May 11, 2022
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In the past decade, we’ve seen a sustained interest in blockchain. With a myriad of blockchain applications sprawling across various industries and growing demand for blockchain development services, the disruptive potential of this technology is no longer doubted. In this article, we discuss why blockchain is a perfect fit for insurance, outline the most prominent use cases, and provide a future outlook for the technology’s proliferation in the field.
To understand why blockchain holds enormous potential for insurance, let’s first recap how it works.
In a nutshell, blockchain is a huge database where data storage and sharing are peer-to-peer-based. P2P implies that there is no need for a central authority to control the ledger, which is why we call blockchain decentralized. The information is stored in groups also known as blocks. For a block to appear on the blockchain, it has to be verified by a consensus mechanism. Users that verify the formulation of blocks essentially verifying transactions are known as miners. After miners validate the augmentation of the blockchain with another block, it is permanently stored on the network. The unique record of transactions on the blockchain is shared by everyone in the network and is routinely updated.
Each blockchain user has a public and a private key. The public key is a unique combination of letters and numbers and is available to everyone. The private key is used to access information sent to your public key.
Every block comes with a pointer (hash) to a previous block. If information stored on a block changes, the hash also changes, so a given block loses its connection to the chain. What makes blockchain an extremely secure way of storing data is that for one block to get altered, the majority of network participants have to agree on doing so.
To further understand why blockchain has huge potential in insurance, let’s discuss this sector’s current state and pain points.
First of all, the insurance industry is notoriously slow in adopting emerging technologies. Compared to other financial industry sectors like, for instance, banking, which actively capitalizes on innovative technologies, insurance’s business model and tech stack have remained largely unchanged for many years.
Relying on paper-based information sharing, an abundance of manual processes, and an outdated tech stack, the insurance industry is riddled with a number of inefficiencies. Given that the insurance industry needs to effectively coordinate a multitude of parties with different incentives, the manual approach to information exchange exposes the traditional insurance framework to many points of failure. Moreover, insurers heavily rely on intermediaries to enforce contract terms, which makes claims handling slow and inefficient. So how exactly can blockchain solve these issues?
The world’s first blockchain was created solely as a means of transferring cryptocurrency. Comparatively recently, in 2015, Vitalik Buterin launched Ethereum, the world’s first blockchain capable of storing any type of digital data and, most importantly, supporting smart contracts.
Smart contracts are 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 placed 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, while every party has access to a single source of truth.
This way, blockchain offers insurance providers a unique opportunity to exchange data effectively and securely, reducing costs and helping to effectively manage risks and enhance customer satisfaction.
In the insurance context, know-your-customer and anti-money laundering practices are especially resource-intensive and cumbersome. Conventional approach to KYC and AML operations involves a myriad of time-consuming tasks, which has proven to be particularly error-prone and riddled with inefficiencies.
Banks, insurance companies, and other financial service providers don’t share KYC information with each other due to regulatory concerns. As a result, when turning to a new financial institution, a customer needs to reenter the same data multiple times, which undermines smooth customer experience. What is more, after one financial institution performs KYC, every other financial institution wastes time performing the work that has already been done. Finally, this conventional KYC approach leads to data discrepancies among financial institutions.
Blockchain is poised to solve these problems, since it allows partnering insurers to share KYC and AML data within a private blockchain. This way, customers need to enter data only once, so it can be securely shared within a private blockchain-based database. Insurers, in their turn, don’t need to spend inordinate amounts of resources to process customer data, as it’s immutably stored on the blockchain.
On top of that, blockchain can also streamline regulatory compliance and significantly decrease compliance costs. Insurers won’t need to submit compliance reports manually, as regulators can access all the necessary information on blockchain in real-time.
One of the insurance industry’s legacy challenges is a lack of trust and transparency as, according to IBM research, 42% of customers don’t trust their insurers. Given that trust is the foundation of long-lasting customer relationships, this is a truly alarming statistic. Importantly, this lack of trust is mutual, with customers often thinking that insurers are deliberately skimping on payouts, while insurers are forced to carefully evaluate each claim to mitigate fraud risks.
However, there is no surprise that insurance is an attractive field for wrongdoers. With multiple insurers and reinsurers constantly shuffling papers between each other, criminals have ample opportunity to make multiple claims for a single accident.
Using blockchain, insurers can combat fraud by permanently storing claims data there and sharing it with everyone within the network. This will significantly lower the risk of double-booking, counterfeiting, and other types of insurance fraud.
For example, ClaimShare uses blockchain and confidential computing to prevent double-dipping fraud. When a customer files a claim, ClaimShare shares a person’s publicly available data with other insurance providers via Corda blockchain. Using an AI fuzzy matching algorithm, the system automatically detects suspicious claims. Once the system identifies a claim as potentially fraudulent, the confidential computing platform Conclave matches personally identifiable information with the claim data to validate a fraud attempt. In this case, confidential computing helps to analyze data without compromising sensitive information, allowing the ClaimShare solution to stay compliant with GDPR.
All in all, blockchain enables users to seamlessly share sensitive information, thus streamlining data analysis and identification of fraudulent activities.
Reinsurance is a crucial part of every insurer’s risk management toolkit. In a nutshell, an insurer becomes a client of another insurance company to protect themself from unpredictable risks like environmental catastrophes or financial crises.
When it comes to reinsurance, there is usually a gamut of parties including clients, brokers, and reinsurance companies themselves with different data standards. This significantly complicates reconciliation and disrupts the flow of information between parties.
For example, the most common type of reinsurance for catastrophic events is excess of loss. Usually, reinsurance companies use facultative reinsurance contracts to avoid unlimited liability. This implies that the reinsurance company will cover losses up to a certain threshold. This contract is advantageous for reinsurers but puts immense pressure on insurers to minimize losses. In case of catastrophic events, facultative insurance becomes almost worthless for reinsurers, as cumulative losses usually far exceed the limits defined in the contract.
On the contrary, excess of loss reinsurance implies that the reinsurer covers all losses above a specific threshold. To avoid taking responsibility for inordinate amounts of losses that catastrophes can lead to, reinsurers often split the percentage of losses with a ceding company.
This is when reinsurance becomes an increasingly complex and resource-intensive process with multiple parties endlessly exchanging documents with each other. For example, every claim submitted by the insured party requires reconciliation between all participants, which is a notoriously slow and inefficient process.
Blockchain allows for significant cost and time savings for reinsurers by providing tamper-proof and time-stamped records of claims. This allows all involved parties to have a single source of truth, eliminating the need for manual reconciliation, enabling reporting standardization, and enhancing risk management. Smart contracts can also be used to automate reinsurance accounting, further streamlining cash flows.
The Blockchain Insurance Industry Initiative is an international blockchain consortium established in 2016 and now helping more than 40 companies to streamline insurance. In 2021, Thai Reinsurance Public Company launched a reinsurance smart contract platform in collaboration with IBM. Given that Thai Re processes more than 10,000 reinsurance contracts every year, the initiative is destined to bring tangible benefits in the coming years.
In short, peer-to-peer insurance involves a group of individuals that pool their resources together and insure each other against various risks. When someone from the group faces a loss, funds from the pool will cover the expenses of that individual. Given that in the P2P insurance model members are both insurers and policyholders, they are incentivized to keep risks low.
P2P insurance eliminates the need for a central authority, decreases overhead costs, and allows group member policyholders to be refunded at the end of the coverage period. However, these immense benefits are conventionally compromised by the lack of trust between group members.
Blockchain can be that very missing ingredient that makes a P2P transaction network self-sufficient and trustworthy. By applying smart contracts, P2P groups at least partially automate claim payouts. For example, when a claim is made, the smart contract application can automatically check if all the necessary documents are attached and whether the claim amount is below the defined limit.
Given that many P2P insurance groups are formed by friends, family members, and people that are socially close to each other, it’s also possible to employ secure voting mechanisms using blockchain. So, when a claim is made, members can vote to approve or refuse it, further simplifying payouts.
In some cases, P2P insurance groups may also purchase reinsurance to provide extra protection for themselves. Notably, a reinsurance company can also use smart contracts to enforce specific terms after which claim payouts will be made.
Conventionally, insurers pay out claims based on a specialist’s estimation of loss. Due to the inherent subjectivity of such assessments, there is a mutual distrust between policyholders and insurers. This is why the insurance industry came up with parametric insurance.
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 may imply that regardless of the actual economic damage, an insurer will pay $1m to a policyholder if the earthquake goes above a specific magnitude value and reaches a particular territory.
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.
The common target audience for parametric insurance is farmers who need to insure against unforeseeable weather events that negatively impact their crops. Let’s imagine a farmer who wants to hedge against drought. With blockchain, it becomes possible to automate claims handling by configuring smart contracts to execute terms based on a predetermined set of parameters like rainfall amount and other weather conditions.
Rainfall data can be obtained from IoT-enabled sensors and/or from publicly available weather APIs. With such a framework in place, a claimant doesn’t have to wait for an insurer to manually process claims and can be confident that he or she will immediately get paid if contract conditions are met.
Last month, the Lemonade Foundation launched a blockchain-based project to provide crop insurance for low-income farmers. Providing insurance to smallholder farmers has always been a hard proposition. Given the small scale of their businesses and correspondingly small claims, it’s simply economically unfeasible for insurance companies to work with these farmers, because the cost of processing a claim can be far higher than the cost of the claim itself.
With the help of self-executing smart contracts, the claims processing costs are getting significantly lower, making it economically justifiable for insurers from the Lemonade Crypto Climate Coalition to service low-income farmers. Importantly, aware of the utmost importance of reliable data sources, Lemonade is partnering with Tomorrow.io, a global leader in weather forecasting and monitoring.
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, it’s critical to note that unlike many other innovative technologies like AI or IoT, blockchain requires collaboration between industry players to realize its full potential.
For a number of blockchain use cases, the lack of blockchain standards and interoperability between different blockchains are significant roadblocks on the path to widespread adoption. However, standardizing such a major technology for one of the largest financial sectors overnight wasn’t a feasible proposition in the first place. Despite blockchain limitations we face at the moment, with more industry leaders tapping into the blockchain space and launching projects that do solve the industry’s real pain points (like the ones described above), others will inevitably catch up.
Lack of regulatory clarity is another barrier to the adoption of blockchain in insurance. For example, record immutability, one of the blockchain’s most praised advantages, directly contradicts GDPR’s data protection legislation, specifically the “right to be forgotten”. The majority of KYC regulations require paper-based legal archiving of documents, which also complicates compliance as blockchain stores data digitally.
In a nutshell, the current regulatory landscape in regards to the blockchain is rather uncertain. This 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 shouldn’t be discouraged from exploring the possibilities of this technology. In its latest paper about blockchain in insurance, EIOPA claims that currently, one of the most important facilitators of blockchain proliferation in insurance is the early dialogue between innovative and ambitious insurance providers and respective regulatory bodies.
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.
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