Since the onset of the COVID-19 pandemic, the insurance industry has approached digital transformation with an unprecedented level of urgency. The need to improve client service delivery, achieve greater efficiency and enable new services has emerged as
an imperative for all insurance executives to explore how new technologies may be harnessed to redesign product offerings and operations.
Distributed ledger technology (DLT) has existed for more than a decade. For nearly as long, advocates have argued that this technology may be leveraged to innovate insurance products and services, increase effectiveness in fraud detection and pricing, and
reduce operational expenditure. In these application areas, insurance companies may address the paramount challenges they face today: limited growth in mature markets, rising costs and diminishing margins.
However, it is fair to say that the insurance industry lags behind banking in the adoption of DLT. With the banking industry, we have seen global regulators express greater comfort with the technology, and DLT-enabled products and services continue to move
from experimentation to the point of commercialisation. Although insurance has the technical ability to embrace blockchain, its adoption remains slow, whilst regulatory protections are considered and integrated into smart contracts (that is, contracts which
are digitally programmed and automatically execute clauses on completion of certain events). More fundamentally, DLT functions as a distributed system, and so its value heavily depends on collaboration with competitors, suppliers and other actors in the value
This is where we have seen a noticeable shift in the insurance industry’s perception of DLT. Insurers are beginning to look beyond DLT as an isolated enterprise technology. Instead, they are starting to understand where DLT’s value truly lies – as a catalyst
for business ecosystem transformation. To build an ecosystem prerequires consensus around data standards to capture risk data, connect it to insurance contracts, and track and upload any changes to the data or the contract.
Yet building and sustaining blockchain consortia is notoriously difficult. Earlier this year B3i, the insurance venture backed by more than 20 insurers and reinsurers, was forced to shut down after shareholders concluded that there was ‘insufficient support’
to continue the venture. Soon after we.trade, the world’s first enterprise-grade blockchain-enabled trade finance platform, also shuttered. It was backed by 12 big banks and by IBM.
The extent to which DLT can thrive in an ecosystem further depends on how well ledgers operate together and how they integrate with external systems. A catalyst for adoption is the growing maturity of private, permissioned DLT networks such as R3 Corda and
Hyperledger Fabric. The most recent Corda release (5.0) allows DLT networks, whether Corda-to-Corda or Corda-to-public chain, to interoperate, whilst also delivering better connectivity to business orchestration platforms. The new wave of private, permissioned
DLT networks is being built to meet stringent requirements around data, security and risk, especially as they move into live production.
As technology maturity and industry sentiment converge, insurers are exploring applications of DLT across the value chain. An overview of some of the more ‘real-world’ blockchain use cases is provided below.
- Know your customer (KYC): A network of insurers shares KYC data within a private blockchain. The customer only has to submit information once, and the application only has to be processed once. Fewer resources are needed to manage KYC processes,
and there is no discrepancy between insurers’ data. Furthermore, regulators can access relevant information via the blockchain in real time, obviating the need for insurers to submit compliance reports manually.
- Fraud detection: DLT ensures that all executed transactions are immutable and timestamped. This means nobody, including the insurer, can alter the data held on the blockchain. This data can also be used to identify potential patterns of fraudulent
transactions and feed into fraud prevention algorithms.
- Pricing and underwriting: a decentralised data lake can provide a large and varied data set for product pricing, as well as facilitate the sharing of data between multiple parties. In the context of medical insurance, for example, DLT can deliver
instant and accurate sharing of patient data amongst healthcare providers and insurers. With encrypted patient records existing on the blockchain, participants can access a patient’s medical data without compromising patient confidentiality. Security is key
and tt is impossible to alter a patient record without creating an audit trail.
- Reinsurance: A risk can be ceded / retroceded using a private DLT network configured to process treaties, inform all parties and then process premium and commission payments. DLT smart contracts can also be used to accelerate claims processing and
- Claims handling: By using shared ledgers, participant insurers, reinsurers, brokers and others can access the same data, removing the duplication of processes. The insurance policy as a ‘programmed smart contract’ means that the policy can automatically
execute claims processing actions, such as pay-outs.
The above examples span the insurance value chain and are written with incumbent insurers (and reinsurers) in mind. That said, the digital revolution is ushering in a new wave of insurtechs – unencumbered by legacy technology and processes – which are revamping
traditional business models with blockchain technology at the core. As with adjacent industries such as capital markets, there is a heavy slant on ethical and responsible business standards that reflect modern attitudes. Take for example Lemonade Inc., the
US insurance provider which recently founded the Crypto Climate Coalition in conjunction with Etherisc, Pula, Hannover Re, Tomorrow.io and TomorrowNow.org.
The coalition functions as a decentralised autonomous organisation (DAO) aimed at building and distributing
at-cost parametric weather insurance to farmers and livestock keepers in emerging markets. One key innovation is that Lemonade receives granular weather insights from its partner network, generating models that can be programmed into smart contracts
to automatically estimate the accurate premium for insuring crops based on the field’s location, size and topography. By parametrically measuring rainfall amounts in an insured field, smart contracts can also trigger flood or drought claims automatically,
paying farmers without them ever needing to file a claim!
The growing crypto insurance sector
It would be remiss to write an article about blockchain without finally touching upon cryptocurrencies. In the public imagination, it is hard to separate cryptocurrencies from the blockchain technology that underpins them. The rise of crypto itself also
opens up new and lucrative opportunities for insurers. Not only are we seeing an upward trajectory in consumer adoption of crypto (which jumped worldwide by over 800% in 2021 alone), but there is also significant momentum among institutional investors such
as hedge funds and pension funds. This is in part due to recent regulatory and legal clarifications (you can read my reflections on the recent MiCA regulation
here), but also the unabated enthusiasm of end investors for this new asset class.
Another key accelerator is the growing acceptance of ‘proof of stake’ (in opposition to ‘proof of work’) as the primary consensus mechanism to validate transactions on the blockchain. Critically, proof of stake is far less energy-intensive than its counterpart
(by about 99%), and overcomes critical limits on network capacity needed to drive institutional adoption. Ethereum’s transition from proof of work to proof of stake in September of this year was a watershed moment for the industry.
As a result, banks are looking to meet institutional demand by launching their own crypto custody solutions. This innovation comes with new risks and exposures that need to be addressed in a balanced way. Banks generally hold cryptocurrency in reserve, and
the private keys for many of their customers in hot or cold wallets (described in figure 5, below), making them susceptible to malicious hacks and natural disasters. This is creating a demand for insurance products to protect against such losses.
A leader in this space is Aon, which in 2019 lined up a panel of insurers to offer a crime insurance product to institutional clients of MetaCo, a digital asset custody technology firm. The product protects their digital assets from loss, damage, destruction
or theft when held in MetaCo’s integrated hot-to-cold wallet management solution for financial institutions (known as SILO).
Insurers are encouraged to formulate a DLT strategy now – and be on the front foot
Whilst more and more insurance projects are moving beyond proof of concept and entering or nearing production, insurance companies working with DLT will have to overcome significant hurdles (both technical and regulatory), before we are likely to see true
industry-wide disruption. Even so, insurers are strongly encouraged to formulate a DLT strategy and qualify relevant value cases now, in preparation for an inexorably decentralised and distributed future operating environment.
As banks jump into the cryptocurrency game, insurance and risk considerations will play a role in driving investor protection, market integrity and financial stability. This is also an area that will open up new opportunities – and challenges – for the insurance