Insurers Are No Longer on the Sidelines with Blockchain. Here Are Its Benefits and Potential Risks
Blockchain technology is making inroads in the insurance sector. Used to automate and streamline processes for paying claims, blockchain is being embraced by more and more insurance entities looking for streamlined transactions.
“Many firms in the financial services and insurance industries believe blockchain technology can be adapted for use in traditional transactions in a way that has the potential to redefine transactions and administrative functions,” said Richard Levin, chair of the FinTech and regulation practice at Nelson Mullins.
“From banking and payments to insurance, blockchain technology has the potential to make interactions quicker, less-expensive and safer.
A prominent example of the development and use of blockchain technology in the insurance industry is the work of the Blockchain Insurance Industry Initiative (B3i), a group of member companies that came together to test the potential of blockchain for insurance.
Levin said the initial focus of B3i was on property casualty insurance and to see how insurers can use blockchain for catastrophe excess of loss coverage.
“The B3i initiative was spun off into a separate entity known as the B3i Consortium. The consortium incorporated as B3i Services AG in 2018 and is 100% owned by 21 insurers,” Levin said.
“More than 40 companies are involved in B3i as shareholders, customers, and community members. B3i is developing a number of blockchain based applications including B3i Reinsurance (B3i Re), the first application built on top of the B3i Fluidity platform.”
Blockchain At Its Core
Generally, there are two types of blockchains – those that require no permission and those that require permission to be a user of the distributed ledger.
According to Levin, on a public (permissionless) blockchain, access to the network is unrestricted.
Despite public misconceptions of the technology, public blockchains are not anonymous. Users in a permissionless blockchain network use a pseudonym and on a public blockchain network, users can validate transactions.
“Validation is the process that ensures that all nodes are synchronized and that there is agreement on the legitimacy of transaction blocks. Consensus must be reached after each new block is added, and only after that can the block be considered immutable,” Levin said.
Permissioned blockchains are based on consensus mechanisms. Only approved participants can update a permissioned blockchain.
According to Levin, a centralized authority must determine which consensus to use, how many nodes should participate in the network, and who authorizes new nodes. In addition, someone must determine and validate cybersecurity requirements, and decide when to upgrade and validate the code.
Blockchain technology is increasing in popularity within the insurance arena due to the capabilities of the technology.
Blockchain offers a series of applications in the insurance industry including:
- Fraud detection and risk prevention: By moving insurance claims onto an immutable ledger, blockchain technology can help eliminate common sources of fraud in the insurance industry.
- Property and casualty (P&C) insurance: A shared ledger and insurance policies executed through smart contracts can bring an order of magnitude improvement in efficiency to property and casualty insurance.
- Health insurance: With blockchain technology, medical records can be cryptographically secured and shared between health providers, increasing interoperability in the health insurance ecosystem.
- Reinsurance: By securing reinsurance contracts on the blockchain through smart contracts, blockchain technology can simplify the flow of information and payments between insurers and reinsurers.
- Life insurance: Blockchain technology can take the burden of filing a death claim away from family members by replacing the manual process of filing claims with an automated system built on a blockchain ledger.
Benjamin Peach, associate director, digital assets at Aon explained, blockchain technologies provide efficient, fast, cost-effective solutions to many of the time-consuming and cost-incurring services currently used on Web2.
“The greatest benefit of blockchain technology is the trustless transparent system at its core. Key to this is the use of a decentralized immutable records which reduce transaction times, costs, and exposure to vulnerabilities seen with Web2 services (such as data leaks, fraudulent activities by centralized asset managers, and cyber hacks),” Peach said.
Patrick Schmid, vice president, RiskStream Collaborative (Blockchain Insurance Consortium) at The Institutes, said blockchain was born through cryptocurrency.
As such, the blockchain and broader distributed ledger technology are significant because they remove the need for confirmation and verification by a central authority.
“Cryptocurrency’s usefulness as a peer-to-peer exchange across borders, along with differences in money-supply expansion with fiat currencies, are leading to cryptocurrency exchange-rate appreciation against major currencies, including the USD,” Schmid said.
“Bitcoin’s rise relative to fiat over the last decade, Ethereum’s performance in recent years, and other opportunities for cryptocurrency investment growth have not gone unnoticed by countries, investors, and industries, including insurance. The insurance industry is no longer sitting on the sidelines.”
The low-interest-rate environment has depressed insurers’ net investment yields, constraining industry-wide profitability efforts since 2020.
For that reason, Schmid said the insurance industry is increasingly looking for positive-yielding investments, including investing in cryptocurrency. This past year saw investment by Mass Mutual and Starr/Liberty Mutual through digital currency companies such as NYDIG and this sort of enterprise adoption of cryptocurrency is likely to continue.
“While insurers are beginning to focus on the investment opportunity associated with cryptocurrency, many carriers have been focusing on leveraging ‘enterprise blockchain’ for data exchange and verification of data for multiparty business processes,” Schmid said.
Minding the Risks
Although the insurance industry now has the technical ability to significantly utilize blockchain, its adoption remains slow whilst regulatory protections are considered and integrated into the smart contracts.
“As smart contracts on a blockchain are immutable, any specific coding required to adopt protections must be pre-considered,” Peach said. “However, it will not be long until insurance becomes synonymous with smart insurance contracts and consumers may even expect insurance providers to provide user-friendly portals which make insurance claims more efficient and, in turn, pay outs faster for pre-defined triggers.”
That said, Peach pointed to key risks are found at the intersection of human interaction with blockchain technology such as:
- Forgetting your wallet address
- Sending tokens between incompatible blockchains
- The potential for a cyber hack into corporate computing systems to gain access to private keys to in turn hack private wallet addresses
- Theft of physical keys
- 51% attack (decentralized blockchains)
“One blockchain can be very different to another. There can be some drawbacks of running some which will not necessarily occur on other blockchains. For example, the Ethereum blockchain is often thought as the main alternative to Bitcoin, yet there are new blockchains such as Cardarno and Solana, which claim to be faster, better, stronger, securer and more environmental than that provided by Ethereum and Bitcoin,” Peach said.
And risk parameters can change when operating a permission-based centralized blockchain. When one corporation holds all nodes in a singular network the risk of bankruptcy, regulatory action, lawsuits and natural disasters could theoretically render all data on-chain irretrievable if the company could no longer operate.
So how easy is it to catch and reverse an error in a blockchain produced contract versus more traditional means?
According to Peach, smart contracts, once loaded onto the block, are immutable and irreversible on commonly used decentralized blockchains such as Ethereum and Solana.
“There are ways to update a contract with code and/or feature upgrades, but you can never cancel and replace, you must always issue a new updated smart contract,” Peach said.
Pen testing and stress testing for smart contracts is now big business from start-ups to established technology audit practices within the Big Four.
“Whilst it can be easy to spot faulty code and configuration errors, it’s what you can’t see as an issuer of a smart contract which can keep you up at night,” Peach said.
“Over the last few years, we’ve seen a large amount of DeFi hacks where hackers have exploited unforeseen oracle failures, backdoors related to poor coding or manipulation of cross-chain applications.”
Catching errors and reversing traditional contracts does have its inherent risks, too. As Peach explained, the misdirection of premiums to wrong bank accounts and subsidiaries of insurers can cause significant administrative work with multiple third parties to rectify.
Human error resulting in typos and misspellings not only cause confusion to insured parties but also run the risk of the legal interpretation of the agreement not being as intended and courts ruling against the name insured.
“Over the next five to ten years, the insurance industry will continue to be faced with an increasingly fast-moving, innovative, and data-driven environment, and blockchain technology will likely result in large-scale changes to traditional investments. This includes through cryptocurrency and new forms of investment through decentralized finance and in operations – through enterprise blockchain and asset tracking using non-fungible tokens,” Schmid said.
“As this progresses, more risks will emerge, and the industry will undoubtedly adapt. It’s an exciting future ahead for blockchain and insurance.” &