Blockchain for insurance: key use cases & implementation tips
December 20, 2023
the value of the global blockchain in the insurance market by 2031
Allied Market Research
CAGR of the global blockchain in the insurance market from 2021 to 2031
Allied Market Research
the total cost of insurance fraud (non-health insurance) per year in the US
How blockchain works in insurance
The root cause of the absolute majority of insurance industry problems comes down to the misalignment of incentives between insurance companies and policyholders, which leads to insurers spending inordinate amounts of resources to combat fraud, examine claims, and resolve disputes. Meanwhile, policyholders who are kept in the dark about the influencing decision-making factors are becoming more incentivized to outsmart the system. Blockchain can be the ultimate solution to this problem by providing a mutual trust layer between the two parties.
The cornerstone of applying blockchain in insurance is smart contracts, programs that automatically execute themselves when events specified in a contract between multiple parties occur. The events that cause the contract execution can be external, which makes smart contracts a particularly valuable technology for insurance. For example, IoT sensors in homes can determine gas leaks and initiate automatic claims processing. Given that smart contracts are stored and validated on the blockchain, no party can change contract terms but all of them can access a single source of truth. With a well-thought-out implementation of smart contracts, companies can drastically increase the efficiency of the insurance process and make it transparent for all parties involved.
Executive & value transfer
Improve your insurance services with blockchain
Key use cases of blockchain in insurance
In the insurance context, blockchain offers a unique and innovative way to improve traditional processes. Let's explore how this technology can be used for insurtech:
Parametric insurance contracts are commonly used to protect a policyholder from a specific accident. Premiums are usually based on the significance of the event rather than on the economic losses. For example, a parametric insurance contract can imply that regardless of the actual economic damage, an insurer will pay $1m to a policyholder if an earthquake goes above a specific magnitude value and reaches a particular territory. Similarly, parametric insurance can protect farmers from unforeseeable weather events like drought that impact their crops. In this case, smart contacts can automatically execute payouts using decentralized oracle data (like Chainlink nodes) based on rainfall data obtained from IoT-enabled sensors and/or publicly available weather APIs.
While the core idea behind parametric insurance originated more than 20 years ago, this approach hasn’t been reliable because of technology limitations. However, with smart contracts, IoT sensors, and smart wearable devices, parametric insurance can become increasingly autonomous, transparent, and efficient.
Scheme title: Example of smart contract for crop insurance
5 benefits of blockchain in insurance
Blockchain and smart contracts offer insurance companies an alternative way of conducting the majority of their operations more efficiently and transparently, eliminating customer distrust and enhancing the security of sensitive data.
1 Fewer disputes
Instead of leaving claims assessment to inherently subjective human opinion, blockchain implementation allows insurers to execute contracts based on real-time data, decreasing the probability of disputes.
2 Improved automation
With well-thought-out smart contracts in place, claims can be processed automatically, resulting in decreased operational costs.
3 Improved reach & inclusivity
Many third-world countries don’t have adequate access to professional insurance services. With more affordable, intermediary-free blockchain solutions, disadvantaged groups can gain access to reputable insurance providers.
4 Enhanced transparency
With the help of smart contracts, IoT sensors, and trusted data providers, insurance companies don’t need to rely on claims processors or policyholders to evaluate cases, effectively eliminating distrust between all parties.
5 Streamlined regulatory compliance
Given that transactions stored on the blockchain are tamper-proof, it becomes easier for insurance companies to maintain an audit trail to comply with regulations.
Adoption risks & limitations
It can be argued that despite blockchain’s massive potential in insurance, there is an apparent lack of real-life applications. At the same time, unlike many other innovative technologies like artificial intelligence or IoT, blockchain can face several limitations, requiring collaboration between industry players to realize its full potential.
The recurrent theme in advocating blockchain adoption in any industry is shifting responsibility from a central authority to a consensus mechanism. While this concept has proven effective in many cases, stating that blockchain is inherently secure and completely tamper-proof is often an exaggeration. The problem is that consensus mechanisms are created by humans, meaning that they can still have vulnerabilities.
There is no clear-cut way to ensure that smart contracts are properly written, as it all comes down to the expertise, experience, and responsibility of the developers writing the code. This should persuade insurance companies to collaborate only with trusted technological partners with a proven track record of successful projects.
Unreliability of off-chain data
Smart contract execution often relies on external information, be it from web APIs, IoT sensors, or public legal repositories. In such use cases, the reliability of smart contracts becomes dependent on the credibility of these off-chain data feeds, also known as oracles. These oracles can be tampered with, making smart contracts execution inaccurate.
One of the ways to significantly raise the oracles’ trustworthiness is to make them decentralized. This is exactly what Chainlink is doing in this space. Their Decentralized Oracle Network (DON) consists of a number of independent data sources that provide data to a particular type of smart contract.
Lack of legal frameworks
Given the relative novelty of blockchain in insurance, industry players often struggle to clearly define the format for legal relationships that govern business processes on the blockchain. The core challenge lies in the lack of horizontal collaboration between insurance market players to establish these legal frameworks.
To address the challenge of lacking legal frameworks, it is crucial for insurance providers to engage in open dialogues and collaborate with each other. Determining the necessary legal frameworks that align with the unique requirements of blockchain technology in insurance is a matter of cooperative effort.
The next frontier of insurance
Undeniably, blockchain is the next frontier of insurance. Blockchain’s ability to harmonize and decentralize data across insurance processes, compensate for the lack of trust between policyholders and insurers, and reduce operational costs can’t be overlooked. The current lack of legal frameworks certainty shouldn’t be surprising, as organizations are still in the midst of exploring blockchain’s real risks, opportunities, and implications in the insurance context. In the meantime, insurance companies are encouraged to explore the possibilities of this technology. Evidently, industry players that take the lead and dive deep into adopting blockchain applications will reap the benefits of this technology and gain a competitive edge. While carefully choosing a technological partner is one of the biggest prerequisites for success in any industry, implementing blockchain in insurance puts even more pressure on making the right choice. With over 25 years in software development, Itransition is no stranger to making the most out of disrupting technologies like blockchain.
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