Beyond The Buzz: Is Insurance Ready For Blockchain?
I was recently involved in a minor car accident in which I was rear-ended in traffic. Although the damage was covered by the other party's insurance, it was a while before my car was back to normal. Between the agent, adjuster, repair shop, car rental office and others, it took over 30 phone calls, hours of effort and 6 elapsed weeks before it was all done. To economists and computer scientists, this would fall into the category of a "Coordination Problem" waiting to be solved.
Turns out complex coordination between participants is fundamental to all kinds of industries:
- Settlement of a single securities transaction requires coordination between brokers, stock transfer agents, regulators and banks, plus a dozen intermediary transactions. An astounding 20% of settlements require correction by hand.
- Coordination of healthcare involves patients, providers, insurers and ancillary services, all of which may have different software systems, resulting in lots of phone calls, faxes and potential for errors. For the critically ill, this could literally become a matter of life and death.
Participants in complex processes like these usually don't have a reason to trust each other. So, they end up using the services of trusted intermediaries. Not surprisingly, these intermediaries introduce the friction, inefficiencies and costs that kept my car in the shop for weeks.
Recently we've heard a lot about the potential of using blockchain technology to address these types of coordination problems by reducing reliance on trusted intermediaries like insurance companies, banks and governments. Specifically, we'll look beyond the buzz to grasp what we can do with blockchains in insurance today and in the near future. But first, a brief history of blockchain's seminal application, Bitcoin, and how blockchain works.
Bitcoin — The Early Breakthrough
In 2009, Bitcoin launched as a modest virtual currency governed not by a nation-state, but by programmatic rules running on a decentralized peer-to-peer data network. Over the years, the popularity and valuation of Bitcoin has continued to grow; at the time of this writing in January 2017, issued Bitcoin currency had a combined value of about $17 billion. Though minuscule compared to the money supply in most countries, it's not bad for something often dismissed as "magic Internet money." By not relying on a central authority as issuer, Bitcoin and other decentralized cryptocurrencies have become attractive alternatives to some volatile national currencies. It is now possible to send money within and across borders in near real time for less than a 1% fee by eliminating banks as trusted intermediaries — intermediaries that might take a few days and charge as much as 10%.
Once Bitcoin successfully demonstrated the decentralization of money, we started considering using its underlying blockchain technology for all kinds of business processes that could be decentralized and coordinated, with similar benefits.
Blockchain — How Alice Buys Tickets from Bob
A blockchain is a ledger containing transactions that record and track the transfer of assets between two or more parties. These assets can be anything of value that has, or can be given, a digital representation — money, goods, property, documents or data.
For example, let's say Alice wants to buy something from Bob, like tickets to a show. Alice pays Bob, and Bob delivers the tickets to Alice. Once the transaction is complete, it's important that Bob should no longer have his tickets and Alice should no longer have her money.
To enforce the terms of this arrangement, Alice and Bob could involve a trusted, centralized intermediary (eBay, PayPal, etc.).
Or, they could agree to use blockchain technology to record the transaction in a distributed ledger. If all goes well, no further action would be required. In the less likely case of a dispute, the details recorded in the ledger could be used for arbitration.
Trust Me: Byzantine Generals and Distributed Trust
But why should I trust this ledger? With most implementations, multiple transactions such as the one between Alice and Bob are recorded together within a data structure called a "block." New blocks are added constantly, and these include cryptographic "hashes" of the contents of previous blocks, effectively linking the blocks together in a chain. The chain is always growing, and it's computationally very difficult to introduce "bad" transactions or change previously recorded "good" transactions. Copies of the blockchain are distributed among "nodes" of a peer-to-peer network. Each node helps to keep the transaction history correct by working to "agree" with all other nodes about the contents of the ledger. This makes the chain extremely reliable, tamper-resistant — and trustworthy.
The state of agreement between blockchain nodes is achieved through the use of consensus algorithms, which offer a practical solution to the famous Byzantine General's Problem.
In this thought experiment, multiple armies are planning a coordinated surprise attack. Success depends on the generals being able to secretly coordinate the attack at a particular time. The problem is that the generals can't trust each other or messengers from coordinating armies, as any of them could be compromised or simply be traitors.
The problem is theoretically unsolvable, but clever consensus algorithms offer practical solutions in decentralized software systems. These algorithms reach consensus when a majority of participating peers agree. Failure or unreliability of some participating nodes can be compensated for by others.
A similar approach also keeps participants in transactions such as the one between Alice and Bob honest. Trust between Alice and Bob is thus enforced by the network and coordinated using consensus algorithms. In fact, many Alices and many Bobs (not to mention Charlies and Dianes) can start transacting directly with one another without centralized intermediaries, reducing friction and cost.
In addition to tracking assets, blockchain nodes have sophisticated software that's able to run applications. These applications can contain complex logic which may interact with off-blockchain applications and traditional enterprise software.
To understand use cases and applications in which blockchain technology may be applied, it helps to consider some of its key characteristics:
- Disintermediation. The decentralized design of blockchains reduces reliance on centralized services. Applications are able to complete transactions without using intermediaries. Applications involving coordination among multiple parties make good candidates for blockchain technology.
- Immutable Assets. Once recorded on a blockchain's distributed ledger, transactions and data are considered non-repudiable, tamperproof by hackers, and resistant to censorship by central authorities such as governments. This is valuable for applications that require accurate recordkeeping and process tracking. Proof of the existence of data or documents at a particular time in history is a common use of blockchain technologies.
- Programmable Assets. Assets stored on blockchains can be programmatically transferred with the use of rules and algorithms, reducing the need for human intervention. As a result, business scenarios that trigger transactions on assets based on events are well suited for blockchain automation.
Blockchain for Breakthroughs in Insurance
Armed with a sense of how blockchain technology works and can be applied, let's consider some possible applications in the insurance industry:
- Asset Tracking and Proof of Ownership. An important prerequisite for insurance is establishing ownership of the property to be insured and tracking transfer after subsequent sales. UK-based Everledger tracks gemstones on the blockchain by recording their unique laser-read identifiers and tracking proof of ownership and provenance. In this way, insurers can track just about any valuable asset and its transaction history.
- Microinsurance. Certain low-value or exotic products may be just too expensive to be covered by traditional insurance policy processing. Blockchain automation is emerging as a means of reaching untapped markets and insuring assets that would otherwise not be worth insuring.
- Smart Contracts for Insurance Processing. Self-executing blockchain programs called "smart contracts" are being proposed for autonomous execution of underwriting, issuance, claims, verification and settlement processes.
- Peer-to-Peer Insurance. Groups of participants not individually eligible for suitable insurance coverage might use the decentralized trust and autonomous processing smart-contract capability of blockchains to self-insure the group by sharing risk at a reduced cost.
- Internet of Things (IoT) Self-Insurance. Smart devices and property aware of their own state can interact with smart contracts to buy their own insurance or file claims as established by their sensors. Just like a modern refrigerator informs a homeowner when the water filter needs to be changed, smart devices and property may also issue alerts when their warranties need to be renewed, or renew them automatically.
Putting It All Together
A compelling collective scenario could be an insurance policy smart contract written on a blockchain. An initial purchase event would trigger an automatic transaction, which deposits monetary assets into the policy smart contract. A second transaction might add documentation for proving ownership and value of the property being insured. Subsequently, a first notice of loss (FNOL) event from an external claims system might trigger a claim transaction, which would execute an autonomous verification and pay-out via a smart contract. The policyholder would not need to file a claim, and the insurer would not have to administer it. Smart contracts can reduce the potential for fraud, decrease administration costs for the insurer and simplify the claims process for the customer.
The buzz around blockchain signals a strong interest in a technology that could fundamentally change the way insurance works. Start-ups and established companies alike are testing the waters and could announce a game-changing development any day. I recommend all players in the industry keep a watchful eye and open mind on this technology, as the future of blockchain is just starting to be recorded.