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Advisen Front Page News - Wednesday, July 12, 2017

Blockchain Enters the Insurance World: What it is and how it could change the marketplace


Blockchain Enters the Insurance World: What it is and how it could change the marketplace

By Mary Borja, Ted Brown & Bonnie Wise

Some lawyers and insurance professionals are still getting up to speed on “blockchain” – the technology that allowed bitcoin and other cryptocurrencies to develop, and that many experts say has much greater potential to change the way the world does business. 

Financial services experts have been watching blockchain for years, realizing its potential for disruption and innovation.  Many of the big names in the industry formed a consortium in late 2015 to research and develop blockchain technology for the financial services sector. That consortium, R3, has led to the creation of a blockchain-inspired distributed ledger platform specifically for the financial services industry.

Now blockchain is coming to the insurance world.  Recently, American International Group (“AIG”) and IBM announced the development of a “smart” multi-national insurance contract using blockchain technology, and several industry-leading insurers and reinsurers have launched the Blockchain Insurance Industry Initiative (B3i) to explore the potential for blockchain to lower costs and improve the insurance experience. The Bitfury Group, a U.S. technology company, has also announced a strategic partnership with the Risk Cooperative to develop uses for blockchain in the insurance brokerage market. 

As blockchain enters the mainstream, with the potential to bring big changes to certain industries – including insurance – we break down the basics.

What is blockchain?

Blockchain, often referred to as distributed ledger technology, is essentially an electronic ledger that tracks all transactions chronologically and publicly (or within a designated group of network participants). It arranges data in blocks that link together using codes, so that each block references and identifies the previous block.  Each block, or data record, contains a time-stamp and the link to the previous block. There is no centralized version of the ledger. These “blocks” and the “links” – which are fundamental to the technology – have developed into what is referred to as “blockchain.”

The key to blockchain is its public nature – it is not stored on any one computer or network or by any one entity.  This means that anyone (or anyone within a certain group with access permission) can view the ledger at all times, maintain a copy of it, and add to it. It is “distributed,” in that each user shares the same ledger.  This provides several notable benefits for any industry requiring complex transactions: real-time updates and access, transparency, and tamper-proof security (with decreased risk of fraud). Assuming parties in a blockchain network agree on common network protocols and technologies, the key drawback is that blockchain requires a lot of computing power across many locations, and in turn requires a lot of energy. In addition, there are still lingering questions about regulatory hurdles and cybersecurity threats. 

The concept of blockchain pre-dates bitcoin, but bitcoin’s development and expansion both stress-tested blockchain technology and introduced it to the masses. The bitcoin blockchain, launched in early 2009, solved a problem inherent in digital currencies and in most digital files – they can be duplicated and falsified. Rather than addressing this problem by creating a centralized bitcoin exchange, or something akin to a bank, to track transactions and ownership, the creators of bitcoin went the opposite route – a totally decentralized system of recording transactions.

At one point bitcoin was seen as a potential game-changer for the way we use currency.  While its growth has exploded (representing over $100 billion in transactions in 2016), it has yet to enter the mainstream as quickly as some envisioned. In the last couple of years, though, the focus on the potential for momentous change has shifted from bitcoin to the underlying technology of blockchain, and the latter’s potential to make waves far beyond the world of digital currencies.  

As noted above, many financial services companies quickly saw the potential in blockchain and began to invest in research and development of blockchain technologies. Those efforts are beginning to work their way into the market.  For example, BNP Paribas, a French bank, announced in late 2016 that it had completed a successful cross-border transaction for two corporate clients using blockchain technology, and several global stock exchanges and major financial institutions are testing blockchain to replace paper-based and manual transaction processing. 

Blockchain and insurance – innovations to date

As described above, blockchain allows companies to make and verify transactions on a network in real time without a central authority. Blockchain’s potential benefits include faster transactions, lower costs, and decreased risk of fraud – along with better service for all stakeholders through the improved flow of information. These changes are likely to improve both the underwriting and claims functions. Several insurance-related initiatives illustrate the emerging potential for blockchain in the industry.

Fifteen Leading Insurers Launch Initiative to Explore Blockchain In Insurance and Reinsurance

In October 2016, a group of insurers launched the Blockchain Insurance Industry Initiative (B3i) to explore the potential use of blockchain in the insurance industry to address key inefficiencies in the exchange of data between contract stakeholders.  B3i has since grown to 15 members, comprised of leading global insurers and reinsurers. B3i’s aim is to identify whether and how the insurance industry can adopt blockchain technologies to better serve insurance customers. B3i members are currently engaged in a pilot project involving reinsurance contracts between member companies, and the initiative has expressed plans to share its first results in the summer of 2017. Just this month, B3i members announced that they had created a prototype for a natural catastrophe excess of loss property reinsurance contract.

Team Employs Blockchain in Pilot Project to Write New “Smart Contract” Insurance Policy

Just last month, AIG, IBM, and Standard Chartered Bank plc announced that they “successfully piloted the first multinational, ‘smart contract’ based insurance policy using blockchain.” Working together, the team converted a multinational controlled master policy written in the United Kingdom and three local policies in the United States, Singapore, and Kenya, into a single “smart contract.” The parties chose those three jurisdictions because the U.S. is large and complex, Singapore represents a growth market for Standard Chartered, and because Kenya has a “cash before cover” regulatory requirement mandating the payment of premium before coverage is valid. The team stressed that the pilot project demonstrated the ability to include third parties, such as brokers, auditors, and other stakeholders, in the network, providing them with a customized view of policy and payment information.  An AIG representative remarked that a process that could have taken months because of local regulatory requirements was cut down to a few days.

Insurance Brokers Explore Use of Blockchain 

Also just last month, blockchain technology company The Bitfury Group announced it was partnering with insurance advisory and brokerage firm Risk Cooperative to develop applications in the insurance brokerage market. Bitfury and Risk Cooperative believe that their partnership will leverage Bitfury’s expertise in designing and implementing blockchain applications with Risk Cooperative’s insurance placement platform and partnership model to spur the adoption of blockchain applications. Further details on the partnership have yet to emerge.

What’s next?

While the promises of blockchain technology are real, there are still challenges for its implementation, and large-scale adoption in the insurance industry may still be years off. But one thing is certain: changes are on the horizon.  Stakeholders are evaluating the technology to assess ways it can be leveraged to improve insurance underwriting and administration of policies – in terms of faster speed, lower cost, better security, and an overall higher quality customer experience, both with respect to the underwriting and claims functions. Industry professionals can expect that the technology will be implemented, in one form or another, to improve the flow of information between policyholders, brokers, insurers, reinsurers, and other stakeholders, such as regulators or outside service providers.

Unlike other technological changes, such as new software implementation, the introduction of blockchain promises to transform business practices – not just technology. In the near term, a broader swath of industry professionals such as underwriters, claims managers, brokers, and other insurance professionals will need to learn what blockchain is and how its implementation will affect the industry. Because these changes will impact the business of insurance, not just the technology used in the business, professionals who are at the core of the insurance business may want to be involved in early projects to explore the potential uses and implementation schemes for blockchain technology. In addition, business leaders will need to reevaluate how they approach training and employee development as blockchain gains traction.

Some examples of specific areas for blockchain implementation in the insurance industry that are most likely to see early application and expansion include:

  • Cross-border transactions – insurers may use blockchain as payment infrastructure where payments must be made across many countries. These changes may make the industry, as a whole, more efficient.
  • Fraud reduction tools – insurers can use blockchain technology as part of an industry-wide database to more easily identify potential instances of insurance fraud. These changes should inure to the benefit of policyholders and insurers alike, in the form of a more efficient market and potentially lower insurance premiums.  In an age of exponentially increasing cyber threats and data insecurity concerns, the enhanced security offered by blockchain will garner serious attention.
  • Smart contracts – insurance and reinsurance contracts can be written and managed to trigger certain events upon the happening of other events. These changes may automate some payment processes and may expedite claims payments.  Smart contracts also may be improved through developments associated with the “Internet of Things” (IOT), so that smart devices can detect and then signal the existence of a particular event – for instance, a sensor identifies a car crash and immediately notifies the insurer.
  • Micro-insurance market development – blockchain has the potential to accelerate growth in micro-insurance markets, both due to increased efficiencies and greater connectivity of underserved populations. Many of the earliest blockchain technologies have been in the micro-insurance market. The potential to serve new markets should drive industry innovation, which in turn will be useful to improving efficiencies gained through newly-developed technologies. 

The early outcomes of blockchain implementation will have a profound impact on the pace of its continued adoption. Successful programs will lead to increased use of the technology. Adoption in other industries is also likely to impact the adoption in the insurance industry, including as service providers begin to demonstrate the improvements offered by blockchain solutions. As use expands across financial industries, the network effects have the potential to dramatically improve the efficacy of blockchain technologies.    

About the authors: Mary E. Borja is a partner and Edward R. Brown and Bonnie Thompson Wise are associates in Wiley Rein LLP’s Insurance Practice in Washington, D.C. Borja represents insurers in complex litigation and arbitration involving professional liability, general liability, cyber, crime, and property insurance coverage. Brown serves as coverage counsel for claims under general liability and various types of professional liability policies, and he routinely advises insurers in connection with cyber insurance and other media and technology risks. Wise represents insurers in connection with coverage issues and disputes arising under professional liability, general liability, and cyber policies.

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