By Jenny Sutton & Mark Wales
No discussion on disruption in any industry would be complete without considering the impact of new technologies, with blockchain being the most recent. While blockchain has the potential to transform the technology industry itself, its greater potential is the disruption of existing business models and entire industries.
Blockchain can enable activity at the market rather than just the enterprise level, and can frictionlessly integrate participants across the ecosystem. Insurance executives should not simply regard blockchain as a new technology to be mastered by their technology team for utilisation within the scope of the organisation. Rather they need to understand its broader implications as a business enabler and as a threat.
What is blockchain?
The blockchain was first conceptualised by Satoshi Nakamoto in 2008 to address the so-called double spending problem – a key vulnerability associated with digital currencies. Without a trusted authority (eg licenced bank) or central server, before concluding a transaction that includes a payment in digital currency, the receiver needs a method to verify that the payer actually has the value to transfer. Bitcoin, launched the following year, has a blockchain as its underlying technology. By recording a transaction on the blockchain, value is irreversibly transferred from the sender to the receiver, preventing the sender from spending the same funds again.
In effect a blockchain is a database in which a continuously-growing, chronologically ordered chain of blocks is written. Each block contains a variable number of transaction records and a permanent link to the previous block. Following defined rules, any participant can write a transaction, and once validated and recorded in a block, and replicated across nodes, the transaction can never be deleted or altered.
While digital currencies were the initial killer app for blockchain, its benefits were quickly grasped by the broader technology and business community, and the concept has evolved to facilitate recording the custody, ownership and transfer of almost any kind of virtual or physical asset.
Why blockchain is so important
The key property of a blockchain is trustlessness – obviating the requirement for parties to trust each other in order to transact. This has implications for the control and recording of any type of transaction – control which has traditionally been exercised centrally through in-house processes and proprietary databases.
By contrast, blockchain’s distributed processing and storage, and the immutability of the data once written, allows parties to transact without trusting or even knowing each other, thus obviating the need for a central authority.
These features make a blockchain suitable for indelibly recording financial transactions, real world events, property titles, and asset provenance, among other things. In effect, blockchain is a value transfer protocol doing for peer-to-peer transactions what the Internet protocol did for peer-to-peer data communications.
Blockchain misconceptions abound
Smart contracts are not that smart
The smart contract, and its potential to replace lawyers, is one of the most hyped features of blockchain technology. In reality, a smart contract is nothing but computer code. However, the executable form of the code is encapsulated into each agreement as it is recorded in the form of a transaction on the blockchain.
Like the other elements of a blockchain transaction, the code cannot be subsequently altered. When contract-relevant event occurs, the preordained actions can execute without requiring explicit confirmation by any of the parties. An event could be automatically triggered by external data (such as interest rates or stock prices) supplied by a mutually agreed independent source (known as an oracle).
In the case of insurance, the code (or smart contract) could hold policy terms, commission calculations or claim conditions that are locked into the blockchain for the term of the policy. When necessary, the smart contract will complete the steps and calculations that were in effect at the time that the policy was issued. This capability is a significant enabler to straight through processing, product version management and continuous product evolution. However, due to its immutability, a smart contract, including the code, should be subject to a comprehensive review and thorough testing before being used in production.
A distributed ledger does not a blockchain make
The terms distributed ledger and blockchain are not interchangeable – a distributed ledger does not necessarily have blockchain properties, and therefore, may not have the immutability associated with blockchain.
Many projects have moved ahead under the hype and interest generated by blockchain, only to evolve away from blockchain principles to a more straightforward distributed ledger architecture, thus avoiding tackling some of the challenges associated with implementing enterprise grade systems using existing, relatively immature, blockchain technology.
Blockchain for Insurance
Some insurers have announced blockchain projects, most of which appear to be focused on streamlining processes (such as on-boarding or claims) that involve the insurance company, the client, and known third parties. In other words, automating existing operations, with the insurer as the central authority. Blockchain technology has far greater potential than this. It can enable new types of interactions between peers of all types within the insurance industry.
A trustless, multi-signatory blockchain solution could enable matching and contracting between people requiring insurance and those with capital to underwrite the risk – thus creating a marketplace that includes additional types of capital providers (regulations permitting) beyond traditional insurers.
A permissioned blockchain could replace the many bi-lateral connections between insurers and brokers with one common platform on which insurance can be sold and administered. And an industry level blockchain register of all coverages for a single client would address fraud, moral hazard and over-insurance issues that indemnity-based insurance schemes experience and which drive up claim ratios and processing costs for the industry.
Potential benefits
While both the types and quantum of costs to build and operate a blockchain may be equivalent to building systems on a traditional technology stack, the sources of benefits and cost saving are far reaching.
A shared system reduces the technology and personnel requirements associated with reconciliations, error handling and corrections across the ecosystem. Customer service effort can be materially reduced when all distributors and insurers have a single reference point for the data held about the client and their transactions.
Game changing implications
A blockchain-based system has the potential to change the dynamics within the insurance industry by providing cost-effective access to occasional or new participants, and facilitating a level of transparency not usually possible. This has the potential to change the attractiveness of the insurance industry to outsiders and improve information symmetry between insurers and clients with implications for pricing and underwriting practices.
Conclusion
Much has been written about blockchain, driving up the hype and setting unrealistic expectations. Therefore, executives need to make sure that they are well informed about its capabilities, limitations and maturity before adopting or dismissing the technology. While blockchain technology enables many new business capabilities, developing robust and secure blockchain solutions is not a trivial exercise.
Conducting a proof of concept is a good way to test out the technology. Good candidates are projects that explore both the business and technology possibilities, and focus on problems that today’s technologies do not adequately solve, rather than just recreating existing systems on a blockchain.
Blockchain technology will enable new business models and is a key weapon in the disruptor’s arsenal. Insurance CEOs must re-conceptualise the insurance industry taking new blockchain-based business models into consideration, embracing the required level of collaboration with other industry participants and competitors.
Originally Published in Asia Insurance Review 1 March 2017
