(Clyde & Co) - The global insurance market is highly competitive. Retail and corporate customers alike expect high-value product offerings at affordable rates with quick, efficient product distribution and claims processing.
The emergence and increasing sophistication and acceptance of blockchain technology provides insurers with an opportunity to take advantage of more efficient workflows, cost savings, greater transparency, faster claims processes and a reduction in fraud.
What is blockchain?
At a high level, the blockchain is a data structure that permits the creation of a digital ledger of transactions and the ability to share this data among a distributed network of computers. The information shared is encrypted as an electronic list of “blocks”. Once information is recorded, the data cannot be erased or changed without changing all existing records. The result is that all information recorded on the blockchain is highly secure.
Blockchain Use Cases for the Insurance Industry
Even in the digital era, the majority of insurance policies and claims are processed manually, and systems have some human touchpoints. While these manual processes are mostly functional, the risk of human error and tampering or misinterpretation of data remains. The integration of blockchain technology can offer a number of process, efficiency, risk management and enhanced customer engagement benefits for insurers. We consider some of these below.
A. Smart contracts
The insurance industry has traditionally relied on trusted intermediaries such as insurance brokers and underwriting agents to arrange and distribute contracts of insurance. However, smart contracts remove the need for human involvement.
At a high level, smart contracts are self-executing contracts between two or more parties that can be programmed electronically and are executed automatically via underlying blockchains responding to the occurrence of certain agreed events. In an insurance context, the terms of agreements between insurers and policyholders are written into the code upon which smart contracts are built.
As all transactions relating to smart contracts are logged on a blockchain, there is a high level of transparency. This is because each transaction on the blockchain is publicly viewable. Separately, as the need for human interference is removed, the risk of errors and unauthorised manipulation of the terms of contracts is significantly reduced. Critically, claims investigation, coverage analysis and processing are dramatically quicker as the need for manual assessment is removed. This significantly increases the efficiency of the insurance function and can assist increase the level of consumer trust and confidence in the industry.
However, there are certain inherent limitations to smart contracts. Currently, the technology can only support relatively simple insurance covers with contract clauses which operate on the basis of “if A occurs, the result is B”. The technology is not yet sufficiently advanced to accommodate more complex contractual arrangements and terms or address the sophisticated nuances of insurance law and regulation including concepts such as “utmost good faith” or adequately address fraud and non-disclosure issues.
B. Parametric insurance
In the late 1990s, parametric insurance emerged as an objective and data-driven approach to insurance claim payments. Under parametric insurance models, claim payments are based solely on the occurrence of a clearly defined event/objective measurable data-led criteria and provide an agreed payments or an amount calculated by reference to agreed formulae. For example, if an earthquake occurs within a set radius of a policyholder’s home (measured in kilometres), then the insurer automatically pays out the agreed amount corresponding to that event.
The parametric insurance model is attractive as it avoids subjective assessment of damages and loss. While the uptake of parametric insurance is increasing in first party loss classes (especially the agriculture and crop sectors), it has not progressed as rapidly as expected due to the historical lack of reliable infrastructure and available data for securely settling these forms of contracts. However, blockchain technology provides a means of managing these gaps by connecting real-world data to the execution of insurance contracts.
In that regard, there have been recent major advances in the realm of so called blockchain oracles. These are entities that connect blockchains with live, real-time data. This enables data to be sourced from outside the blockchain and used to trigger the execution of parametric insurance smart contracts in a way that helps reduce concerns about data manipulation. This improved level of transparency in claims processes and decision-making assists to build the level of consumer trust in blockchain models.
The application and adoption of blockchain technology enables parametric insurance products to be accessible to almost anyone with an internet connection. For example, a smart contract between a farmer and an insurer may provide for payment to be made automatically after 30 continuous days without rainfall at the stipulated covered location. The smart contract can be tied to reliable external independent weather data such as official rainfall statistics which immediately trigger claims payments once agreed data thresholds are reached. In other words, a claim payments may be triggered and effected without the need for the usual claims process or the intervention of either internal human decision-making points or the involvement of any other third party service providers. Insurers are able to significantly reduce, even avoid conventional claims management costs, while providing certain, non-contestible and immediate claims service and payment to customers.
The technology and methodology are applicable in theory wherever independent, trusted and verifiable data relevant to the risk is available, or a payout trigger methodology or other formula can be agreed by the insurer and insured. For example, outside the agricultural sector, air travel interruption or delay claims payments may be automatically triggered and paid when linked to data from official air transport authority databases. Perhaps even trauma and life insurance policies linked to public health authority records, and birth and death registries. The latter obviously presents significant (perhaps insurmountable) privacy, data and regulatory considerations, but serves the point of illustrating the enormous potential use and application of blockchain in the insurance sector.
Conclusion
Blockchain technology has evolved beyond its original function of being the underlying Bitcoin cryptocurrency. There are now far more use cases that have been implemented across a wide range of industries including banking, media, healthcare and telecommunications.
The manual processes still used in the insurance industry to arrange insurance policies with insureds and through intermediaries are prone to human error and data issues. Insurers who innovate by exploring ways to apply blockchain technology to their existing processes will benefit from improved data quality in their records and enhanced transparency across parties involved in the insurance value chain.
When blockchain technology is combined with other innovations such as parametric insurance products, insurers can develop a new suite of products to target customers who are focused on efficiency and speed of claims payments, to remain competitive and agile in the rapidly developing global insurance market.
Clyde & Co’s Resilience Hub contains further insights from our global network on managing emerging risks and disruptions arising from climate change, digital transformation and post-pandemic risks, including the use of innovations such as parametric insurance products to build resilience to such risks.
By Dean Carrigan and Yvonne Lam
23 November 2021
