The road to a blockchain-centric insurance industry.
The State of Play
The global insurance market is as big as ever with an estimated $4.8t worth of gross written premiums being issued in 2017, an increase from subsequent years. Within the industry itself, the total InsurTech investments in 2017 increased to $2.3b. What are these investments and why has there been so much focus on InsurTech potential? Currently, technology in the insurance industry continues to change the nature of risk, open doors to new types of clients, as well as create ecosystems.
It is perhaps no surprise that insurance companies globally are exploring new technologies that can capture untapped value — not only for the insurers themselves but for their clients too - after all, insurers want and need to stay competitive.
In 2017, Shaun Crawford (EY Global Insurance Leader) even stated that:
“Insurers have a unique opportunity to leverage multiple data sources to create deeper customer relationships and to become more efficient. If we help our clients in this effort, the sector will be well positioned to play a prime role in emerging ecosystems.” (Global insurance trends analysis, 2017)
So what has been a major tech development in allowing insurers to capture value that has been relatively untapped? Blockchain.
The Transaction of Risk
This blog post assumes the reader has some working knowledge of how the insurance industry operates as well as a basic understanding of the underwriting process. For an overview of the basics, The Balance do a great piece here.
As you are probably aware, blockchain technology/distributed ledger technology (DLT) has been discussed, hyped, introduced, as well as criticised across multiple industries. The insurance industry is no different with insurers being both excited and reserved depending on the extent of change that the technology transformation h as on their business— this is something we will come back to later.
For now, let’s start with the basics. How can blockchain solutions change the face of insurance? Firstly, think of blockchain as a technology that enables value transactions without one person overseeing the marketplace (i.e. in a decentralised fashion). Note, that transactions do not have to be monetary and can effectively be any type of data types — effectively any simple or complex data structures. Bringing it to the insurance industry, a blockchain framework essentially allows insurers to transact in a decentralised marketplace of risk. Furthermore, with the adoption of smart contracts, the risk to capital value chain can be automated by handling claims and investments automatically.
The insurance industry process is seemingly simple on the surface. When underwriters need to determine the risk, they need to determine the profitability in providing the insurance for the clients. Getting this right means good pricing strategy and good underwriting. Sounds great. However, one of the hardest aspects of the insurance industry already is being able to assess and price the risk in the right way. How do you get the rates going? What data do you use? The capital to risk journey is extremely complex but perhaps even more so in a decentralised framework. To add further complexity, separate technology initiatives are being built to allow for self sovereign data solutions which covering identity and self-provenance.
So what does this all mean?
The ability to run a price and risk assessment through a smart contract without the need for any further input.
The 4 spokes of long-term blockchain potential
The end goal of blockchain protocols for P2P risk transfer can be framed like this:
Prediction Markets — The combination of prediction markets with risk pooling and risk placement. Prediction markets can be used to assess and price risk
Automation through smart contracts — Decentralised Autonomous Organisations (DAOs) construction by handling claims and investments as well as connecting data sources with smart contracts and AI.
Social Capital — The construction of a trustworthy rating system utilising identity solutions (human capital). A critical aspect of this area is selective data exposure. Development of blockchain privacy solutions such as ZK proofs are key (which is discussed further below).
Oracles, Provenance, Data — IoT devices and trusted data providers funnelled to (automatic) smart contracts.
A Distant Dream…
Clearly, at the moment, the insurance industry does not operate anywhere near the above infrastructure. Far from it. So why are the vast majority of insurance companies making large Insurtech investments within blockchain right now?
Simple. The benefits of being involved in a ‘blockchain consortium’ have been acknowledged by companies in the insurance industry. Given that distributed ledgers can be used a business-to-business workflow tool, consortia are an effective way of companies to band together to collaborate, plan, and invest in collective blockchain infrastructure.
R3 is the leading consortium blockchain technologies for insurance incumbents. Only last year, it was revealed that insurers are quickly joining R3’s blockchain consortium. Unknown to most, the R3 Corda platform now helps with some of the largest insurance companies in the world, such as Chubb, Marsh and Liberty Mutual.
The way to think about the current landscape is that insurance companies always have an appetite to streamline existing intra processes (e.g. input of data sources and business process efficiency) and inter-blockchain processes (e.g. B2B relationship, contractual risks).
Incumbents may also be looking at blockchain as a way to generate scalable and cheaper automated products to reduce operational costs. This is far from the decentralised marketplace of risk described above.
It is important to understand what incumbents do not see in blockchain right now. As briefly mentioned above, the likelihood of adoption is somewhat correlated with the extent that the blockchain solutions will change an insurer’s business and processes. Large change in business processes in any industry might be highly risky or not even desired.
With this in mind, incumbents probably do not want to currently utilise blockchain as:
- a mechanism for a decentralised P2P risk placement
- a technology that can provide new business models (i.e. monetisation)
- a way solution to handle complex or high/extremely high risk — using safe and vetted sources to act as oracles is a huge problem for both the accuracy and stability of a decentralised risk pricing framework.
In other words, insurance companies don’t necessarily understand or currently have the desire to invest heavily in the distributed solutions space yet. There are many factors at play as to why which can generally be categorised as either technological limitations which can often be synonymous with business risks limitations.
In order to unlock the full potential of blockchain technology, insurers would have to ensure that their solutions can scale form a throughput perspective. If an insurer can only handle 10 per cent of their current transaction demand through a distributed ledger, it is clearly not a suitable or sustainable solution.
Another example are insurers not being able to effectively utilise self sovereign identity solutions from a cyber risk perspective as the security needs that they want are not in place. How do you even agree and enforce on governance structures with the consortium?
Enabling an Ecosystem of Value
One of the simplest and clear examples of how insurance companies can collaborate effectively using a distributed ledger is the prevention of double spend insurance fraud. Interestingly, ABI insists that within the UK alone, insurance fraud cases reached 500,000 in 2017. It is perhaps no surprise that insurance companies are looking at blockchain solutions today to tackle this very problem.
If we take a case where an individual claims insurance twice with two distinct providers, companies would typically have a hard to reconciling and communicating their own company’s data with each-other. There are certain business risks to consider at this point from the perspective of the insurers when such a case arises:
- What are the implications of insurers openly sharing data regarding what clients have what insurance policies?
- Do I want my competitors to know who my clients are?
- Do I want my competitors to know my wider portfolio?
- What If a business settled the fraud claim and stated to other businesses that their client was involved? Would competitors steal that client away by using the revealed identity information?
Using blockchain, insurers are now able to collectively store data on a distributed ledger where they can communicate to one another knowing that data they communicate to other insurers does not disclose specific information about their own clients. Confused?
Let’s see how it can work:
An insurer may take certain critical information like a passport number or vehicle identification number. This information can be ‘hashed’ on the blockchain. Hashing essentially refers to transforming any set of information together and creating an output that can’t be linked back to the original data if the hash is read by someone.
Now, if an insurer logs this hash onto a share ledger, they are able to easily check whether the hash has already been logged by another insurer then there would be clear evidence of a double claim fraud. If it hadn’t been logged yet, the insurer would continue to log it in and wait for another insurer to check it afterwards.
The way to think about this is to think about the distributed ledger as a shared but agnostic database but insurance companies are able to de-encrypt information if they uploaded the information to the distributed ledger in the first place. The net benefit being that companies are able to synchronise their data with other companies without revealing the data to these companies — Seemingly trivial, this simple benefit is something insurance companies have not been able to do before and brings extraordinary value to their businesses.
Being Smart with Smarter Contracts
Blockchain doesn’t just stop at mere data synchronisation for insurers. It also allows for the possibility of process standardisation and automation which directly reduces human resource demand and cost.
When we think about settlements in the insurance industry, there are many types of settlements that can be addressed and improved using smart contract on a blockchain.
- Real-time clearing and settlement of securities
- Subrogation — the assumption by a third party of another party’s legal right to collect a debt or damages often involves conflict of interest which can be streamlined with automatic contract settlements
- Smart contract enabled claims triage — settlement of high priority claims over lower priority ones
- Smart contract billing and invoicing
While insurers are looking to building blockchain-based settlement solutions, they are eager to understand how sustainable and stable it is (e.g. the number of transaction per second a blockchain can handle). Do insurers want to commit most of blockchain processes for billing and invoicing? Perhaps not. There is an argument that billing and invoicing in a semi-trusted environment are perhaps a less intriguing impact area for insurance companies because such processes can easily be done in a centralised fashion.
On the other hand, current invoicing and billing processes leave significant room for human error which directly leads to reduced efficiency and potentially increased costs — something that blockchain-focused insurers are precisely wanting to eliminate.
New Breakthroughs, New Questions
Risks of automation
With any industry transformation, there are risks but most of these problems arise across any industry using blockchain. Right now, insurance companies that are utilising blockchain technology for automation have several risk areas that they currently monitor. Some of the most notable ones include:
- Internal automation — data sources, bugs, cyber risks
- Intra ecosystem automation — contractual risks (as well as the above)
- Automation in existing consortia — governance risks. Who are operating as the network nodes and how are they selected? Is there a criteria?
Risks of disintermediation
Let’s assume that the long-term vision of a fully decentralised marketplace for risk is common-place. It is fair to say that such progressive use of blockchain technology in insurance asks profound questions that have not yet been fully thought out yet (and will likely not be answered in the near future either).
The idea of disintermediation (underwriting without underwriters) has raised several important questions:
Cyber risk exposure — Are there any faults in the escrow system and solvency models?
The Too Big To Fail problem — a highly scalable P2P insurance ecosystem may lead to systemically important DAOs. What regulation is in place for DAOs that effectively operate cross borders?
Black Swan problem — Who is responsible for catastrophic events? How is liability assigned?
Oracle problem — How safe are the data sources? What data is being used? Who are the oracles? Are oracle data immutable to the same extent as other data on the blockchain?
Risks of new data models
Tokenisation of assets, behaviour, and social capital has the potential to transform how insurance companies provide more accurate and personalised risk assessments. However, insurers may be selective in deciding what information and risk to take on. A ‘model exhaustion’ scenario dictates that if one insurer decides to use only use a certain type of data source, then it may be problematic for clients to get insurance if all insurers follow suit. In other words, individuals may not be insurable if they are not able to provide data through this source (i.e. using a Fitbit for life insurance).
Last year, John Hancock was one of the companies to sell only interactive life insurance and demonstrates the first phase of a ‘model exhaustion scenario’.
Insuring Blockchain Technology Itself
We’ve briefly touched up on the questions and risks that insurance companies face with blockchain adoption. But what about insuring clients that are using blockchain technology itself? How many of these supposed risks are insurable for the insurance companies?
This is because insurers now have to consider blockchain technology as a risk consideration in itself for when they carry out policy assessments. With blockchain being in its infancy, insurers have a business interest to understand how the technology works so it can even be involved in certain client risk assessments. Insurers that take out policies with clients using blockchain, they are naturally covering ‘silent blockchain risk’
Critically, insurers can identify different types of risk along the different layers of the DLT stack which often requires extensive knowledge of blockchain architecture:
Inherent design risks — at the protocol layer of the blockchain
Implementation risks — How is it being used? is it suitable?
Operational and functionality risks — is it sustainable?
Ecosystem design risks — who is using it?
Cryptocurrency specific risks — unique design risk for each coin/token
Conclusion
Blockchain is currently transforming the face of the insurance industry in many aspects. While current implementation of blockchain hovers around the synchronisation and automation facets of blockchain, the net phase is likely to involve new infrastructure for new analytics. The long term impact of true peer-to-peer models and fully decentralised risk matching marketplaces is far away.
While such a long term vision asks difficult questions about the role of underwriters as well as the overall viability of such an architecture, such as marketplace allows for contrarian insurance issuance models as well as provide new innovative products for new types of risk. The insurance industry is truly set to be flipped on its head. Nervous?
