19 January 2018
Henry Hilska

Disruptive Innovation

Henry Hilska - Convexity Solutions

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Innovation in Financial Services

Innovation in Financial Services

A discussion of trends in innovation management within financial institutions, and the key processes, technology and cultural shifts driving innovation.

Could Blockchain Transform the Direct Selling of Insurance and Annuity Products

23 December 2017  |  9546 views  |  0

It is hard to avoid hearing about Bitcoin these days as mention of the meteoric rise in value of the crypto-currency has become so prevalent in both the traditional and social media.   What is less prevalent, but what should ultimately have a greater impact overall is the technology that underpins this phenomenon, namely Blockchain.  Despite some current issues with privacy and scalability Blockchain, or as it is more generally called, distributed ledger technology (DLT) provides enterprises with the ability to transform the process of transferring assets and information between parties without a central authority.  

Currently, there are many use cases that might be appropriate for the transformation provided by implementing this technology.  Let’s consider one such example, the direct market for life and annuity products, a distribution channel for insurance carriers to sell fixed and variable annuities and products such as long-term care insurance through registered broker dealers.  In the US many broker dealers sell both traditional equity and fixed income brokerage products but may also have licensed financial advisors to sell insurance and annuity products as well.  These broker dealers have selling agreements with the insurance carriers.  They typically utilize a clearing firm, if they are not self-clearing entities, for their traditional brokerage business and often deal direct with insurance carriers utilizing an ACORD standard order entry system for trade capture.  The exchange of premiums and commissions and trails is often executed on a gross basis according to their selling agreements.

In practice, most insurance carriers electronically report client position, registration and commission payment information to their broker-dealer distributors through DTCC's Insurance Processing Service or other providers.  However, there are broker-dealers still processing up to 50% of their direct business manually with paper statements and checks.  This process is inefficient, often disjointed and requires manual reconciliation.  It creates both operational and regulatory risk.  An example, broker dealers are required to open brokerage accounts for their life and annuity clients to comply with KYC, OFAC and FINRA 17a-3 books and records regulations.  However, in practice, the governance of these rules can be challenging since most broker dealers lack a truly connected straight-through process for their direct business.

However, when considering this technology, we must keep in mind that DLT may be implemented in different ways.  For example, Bitcoin is built on a public permission-less network where each node maintains a copy of the blockchain and miner nodes are used to validate new transactions or blocks that are added to the chain.  This configuration contrasts with one that includes a private permissioned network that utilizes consensus algorithms and that limit access to information to only the parties to a transaction.  However, in each case there is no need for a central authority.  These are just two different examples of configurations for this technology.       

To develop the appropriate solution, we must first understand the business case.  The solution should never be in search of the problem.  In the direct insurance and annuity business case there are clients, financial advisors, broker-dealers and insurance carriers.  They would be represented on the network as nodes.  Each type of node would have specific permissions.  The client would initiate the account creation process by providing the necessary personal and suitability information to the broker-dealer to satisfy KYC, OFAC and 17a-3 regulations to establish a brokerage account.  The financial advisor assigned to the client would have access to the client and transaction information.  Due to privacy rules this information would not be shared with other financial advisors or clients. 

Similarly, once an account is established the client could initiate a transaction.  The transaction information would need to be accompanied by an upfront payment.  The transaction including certain client information and payment would only be shared with the issuing carrier.  The transaction would not be shared with other financial advisors or carriers that are not party to the transaction.  The issuing carrier would establish the policy with the client and would pay the broker-dealer an agreed to amount as commission.  These payments would be defined in a selling agreement between the entities.              

The business requirements for implementing a DLT solution for this direct business would clearly require a version of a private permissioned ledger.  Privacy concerns would rule out the sharing of personal and transaction client information.   The same would also be true for commission information as financial advisors would not want to share their compensation with others.

Though all client and transaction information would be maintained to provide consistency within the ledger it would only be shared with those nodes that are party to the transactions.  Any subsequent transactions would flow similarly from the client nodes to the broker dealer nodes.  The data maintained in the chain would validate the client and the transaction information to ensure that it is in good order.  The transactions would be released to the carrier nodes.  Upon receipt of the transaction and any payment the transaction would be confirmed and added to the ledger.   The ledger would reach consensus when the broker dealer confirms the transaction information to the client and is accepted.

Currently, there is no central authority maintaining or clearing these transactions.  Each broker-dealer must maintain their own book of business.  For a registered broker-dealer FINRA 17a-3 regulations require the on-going maintenance of client books and records, which is a process that would be greatly simplified by allowing the client to maintain their information directly through to the ledger.  This would replace the current method of mailing letters and the subsequent manual process of updating account owner and registration information.

Of course, challenges remain for the wider use of DLT until solutions for issues such as scalability and the integration with legacy systems are developed.  The development of APIs is necessary to provide the integration with off-chain legacy business applications.  These challenges limit wider implementation of the technology.  However, clearly DLT provides many industries a new set of tools to tackle business issues that cannot be easily solved using current technology.  The appropriate use of DLT would prove benefits that would be transformational. 

This would include:

  • Improved efficiency by the elimination of manual processes
  • Reduction of reconciliations required for independent ledgers
  • Faster and more dependable confirmation of transactions
  • Straight-forward regulatory compliance process for books and records
  • Consistent data across the various parties involved
  • Improved regulatory compliance and reduced operational risk 

Ultimately the technology must overcome the challenges to derive these benefits, but much focus is being placed on developing solutions for a host of business cases.  As the example illustrated above for the direct market for life insurance and annuity products there are opportunities to greatly improve business processes with this emerging technology.  The success of DLT will be determined by the ability to overcome challenges and to identify these appropriate business cases.

 

Distributed Ledger Technology Beyond the Hype? TagsBlockchainRetail banking

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job title Managing Principal
location New York
member since 2016
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I look to provide a pragmatic approach and leadership to financial services, project management and information technology. My areas of focus includes disruptive technology, business process design, r...

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