Blockchain can be viewed as a chain of data blocks that store transactions. Experts expect the technology to play an important role in the digital transformation of the insurance industry. Professor Dr. Alexander Braun (Sankt Gallen University), Philipp Sandner (Frankfurt School Blockchain Center) and Dr. Moritz Finkelnburg (Goethe Business School Frankfurt) report on its potential in this context.
Let us begin with a brief refresher. Usually blockchains are described as decentralized registers (distributed ledgers) or transaction protocols. A distributed ledger is a database that registers transactions in chronological order. All participants in a private or public network can view the transaction history. It is important that, when based on a blockchain, this transaction protocol is not administered by a central organization, but is shared in the network of the participants. This way, all participants have the same verifiable level of knowledge– a common truth. Based on this common truth one may for instance unequivocally ascertain the number of units of a cryptocurrency (such as bitcoin) owned by each user (this is currently the most popular application of blockchain). Because of the shared recordkeeping, differences in opinion are by definition impossible. Every transaction is registered in the decentralized ledger, which itself is continuously updated by all nodes in the peer-to-peer network. Therefore, every client in the network stores an identical copy of the register. This copy can only be updated if all other clients concur. The entries cannot be deleted thereafter, and therefore a blockchain contains an accurate and verifiable record of every transaction.
Blockchain technology is gaining interest in the operational insurance world as well. If all participants in a particular network have an identical level of knowledge, then it can also be maintained by a competing participant. In the insurance industry blockchain technology is suited for shared knowledge, for instance to avoid multiple payments in claims handling. The shared database is in this case the same for all competitors. A further application is a shared level of knowledge regarding the entire value chain. Policyholders, intermediaries and insurers could maintain such a shared database to ensure clarity on commission percentages, coverage and the validity of policies. Due to the low transaction costs, dynamic insurances (those that are only valid for a few hours or days) are an interesting application, too - because the blockchain technology records both beginning and end of the insurance for participants. This could become very useful for ad hoc insurances in the mobility market. The blockchain initiative B3i (Blockchain-Insurance-Industry-Initiative) that was established in October 2016 is already showing what significance is attributed to this development. Maintained by its founding partners, the insurers AEGON, Allianz and Zurich, as well as the reinsurers Munich Re and Swiss Re, the initiative has attracted ten additional participants to date.
So how can we summarize and categorize the potential that blockchain technology offers to the insurance industry? One way is to distinguish the following four archetypical areas of application:
1. Cost efficiency
Insurers are continuously under heavy pressure to perform, partly because of the ongoing low-interest rate environment as well as the required regulatory capital charges. The solution to these problems is two-fold: a balanced and cleverly designed non-life insurance portfolio, as well as an optimization of the cost structure. The key to this are lean well-designed processes with a maximum efficiency. This can only be achieved with digitized procedures, in which blockchain plays a central part. One recent example has just been announced by the B3i-initiative. They are trying to use blockchain technology for the administrative handling of reinsurance-contracts. Even though this project is still in the stadium of beta-testing, results are expected soon. Savings up to 30% by reduced administration fees, coverage tariffs and following commissions seem to be possible.
2. Operational excellence
Insurers tend to slightly overuse the term ‘operational excellence’ to describe themselves as faster, less prone to mistakes, and better than the competition in all core operational processes of the business. This includes: transparent products, a speedy application and decision-making process, digitized signatures and uncomplicated payments, error-free and swift policy management, rapid damage assessment, and consequently swift payment or rejection. A specific use case of blockchain technology in this area is the project iXLedger, a next generation marketplace for the insurance industry. By means of Ethereum blockchain technology, insurers, reinsurers and brokers will be able to exchange policies directly based on efficient downstream processes for contracting and payments of premiums and claims.
3. Optimized customer service
A company that offers not only favorably priced products, but also makes them customer-oriented, fast and transparent as well, is an attractive partner. The cost benefits of slim structures and processes are reflected in the rates. Swiftness in offering, application and closing distinguishes the company from the competition. The German insurtech Etherisc may serve as an example here. They currently have a crop insurance solution under development that will automatically make payments in cases of droughts or floods. Many farmers in developing countries still suffer from a lack of access to adequate insurance coverage, since margins are so low that insurance companies struggle to create profitable products. Blockchain can help to solve this issue, since insurance products for developing countries become profitable, if all processes can be automated. At the same time, customer service can be optimized by means of an easy-to-use web interface on both desktop and more importantly mobile devices. In combination with chatbots, this allows a streamlined communication to the customer albeit entirely automatically.
The insurance industry is famous for its consistency and continuity. Not for its creative ideas, new coverage approaches or alternative risk models. However, to more and more younger customers these are considerable needs: on-demand insurance, pay-as-you-drive, or parametric products (which do not require proof of damage for a payout) are just a few examples. Technology that enables completely new business models may lead to substantial competitive advantages. AXA, for example, is the first major insurance company to offer insurance based on Smart Contracts, using blockchain technology. More specifically, they have just launched ‘fizzy’, a fully automated and secure flight delay insurance policy that pays out to the policyholder based on a parametric trigger.
Advantages in the core business
Does blockchain technology really offer all these benefits in these four areas or are expectations too high? It is certainly too early for a final verdict, as the process of technology adoption has only just begun. First reports, however, are altogether encouraging, despite the complexity. Manipulation-safe databases, identification with digital signatures, the use of ‘hashing’ for secure and error-free digital data transmission, or the automatic synchronization of the blockchain databases show promise for numerous operative advantages. Whether these advantages will be realized in all of the discussed areas, e.g., for situational offerings, parametric coverages, the rapid regulation of frequent damage cases or in the fraud prevention segment, is yet to be seen.
Apart from the established insurers, the insurtech sector is looking into blockchain applications as well. A study of the current insurtech landscape conducted by the Institute of Insurance Economics of the University of Sankt Gallen shows that several startups are already active as solution providers in the area of blockchain technology and therefore represent potential partners for insurance companies. However, genuine business model innovations in the area of insurance, e.g., using so-called smart contracts are still rare. Smart contracts are computer protocols based on modern blockchains such as the Ethereum platform that can be employed to completely digitize policies. They verify autonomously whether all respective conditions have been met and subsequently settle the transaction by paying claims automatically.
A decentralized marketplace for insurance risks
Etherisc that we already briefly mentioned above sets out to create a decentralized marketplace for insurance risks. In contrast to the classical risk transfer markets, this business model works without having insurance companies as intermediaries between policyholders and risk-bearing capital. Policies are issued from the outset as fully digital Smart Contracts. At the same time, Etherisc emits the total sum insured as automated ‘cryptographic tokens’ to investors, who by buying these provide capital that will cover the entire risk at any given moment. Cryptographic tokens (also referred to as crypto-assets or crypto-currencies) are digital items of property that cannot be created or copied at will. Consequently, they are fundamentally designed in a deflationary fashion, thereby solving the ‘double spending problem’ in that they prevent the same unit of value from being spent twice.
Risk is directly linked to capital
The entire process with full collateralization is much more similar to the working of insurance linked securities than to the classic insurance undertakings, because the risk-bearing capital held by the latter is typically just a small fraction of their insurance-technical provisions. In essence, we are dealing with a ‘real peer-to-peer insurance’ based on blockchain technology that connects risk directly with capital. Customers are offered comprehensive transparency and efficiency, while investors get access to a system of insurance risks that is uncorrelated to traditional asset classes. We draw on the term real peer-to-peer insurance to describe a business model that connects risk directly with capital and consequently works without an intermediary. In contrast, concepts that are frequently also referred to as peer-to-peer insurances, such as for instance Friendsurance, are essentially built on the classical principle of an insurance society based on reciprocity.
Established risk bearers should exercise increased vigilance
As an MVP (minimum viable product), Etherisc offers a parametric coverage for flight delays. In this case parametric means that reimbursements can be made quickly and easily based on an observable variable such as the time of arrival of the plane (evident in online databases like Flightstats.com). A proof of damage by the customer is unnecessary. Further non-parametric products for common risks of daily life are already in the planning. Due to the complete automatization and decentralization using blockchain technology, operative costs can be substantially reduced compared to classic insurance undertakings. It can be assumed that Etherisc will offer customers extremely competitive premiums. Thus, established risk bearers are well advised to exercise increased vigilance. If this insurtech business model based on disintermediation should gain wider acceptance in the future, it could actually bring a disruptive change to the industry.
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