BLOCKCHAIN - The Burnie Group · 2018. 9. 7. · 2 | BLOCKCHAIN: APPLICATIONS IN INSURANCE The...

BLOCKCHAIN:APPLICATIONS IN INSURANCE

JANUARY 2018

INSIGHT REPORT prepared by The Burnie Group

2 | BLOCKCHAIN: APPLICATIONS IN INSURANCE

The insurance industry will undergo a significant transformation in the next decade. Technology forces, such as mobile computing, Internet of Things (IoT), and blockchain, are already changing customer interaction models, opening up new markets with new offerings, and lowering barriers of entry for new innovative startups. Furthermore, the regulatory environment is evolving, demographics are shifting, and customer expectations for increasingly personalized and specialized offerings are mounting. These forces are driving insurance companies to develop more personal relationships with their clientele and to adopt a more aggressive culture of innovation.

A new group of companies, known as “InsureTech,” has emerged to leverage these forces and, disrupting the insurance industry in much the same way that FinTech companies disrupted the financial services industry. These companies are focused on leveraging technology and digital platforms to drive new cost and productivity improvements and expanding insurance offerings into new market niches.

Traditionally, the insurance industry has been slow to innovate, adapt and struggled to understand its place in the digital revolution. While technology conventionally has been considered a tool of productivity, increasingly it is being thought of as a fundamental strategic asset. Information sharing and increased connectivity have changed the way in which people interact with their environments and, as a result, how they want and expect to interact with insurance providers. In order to survive and thrive, insurance companies need to recognize both the perils and advantages of a rapidly evolving business landscape. They must be much more aggressive in their adoption of digital technology and position themselves in the flow of innovation ecosystem activity.

Blockchain is one of the technologies at the centre of the innovation conversation. It offers solutions to many of the most pressing challenges facing the insurance industry today. Benefits of blockchain include:

• Increased efficiency of information exchange and claims processing;• Improved security for client records; • Increased accuracy and simplification of underwriting and assessments;• Improved customer engagement with personal guardianship of data;• Reduction and prevention of fraud;• Reduced transaction cost associated with intermediaries, auditors, and regulators; and• Increased automation of claims processing and other processes.


WHAT IS BLOCKCHAIN

A blockchain is an immutable, encrypted, decentralized ledger of transactions. Participants can confirm transactions and agree on a common version of the truth without the need for a central certifying authority or intermediary.

What makes blockchain valuable:

• Decentralized consensus: Trust is fundamental to any transaction. The secret to trust is consensus by transactional parties about a version of the truth. Blockchains achieve consensus by having participants broadcast requested transactions to a peer-to-peer network consisting of computers known as “nodes”. Once transactions are verified for veracity and formatting, they are bundled into “blocks” which are “chained” together by the inclusion of a distinct digital signature derived from the previous block. The net effect is a highly reliable, immutable, and hacker proof ledger, which can be leveraged by all ecosystem participants.

• Redundancy: The resulting chain of blocks, or blockchain, is agreed to by the network participants through a consensus algorithm and synchronized between distributed nodes. The many synchronized copies of the blockchain mean that there is no central point of failure.

• Immutability: If a transaction is altered in any way, its digital signature, known as a “hash,” will be altered, as will the hash of the block into which it has been bundled. This alteration is immediately identifiable by looking at the previous hash in the chain. If the hashes of the various copies of the chain are out of sync, the alteration is obvious, and the collective network can remove the altered copy from the network.

• Encryption: Network participants can authenticate transactions, sign contracts, and verify identities using cryptographic public key pairs such that only the right people in the right situation may access the data.

• Automation: Distributed application code, known as “smart contracts,” can also reside on a blockchain. Smart contracts can self-execute based on predetermined situational criteria. This means that high degrees of automation are possible in a highly trusted multi-party environment.


FIVE MAJOR IMPACTS OF BLOCKCHAIN IN THE INSURANCE INDUSTRY:

1. Improving customer engagement

Customer engagement in the insurance industry has been traditionally very low. This is both because the number of traditional touch points in a given period is few and because those touch points are often intermediated by brokers. It is also true that people have an innate fear of sharing their private data, and resent the repetitive data-entry processes typical of insurance company interactions. Digital identities build on a blockchain will allow for new kinds of discrete interactions with customers while protecting privacy and satisfying regulators.

Soon, blockchain-based digital identity will power know-your-customer (KYC) utilities. KYC is used in insurance, and other customer-serving industries, to understand and adequately manage a company’s regulatory risk associated with fraud, money laundering and terrorist funding. KYC can also help to predict a customer’s expected transaction pattern, monitor these transactions, and compare them to the expected behaviour, thereby reducing the customer’s risk of identity theft.

Blockchain-based digital identity and KYC should accelerate and simplify customer onboarding across various parts of an organization and entire ecosystems. It offers customers a mechanism to control their personal data, reducing the cost of data being maintained and managed across different sources while also reducing risk and fraud.

Customers’ perceived sense of fairness of tariffs and claims handling is also a current point of contention. Blockchains can solve this by offering greater process transparency between organizations and their customers. By revealing the logic and lack of subjectivity applied to a customer’s claim, blockchain can alleviate tensions.

Smart contracts can be used to enhance this transparency. For instance, they can review weather APIs to verify a hurricane insurance claim and issue an automated payout if criteria are satisfied thus streamlining the customer insurance experience.


2. Efficient servicing of emerging markets

Blockchain technology presents opportunities for cost-efficient product offerings in emerging markets. These markets include P2P, microinsurance, and parametric insurance.

P2P is a new model of insurance, similar to crowdfunding, which taking shape using blockchain. In this new model, insurers focus their efforts on matching supply and demand, providing risk assessment, and reducing the emphasis on asset management. New marketplaces are being created by insurers to match a product with a customer’s specific insurance demands. They do this by leveraging risk models and historical data to perform a premium calculation and posting the expected return.

In the P2P model, investors, either as a group through crowdfunding or individually through P2P interactions, bid on the demanded insurance filtered by risk tolerance. Smart contracts are used in an escrow-like capacity to guarantee payment from the investor in the case an insurance demand event occurs. This automates the entire transaction without the need for a third party such as a bank. Additional savings are possible as there is no longer a need to invest the capital required to insure since this role is taken on by investors.

Blockchain will also allow insurers easier access to emerging markets that use P2P blockchains, such as microinsurance. Microinsurance uses smart contracts to automate underwriting and claims processing for a very low handling cost. In this new model, populations in remote regions benefit from the trust and transparency of the blockchain and the minimized impact of organizational and governmental bureaucracy.

Another emerging market is parametric insurance. Parametric insurance deviates from the classical insurance model, in which an individual pays a premium to mitigate the risk of loss or damage through compensation of the pure loss by an insurance company. Parametric insurance automatically compensates the individual an agreed upon amount when the smart contract’s parametric trigger occurs. This parametric trigger refers to the parameters of a risk event. For example, if flooding or drought were to occur in a specified region to a potentially variable extent, and reported by sensors or satellite images, a smart contract would automatically pay some percentage of the insurance claim to policyholders, as defined in the contract.


3. Development of new offerings leveraging the Internet of Things.

The Internet of Things (IoT) refers to the connection of devices to the internet, often using sensors and network connectivity, which enables these devices to collect and communicate data. Cars, electronic devices, wearables, or home appliances are potentially insurable products that can be registered, and policies administered, by smart contracts in a blockchain network. Communication between IoT devices and insurance smart contracts will facilitate the automatic detection of damage, triggering the repair, claims, and payments processes without friction or lag time.

In an IoT enabled world, there will be a significant increase in the amount of data that will be available to insurers. This data will allow insurers to proactively assess client’s risk levels and create accurate actuarial models to provide a more personalized customer experience. As insurers gain a better understanding of customers, policies will be built to match customer need more closely, such as usage-based insurance (UBI) models. These policies will begin to shape customer behaviours through discounts and rewards for safe behaviours.

The blockchain offers unique value by enabling the P2P contractual behaviour without needing a third party to certify the IoT transaction. It offers immutable transaction time stamping and enhances privacy, trust, and scalability to the IoT infrastructure. The use of blockchain with IoT products also helps to reduce and prevent fraud through smart contract enabled damage detection and claim handling. The combination of the Internet of Things (IoT), authoritative data sources, increasingly good analytics, and blockchain means that customers can take insurance hedges against very granular risk, and insurance companies can assess the risk affordably and administrate the policy.


4. Reinsurance reconciliation

Blockchain provides a solution for reinsurers seeking contract transparency and risk exposure insights. The immutable ledger of the blockchain provides insurers with visibility into reinsurer attempts to offload portions to a subsidiary. It also ensures appropriate and responsible rebalancing of their capital exposures against specific risks. The audit trail becomes easier to follow with greatly reduced modelling requirements.

Current reinsurance expense ratios are typically five to ten percent of premiums. One PwC analysis suggests that fifteen to twenty percent of expenses related efficiency in data processing, claims leakage, and fraud could be mitigated using blockchain. This equates to an industry-wide saving of five to ten billion USD. Using a single shared ledger for the entire end-to-end process, from placement to payment, means data can be shared amongst all parties simultaneously, enhancing efficiencies for auditing and data entry. On this shared ledger, each party can access necessary information that does not need to be rekeyed into the systems of the reinsurer and other interested parties, thereby improving efficiency and reducing errors.


5. Fraud Detection

Fraud is a massive problem in the insurance industry. Blockchain can significantly reduce instances of fraud through its ability to validate authenticity and ownership and connect to external databases. With a decentralized digital repository, insurers can easily insure identity, identify duplicate transactions, and prove the date and time of policy issuance or product purchase. The blockchain provides a complete and immutable history of a client’s activities, authenticating identity and transaction, making the execution of fraud exceedingly difficult while simultaneously improving the ease of fraud detection.


CREATING NEW VALUE

There is an enormous latent demand for insured risk mitigation. New data tools and network-connected devices are changing the accuracy and cost of risk assessment. New market entrants with new offerings, built on new technology platforms with new cost dynamics, will transform the industry. In order to navigate these rapidly evolving industry dynamics, it is necessary to understand how blockchain will enable new business models and allow the formation of new business networks.

Blockchain offers insurers the ability to optimize the back-end process across the value chain. It allows for a more efficient exchange of information, simplification of the claims submission process, reduction of fraud and costs, as well as integration with IoT and other emerging technologies. Blockchain also moves the power of transactions closer to the individual consumer, giving them more control over their information. The transparency of claims processing and the feeling of control over of personal data enhances the consumer’s sense of fairness, security, and trust in the insurer. Services also become more personalized and increasingly digitized as more data becomes available for analysis.


USE CASE: CATASTROPHE SWAPS AND BONDS

Catastrophe swaps and bonds transfer the risks of insuring natural disasters, such as tornadoes or floods, from an insurer to an investor (sometimes in the capacity of other insurers). Allianz Risk Transfer AG (ART) and Nephila Capital Limited (Nephila) are the most recent organizations to successfully deploy blockchain smart contract technology for transacting natural catastrophe swaps.

Their pilot platform can conduct 80,000 transactions per second. Each contract validated on the blockchain has data and self-executable codes applied. When a triggering event, such as a flood which meets the agreed upon parameters, occurs, the smart contract automatically activates and determines payouts to or from contract parties. This process significantly minimizes the need for human intervention currently embedded throughout the entire risk transfer process, reducing cost, frictional delays, and the risk of errors.


USE CASE: HIGH-VALUE ASSET INSURANCE

Many types of high-value asset insurance are infamously inefficient. They are over-capacity, extremely costly, and administratively overwhelmed. These were some of the reasons Danish shipping giant, Maersk, working with insurers MS Amlin and XL Catlin, decided to apply blockchain technology to the high-value, yet “tedious and frictional,” marine insurance sector.

The 400-year-old marine insurance sector has around thirty billion USD in premiums paid each year but is one of the most inefficient areas in the insurance industry. It has previously relied on physical contracts being shipped from one port to another seeking signatures. The ability to access a distributed ledger with commonly shared information which can be integrated into individual contracts will facilitate a smooth and efficient system of business for Maersk’s new blockchain-based freight insurance infrastructure. This new system is set to be implemented in January 2018.


USE CASE: WORKING TOGETHER FOR COMMON GOOD

As a distributed system, blockchain delivers value in situations where untrusted parties, such as competitors or suppliers, need to interact. As a consequence, one of the biggest potential challenges to industry-wide implementation of blockchain is collaboration between ecosystem participants. The Blockchain Insurance Industry Initiative (B3i) is a consortium of insurers and reinsurers currently working together to explore the potential use of distributed ledger technologies. The organization currently consists of fifteen members from across the globe including Achmea, Aegon, Ageas, Allianz, Generali, Hannover Re, Liberty Mutual, Munich Re, RGA, SCOR, Sompo Japan Nipponkoa Insurance, Swiss Re, Tokio Marine Holdings, XL Catlin and Zurich Insurance Group.

B3i is dedicated to developing trading platforms across the whole insurance value chain using blockchain-based technologies. The B3i team has also developed an industry business case for the platform across the entire value chain. The consensus amongst the companies is that a productivity gain of up to thirty percent is achievable.


USE CASE: WEATHER INSURANCE

Several prototypes have been developed using blockchain technology to insure against weather events. One such prototype uses weather APIs to offer crop insurance to farmers. If weather events cause crop failure, a smart contract is triggered to issue payout.

The idea of wedding day rain insurance has also been discussed as a potential add-on to other conventional wedding insurance policies. Similarly, day-specific insurance for event disruption may be a new possible product for independent stallholders at local events who are otherwise unlikely to purchase more conventional insurance policies.


USE CASE: HOME INSURANCE

Internet of Things products are slowly but surely infiltrating every aspect of people’s homes. As these products contain more and more accurate sensors and innate connectivity, it increases the possibility of using blockchain technology for home insurance. In a connected home, a burst pipe or a broken refrigerator could be identified instantly, and an automatic payout made accordingly. This transaction, having been instantly completed and recorded, prevents administrative slow-down, loss of customer trust, and fraudulent claims later on.

The Burnie Group is an experienced management consulting firm that helps clients design innovative strategies and continuously pursue

operations excellence.

© 2018. All Rights Reserved.

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