How Does Blockchain Create An Impact In The Insurance Industry Today?
The most known blockchain is the ledger of transactions for cryptocurrency bitcoin. Blockchain technology is a distributed ledger that maintains a continuously growing list of data records on decentralized servers, working as nodes. Each node holds a complete copy of the blockchain, a shared single source of truth. Nodes are incentivized to retain a copy of the ledger by rewarding them with the cryptocurrency through a process called mining. A transaction would only be added to the ledger when a majority of the nodes agree on the validity of that transaction.
The core advantage of the blockchain as the decentralized ledger is that it exists in an endless number of nodes. This guarantees transparency, even when nodes are run anonymously, have poor connectivity with one another, and have operators who may be dishonest or malicious. Furthermore, through the removal of intermediaries, blockchain ensures lower fees, whatever the ledger may hold.
The data in the distributed ledger can hold any amount of information, not just a cryptocurrency like bitcoin. The data is both individually identifiable and programmable. This translates that users can assign properties to the data. Users can program the data to represent an amount in a currency, a share in a company, or even diamond certificates.
An idea that lends itself ideally for the blockchain is called the smart contract. A smart contract is a contract between two or more parties that is created and stored in the blockchain, it involves more than the mere transfer of an amount and is self-executing upon programmed rules.
The concept is most easily explained with an example. Imagine a life insurance smart contract that pays a benefit to the designated beneficiary upon the death of the policyholder. The contract can do real-time checks on online death registers to determine the moment of payout. Smart contracts are trustless, autonomous, and self-sufficient.
The Ethereum platform, by some experts, called as ‘Blockchain 2.0’ or ‘Bitcoin 2.0’, is a programming framework to allow a network of peers to create and administer their smart contracts, without a central authority. It integrates a blockchain network with a universal programming language that would allow users to invent whatever smart contract they want. These smart contracts, or apps, perform exactly as programmed without any possibility of downtime, censorship, fraud or third-party interference.
Implications for the insurance industry
Bringing down operating costs are the biggest beneficiary for insurers that utilize smart contracts. Because the contract would be self-sufficient after its creation, no costly human interaction would have to take place afterward. Furthermore, the self-executing character would highly increase speed and efficiency in claims processing. Smart contracts are also said to steer away from the textual ambiguity of traditional contracts, preventing legal disputes. Because the rules of the smart contract are arranged at creation, the contract would only execute according to said rules.
The programmable character also authorized for less insurance fraud. Think of a car insurance payout that can only be used for repairs at certified parties. Whether someone follows the rules is no longer verified in the bureaucratic process afterward. The payout can even be programmed in such a way that it will automatically return to the insurer if the receiver doesn’t use it within a certain amount of time.
By connecting with the Internet of Things, insurers could even take this one step further to tailor their products. Think of travel insurance premiums that are only collected when your phone tells the contract you are abroad or car insurance premiums that are only collected when your car tells the contract you are driving. The possibilities of smart contracts depend on the creative minds walking around in the offices of the insurer.
Whether the current blockchains are the most suitable for smart contracts is still doubtful. Blockchains rely on an underlying cryptocurrency that is highly volatile. Furthermore, the networks are maintained by miners that expect a reward to compensate for the energy consumption this requires. You would expect a consumer of insurance to be able to depend upon a network for more than a decade without having to worry about crypto-economic game theory issues. And are consumers going to rely on networks where jurisdiction and regulation have no reach?
Distributed ledger systems are said to overcome these issues. Rather than existing in anonymous nodes, these ‘permissioned’ ledgers use legal entities to validate transactions. Imagine a distributed ledger between an insurer, intermediaries and a network of health providers. These distributed ledgers apply to all assets, including fiat money and shares, but can still replicate all applications pioneered by the cryptography community. Furthermore, they are relatively compatible with existing regulations.
Some of these distributed ledgers still use a cryptocurrency. But, these currencies or tokens are being built without the expectation or intention of making these coins available for purchase to retail customers. These tokens are only used as verifiable cryptographic receipts internally between permissioned parties, as a way to prove that certain events happen at certain times for the parties involved, as well as for outside compliance and auditing agencies. Other distributed ledgers do not even have a built-in cryptocurrency.
The distributed ledger is more attractive because of the control they afford to offer over the system. They are not subject to price volatility of underlying currencies, offer less regulatory risk and have a more secure authentication process that doesn’t rely on the incentives for miners to authenticate transactions.
Lastly, it is for the organization to question whether the blockchain or distributed ledgers could provide in its requirements. The possibilities of the smart contract are endless. It is for the insurance industry to experiment with it before everybody else does.