To some it sounds too good to be true: an online trading system that can’t be hacked, costs almost nothing, more or less runs itself and has potentially vast applications for transactional and data-driven business — like insurance.
To some it sounds terrifying: no one’s in charge and my money and data are involved? No thank you.
To some it sounds like a dream that may never come true: the technology has been in use at least seven years and still faces serious limitations in terms of speed and capacity.
To me, it’s fascinating. Time will tell if it deserves the hype it’s getting, but I suspect it will play a big role in the future of the risk mitigation and transfer business as people and institutions figure out how to use it. They’ve already started. I recently had the chance to sit down with a colleague and expert on the subject, Magda Ramada, and she did a great job of helping me understand where we’re at with the technology now and where it may be going – in the very near future.
How can anything online be truly hack-proof?
Blockchain technology is the backbone of Bitcoin and other virtual currencies and when Bitcoin arrived in 2009 I was sure it would be the target of every cyber criminal around. Eventually its lock would be picked.
What would happen, however, if the goods weren’t stored in one place, but in many — in fact, in every computer that uses the system? That would mean a hacker would have to pick the lock on everyone’s computer — at the same time — to break into the system. That suddenly sounds pretty hack-proof. That’s how blockchain works.
Blockchain is a distributed ledger, which is kind of like a shared spreadsheet, but instead of users updating cells and rows on their own, the blocks of data are created by consensus. Those blocks are chained to other blocks of data also by consensus. It really is as sturdy as its name.
The data is also encrypted and can be anonymized (there’s a 21st century word for you). The consensus system keeps the transactions above board and accurate while privacy – of course essential in any financial transaction – is maintained.
And there’s the accuracy. The data doesn’t get into the blockchain system unless it’s verified. Blockchain removes typos and other human errors from the field of play.
So how does it apply to the insurance business?
In addition to virtual currency, blockchain is already in use in several ways, including:
- real estate transactions
- employment contracts
- managing government IDs
- selling music
- tracking diamonds
- (this one really stands out to me) organizing democratic elections
As for insurance, we are already seeing its first applications. But before we get there, we have to talk about smart contracts.
Smart contracts are data-driven, automated systems that can fulfill the terms of a contract on their own. Say, for example, you made a deal with an airline that for a few extra dollars on your ticket price, you’d be paid a partial refund if your flight was delayed. Flight delays are public information. Your bank account information can be (and probably has been, by you) put online and encrypted. So if the flight is delayed, some money could appear in your account without you – or anyone – lifting a finger or clicking a mouse. Sounds like a form of insurance? It is. One of the first direct insurance applications of blockchain technology is flight insurance.
The next obvious steps involve other insurance transactions that can be turned into smart contracts. Crop and weather insurance is usually indexed against some parametric measure of weather: rainfall, snowfall, temperature, often over time. This is just the kind of data-driven context that is perfect for a smart contract and hence perfect for blockchain.
The efficiency is clear. No claims adjustment necessary — in fact no claim submitted at all. No check cut. All automatic. The decentralized nature of blockchain means there may be no need for any intermediary – no broker, no agent, no front office or back office help. The cost implications are obvious. Low cost to produce the product means low cost to customers. Insurance that lends itself to smart contracts is the low-hanging fruit of the blockchain revolution.
Where do we go from here?
It’s easy to see where further insurance efficiencies might be found. Claims processing and other administrative tasks can leverage the security, accuracy and safety of blockchain systems. Just because blockchain was designed and is used for public access, disintermediated transactions doesn’t mean the technology can’t be used in other ways.
There are many varieties of blockchains: public, private, permissioned, permissionless. Bitcoin is a public, permissionless system; you login and go. But companies can create internal blockchain systems that can help improve operations. Few would complain about a method that would remove math and keying errors and automate manually intensive processes.
Blockchain also opens up possibilities for types of insurance that big companies don’t focus on because they involve small amounts of money and, in the old school systems of underwriting, lots of effort. These include spot insurance, micro-insurance and peer-to-peer (P2P) insurance that’s rising with the sharing economy. The efficiency of blockchain may in fact enable global insurance companies to create products and services for many previously underserved segments of the population and the economy.
There are, in fact, already P2P, sharing economy and microinsurance products out there that are using blockchain.
Microinsurance is a particularly good example. Small premiums, low customer loyalty and high rates of policy cancellation make this an economic challenge for a business looking to grow profits. The efficiencies of blockchain are changing that.
Blockchain technology is also ripe for use in conjunction with other 21st century technologies. The Internet of Things will deliver data about home appliances, for example — how about an insurance policy that responds when one of those appliances breaks down? A policyholder could be paid before he or she evens knows that her coffeemaker went on the fritz. People today share health and driving data — products could use that information to adjust pricing. Good driving data could send insurance rates lower without as much as a nod to or from an insurance agent.
The possibility of capturing detailed data about risks and policyholders raises the likelihood of insurers offering individual pricing that does not require the time and expense of an underwriter. Ironically enough, the machinery of blockchain may help personalize aspects of the insurance industry — a useful step in the age of the customer.
So what are we waiting for?
Today, blockchain has technical limitations. Just as the system is not as simple as a spreadsheet, it takes more than a few instantaneous key strokes to add data to it. It also faces limits in the number of transactions it can handle. So blockchain is in fact not quite ready for the prime time that some of us expect it will grow into.
One of the reasons we believe in this eventuality, however, is that big resources are being focused on blockchain implementation. Over a billion dollars has been spent on advancing the technology. Some $430 million was invested in blockchain startups in 2015. Dozens of major financial institutions are supporting blockchain R&D. And the technical challenges are already being addressed. Certain start-ups are claiming to process 80,000 transactions per second in their blockchains, and the Australian Stock Exchange is piloting its use.
If I seem excited by the prospect of this kind of innovative advance, good. I like technology and I like progress. But I must also admit to some nervousness. I’m an insurance intermediary and blockchain is built on the principal of disintermediation. That kind of sounds like I’m rooting myself out of a job.
I don’t believe that’s the case. Even when blockchain realizes its potential, however far and fast that may be, there will likely be ample room for the risk and insurance adviser — to give consul, for example, on which blockchain-based services and systems an organization might benefit from.
In the meantime, I’m sure that all insurance professionals will benefit from understanding what blockchain is about and keeping an eye out for where it will be taking us.
This post was co-written with Magdalena Ramada, a Senior Economist on Willis Towers Watson’s Research & Intellectual Property Team. She has previously written here about blockchain in For insurers #blockchain is the new black.