Blockchain, Smart Contracts, and Index Triggers: Count the Frictional Costs As They DisappearBy Tom Johansmeyer | April 6, 2016
Is the insurance industry watching developments in blockchain technology? Some of our folks in the market are, but it’s pretty clear to me that the focus is the other way around. The blockchain community has its eye on insurance and is bringing plenty of potentially disruptive ideas. And smart contracts are at the top of the list.
Insurance industry disruption is the topic du jour in the tech sector right now. Some innovators outside the industry claim that insurance operates on a dated model—one that’s ready to be turned on its head. Meanwhile, the insurance industry (justifiably) counters that consumer behavior and regulatory requirements may impede the flashiest of new ideas from outside the industry. In the next couple of years, we’ll see a battle defined by strength of will and intellect as prospective new models face off against those that have earned their place in the establishment.
But let’s get back to blockchain and smart contracts. They tie into some of the other disruptive forces trying to eke their way into the global insurance industry.
So, the benefits of blockchain (check here for a definition) are reliability, speed, consistency, and auditability. A great article on the website Banking&Insurance by Sia Partners lays out an example of how blockchain could help consumers claim on travel insurance—without having to remember to submit a claim or even remember that they’re covered.
Let’s take a breath on that.
The implications are profound. Here are a few of them:
- The claim experience could theoretically begin—and end—without the claimant knowing it until payment arrives.
- The need for claim handling could decline significantly, especially with effective claim scoring and an integration with smart devices/homes and general “Internet of Things” technology (especially for property—liability claims could be a little thorny).
- Transparency could increase significantly throughout the claim-handling process, improving communication with the claimant.
- Just about every cost to handle a claim could plummet.
Of course, claim-handling expenses have a clear impact at every link in the global risk and capital supply chain. And as we move further up the chain—through reinsurance and retrocession—other applications for blockchain could reduce frictional costs, settlement time in the case of the event, and uncertainty regarding triggering.
The case study mentioned above involves scanning data sources for evidence of a triggering event to notify and satisfy prospective claimants who may not know they had a claim. Now, think about how this would work with an industry loss warranty (ILW) or index-triggered catastrophe bond. This could apply to property catastrophe instruments triggered on the PCS Catastrophe Loss Index, offshore energy instruments that use Wood Mackenzie data to enhance cat in a box triggers, or parametric global terror instruments linked to Verisk Maplecroft data.
- The reporting agent [Property Claim Services® (PCS®), Wood Mackenzie, or Verisk Maplecroft] conducts its normal operations and reports in accordance with a relevant ILW or catastrophe bond.
- Using smart contracts, the instrument structure simply scans for updates from these predefined data sources.
- When a triggering event occurs, the blockchain-based smart contract picks up the data and begins the triggering and settlement process.
The entire notion of reporting, calculation, and settlement is turned on its head. Speed becomes paramount, and the need for anyone to sit in the middle of that sensitive process disappears. Criteria for triggering would need to be defined carefully, particularly regarding weighted estimates (in the case of PCS), reporting time frames, and mapping to data elements. Those challenges, however, are relatively easily addressed. The frictional cost reduction benefit far outweighs the minor technological investments necessary.
For indemnity-triggered transactions, the use of blockchain and smart contracts could be a bit more difficult. The role of proprietary sponsor data becomes a factor, and it’s likely the process won’t work as well—especially given the blockchain bias toward transparency (not a strong suit for indemnity triggers).
Index-triggered transactions—whether industry loss or parametric—can benefit from the implementation of blockchain technology. At the efficiency end of the innovation spectrum, it could shave further basis points from the cost of capital. The question now is who will be first.
P.S. Blockchain is one of the more than 40 curated research topics the ISO Emerging Issues team manages on the Emerging Issues Portal, available to all ISOnet® subscribers.
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