The State of Play

The global insurance sector remains robust, with an estimated $4.8 trillion in gross written premiums reported in 2017, marking a continued upward trend. InsurTech investments surged to $2.3 billion that same year. This significant interest begs the question: what drives these investments, and why is InsurTech capturing so much attention? The integration of technology within the insurance landscape is reshaping risk dynamics, attracting new clientele, and fostering innovative ecosystems.

It's no surprise that insurers worldwide are investigating cutting-edge technologies to unlock previously inaccessible value—not just for their own benefit but also for their customers, as maintaining competitiveness is crucial.

In 2017, Shaun Crawford (EY Global Insurance Leader) remarked:

> “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)

A pivotal technological advancement enabling insurers to realize untapped potential is Blockchain.

The Transaction of Risk

This discussion presumes the reader possesses a fundamental understanding of insurance operations and the underwriting process. For a comprehensive overview, refer to The Balance's excellent resource.

Blockchain technology, often referred to as distributed ledger technology (DLT), has been extensively discussed, praised, and critiqued across various sectors, and the insurance industry is no exception. Insurers exhibit a mix of enthusiasm and caution regarding how transformative this technology may be for their operations—a point we will explore further.

To begin with, let's consider how blockchain can revolutionize the insurance sector. Blockchain facilitates value transactions without a central authority, allowing for a decentralized marketplace. Transactions can encompass various data types, not limited to monetary exchanges. Specifically, in insurance, a blockchain framework enables insurers to engage in decentralized risk transactions. Furthermore, the integration of smart contracts can automate the capital value chain, streamlining claims processing and investments.

At first glance, the insurance process appears straightforward. Underwriters evaluate risk to ascertain the profitability of offering insurance to clients. Achieving accurate pricing and effective underwriting is essential. However, accurately assessing and pricing risk is one of the most challenging aspects of the industry. How can rates be determined? What data should be utilized? The journey from capital to risk is intricate, particularly within a decentralized framework. Additional complexity arises from the emergence of self-sovereign data solutions addressing identity and provenance.

What does this mean in practice?

> The capacity to execute price and risk assessments via smart contracts without requiring additional input.

A Distant Dream…

Currently, the insurance industry does not operate within the above framework. So, why are most insurance firms heavily investing in blockchain through Insurtech initiatives?

The answer lies in the recognized advantages of participating in a 'blockchain consortium.' Distributed ledgers can serve as a business-to-business workflow tool, allowing companies to collaborate, strategize, and invest in shared blockchain infrastructure.

R3 stands out as a leading consortium in blockchain technologies tailored for insurance. Recently, it was disclosed that numerous insurers are rapidly joining R3's blockchain consortium. The R3 Corda platform now collaborates with some of the world's largest insurers, including Chubb, Marsh, and Liberty Mutual.

When considering the current landscape, insurance companies are motivated to streamline existing internal processes (e.g., data source input and operational efficiency) and inter-blockchain processes (e.g., B2B relationships and contractual risks).

> Incumbent insurers may also view blockchain as a means to develop scalable, cost-effective automated products to lower operational expenses. However, this is far from the decentralized risk marketplace previously described.

It's essential to grasp what incumbents currently do not perceive in blockchain. As noted, the likelihood of adoption correlates with how significantly blockchain solutions will alter an insurer's operations. Substantial changes to business processes can be perceived as risky or even undesirable.

With this perspective, it is likely that incumbents do not wish to use blockchain for:

• Decentralized peer-to-peer risk placement
• Introducing new business models (i.e., monetization)
• Addressing complex or high-risk scenarios—relying on trusted sources to act as oracles poses significant challenges for accuracy and stability in a decentralized risk pricing framework.

In essence, insurance companies may not yet fully grasp or desire to invest heavily in distributed solutions. Various factors contribute to this hesitation, generally categorized as technological limitations often synonymous with business risk constraints.

For insurers to unlock the full potential of blockchain technology, they must ensure that their solutions can effectively scale in terms of throughput. If an insurer can only manage 10% of its current transaction demand through a distributed ledger, it is clearly not a viable or sustainable solution.

Moreover, insurers may struggle to effectively utilize self-sovereign identity solutions due to insufficient security measures. How can governance structures be agreed upon and enforced within the consortium?

Enabling an Ecosystem of Value

A clear and straightforward example of how insurance companies can collaborate using distributed ledgers is through the prevention of double-spend insurance fraud. The ABI reported that in the UK alone, insurance fraud cases reached 500,000 in 2017, which underscores why insurers are keen to explore blockchain solutions to combat this issue.

Consider a scenario where an individual files insurance claims with two different providers. Insurers typically face challenges in reconciling and communicating their data with each other. Several business risks arise in such situations:

• What are the implications of insurers sharing data about clients and their policies?
• Do I want my competitors to know my clients?
• Am I comfortable revealing my entire portfolio to competitors?
• If a business settles a fraud claim, could it inadvertently reveal a client’s identity to competitors, risking client loss?

By leveraging blockchain, insurers can collectively maintain data on a distributed ledger, enabling communication without exposing specific client details.

> Let's see how it can work:

An insurer could take critical information, such as a passport number or vehicle identification number, and 'hash' it on the blockchain. Hashing involves transforming information into an output that cannot be linked back to the original data when read.

When an insurer logs this hash onto a shared ledger, they can easily verify if another insurer has already recorded it, providing clear evidence of double-claim fraud. If it hasn't been recorded, they can proceed to log it in and await verification from others.

Think of the distributed ledger as a shared yet neutral database. Insurance companies can decrypt uploaded information while keeping their data confidential. This capability enables companies to synchronize their data with others without disclosing sensitive information—an unprecedented advantage that brings immense value.

Being Smart with Smarter Contracts

Blockchain extends beyond mere data synchronization for insurers; it also facilitates process standardization and automation, effectively reducing reliance on human resources and costs.

In the realm of insurance settlements, various types can benefit from smart contracts on a blockchain:

• Real-time clearing and settlement of securities
• Subrogation—the transfer of a third party's legal right to collect a debt or damages, which can often involve conflicts of interest that smart contracts can streamline
• Smart contract-enabled claims prioritization—settling high-priority claims over lower-priority ones
• Smart contract-based billing and invoicing

While insurers are eager to develop blockchain-based settlement solutions, they are also concerned about sustainability and stability (e.g., the number of transactions per second that a blockchain can handle). Insurers may hesitate to fully commit to blockchain processes for billing and invoicing, as such functions can be effectively managed in a centralized manner.

Nevertheless, existing billing and invoicing processes are prone to human error, which can decrease efficiency and increase costs—issues that blockchain-focused insurers aim to eliminate.

New Breakthroughs, New Questions

Risks of Automation

Any industry transformation carries risks, many of which are common across sectors utilizing blockchain. Currently, insurance companies employing blockchain technology for automation monitor several risk areas, including:

• Internal automation—data sources, bugs, and cyber risks
• Intra-ecosystem automation—contractual risks (and the aforementioned)
• Automation within existing consortia—governance risks: who operates the network nodes, and how are they selected?

Risks of Disintermediation

Assuming a long-term vision of a fully decentralized risk marketplace becomes commonplace, it raises profound questions that remain largely unanswered:

The concept of disintermediation (underwriting without traditional underwriters) introduces critical inquiries:

> Cyber risk exposure—Are there vulnerabilities in the escrow system and solvency models? > The Too Big To Fail issue—Could a highly scalable P2P insurance ecosystem create systemically important DAOs? What regulations govern such DAOs operating across borders? > Black Swan events—Who bears responsibility for catastrophic occurrences? How is liability assigned? > Oracle challenges—How reliable are the data sources? What data is being utilized? Who are the oracles? Is oracle data as immutable as other blockchain data?

Risks of New Data Models

Tokenizing assets, behaviors, and social capital has the potential to enhance how insurers conduct accurate and personalized risk assessments. However, insurers may be selective regarding the information and risks they choose to underwrite. A 'model exhaustion' scenario could arise if one insurer opts to rely solely on a specific data source, potentially making it difficult for clients to secure insurance if others follow suit. For instance, individuals may struggle to obtain life insurance if their only option involves data from a Fitbit.

Last year, John Hancock was among the first companies to offer interactive life insurance, showcasing an early instance of a 'model exhaustion scenario.'

Insuring Blockchain Technology Itself

We have briefly examined the questions and risks insurers face concerning blockchain adoption. But what about insuring clients that utilize blockchain technology? Which of these risks are insurable for insurance companies?

Insurers must now consider blockchain technology as a risk factor in policy assessments. With blockchain still in its early stages, insurers have a vested interest in comprehending how the technology operates to effectively assess risks for clients using it. Insurers that partner with clients employing blockchain inevitably cover 'silent blockchain risk.'

Importantly, insurers can identify various risk types across the layers of the DLT stack, requiring extensive knowledge of blockchain architecture:

> Inherent design risks—at the protocol layer of the blockchain > Implementation risks—How is it being utilized? Is it appropriate? > Operational and functional risks—Is it sustainable? > Ecosystem design risks—Who is utilizing it? > Cryptocurrency-specific risks—Unique design risks for each coin/token

Conclusion

Blockchain is currently revolutionizing various facets of the insurance industry. While present implementations focus on synchronization and automation, future developments are likely to introduce new infrastructures for advanced analytics. The long-term implications of genuinely peer-to-peer models and fully decentralized risk-matching marketplaces remain distant.

Although this long-term vision poses challenging questions about the role of underwriters and the overall viability of such architectures, the potential for contrarian insurance issuance models and innovative products for emerging risks is immense. The insurance industry stands on the brink of substantial transformation. Are you ready for the change?