Well, technically, the answer is neither. But we’ll get to that a bit later.
Over the past few years we have seen a number of novel applications of blockchain in insurance. Blockchain has been deployed in both commercial and retail insurance lines, with a mix of both private and public blockchains.
What is blockchain?
In a nutshell, blockchain refers to the subset of digital ledger technologies (DLT) where information is stored in groups (blocks) on a distributed network. These blocks are then added to the ledger by miners, through a process known as mining (see what I did here). Blocks cannot be changed.
A copy of the blockchain is stored by each participant (nodes). Participants are involved in validating transactions and adding them to the chain. In public blockchains like Ethereum, this happens when consensus is attained.
Some benefits of blockchain in insurance are:
- Automatic contract execution for parametric based products
- Efficiency savings due to reduced administrative paperwork and risk of error
- Greater transparency of data which can be shared
- Provide a single source of truth
- Act as an enabler for p2p insurance
- Provide a platform for DeFi insurance applications
Blockchain with smart contracts unlock a number of exciting use cases. A smart contract is a self executing transaction protocol deployed on a blockchain. While a smart contract is not a legal contract per se, it can execute events that are relevant to a legally binding contract.
For example, a smart contract can be set up to automatically pay a certain amount to an insured if the insured’s flight is delayed, as verified by third party data (blockchain oracle). Such uses can be useful in parametric type insurance products.
In another example, insurtech Insurwave is a blockchain based platform allowing the tracking of ship location, hazards and marine insurance.
Global insurer Allianz has recently launched a blockchain claims solution in 23 countries to streamline motor insurance claims.
Public blockchains such as Ethereum can also help facilitate insurance transactions brought about by decentralised finance (DeFi) solutions.
Things to think about
While blockchain creates exciting new opportunities to streamline insurance processes, it also introduces new risks which deserve due consideration. Blockchain is not the panacea for all data issues.
Consumer risk: Consumers may not know that if they lose their private keys, access to the wallet will be lost forever. There is no way to recover lost private keys. In the insurance context, the peril insured may itself cause the loss of private keys. While a number of wallets emphasise the importance of having multiple backups of private keys, public education is important while technology becomes more mainstream.
Oracle risk: To enable execution of smart contracts, particularly in the insurance context, blockchains must interact with the outside world. This is done through oracles. However, oracles can be vulnerable and introduce security risks. There have been some well documented oracle ‘hacks’. If an oracle is hacked, self-contracts
Money laundering risk: A key feature of public blockchains, anonymity, may also be its key vulnerability when trying to manage money laundering / terrorism financing risk. While KYC may be conducted at an exchange, KYC may not be conducted beyond that gateway into the blockchain world.
Counterparty risk: DeFi enables parties to transact directly p2p without any clearing house or involvement of a centralised institution, which would traditionally take on the counterparty risk. Accordingly, parties may take on counterparty risk themselves directly. Controls can be used to manage this risk however query whether participants truly understand the nature of the risk and how the risk may (or may not) be mitigated.
Unforeseen events: In the insurance context, the self-executing nature of smart contracts may be a strength but also a pitfall. While it is a good thing that a payout occurs when a trigger occurs, there may be some instances where a manual intervention is preferred to account for contingencies. This is impossible for smart contracts.
Concentration risk: If the blockchain itself is down, then transactions cannot be processed and the ledger cannot be viewed. While public blockchains have had a good record of uptime, outages are possible. This may have ramifications for the stability of the insurance sector from a supervisory perspective.
Platform risk: It’s important to note that while public blockchains are not ‘owned’ by any one entity, interventions are possible and have happened in the past. For example, Ethereum was subject to external intervention following the DAO hack, resulting in a hard fork.
Technical vulnerability: Users may be subject to exploitation by cyber criminals / hackers, and in cases of major hacks, affect the stability of the insurance sector globally.
Legal risk: Regulations and laws around the world are playing ‘catch up’ with the potential applications of blockchain in insurance. Especially where a public blockchain is in use, laws of different jurisdictions may have potential application. There is also the risk that the smart-contract does not reflect the underlying legal obligations which have been agreed between the parties. Regulations and laws may also apply to cryptocurrencies which may be used as a form of payment, and these themselves are subject to potentially high volatility.
Blockchain has the potential to deliver some exciting applications to insurance. As we have explored, some of these applications may be more appropriate at an enterprise level (internally) rather than directly connecting with customers. However, the use of blockchains, particularly public blockchains, create some risks which have not been seen in the traditional insurance context.
A risk-based commercial mindset is therefore encouraged when determining which applications are best suited for adoption via blockchain. As more creative ideas emerge for the use of blockchain in insurance, these decisions will definitely have to be revisited.
Tim Chan is an insurance & insurtech lawyer at global law firm Norton Rose Fulbright and Founder of The InsurTech Lawyer blog. He regularly advises insurers and startups on emerging legal issues affecting the industry. Follow Tim on Twitter: @timinsydney