6 Ways Blockchain could Disrupt the Insurance Industry
By Doug Mohr, VP of Solutions Consulting
There’s been a lot of InsurTech news in 2016 but no topic has commanded the attention of the insurance technology community like the potential of blockchain. It’s still early in the hype cycle and it’ll take a few years for today’s ideas to become tomorrow’s new normal – but some of these ‘crazy’ out-there ideas are coming to reality much, much sooner. Some, like SmartContracts, are even available today. The real question is: What are the substantial ways in which blockchain could disrupt the insurance industry?
I turned to Magdalena Ramada to find out. PHD, Senior Economist at Willis Towers Watson, and author of one of the best articles on the topic, Want to get an insurer’s attention? Just say blockchain, Dr. Ramada has identified the areas where blockchain has the greatest potential to disrupt insurance sales, products, and operations.
If you’re brand new to the topic I’d suggest starting with an overview of bitcoin, blockchain, and insurance disruption. For those ready to dive in, hold onto your hats, this is an amazing interview chalked full of real world examples, predictions, and guidance applicable to anyone interested in the intersection of insurance and technology.
Vertafore: Your recent article describes six ways blockchain could disrupt insurance:
- Event triggered smart contracts: Automatic claims, self-executing contracts, reduced fraud
- Increased back-end efficiency: Less human error, no data duplication, fewer processing delays, decentralized, fully digital, safe markets
- Disintermediation: Decentralized carrier consortium, automatic identify validation, self-executed transactions
- Better pricing and risk assessment: real-time and individualized, automatic data sharing for analytics and pricing, connected to the IoT, big data, and health trackers
- New types of insurance: P2P, shared economy, spot insurance, hybrids, more transparency, less cost, social media and crowdsourced oracles
- Reaching the underserved: Solves many mircoinsurance challenges, Automatic construction of distributed database, better prices through simplicity and efficiency.
Each potential disruption on your list warrants its own conversation, and we’ll dig into a few of them in this interview, but before we do, it’s important to note that you’re dedicating a majority of your time to the topic of the blockchain…my question is why? For those who might not have a lot of exposure to the concept of the blockchain, can you help them understand what made you a believer, what gets you fired up? Take us back to the moment you realized the blockchain was going to change the world, tell us that story, and help us understand why we should get excited.
Magdalena: Around the beginning of 2015, I was helping a client with developing its strategy to enter the African insurance market. Part of my assessment looked at opportunities at the bottom of the pyramid, specifically around microinsurance, which has been a passion of mine since 2010, when I worked on projects on innovation and financial inclusion for various NGOs and multilateral organizations. I was researching on ways of being able to automate and scale up microinsurance when I came across blockchain. I guess it is in my nature to dig in and leave no stone unturned when I stumble across something interesting and somehow I couldn’t get enough. I guess what gets me most fired up when I spend my time with blockchain is the combination of the technical challenge and actually understanding the mathematical intricacies of the algorithms behind the blockchain protocol, with getting my hand dirty again and programming – last time I had really programmed was Fortran95 back in 2001! –, with the creative part of trying to figure out how it can be used in the insurance industry, what type of new solutions are needed, how it will change the role of brokers and underwriters and where it could have the largest impact for customers. In addition, I think it has a fascinating sociological aspect related to how societies and networks work and can generate consensus and organize themselves. Blockchain is not only fascinating: it is just so full of potential and opens so many new possibilities (and areas of research)!
Vertafore: Why is the blockchain revolutionary?
Magdalena: Blockchain technology is revolutionary for three reasons:
1) It is decentralized, so there is no single party in charge of the network, nor storing or owning the information contained in the ledger.
2) It’s believed that it can’t be corrupted or hacked, since every single participant in the network holds a complete history of the transactions in the ledger. The records of issuance, transfer and ownership of assets transacted in the network are recorded permanently in the ledger and stored by every user participating in the network. To modify it, one would have to be able to alter every existing record, attacking all existing users simultaneously.
3) Data flows are public, but also fully encrypted: Blockchain first verifies the identity of participants in a transaction and then guarantees the deal isn’t corrupted by ensuring that data can’t be modified or intercepted.
In summary, it is revolutionary because it is able to generate shared consensus among non-trusted, even unknown, parties, despite conflicts of interest, without the need for a third party or central authority to oversee that process. It allows multiple databases to communicate with each other in an automated way, to reconcile and be kept in synch, to get information from external oracles, to validate transactions, keeping an immutable, digital ledger of “shared truth”, distributed among all parties, highly encrypted and extremely difficult to hack.
Watch: Blockchain may or may not be poised to revolutionize the insurance industry but it's worth keeping a close eye on. Richard Magrann-Wells of the Financial Institutions Group and Magda Ramada, Senior Economist for the Research and Intellectual Property Team, discuss where blockchain is now and where it could be going.
Event-triggered smart contracts
Vertafore: Let’s dig into the first thing on our list. What are “SmartContracts” and how can they help the insurance industry become more efficient? Can you provide us with an example of a SmartContract?
Magdalena: SmartContracts are self-executing pieces of code. We can think of SmartContracts in the same way we can think of a logic tree or a flow chart: when we sign an insurance contract for example, all we are doing is agreeing on a predefined set of rules. These rules can be broken down and translated into code. For instance, when I buy flight insurance I’m agreeing on a rather very simple product – if my flight is delayed or gets canceled, I get paid a certain fixed amount of money – or on a more complicated one that for instance also takes into account things like for how long it was delayed, or whether that delay forced me to stay overnight somewhere, etc. But at the end of the day, that insurance product can be decomposed in a series of “if/then” statements that each depend on a single source of information to be resolved. Most people – like myself – never find the time to actually file a claim after their flight was delayed and they would hence be willing to pay a premium for a product that self-executes and pays you automatically every time your airline had trouble getting you somewhere in time.
That product exists!
And given its cost-efficient automation, you do not even have to buy it at a premium! During a hackathon in London last year, a team called InsurETH developed a flight insurance product that connects through a so-called Oracle to your airline’s departure and arrival records, and if your flight was delayed, it automatically executes the contract and credits a certain amount to your online account. This principle can be used for every type of parametric insurance, like crop and weather insurance products or even cat swaps and bonds.
Vertafore: Wow…that’s pretty amazing to think that this type of technology already exists. As a consumer I’m intrigued by the idea of a SmartContract that has the capability to respond automatically when triggered by an event. If I understand you correctly, that means I could be living in a world where I receive a check in the mail when my ‘smart car’ (or anything else connected to the internet) spontaneously combusts – and without having to talk to anyone? Is that right? And if so, can you explain how that would work and the impacts it would have on the insurance industry?
Magdalena: That’s right! Imagine product insurance that uses the internet of things to self-execute: your refrigerator will not only communicate with the grocery store to get more milk, but it will also let your product insurance smart contract know that a certain component is failing, triggering that contract to pay you or even communicate with a service vendor that will come and replace that component and get paid for it automatically. This type of product would not only significantly improve the customer’s experience, but it will also reduce or eliminating claims processing costs for simple insurance products. In addition, this type of product generates unbreakable escrow, so that in case certain rules are met, the decision making process on whether to pay out or not, or delay the payment, ceases to be in the sphere of influence of the underwriter. The fact that it is decentralized and automated make it unstoppable and to compensate instantaneously. This could have important implications on how we think about solvency and reserves.
Increased back-end efficiency
Vertafore: I guess we’re officially coming to an end of an era where the next generation of kids won’t understand the old joke “Is your refrigerator running?...Better go catch it!" Sad.
But in all seriousness, you made a great point in your last answer about the potential to eliminate claims processing costs – I’m curious to know more about the promises blockchain offers when we focus on increased back-end efficiency.
What’s so revolutionary about having a decentralized insurance market where transactions are registered in a distributed ledger? How does this increase back-end efficiencies for the insurance industry?
Magdalena: Some interesting new players like Dynamis and ChainThat are working on developing fully distributed autonomous insurance organizations, which do not need an underwriter or central authority regulating it. Dynamis launched a peer to peer supplemental unemployment insurance protocol which they claim “uses policy holders' social capital to replace underwriters” and it is programmed on Ethereum. ChainThat has the vision of a fully digital and automated, blockchain enabled marketplace, running on smart contracts and without the need for a physical authority overseeing the marketplace. ChainThat’s initiative reinforces the importance of data standards. They use Accord data, similar to the FIX standard for capital markets. The fact that transactions are registered in a distributed ledger using blockchain technology implies that there is no data duplication and processing, no redundant data is stored, there is less transaction costs, there is increased security given two way node-by-node encryption and the fact that every node owns a copy of the ledger and processing times are significantly reduced. Finally, in a world in which carriers are distributed autonomous organizations, trustworthiness is given through decentralized cryptographic proof instead of being provided by a single party.
Watch: ChainThat's Commerical & specialty (re)Insurance demonstration video
Vertafore: One thing on everyone’s mind in the insurance industry is fraud. How can a virtual marketplace reduce risk and costs?
Magdalena: Virtual marketplaces enabled through blockchain protocols are believed to also reduce fraud risk and brokerage costs since every piece of communication during negotiations is registered and stored in the ledger and validated through shared consensus. Through so-called Gossip protocols there is exponential sharing and storing of information, so that the ledger gets validated and distributed to as many nodes as possible, as quickly as possible. Insurance fraud gets easier through human error and intervention. If a marketplace has multiple – random, unknown, unrelated – nodes validating contracts and claims, mainly using predefined sources of information and standardized contracts, there is less room for mistakes and for collusion and fraud. Even in the more experimental ideas around crowdsourced oracles or Uber-like claims processing, the argument goes that if defined correctly, decentralized consensus-driven claim verification will make it more difficult for fraud to go unnoticed.
Making intermediaries obsolete for some coverages
Vertafore: How does blockchain support disintermediation? What are the benefits for carriers? And because someone has to ask the tough question, where does that leave the independent agent? Does their role disappear? Or does it continue to change and evolve over time with the industry?
Magdalena: Blockchain supports disintermediation at many levels. Let’s look for example at a recent pilot on a blockchain enabled natural catastrophe swap. This pilot showed that there was an acceleration of transactional processing and settlement and less manual processing and authentication. Not only did this increase this reliability and auditability, but it increased this instrument’s tradability. The idea is also applicable to cat bonds and the firms which developed it are now looking into blockchain enabled payment processes in international fronting for captive insurers. The increases in efficiency, transparency and market liquidity are clear benefits for carriers and customers. Greater ideas include marketplaces that use smart contracts to automatically determine a customer’s risk profile and match it to an investor’s profile in an automated portfolio management fashion. Obviously, this will have a huge impact on brokers and intermediaries, but it also generates interesting new opportunities.
Brokers provide impartial advice and negotiate on behalf of their clients, but most importantly, they have the role of being trusted partners that make sure their clients are getting the best deal – one that matches their risk profile and needs – at the best price. They hold the relationship with clients and they verify conditions and the trustworthiness of products and underwriters for these clients. Therefore, a truly decentralized autonomous insurance marketplace, where optimal pricing, full transparency and even risk-pooling are automatically brokered through smart contracts and verified by distributed consensus certainly has the potential to disrupt the way in which the insurance ecosystem works today. Brokers will thus have to redefine the way they add value and interact with both clients and underwriters to survive and to be able to leverage the potential of blockchain.
Vertafore: One huge issue that plagues a variety of industries is online identity verification. Is blockchain a potential solution? If so, how would the insurance industry be able to take advantage of it? Are there any other types of titles or identity cards that could exist on the blockchain that would have an impact for insurers and insureds?
Magdalena: Blockchain is actually very similar to e-signature protocols and therefore very apt for identity validation. Countries like Estonia and Morocco are considering moving their whole I.D. systems onto a blockchain. The State of Delaware is considering moving the registry of all its corporations to a blockchain. Asset authentication and provenance (e.g. Everledger is doing this for diamonds) for jewelry, art or antiques is another area where blockchains can be used within the insurance industry and where it will increase efficiency and reduce costs and fraud. Still, there is a lot of work to do around bridging the gap between the real, physical world and the digital one in which blockchains operate. Indeed, the blockchain protocol was developed to track provenance and avoid double spending of a fully digital asset – the cryptocurrency Bitcoin – but once we have to transition from the real world to the digital one and back, there is more room for tampering with the truth.
Better understanding of pricing and risk
Vertafore: Why would insurers favor a decentralized network using distributed ledgers? How would platforms powered by blockchain give them a better understanding of pricing and risk?
Magdalena: The main reasons are those related to any type of automation: greater speed, more efficiency, reduced costs and less room for human error. In addition though, blockchain also bring the advantages of transparency, auditability, immutability and safety. Blockchains can also be scaled down and up providing a lot of flexibility that will translate into simpler, more personalized, cheaper products. But in my opinion, what will really make the case for blockchain enabled platforms and insurance smart contracts is the potential it has to connect and combine with other technological advancements like the Internet of things, artificial intelligence, big data and risk analytics. This is where better understanding of risks and pricing can be generated. The insurance industry is irreversibly moving into a world in which the voluntary sharing of data, the ability to constantly reassess customer behavior and risk profiles and the tracking of risky behavior in real time is leading to real-time adaptive pricing and fully flexible, personalized insurance products and risk mitigation services. That will have an impact on the way risks are tracked but also mutualized, so that risk and pricing models will have to change. We will end up with a lot more of the tails and less of the center of risk distributions. New type of customers want spot insurance that they can activate before they do a bungie jump and deactivate right afterwards. So, what better place than blockchain to place all this information, in a transparent, chronological and immutable ledger, where we can make sure that smart contracts access all these data points in real time and adapt pricing and risk assessments accordingly?
Vertafore: For incumbents who might view their data as an asset, what’s your 30-second elevator pitch about why living in a world where data accessibility to all is a good thing?
Magdalena: As a former professor for Econometrics my first reaction would be to say that the more data is shared, the better our models become and the less risky the business is for all of us. Still, I think that given the very large amount of historical claims data owned by incumbents already, the marginal improvement in model accuracy granted by accessibility to all would probably negligible. But, the beauty of blockchain is that the amount of data that is accessible to all is customizable! So, you choose how much information you want to share and with whom, while the verification of transactions uses so called zero-knowledge algorithms, that can verify transactions using a very basic amount of information – basically, who and when – while the “what” is protected by two-key encryption. In addition, hybrid blockchains and private blockchains can further tailor their consensus mechanisms and how they define writing and reading permissions across the network. In other words, blockchains within the financial services industry will probably NOT grant data accessibility to all, but will work with selective data sharing mechanisms that allow different players in the ecosystem – e.g. regulators – to access, modify and/or verify specific parts of the full dataset.
Enables new types of insurance
Vertafore: How does blockchain enable new types of insurance? Can you give us an example of a company and how they might use blockchain to their advantage to create new products or increase efficiencies?
Magdalena: Besides some of the examples I mentioned before, I think a key area in which blockchain can be highly disruptive is P2P insurance. The idea of P2P insurance is not new, but blockchain has now enabled this type of solutions to achieve scale and generate communities where participants do not need to know each other. One could even go further and imagine an additional blockchain layer using prediction markets – some of which already run on blockchain – to assess participants’ reputation or trustworthiness. Even more, it could change the current notion of group insurance, with groups and risk pools of participants being matched and generated in the blockchain through coded algorithms, verified through zero knowledge proofs and then connected to the adequate insurance products and carriers. Blockchains therefore will in many aspects change the way risks are mutualized, forcing the industry to generate new product design and pricing models, in a similar fashion to what happened in the hotel industry with AirBnB or in the transportation industry with Uber.
A second, very important area of new types of insurance stems from the fact that blockchain is reshaping business architecture and processes in other industries, which are financed and insured by the financial services industry. Amongst other things, this means that at some point blockchains themselves will need to be insured and a new thinking is going into determining whether and under which conditions a blockchain can be insured. For that to happen, insurers and reinsurers will have to develop models that understand the risks associated with blockchain protocols, their legal validity and the consequences of blockchain enabled processes to fail, as well as how these things will vary from one industry to another and depend on the blockchains’ design, consensus mechanism and underlying cryptocurrency.
Reaching the underserved
Vertafore: What are the largest issues with microinsurance today and how could blockchain help solve them?
Magdalena: Well, we could do a whole new interview on the challenges of microinsurance only! Microinsurance has many challenges: it is a large scale, low margin business, it requires very simple products and deals with an unaffiliated customer base that in many cases lacks adequate financial literacy, it has large costs associated with the administration of large volumes of volatile policies, it requires partnerships with distribution channels that usually keep the customer relationship, among many other challenges.
Why could blockchain help here? Firstly, it would be a great tool for mapping the unmapped. Indeed, mobile technology has proven to be the best way to access population that is unbanked, undocumented, geographically dispersed and distrustful. In addition, blockchain could lower administration costs associated with low customer loyalty, high volume of cancellations and also lower claims processing costs. Besides the obvious benefits stemming from lower costs, that would make many microinsurance products financially viable, blockchain could also help tackling the largest problem of serving the underserved: the lack of data and adequate risk models, by generating a distributed and immutable database tracking risk and behavior among this segment.
Vertafore: In your opinion, does the greater impact of bringing insurance to the underserved constitute making blockchain a larger focus for the insurance industry as a whole?
Magdalena: Sadly, I don’t think so. I think it is an additional benefit, which complements very well all its other benefits, but I do not think it is powerful enough yet to drive the industry’s focus towards blockchain.
Vertafore: Is there anything else you’d like to share with our audience? Please, let them know. Also, where can they connect with you online? Offline? Provide any info you’d like us to include at the end of the article.
Magdalena: The only additional thing I would want to say is that they shouldn’t feel discouraged or overwhelmed if most of this is new to them. Institutes that are dedicated to tracking new technologies and innovations didn’t have blockchain on their radar a year ago! And today the hype is generating so much noise and expectations that new articles, conferences, seminars and even firm consortiums like the newly formed B3i, are announced every day. It is a lot of information to take in and it takes time to assimilate. Most of these changes will not happen overnight, but they will happen probably in the next 2 to 5 years. It is likely that they will be highly disruptive, so putting the topic in their agendas and having a look at their innovation functions is a good place to start. And if they have any questions or would like to discuss any of this, they can feel free to ask us. I am based out of Miami, FL and I am available over email at Magda.Ramada@willistowerswatson.com. I also post regularly on the topic in our Willis Towers Watson Wire blog and on Twitter (@MagdaRamada) and LinkedIn.
Doug Mohr Career Bio
Doug is the vice president of solution consulting at Vertafore. He joined Vertafore seven years ago to lead a group of subject matter experts that provide presentations on the entire Vertafore suite of solutions to customers and prospects in support of the sales team. Doug brings over 20 years of software experience having worked at companies that provide solutions to a variety of industries including insurance, healthcare, apparel, professional services, high-tech and manufacturing.