Australia: Blockchain: A catalyst for new approaches in insurance

Last Updated: 2 March 2018
Article by Fred Hawke and Nina Krys

Insurers should actively prepare for blockchain innovations which are emerging as game-changers in the insurance industry.

All eyes are on blockchain.

Blockchain has become a fixation in the financial sector, perceived as a force multiplier for organisations seeking to overturn outdated business models.

Blockchain's value-adding capabilities also present an enormous opportunity for the commercial insurance landscape to improve the efficiency and security of its processes, to the advantage of all concerned, because it can be used across the entire insurance value chain to reduce operating costs and increase security, in exchanging and entering data in areas including underwriting, policy issuance, claims and reinsurance. A blockchain platform can accelerate processing, improve data quality, reduce the scope for fraud and provide real-time transparency into the status of transactions. It will not, however, affect the duty of disclosure, the need for utmost good faith or the pricing of risk.

This article is a Blockchain 101 of sorts - a helpful starting point to consider the ways in which insurers could capitalise on the early blockchain momentum and prepare for the disruptive technology today, as well as looking at some of its inherent challenges.

Blockchain - what is it?

A blockchain is digital technology in the form of a distributed general ledger, operated by a peer-to-peer network of users. It is a system for maintaining a continuously growing list of ordered records on a decentralised network of computers, without the need for a central registry or clearing house. Imagine the blockchain as a shared tower of digital Lego blocks that is stored by every user participating in the network. Each block represents a proven, robust record of a transaction or contract.

Each new transaction adds to this chain of information blocks and the resulting structure cannot be modified, including by the addition of further information blocks, without consensus of the other participants. This is because each block contains the encrypted content of the preceding one, along with its own data and a time stamp. So to change the data in a block in order to "fudge the ledger", so to speak, involves changing all the subsequent blocks as well. This cannot be done without the co-operation of the network members who added them, in accordance with whatever protocol (100% acceptance, 51% consensus or uniform validation) governs the network.

Applying Blockchain to insurance: "smart contracts"

One key, emerging blockchain application is the use of "smart contracts" in the underwriting and claims management processes." Smart contracts" are digitally-recorded agreements featuring protocols which verify and execute contractual terms, once predefined conditions encoded within the contract have occurred, without the need for human involvement. Policies which bind cover immediately once all the underwriting requirements for proposal acceptance have been met, and pay claims as soon as the preconditions for indemnity are complied with, are obvious examples. A smart contract platform could result in a shift away from the traditional underwriting and claims management paradigms towards processes that are more transparent, responsive and difficult to dispute, by reducing the amount of subjective, human evaluation and document-handling required.

We have already seen first movers adopting blockchain-powered smart contracts to catalyse efficiency gains in the re/insurance industry. The Blockchain Insurance Industry Initiative (B3i) is the most influential consortium, launched by Allianz, Aegon, Munch Re, Swiss Re and Zurich last year. B3i has engineered a prototype to enable handling of property catastrophe excess-of-loss "smart contracts" using the distributed ledger technology, due to be introduced into the market by 2019.

Blockchain can therefore expedite underwriting and claims processing by providing a direct link between policyholder and insurer, simultaneously creating an indisputable and unfalsifiable audit trail for every step. Reducing the need for humans to actively administer processes makes contractual relationships, including insurance, more efficient, with fewer opportunities for error, misunderstanding, fraud or delay, resulting in an overall improved customer experience. It is not, however, the panacea that some over-enthusiastic commentators appear to be suggesting.

Road blocks to the insurers' use of blockchain

While the promises of blockchain are real, so are the limitations. The impossibility of reversing or disrupting transactions gives rise to a range of legal issues in the context of complying with injunctions, restraining orders and requirements for customer remediation, while the prospect of lawyers' bills that pay themselves as soon as the work is done may be a bridge too far for most insurers. Blockchain's immutability, therefore, is both a strength and a weakness. While it presents an opportunity for our law-makers to adopt a creative regulatory approach, in the meantime it inevitably will breed difficulties and uncertainty regarding compliance. Insurers therefore will need to ensure they keep up with the legal and regulatory reforms as they evolve in this complex space.

The resilience of automated systems will need to be enhanced as insurers become increasingly dependent on them especially to secure sensitive information, and the blockchain is undoubtedly a significant step forward in that respect. It is robust rather than impregnable, however, and while the distributed ledger itself may not be able to be hacked, the public key encryption which secures the access protocols is only as strong as applicable legislation will allow. Nor does blockchain offer any defence against phishing, waterholing, diversion theft or other psycho-social engineering scams that exploit human cognitive bias.

Not a magic wand, but a foundational innovation for insurers

While blockchain technology is still in a nascent stage of enterprise adoption, it is already being tapped for an expanding range of applications. Along with their banking and brokerage colleagues, insurers are undertaking proof of concept and pilot projects to apply, to their core business processes, blockchain-based systems that already are in use for related activities such as tracking of insured cargos, expediting supply chain and payment systems. Some say that there must be organisation-wide cultural change to exploit the full range of blockchain benefits however, outside the realm of digital currencies, the blockchain appears to be more of a foundational innovation, a more efficient and secure means of performing recognised processes, than a true business disruptor which renders the processes themselves otiose.

Blockchain therefore is more than a buzzword but less than a magic wand. However, these are still early days and full exploration of all potential applications of the technology may still be years off. Therefore, the question for most insurers is not whether they will adopt blockchain, but where to start testing and exploring its value proposition.

Laying the foundation to address the blockchain model today will put insurers in a position to take advantage of new opportunities and efficiencies as they emerge, propelling the advancement of insurance to the benefit of all constituencies.

Clayton Utz communications are intended to provide commentary and general information. They should not be relied upon as legal advice. Formal legal advice should be sought in particular transactions or on matters of interest arising from this bulletin. Persons listed may not be admitted in all states and territories.

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