that requirement.

Greg: We can break the “unit of account” concept down to three features: divisible, fungible and countable. Divisible means one dollar is always equal to four quarters, 20 nickels, 10 dimes and 100 pennies. Fungible means a dollar is a dollar, whether you get it from the bank or receive from your customer. They are always perfectly exchangeable. Countable means you can add, subtract, multiply and divide money anyway you want and still get the same result. Multiplying $1 10 times gets you $10, dividing $1 million by 4 gives you $250,000, and so on and so forth.

Joy: And that brings us to the last requirement of money as “the medium of exchange.” It essentially says money must be accepted as a way of payment. If you look at a dollar bill you will see a tiny note that reads: “This note is legal tender for all debts, public and private.”

Kimberly: But crypto is not legal tender.

Greg: True, but being a legal tender is not a required criterion of money. In other words, not being a legal tender does not eliminate stablecoins’ function as a medium of exchange for those backed by fiat, which are all legal tenders. The true test is market acceptance. The more a currency is accepted, the higher value it has as a medium of exchange.

Lily: Are you saying not all currencies are equally accepted? I would imagine being a government issued legal tender guarantees its acceptance.

Greg: That’s right. In the near future cryptocurrencies, including stablecoins, are unlikely to compete with fiat in terms of market acceptance but the important thing is to have some and increasingly larger acceptance among some parties in the market. Stablecoins fit that requirement.

Lily: What’s the unique things a stablecoin provides but not by the dollar?

Greg: There is an article in Investopedia that summarizes the advantage of stablecoins well: “Stablecoins promise cryptocurrency adherents the best of both worlds: stable value without the centralized control attributed to fiat.” It also lists a few unique use cases that only stablecoins can do, like “using stablecoins to trade goods and services over blockchain networks, in decentralized insurance solutions, derivatives contracts, financial applications like consumer loans, and prediction markets.”

Lily: I don’t understand why these things cannot be done with dollar.

Joy: All decentralized transactions happen on blockchain, but the dollar is an off-chain asset, not an intrinsic part of blockchain. As far as blockchain is concerned the dollar does not exist. Trading with stablecoins allows investors to stay onchain all the time, not on- and off-chain.

Greg: I won’t say the dollar does not exist on blockchain because the value of all cryptocurrencies is still measured by the dollar. In fact, the link between crypto and fiat is like the “umbilical cord” we all carried on when we came to this world. It explains a great deal why the crypto price movement has so much to do with the fiat, just like decentralized finance or DeFi has so much to do with traditional finance TradFi.

Joy: You are right. I think the notion that Bitcoin is a hedge against inflation also makes little sense, even though its supply is set by algorithm at 21 million. An article by the economist Eswar Prasad said it right, scarcity alone is not enough to create value, there must be demand.

Greg: I won’t use the term “scarcity” for Bitcoin because by the time you call something “scarce” you already implicitly imply a short supply relative to demand. Bitcoin is simply a story of “limited supply,” not scarcity, because Satoshi’s algorithm only governs the supply side. It had no idea how much demand there would be when the algorithm was written. Supply side was all Satoshi could control.

Joy: Okay I’ll buy that. There is a recent report by Bank of America that shows the correlation between Bitcoin and S&P 500 has been very high, while its correlation remain near zero with gold. This defeats another myth that Bitcoin is like digital gold.

Greg: The other “umbilical cord” for Bitcoin, or all cryptocurrencies for that matter, is financial regulations. Satoshi envisioned Bitcoin to be unregulated and disintermediate, meaning banks and existing financial institutions will be cut off from playing any role related to Bitcoin. But that’s utopian as it’s impossible for Bitcoin and all cryptocurrencies to be unregulated completely. If I were Satoshi, I would try my best to gain all the regulatory supports I can get for my innovation.

Joy: I agree. It is also dangerous without regulation. This explains why the price of cryptocurrency is so sensitive to the monetary policy of the Fed. I would change the famous saying: There are three certainties in life: death, regulations and taxes.

Tags Financial regularations, liquidity, medium of exchange, Over-collateralization, Reserve & collateral, Speculative risk, Stability, stablecoins, Store of value, Tether