Chain Reaction

The digital currency bitcoin is often discussed with a high degree of skepticism. Some praise it while others are super cautious about the potential for fraud.

So it’s understandable if the underlying architecture—blockchain—is viewed with the same jaundiced eye.

Few technology subjects have received more attention in the insurance industry over the past few months than blockchain-enabled insurance solutions. While blockchain is being praised as an industry game changer that will create enormous efficiencies and cost-effectiveness for insurance companies, less has been written about its impact on brokers.

Though plans have been put forth to implement blockchain-enabled technology by Lloyd’s of London, the specialist insurance market that couples registered Lloyd’s brokers with insurance companies as syndicates, no large insurance broker in the United States has announced similar intentions.

At this juncture, brokers say they are studying the use of blockchain-enabled technology to improve their operational efficiency. They also affirm that blockchain is of great interest and, more importantly, significant concern. As Magdalena Ramada, senior economist at Willis Towers Watson’s Research and Innovation Center, says, “The concept has the potential of disrupting the very nature of brokerage.”

In the years ahead, it is expected that many insurance companies (if not the entire industry) will incorporate blockchain-enabled technology to increase data access, transparency and processing speeds and to reduce administrative costs and the risk of fraud. At the same time, a cottage industry of new competitors merging insurance and technology under the banner of insurance technology—popularly dubbed “insurtech”—are already implementing blockchain technology to achieve scale and generate communities where participants do not need to know each other.

To generate more efficient and cost-effective insurance products, the Ethereum Foundation is assisting many of the startups in using blockchain-enabled smart contracts, in which computer protocols both verify and enforce the performance of a digital transaction.

Eventually, the entire insurance ecosystem—carriers, brokers, reinsurers, claim administrators, regulators and many other third-party organizations that are directly or tangentially involved in the business of insurance—will move to a blockchain-enabled framework where data duplication, manual processing and many other current inefficiencies will cease to exist. “The question is not how or whether blockchain will make a difference, but when,” Ramada says. “I believe blockchain will have a profound impact on every aspect of today’s insurance industry.”

For now, most brokers can be comforted that the technology is stuck where the Internet was in the early 1990s—just out of the starting blocks. There is still time for brokers to continue to evaluate the impact of blockchain and determine how to take necessary steps to become part of this new technology framework. Consequently, it is okay in the near future for brokers to sit on the fence, watching closely as insurance and reinsurance companies do much of the early lifting. They can still do what they’re great at doing—attracting, securing and servicing the customer.

What brokers simply cannot do is ignore a future in which insurance transactions and servicing are likely to occur on a blockchain platform.

“The competitive challenge for all brokers in the future is how well positioned each of them will be when it comes time to channel blockchain technology into their operations,” says Eric Boyum, technology practice leader at Aon Risk Solutions.

Ramada concurs. “Brokers’ ability to host blockchain-enabled solutions in their own blockchain-powered platforms will be the key to thriving in an environment that is irremediably moving towards automation and self-executing smart contracts,” she says.

Blockchain Basics

The best way to understand blockchain-enabled technology is to simplify it to its basics. Otherwise, the technology can seem as dauntingly confusing as trying to understand Sanskrit.

Here goes: A blockchain is basically a database to store and record a set of transactions (for example, a currency transaction or a smart contract) as a “block.” This distributed ledger is akin to a database—a digital record of who owns what within the ledger. Unlike traditional database technology, however, there is no central administrator of distributed ledger technology. Instead, a set of independently incentivized “miners” (computer owners who solve complex cryptological proofs to validate transactions) validates each block of transactions. Anyone with appropriate encryption rights (in a private blockchain, those who have been granted permission; in a public blockchain, it could be anyone) can view transactions in the database. With a public blockchain, those transactions are typically pseudonymous; they do not disclose the identities of the parties to the transactions, only the facts of the transaction and its digitally marked origin and destination.

An insurance company, for example, might “settle,” or store a smart contract involving a transaction with an insurance buyer in the blockchain, where it is registered and time-stamped—ensuring authenticity. This block is then linked to additional blocks previously stored in the database by the other authorized participants in the insurance ecosystem, creating a “chain” of transaction “blocks,” hence the concept of a blockchain.

All the blocks are secured from tampering, revisions and removal, preventing forgery and fraud and allowing for a full and complete audit trail. “All the relevant parties to a particular transaction become part of the blockchain, which can store hundreds of thousands of records that no longer need to be verified and validated,” says Kaenan Hertz, insurance innovation and fintech leader at advisory firm Ernst & Young.

Since human involvement in the inner workings of the blockchain is essentially removed, a new corporate structure representing the ownership, management and control of the blockchain can be created. This is called a decentralized autonomous organization, or DAO. These corporate structures are predicated upon replacing human governance with a programming code written by a service provider, and indeed they contemplate replacing complicated legal interpretations with clearly executed code. Nevertheless, they are still in their evolutionary stages and can be extremely complicated to understand.

What is more comprehensible is the perceived value of blockchain-enabled technology. “Distributed ledger technologies and smart contracts increase transparency and enable more self-enforcing automation,” Ramada says. “More importantly, they have changed the way in which a network of non-trusted partners can function, enabling them to generate a shared digital ledger in a safe, transparent and immutable way, via consensus mechanisms that do not require a central authority or intermediary.”

It’s that latter point that should ring alarm bells for readers. At present, brokers not only provide impartial advice and negotiate on behalf of their clients, they’re considered trusted partners that ensure a client gets the best insurance deals possible—matching risk profile and needs at the best price with the best risk transfer mechanism, such as insurance or a capital markets provision. Brokers also verify the terms and conditions of insurance policies, as well as the trustworthiness of underwriters. Blockchain-enabled technology effectively assumes most of these responsibilities.

“If a DAO that is enabled through blockchain technology and smart contracts is explored in the context of insurance, one could imagine a truly decentralized market for insurers to interact (directly) with clients,” Ramada explains. “Optimal pricing, full transparency and even risk-pooling would be automatically brokered through smart contracts and verified by distributed consensus.”

While none of this will happen overnight, she and others believe blockchain-enabled technology has the potential to disrupt the long-standing ways in which the insurance ecosystem currently functions. “The brokers able to develop a vision and redefine how they add value and interact with both clients and underwriters will be the ones best able to leverage the potential of blockchain,” Ramada says.

As for those brokers unable to achieve this momentum, they are likely to lose their way. “If the job of the broker changes considerably, as is highly possible in a blockchain world, their numbers will shrink considerably,” predicts Eric Piscini, a principal and global financial services leader in the blockchain practice at Deloitte Consulting.

The Encroaching Future

No one disagrees that the potential for the insurance industry engaging blockchain-enabled technology is huge. By improving data integrity and security, insurers would no longer need to rely on a customer’s version of the truth—for instance, when a claim is filed. That’s because the blockchain contains an inherently verified and authentic record of the underlying information, reducing the possibility of fraudulent claims, while paring the time, effort and cost involved in claims processing.

Here’s an example of this value at work using travel insurance, whereby a policyholder is reimbursed for the cost of a plane ticket if the planned flight is canceled. At present, the policyholder would file a claim with the insurer pointing to the canceled flight as the reason. The insurer either trusts the person or takes the time to discern whether the flight was, in fact, canceled. With blockchain-enabled technology, the external data on the flight can be automatically entered into the distributed ledger system by the airline as an authorized participant or linked data source. The smart contract between the policyholder and the insurer is also in the ledger and linked to the airline’s data. A coded algorithm takes over from there, ensuring the claim is truthful and immediately “cutting a check” to the claimant.

“It’s just a much faster and more secure way of processing information,” Hertz says.

Others agree. “In the context of an insurance contract, you provide for an automated claims settlement that is based on certain triggering events happening,” says Alan Cohn, of counsel at law firm Steptoe & Johnson and formerly the assistant secretary for strategy, planning, analysis and risk in the Department of Homeland Security’s Office of Policy, where he oversaw the department’s cyber-crime policy.

“Say the trigger is predefined as a certain category of hurricane,” Cohn adds. “If an authorized news source or the National Oceanic and Atmospheric Administration reports sustained winds over a certain threshold that equate to this particular hurricane category, this information now goes into the blockchain. There is no need for the insurance company or an intermediary to validate evidence of the hurricane for claims purposes. As long as the information meets the terms and conditions of the smart contract between the insurer and the policyholder, it automatically determines the claims payout to the insured party and then activates this payment.”

Both Cohn and Hertz envision the Internet of things joining the list of authorized providers of information to a blockchain. “I can see a day when we will have sensors in a car reporting to the blockchain that the vehicle was in an accident,” Hertz says. “The sensor will even provide data on the extent of the damage and where the accident occurred, which then becomes part of the claim automatically filed in the blockchain.”

Not only does the driver not have to file a claim in the customary sense, the person would receive instant information on which repair shops are members of the insurer’s preferred network. “Since the repair shops are authorized to be participants in the DAO, their smart contracts with the policyholder also become part of the blockchain,” Hertz says. “All this information is immediately verifiable, allowing a check to be instantly sent to the owner of the vehicle or for the money to be deposited immediately in the person’s bank account.”

Small wonder insurers are interested.

Good for Them, Good for Me

These wide-ranging efficiencies also trickle down to brokers. As the major distribution channel for insurers, the more cost-efficient and automated brokerage processes become, the faster and cheaper products and services will be for a broker’s clients and customers. To achieve this state, key tasks would be relinquished.

Leveraging the aforementioned automobile insurance example, the policyholder’s insurance agent today handles much of the claim particulars, reviewing the police report and the assessment of damage provided by the auto repair shop. No longer would these and other routine administrative actions be required, for they are automated in the DAO. “There’s no doubt that smart contracts will have a direct impact on lowering a broker’s administration costs, by improving claims processing and generating the documentation required for payments, certificates, policies and coverage,” Ramada says.

Other brokerage benefits include significant reductions in human error and the costs associated with database synchronization and reconciliation. Improvements in accounting reconciliations when dealing with managing general agents, the wholesaler market and retail agents can also be realized, says Aon’s Boyum.

“Brokers have the opportunity through blockchain to improve the efficiencies in the associated programs that are managed through MGAs,” he explains. “This is low-hanging fruit that the industry should grab. The same can be said for brokers in the health arena. Right now healthcare claims resolution is an awful mess. What wonderful simplicity this could bring to the process.”

Do these enhancements eliminate vital services that brokers provide? Yes and no. “Blockchain takes over non-core services that technology can simply do better,” says Joseph Calandro Jr., managing director in PwC’s insurance advisory practice.

But a broker’s primary service—as the natural connection to the insurance client—is not affected at all, he says. “Rather, by making brokers more efficient, blockchain liberates them to put more of their resources into enhancing the relationship with the client,” Calandro says.

Other management consultants share this opinion. “Blockchain would eliminate the need for an insurance customer to file a claim with a broker when something goes wrong,” Piscini says. “That puts the broker at some risk of disintermediation but should not affect the overall purpose of the broker.”

His colleague, Rohit Malhotra, a principal in Deloitte Consulting’s Strategy & Operations practice, where he focuses on insurance, concurs. “Blockchain does not affect how the business comes to an insurer, which has been the traditional role of the broker for decades,” he explains. “Rather, it is generally focused on claims handling, improving the customer experience by immediately paying a verifiable claim. This, in turn, is good for the broker, as it improves the customer’s satisfaction, reducing the possibility of losing that person or business to another broker.”

Ramada agrees. “Clients will benefit from lower costs due to more efficiency and better pricing ability,” she says. “They also gain value from a more customer-centric platform with enhanced transparency, verifiability and data safety.”

Perhaps the most important value of blockchain is improving how a client’s risk profile and needs are coordinated with available risk transfer mechanisms. A customer’s risks can be individually assessed in real-time and then matched to appropriate products that can be procured via self-executing contracts, as well as to investors with the right risk appetite, Ramada says. “Smart contracts will enable the industry to go from a segmentation approach to a personalization approach,” she adds.

Boyum visualizes the impact on brokers in much the same way. “Ultimately, blockchain will allow for improved customer experiences, more secure services, a reduction in fraudulent claims and lower overall costs,” he says. “Yes, the technology displaces elements of what brokers do today, but it is not disruptive in the sense that it provides a comprehensively better way of doing everything.”

Time Will Tell

The real challenge for brokers, and it is a competitive one, is how each firm plans to operationally address the future blockchain environment. “This will take time for all parties, as you can’t build trust quickly,” Boyum says. “You build this trust over time with clear proof of concept.”

Blockchain is all about trust and security, design characteristics built in as necessary elements to be the distributed ledger for bitcoin transactions. Nevertheless, a leap of faith will be required at some point for all parties in the insurance ecosystem to make the necessary investments in the technology. This may take time; trust in the bitcoin exchange has eroded following several recent scandals, including the theft this summer of $65 million of the digital currency by hackers. “There is no bitcoin without blockchain,” says Cohn, whose department oversaw criminal investigations involving the digital currency conducted by the U.S. Secret Service and U.S. Immigration and Customs Enforcement.

Blockchain has other shortcomings. For instance, the technology in its current state cannot quickly handle very large volumes of transactions occurring simultaneously. The replication of ledgers across a distributed network of computers also can require enormous data storage space and optimization. Another uphill climb is that regulations have yet to be created to ensure more widespread trust in the technology.

“For blockchain-enabled solutions to work sustainably, a certain amount of regulation and oversight will be needed,” Ramada says. “It’s difficult to imagine regulators will permit people to trust in a fully unregulated system.”

Others agree. “Our experience in the banking industry with blockchain indicates you need involvement from parties in multiple sectors, in addition to having the regulators on board from day one,” says Matt Higginson, an associate partner in McKinsey & Company’s Global Banking & Securities practice. “If the regulators are not asked to be involved, they will sense a potential threat” to consumers.

Such drawbacks and stumbles are to be expected with any new technology. They also help explain the careful pace of progression to date. “If you had asked a lot of the (blockchain) innovators and adopters nine months ago when they would expect full, at-scale implementations to occur in the insurance ecosystem, they would have responded ‘in 18 months to two years,’” Higginson says. “We now see through our subsequent surveys that most people are saying ‘five years,’ given the time needed to fully understand the implications of the technology.”

Why the sudden foot-dragging? “Most blockchain solutions, and this is indeed the case with the insurance industry, require cross-industry collaboration,” Higginson says. “That’s not easy to achieve quickly.”

Certainly, this is the case with a technology that requires so much buy-in. Any party with a direct or even tangential relationship to an insurance contract would need to participate in the DAO for it to achieve full potential. For car insurance alone, this would require participation from automobile manufacturers, local police departments, car repair shops, sensor manufacturers, insurance companies, consumers and regulators—to name a few.

To get the ball rolling faster, Willis’s Ramada advises, the insurance industry should take a cue from the banking sector, which is moving to implement blockchain-enabled technology through the R3CEV consortium, whose 45 members include Bank of America, Morgan Stanley and Deutsche Bank. Large insurers may want to form their own consortium or join the R3 (MetLife just signed up).

“The insurance industry will soon have to start discussing how to design private or hybrid blockchains to improve the way in which data is shared, stored, analyzed and reconciled,” she says.

Caution

There is one factor that may dampen the current enthusiasm over blockchain-enabled technology: the possibility of an even better technology that has yet to surface supplanting it.

“It’s too early to say for the insurance industry that blockchain is inevitable,” says Bjorn Munstermann, a partner in McKinsey & Company’s Munich-based European insurance practice. “Another technology could come on the scene. Our recommendation is for brokers and their trade associations to keep their eyes open, go to blockchain conferences, read up on new developments, and engage in ongoing conversations with large carriers and regulators.”

Rushing to market with a blockchain-enabled solution tomorrow would be unwise, says Deloitte’s Piscini. “In my mind, there is no value to being a first mover or even a fast follower in the blockchain world, since it needs multiple parties for everyone to extract utmost value from it,” he explains. “There’s a lot of thinking that ‘if I don’t do this myself, someone will do this to me, so I better get up to speed.’ The truth is, brokers can take their time for now. At some point, they will need to participate.”

Brokers can prepare for this day by digitizing their data and streamlining their processes, Higginson says. “This is something they should be doing anyway.”

“What is fundamental for the insurance industry is to rebuild their IT systems and redesign their processes to improve basic things like customer onboarding and management of customer identity. Ultimately, these steps will also serve the needs of the blockchain if and when it happens in the industry.”

Certainly, ignorance of blockchain-enabled technology is not a solution, as the risks and benefits are too strong to disregard. There’s a lot to be said for simplified processes, guaranteed data accuracy, faster execution of insurance policies, and near-real-time payment of claims. “We’re at the beginning of the beginning of something that can be truly remarkable for the industry, but insofar as the day-to-day implications, it’s too early to assess for brokers,” Hertz says. “The carriers themselves are still exploring them.”

Cohn shares this opinion. “This is all still very much in the experimental stage,” he says. “Blockchain is where the Internet was in the early 1990s, when people just started to go into chat rooms or tried out this new email thing. We’re nowhere near full-scale implementation.”

The Bottom Line

Just like all revolutionary technology breakthroughs, what is most important about blockchain-enabled technology is that it requires organizations affected by the new ways of doing things to rethink their traditional value proposition. For brokers, this value has long been represented by the close relationships they have cultivated with clients, affirmed by their deep knowledge of the customer’s business and how to mitigate their loss exposures.

“If you’re a broker that sees its primary role as matching demand to supply, that job will perish in a world with blockchain,” Piscini says. “But if your role is to provide hands-on advice on risk management and to arrange optimal insurance coverages from financially secure carriers and other markets, you’ll be just fine. Brokerage should be less about the transaction, anyway, and more about the advisory value.

“This has always been a relationship-driven business,” he adds. “I don’t see that changing.”