Absence of capital providers

To remove the profit-motive of shareholders and resulting misaligned incentives, tDAO funds are designed to be fully community-owned. As a result, there are no external shareholders or capital providers. Typically, external capital providers provide capital to a stock insurance company not for the purposes of being insured, but as an investment that will yield a profit. Hence external capital providers will claim the underwriting surplus as profit. External capital providers are most important in the early years when the fund is small and premiums alone may not be sufficient to cover claims that have a defined benefit.

Imagine a scenario where in the first month of fund inception, there are 100 members who have contributed $100 each. The fund will have total contributions of $10,000. Suppose one of the members makes a successful request for a payout (defined benefit) of $100,000, then the fund is wiped out. Having external capital at this time will be very useful to maintain the capital needed to keep the fund going.

The down side of introducing external capital is that it reintroduces the zero sum profit motive that pits insurance companies against their customers, the insured. In this case, capital providers will not look favorably upon claims being paid as this will directly reduce the underwriting surplus, and therefore reduce their profit.

A tDAO fund is structured to operate without external capital providers. To avoid a scenario where the fund is wiped out by claims, Takadao applies dynamic underwriting that utilizes a “base benefit multiplier” and “benefit multiplier adjuster”. The underwriting algorithm adjusts benefit payouts according to the performance of the fund.

Back to the example of 100 members in month 1 of the fund, who have contributed $100 each. The fund has a total contribution of $10,000. Member Q makes a successful payout request. Making a payout in month 1 in a fund with only 100 members is highly unusual and generally not predicted in actuarial models, which means that the fund has performed poorly.

Note that such a scenario is extreme and is only likely in the early days of the fund when capital is low. As the fund matures and the number of participants increases, the risk is spread out among many more participants and hence the individual impact is lower. The older and larger the fund is, the lower the individual impact of poor fund performance.

On the flip side, if the fund performance is better than expected, the BM.A will be restored to 1x and the excess funds become surplus which are redistributed back to members. This goes back to the fundamental principle of risk sharing where both losses and rewards are shared.

The BM.A, an indicator of fund performance, does not fluctuate based on market conditions. Investment returns are conservatively modeled to be a minority portion of the total available capital, the majority of the fund being allocated to reserves that are maintained for payouts. The main factor that causes fluctuations in fund performance are payout rates for a specific risk, which tend to be stable over a long enough period of time.

Given the global nature of tDAOs, catastrophic events in a single country or territory will affect the tDAO funds less than a national insurance fund. For example, an earthquake in a single country will likely wipe out the insurance funds in that country as all the risk is concentrated in that geographic location. With tDAOs, risk is spread out globally, so a catastrophic event in a single country will have less impact than a national insurance fund.