Tag Archives: peer-to-peer

Blockchain’s Future in Insurance

Blockchain is a revolutionary technology that is likely to have a far-reaching impact on business – on a par with the transformative effect of the internet. Not surprisingly, the huge potential promised by blockchain has prompted a flurry of research activity across different sectors as diverse organizations race to develop applications.

In this article, we’ll explore the many benefits that blockchain could bring to the insurance industry and the different challenges that will need to be overcome.

Overview

Blockchain has strong potential in the short and long term in several different areas, particularly where it links with emerging technologies such as the Internet of Things (IoT) and artificial intelligence (AI). But its potential for delivering new applications also depends on the development of blockchain technology itself. In the medium and short term, there are three categories where blockchain can be applied:

  • Data storage and exchange: Numerous data and files can be stored using blockchain. The technology provides for more secure, traceable records compared with current storage means.
  • Peer-to-peer electronic payment: Bitcoin (and other blockchain-based cash systems) is a cryptographic proof-based electronic payment system (instead of a trust-based one). This feature is highly efficient while ensuring transparent and traceable electronic transfer.
  • Smart contracts: Smart contracts are digital protocols whereby various parameters are set up in advance. When pre-set parameters are satisfied, smart contracts can execute various tasks without human intervention, greatly increasing efficiency.

Data storage and peer-to-peer electronic transfer are feasible blockchain applications for the short term. At this stage, the technical advantages of blockchain are mainly reflected in data exchange efficiencies, as well as larger-scale data acquisition.

See also: The Opportunities in Blockchain  

Smart contracts via blockchain will play a more important role in the medium to long term. By that time, blockchain-based technology will have a far-reaching impact on the business model of insurance companies, industrial management models and institutional regulation. Of course, there will be challenges to overcome, and further technological innovation will be needed as blockchain’s own deficiencies or risks emerge during its evolution. But just like internet technology decades ago, blockchain promises to be a transformative technology.

Scenarios for blockchain applications in insurance

Macro level

Proponents of blockchain technology believe it has the power to break the data acquisition barrier and revolutionize data sharing and data exchange in the industry. Small and medium-sized carriers could use blockchain-based technology to obtain higher-quality and more comprehensive data, giving them access to new opportunities and growth through more accurate pricing and product design in specific niche markets.

At the same time, blockchain-based insurance and reinsurance exchange platforms – that could include many parties – would also upgrade industry processes. For example, Zhong An Technology is currently working closely with reinsurers in Shanghai to try to establish a blockchain reinsurance exchange platform.

Scenario 1 – Mutual insurance

Blockchain is a peer-to-peer mechanism, via the DAO (decentralized autonomic organization) as a virtual decision-making center, and premiums paid by each and every insured are stored in the DAO. Each and every insured participant has the right to vote and therefore decide on final claim settlement when a claim is triggered. Blockchain makes the process transparent and highly efficient with secure premium collection, management and claim payment thanks to its decentralization.

In China, Trust Mutual Life has built a platform based on blockchain and biological identification technology. In August 2017, Trust Mutual Life launched a blockchain-based mutual life insurance product called a “Courtesy Help Account,” where every member can follow the fund. Plus, the platform reduces operational costs more than a traditional life insurance company of a similar size.

Scenario 2 – Microinsurance (short-term insurance products for certain specific scenarios)

An example of short-term insurance could be for car sharing or providers of booking and renting accommodation via the internet. Such products are mainly pre-purchased by the service provider and then purchased by end users. However, blockchain makes it possible for end users to purchase insurance coverage at any time based on their actual usage, inception and expiring time/date. In this way, records would be much more accurate and therefore avoid potential disputes.

Scenario 3 – Automatic financial settlement

The technical characteristics of blockchain have inherent advantages in financial settlement. Combined with smart contracts, blockchain can be applied efficiently and securely throughout the entire process of insurance underwriting, premium collection, indemnity payment and even reinsurance.

Micro level

Blockchain has the potential to change the pattern of product design, pricing and claim services.

Parametric insurance (e.g. for agricultural insurance, delay-in-flight insurance, etc.):

Parametric insurance requires real-time data interface and exchange among different parties. Although it is an efficient form of risk transfer, it still has room for further cost improvement. Taking parametric agricultural insurance and flight delay insurance as examples, a lot of human intervention is still required for claim settlement and payment.

With blockchain, the efficiency of data exchange can be significantly improved. Smart contracts can also further reduce human intervention in terms of claim settlement, indemnity payment, etc., which will significantly reduce the insurance companies’ operating costs. In addition, operating efficiency is increased, boosting customer satisfaction.

Some Chinese insurers are already working on blockchain-based agricultural insurance. In March 2018, for example, PICC launched a blockchain-based livestock insurance platform. Currently, the project is limited to cows. Each cow is identified and registered in the blockchain-based platform during its whole life cycle. All necessary information is uploaded and stored in real time in the platform. Claims are triggered and settled automatically via blockchain. The platform also serves as an efficient and reliable food safety tracing system.

Auto insurance, homeowners insurance: 

Blockchain has wider application scenarios in the field of auto insurance and homeowners insurance when combined with the IoT. There are applications from a single vehicle perspective as well as portfolios as a whole. From a standalone vehicle perspective, the complete history of each vehicle is stored in blocks. This feature allows insurers to have access to accurate information on each and every vehicle, plus maintenance, accidents, vehicle parts conditions, history and the owner’s driving habits. Such data facilitates more accurate pricing based on dedicated information for each and every single vehicle.

From the insured’s point of view, the combination of blockchain and IoT effectively simplifies the claims service process and claim settlement efficiency.

From the perspective of the overall vehicle, blockchain and IoT can drastically lower big data acquisition barriers, especially for small  and medium-sized carriers. This will have a positive impact on pricing accuracy and new product development in auto insurance.

Taking usage-based insurance (UBI) for autos as an example, it’s technically possible to record and share the exact time and route of an insured vehicle, meaning that UBI policies could be priced much more accurately. Of course, insurers will have to consider how to respond in situations where built-in sensors in the insured vehicle break or a connection fails. Furthermore, insurance companies also have to decide whether an umbrella policy is needed on top of the UBI policy, to control their exposure when such situations occur.

Cargo insurance:

Real-time information sharing of goods, cargo ships, vehicles, etc. is made possible with blockchain and the IoT. This will not only improve claims service efficiency but also help to reduce moral hazards.

In this regard, Maersk, EY Guardtime and XL Catlin recently launched a blockchain-based marine insurance platform cooperation project. Its aim is to facilitate data and information exchange, reduce operating costs among all stakeholders and improve the credibility and transparency of shared information.

International program placement and premium/claims management:

Blockchain-based technology allows insurance companies, brokers and corporate risk managers to improve the efficiency of international program settlement and daily management, at the same time reducing data errors from different countries and regions and avoiding currency exchange losses.

Coping with claim frauds:

Blockchain is already being applied to verify the validity of claims and the amount of adjustment. In Canada, the Quebec auto insurance regulator (Québec Auto Insurance) has implemented a blockchain-based information exchange platform. Driver information, vehicle registration information, the vehicle’s technical inspection result, auto insurance and claims information, etc. are all shared through the platform. The platform not only reduces insurance companies’ operating costs but also effectively helps to reduce fraud.

All insurance companies that have access to the platform receive a real-time notice when a vehicle is reported to be stolen. Insurance companies have full access to every vehicle’s technical information, which promotes more accurate pricing for individual policyholders.

Claims settlement:

Using a smart contract, the insured will automatically receive indemnity when conditions in the policy are met: Human intervention will not be needed to adjust the settlement. In the future, some insurance products will effectively be smart contracts whereby coverages, terms and conditions are actually the parameters of the smart contract. When the parameters are met, policies are triggered automatically by the smart contract and a record stored in the blockchain.

Business models like this will not only build higher trust in the insurance company but will also greatly increase its operational efficiency, reducing costs; it will also help to reduce moral hazard.

Internal management systems:

Internal management systems could be automated through use of blockchain and smart contracts, helping to improve management efficiency and reduce labor costs as well as the efficiency of compliance audit.

See also: How Insurance and Blockchain Fit  

Challenges and problems

Decentralization strengthens information sharing and reduces the monopoly advantages that information asymmetry provides. Under such circumstances, insurance companies have to pay more attention to pricing, product development, claims services and even reputation risk. All this adds up to new challenges for the company management.

At the same time, every aspect of the insurance industry must be more focused on ensuring the accuracy of original information at the initial stage of its business. Knowing how to respond to false declarations from insureds will be crucial.

From a more macro perspective, “localized blocks” of data will be inevitable in the early phase of development in line with the pace of technical development and regulatory constraints.

In theory, it is impossible to hack blockchain, but data protection will be an issue for localized blocks. Therefore, higher cyber security protection will be required to protect these localized blocks.

The interaction of blockchain with other technologies could mean that existing intermediary roles are replaced by new technologies in different sectors. If the insurance industry wants to ensure the continuous development of the intermediary, it should address the possible disruptive risks to existing distribution business models posed by blockchain.

The necessary investment (both tangible and intangible costs) associated with adopting blockchain technology is a big consideration for many companies at this stage. Insurance companies and reinsurance companies operate numerous systems, and the decision to integrate blockchain-based technology/platform shouldn’t be taken lightly. At the current stage of blockchain evolution, this could be one of the biggest obstacles facing insurers.

Overall, blockchain is an inspiring prospect, and there is every reason to believe that this technological breakthrough will bring positive effects to individual insurers everywhere. But at the same time, we need to understand the mutual challenges that lie ahead and work together to promote our industry’s development in what promises to be an exciting new era.

Download PDF version for endnotes and further reading.

Distributed Ledgers in the Risk Markets (Part 3)

In the opening segment of this series on complexity, I discussed the three network graphs that have emerged in the risk markets and which business models embody them.

For quick reference:

In the second segment, we discussed the emergence of P2P insurance, which will formalize the three core functions of the risk markets that currently exist in a “black market,” unformalized state. These functions are:

  • Risk transfer;
  • Escrow of funds for a defined purpose; and
  • Management of reallocation of escrowed funds.

This formalization will occur via the emergence of a platform that enables all of these functions to be accomplished by the users of the platform, bringing the existing P2P economic activity out of its black market state and into the light of day.

Risk is the killer app for distributed ledgers!

The focus of the blockchain community on banking has been an interesting side effect of the timing of the Bitcoin innovation that coincided with the collapse of the U.S. banking industry. The blockchain technology software went open source in January 2009, while the markets (DJIA, S&P 500 and NASDAQ) bottomed out in March 2009.

The term “distributed ledger” is synonymous with blockchain. Both refer to the technology of a shared digital ledger, upon which transactions are validated by a distributed set of servers using chronological, public and cryptographically secure methods. I prefer the term “distributed ledger” because, at its core, this technology is an accounting tool that enables a set of capabilities not previously attainable.

In a distributed ledger:

  • All transactions — or, in accounting vernacular, “ledger entries” — are validated using a distributed method, without requiring users to trust in a central authority who has control over all entries on the ledger.
  • There will be lower transaction costs — both in terms of less time and lower labor costs — because there will no longer be a need to coordinate a multitude of private, centralized corporate ledgers.
  • It will create an ability for end users to publicly escrow value on a platform that enables them to connect directly with each other, creating a P2P distributed graph and enabling both the trusted communication of and individualized control over the reallocation of their escrowed value.

I would like to introduce the idea of a “risk ledger,” which is any ledger where value is escrowed as a hedge against a risk so that the risk can be safely carried through time. Currently, insurance carriers operate risk ledgers as they escrow money against a risk over a segment of time. (I wonder if this is why insurance companies are called “carriers.”) The same goal can be easily accomplished using distributed ledger technology, albeit with some advantages over private, opaque, centrally controlled corporate ledgers.

See also: 5 Steps to Profitable Risk Taking  

Distributed ledgers enable individuals to escrow value in the light of day against a risk, carrying the risk safely through a segment of time until a loss event necessitates the reallocation to the user who experienced a loss event and the removal of that value from the distributed ledger. Risk is the killer app for distributed ledger technology; as such, I believe the timeline for adoption in the risk markets will be shorter than observed in the banking markets, where the technology itself needed time to mature.

Trust is a fundamental ingredient in all financial services, and trust is something that distributed-ledger technology has a unique ability to enable. Because all money that is escrowed on a distributed ledger as well as the movement of that money is visible to all, users can trust in the system without needing to trust any single validator, company or peer participating in the network.

It must be understood that all distributed ledgers are, inherently, a network. There are many distributed ledger networks out there, but I will use Ripple’s to exemplify how a P2P distributed risk ledger platform may look. Thankfully, Ripple spearheaded acceptance by international regulatory bodies on issues associated with distributed ledger technology. Another reason I choose to use Ripple is because of its two technical features: 1) It has built-in “trust lines,” which enable individuals to create an explicit network of other peers whom they trust, and 2) it has the built-in ability of order books, which can be used to make markets between different stores of value. There are other technical advantages of Ripple, but these two elements combine to make a powerful and open-source solution.

Trust lines function as roads upon which value can move around the ledger. If I trust you, then you can send me value. If I do not trust you, then you cannot send me value because there is no path for the value to travel upon. This capacity for individuals to control who they are willing to trust enables individual peers to self-assemble a “trust graph” mirroring and to document the reality of who is trustworthy. Because all financial services are predicated on trust, this can be thought of as the finance industry’s equivalent to Google’s link graph, Facebook’s social graph and LinkedIn’s colleague graph, etc. Whoever ends up building this “trust graph” will likely be capable of creating much more value for society than those other graph types because of the significant role that finance plays in society.

Peers can extend trust lines to other peers they personally know, trust and are willing to help. These trust line connections create a trust graph in the same way as friend connections on Facebook create the social graph. In this way, a P2P distributed trust graph can be self-assembled and emerge out of the actions of the individual peers. Building a distributed graph of roads and creating many paths upon which value can travel across the distributed risk ledger network is an example of a distributed managerial process.

To give some example of how escrowed funds would flow through this distributed trust graph, let’s look at a hypothetical loss event. When a loss event occurs, a user documents the loss, and other peers who trust that user can choose to send a small amount their own escrowed funds to help their friend. (There is a formalized financial model  I will not detail.) However, I was surprised to discover, after working out the model’s details, that the model actually existed 1,000 years before modern insurance methods came about in the mid-1600s.

Order books — and the ability to make markets — enable agents and insurance carriers to retain their relative roles as they exist in the industry today.

The platform can be set up in a way that agents can capture a fixed fee as a spread or a percentage of the money that flows through the users that trust the agent by extending the agent a trust line. This is akin to commissions.

The platform can be set up in a way that carriers can manage the funds, which users put on escrow, and can control which agents are allowed to access the carrier’s gateway. This enables carriers to essentially mirror the same function that the appointment process accomplishes today. Carriers can do this activity without invoking the regulatory burden of insurance laws; they only need to comply with MSB regulations. This would also enable carriers to earn float income on the newly escrowed balance.

Phase change innovations typically emerge to address an order of magnitude more complex than what preexisting methods could in the prior industrial age paradigm. Consider how much economic activity and the number of actors Uber can organize on a global scale versus the top-down methods of an industrial-age taxi company. In the risk markets, coming out of the industrial age, we can see many companies operating independently in each of the three graphs (which are intentionally siloed). To achieve an order of magnitude improvement, we must encompass and coordinate all three graphs structures onto a single platform.

See also: Are Portfolios Taking Too Much Risk?  

Currently, agents function as a hub of client trust. Agents enable clients to navigate the complicated insurance product space and achieve the distribution of insurance products backed up by carriers. On a Ripple ledger, the agent would be a centralized hub of trust lines, and the graph would show that many users trust the agent node.

Currently, carriers function as an access point and product provider, lifting the burden of regulatory compliance, administration and product creation from agents. Engaging with the platform, each carrier can independently escrow client money without hampering the client’s ability to connect with other peers who they trust but who may not be clients of the same insurance carrier. With order books, the carriers can trade escrowed funds to enable a user who has experienced a funded loss event to receive a single check from the carrier that that user does business with, even though many of the peers funding the coverage are not clients of that carrier and do not have funds escrowed with the carrier issuing the check. Via these order book connections, carriers’ relationships will create a decentralized graph on the platform.

Combining the peer-to-peer distributed trust line graph, the centralized graph that is the hub of trust connections surrounding the agent and the decentralized graph of carrier-to-carrier order book connections, the platform can facilitate the coordination of all three graphs within a single system — all while relinquishing ultimate control of the flow of funds to the individual peers of the platform. This achieves a distributed managerial method of the reallocation process applied to the escrowed funds. This also alleviates the cost of adjusting claims and the exposure to fraud from the participating carrier’s perspective, as well as the distribution of the costs associated with the adjusting process across the peers participating in the network.

As is explained in his book “Why Information Grows: The Evolution of Order from Atoms to Economies,” MIT’s Cesar Hidalgo argues that we are at a point when firms need to network if they desire to continue to create value for society in excess of what any single firm can create alone.

Via a distributed risk ledger network, many carrier firms can run the servers that maintain the whole ledger. This gives each carrier an equal vision into the ledger and removes the need for any carrier to submit control to another carrier that is tasked with running the entire system. Most importantly, these methods function as a shared back office so that no single firm bears the burden of the costs associated with managing all of the small loss events. Additionally, the cost of the system’s management does not need to be duplicated and absorbed by each participating firm. This is essentially how Ripple is being implemented in the banking industry to reduce the costs of international payments and increase the speed of international flow of funds.

Some examples:

  • Firms in the home and auto insurance business can network to facilitate a ledger with other home and auto insurance firms, helping homeowners who experience losses that are under the deductible or excluded from the policy form.
  • Life insurance firms can facilitate their own ledger networking with other life insurance firms, enabling coverage for clients who do not meet underwriting requirements, such as those over the age of 75 or with a terminal disease.
  • Firms in health insurance can network to facilitate a ledger with other health insurance firms to better enable users to cover high deductibles, only invoking their traditional insurance contracts for unexpected, large incidents.

By networking, firms can enable the existing P2P risk transfer behavior to occur with less friction and bring this important economic activity out of its black market state and into the light of day on a formalized platform. Once the economic activity is occurring on a formalized platform, one would expect to see, like was observed with Uber and AirBnB, a resulting boom in the aggregate amount of the economic activity, growing the entire risk market’s pie and improving the risk market’s value add to society.

See also: 4 Steps to Integrate Risk Management

In the next segment of this series, I will consider possible changes to the risk market’s current equilibrium state and what that equilibrium may look like after the phase change has occurred.

The Spread of P2P Insurance

The sharing economy is not just a U.S. experience. It is truly a global phenomenon that has infiltrated and influenced multiple industries in both developed and developing countries. Even the ultra-conservative insurance industry has not been immune to these advancements.

While U.S.-based insurer Lemonade has been receiving much of the recent domestic headlines for being an innovator, the insurance sharing model, or peer-to-peer insurance, has, in fact, been in existence in several countries since as early as 2010. Companies such as Friendsurance, PeerCover, Riovic and Guevara have played key roles internationally in the disruption of the traditional insurance model in countries like Germany, South Africa, New Zealand and France — among others. While peer-to-peer insurers shift focus toward technology, automation and social networking, it is apparent that the core concepts of traditional insurance — such as sharing losses through mutual insurance arrangements, avoiding adverse selection and mitigating moral hazards — remain fundamental to its business model and, quite frankly, its survival.

Peer-to-peer insurance, much like traditional mutual insurance, is a group of “peers” who pool their premiums to insure against a risk and across both types of insurance the perils that buyers are insuring against remain homogeneous. It is, in essence, the centuries-old concept of mutual insurance being given a 21st century makeover.

This new peer-to-peer model of insurance adheres to traditional pooling and sharing of losses, but it is now combined with today’s technology, providing a product for increasingly savvy consumers who require transparency in an on-demand economy. Further, peer-to-peer and traditional insurers also group policyholders in similar ways; however, the peer-to-peer model may provide more refined classes because of advances in computer algorithms and artificial intelligence (AI).

Simply, peer-to-peer companies allow participants to insure a common deductible, while large claims are still covered by traditional insurers. When smaller claims occur that fall within the deductible, this loss is shared among a small circle of friends or similar policyholders. Traditionally, when policyholders had a good year and a favorable loss ratio, premiums would be returned in the form of a dividend. This concept has also been adopted by some peer-to-peer insurers, while others have also designated excess premiums be sent to a charity chosen by the policyholder group. So while peer-to-peer insurance may provide more refined methods of grouping policyholders or more options for distributing unused premiums, the underlying core concepts of traditional insurance are still maintained.

See also: Examining Potential of Peer-to-Peer Insurers  

Sharing economy businesses express their desire to reduce costs and increase transparency for consumers. Peer-to-peer companies are working to accomplish this by insuring self-selecting groups. Their philosophy is that they can improve the quality of the risk because of the relationship between the members. The peer-to-peer models strengthen the sense of responsibility within the group, which results in a reduction in both moral and morale hazard. As the two often get confused, we define moral hazard as a situation in which one party gets involved in a risky event knowing that it is protected against the risk and the other party will incur the cost — in other words, an intentional act. Conversely, morale hazard is an increase in the hazards presented by a risk arising from the indifference of the person insured to loss because of the existence of insurance, which, in comparison, is more unintentional behavior.

Allowing policyholders to actively choose the members of their policy group could foster a greater sense of belonging, responsibility and duty to others. Groups in which close-knit friends or family share in losses tend to manifest a stronger aversion to risk with the knowledge that your actions will have a direct impact on your family’s pocketbook. That family vacation everyone was planning — and paying for with the year-end dividend payment — could be put on hold because of a recent insurance claim. Similarly, if any proceeds from premiums were designated for a specific charity (i.e. pediatric cancer research in honor of a niece stricken with the disease), a member of a close-knit group may engage in better driving habits to avoid being the person responsible for a drag racing accident that could result in the loss of that donation. With more at stake, pooling participants are more likely to engage in responsible behavior — better for them and the insurer.

For peer-to-peer models where groups can unconditionally decide on their members, there can be even greater benefits — for both the group and insurer. One such advantage is the reduction of adverse selection. Typically, it can be very difficult for insurers to assess the full nature and habits of applicants at the time of an underwriting review. The insured is typically in a position to palliate their risk, often without making material misrepresentations. However, in peer-to-peer models that rely on referrals from other group members, the likelihood that the complete risk exposure of a potential insured is revealed is much greater. For example, perhaps several family members have decided to submit an application for shared automobile insurance with a peer-to-peer insurer. While most of the members have superior driving history and habits, they all know to never drive with Aunt Susie. She’s known to them as a speeder, tailgater and road-rage extraordinaire; however, she has been lucky enough to avoid any serious accidents, which has kept her record looking clean. Though she may appear to be a good risk for a half-sighted insurer, her relatives know better and, in preservation of their premium and potential dividend, deliberately do not ask her to join their group.

See also: An Overview of VC Investment in Insurtech  

Although peer-to-peer insurance models have promoted their new-age benefits with the introduction of digital platforms, AI and cost transparency, their business model is built on the foundation on traditional insurance, and their ability to succeed will be based on how well they can deliver the best of both worlds. Peer-to-peer insurers will continue to develop their models and philosophies on distribution channels, return-of-premium programs and scope of coverage.

While it is too early to calculate how much market share they can siphon from traditional insurance companies, it is clear they have many valuable attributes both operationally and philosophically that will assist them entrench their business among mainstream competitors.

Does Peer-to-Peer Fit in Risk Markets? (Part 2)

In the first of this series of four segments, we looked at the current state of the risk markets and the insurance industry. In this segment, we will look at how peer-to-peer (P2P) fits.

First, P2P is not mutual insurance. While the mutual insurance model is in more of the same spirit as P2P than corporate insurers are, mutuals are still operating primarily with the same business methods that corporate insurance companies use, and the financial service is still an indemnity insurance contract. The same would apply to the fraternals.

P2P is also not just a behavioral economic twist on insurance to reduce fraud. While elements of P2P methods do invoke (and should employ) behavioral economic principles, employing these principles alone will not qualify a service offering as P2P. P2P is hyped to get insureds to convert their social network into insurance leads.

When done correctly, a P2P service offering should demonstrate a level of virility in excess of existing insurance offerings. But traditional insurance already achieves some virility — I am an insurance broker, and much of our business is already generated via client referrals — so virility alone would not be a key differentiator for P2P.

P2P, today, is not actually disruptive. Rather, it is only an iteration of insurance as we know it today. To believe otherwise is a route to strategic disaster.

But there are other methods that more fully embody P2P methods and will prove to be quite disruptive to the current balance existing in the risk markets.

See also: Examining Potential of Peer-to-Peer Insurers  

Okay, so what is P2P?

In the first segment of this series on complexity, I discussed the three network graphs that have emerged in the risk markets and which business models embody them. For quick reference:

To dive into this, we first need to define the activity that the risk markets perform for society. Why did the risk markets emerge, and why does society engage with the market? There are three core societal functions that risk markets perform for society:

  • Risk transfer;
  • Escrow of funds for a defined purpose; and
  • Management of reallocation of escrowed funds.

Let’s take a look at each of these functions and the methods deployed to accomplish them.

Risk Transfer

One of the core elements required to legally define a contract as an insurance contract is indemnity. Inherent in the term “indemnity” is the idea of risk transfer. Indemnity is defined as “compensation or payment for losses or damages,” which essentially means that experienced risk from a loss event has been transferred from one party to another.

While insurance is a highly efficient method of accomplishing some portion of total risk transfer, an insurance contract is only one of many methods humans use to transfer risk around society, and the method has its limitations.

Other formal risk transfer methods include: companies that offer consumers a warranty on their products and service companies that are bonded by creating the same effect as a warranty does for consumers of their service. In the financial markets, we see options and swaps, as well as letters of credit. Formalized charity efforts also amount to risk transfer. In the public sphere, as was demonstrated in 2008, society has formalized methods for transferring risk from systemically important private companies to the public, all backed by the government’s access to taxation revenue.

Informal methods of risk transfer that can be routinely observed include families and friends compensating each other for some risk that the other has experienced. The same behavior also emerges within groups and communities, both with and without the intentional purpose of risk transfer. These methods amount to “black market” methods because they are not formalized, and the economic activity is not taxed and does not contribute to GDP. However, the economic activity does and always will occur.

Escrow of Funds

With indemnity insurance and other formalized methods, every insured has paid a premium for the legal right to transfer their risk exposure to another party. Presumably, this transfer shifts risks from individuals to a group as a whole. These premium funds are held in escrow to assure participants that the system will work. This behavior can be viewed as an “escrowing of funds for a defined purpose.”

With informal methods, we do not observe this escrow pattern. Indeed, many families and friends have received news that someone has experienced a loss that they do not have the means to bear. It is important to note that the person who has experienced the loss, in many cases, has already engaged with the available formalized methods that the risk markets have on offer — but the risk is in excess of what those methods can cover. With insurance, this uncovered risk amount can take the form of a deductible, the exclusion of a peril or a limitation of coverage on a covered peril.

See also: 3rd Wave of P2P Insurance  

Informal methods of risk transfer emerge to fill these segments of total risk, which formalized methods do not address. Because there are no funds that have been pre-paid and escrowed for the purpose of addressing these segments of risk, we observe informal methods of risk transfer employing a post-pay method of achieving coverage. This can be observed in the digital environment on crowdfunding platforms such as GoFundMe, where coverage for a loss is achieved after the event has occurred.

Management of Reallocation of Escrowed Funds

Formalized methods of redistributing escrowed funds, like insurance methods, employ a legal contract. In black and white, rules specify for what purpose escrowed funds will and will not be paid out by the system as coverage, and how the dollar amount of that coverage will be calculated. This legal contractual methodology creates the requirement for actuarial work.

Insurance companies employ statistical and actuarial methods to ensure that enough money is escrowed to accomplish the purpose for which the society agreed to escrow the funds but also that there are additional funds to pay for the costs of centralized managing of the reallocation process, including some additional funds for profit for the insurance company.

The degree to which these formalized methods necessitate the burning of escrowed funds is a reduction in efficiency. Internal process inefficiencies that exist in the companies managing the process effectively add to society’s realized risk from engaging with the insurance system’s methods.

Currently, informal methods obviously do not employ legal methods, as no funds have been put into escrow for any specific purpose. These informal methods for the redistribution of funds to achieve a transfer of risk unfold as individual peer decisions, directly between the two peers involved. This is an example of an emergent P2P behavior.

The Question

Now, let’s get back to the original question. What is P2P?

Whether we are taking about music files via Napster, transportation via Uber, housing via AirBnB or work via TaskRabbit, the amount of economic activity resulting from those P2P methods blossomed — but only after a platform enabled the formalization of the behavior that already existed in the world, albeit informally. In each of these markets, society built wonderful centralized organizations to accomplish the fundamental economic activity of the market.

In each of these markets, when a P2P platform was built — offering just the right degree of formalization, but not too much, to enable, but not inhibit, the connection of individual peers on the platform — economic activity grew drastically.

This is, fundamentally, an expansion of the market’s economic pie.

In the risk markets, we will see the emergence of a P2P platform that enhances the individual’s ability to network using distributed methods of management and to accomplish the process of reallocation of escrowed funds. With this platform, the three core functions driving society to engage with the risk markets will be accomplished by the individual actors without necessitating a central authority.

New technologies (such as distributed ledgers) and methods that, as it turns out, predate insurance by 1,000 years will converge, and the risk markets will see a P2P network come about. This network will be designed to accomplish a positive financial network effect that will create financial leverage, amplifying the amount of risk that individuals can cover with their own individually escrowed funds. P2P will effectively give users the option of “networked self-insurance” to better cover the gaps in total risk left by already formalized methods.

Insurance methods will not go away. The methods play an important role in how our existing financial system works.

But note what is not necessary for P2P: indemnity legal contracts, actuarial methods and a centrally controlled escrow account for processing the reallocation of those escrowed funds.

There is nothing wrong with these methods. They work quite well and systemically serve to mitigate the risk housed on lending banks’ balance sheets, albeit at the borrower’s cost. Lending activity also serves a systemically important role of enabling financial leverage for large capital purchases. However, that leverage comes with a risk. If a bank lends on a mortgage or auto loan and the underlying asset is destroyed, the loan on the bank’s balance sheet will have lost value. Indemnity insurance is likely to remain the only method of mitigating this balance sheet risk exposure that lenders will agree to accept. It would not be surprising to see the rise of insurance policies sold to banks on their loan portfolios — much like we see today occur in the process of securitization of the loan portfolios and somewhat similar to what we see with forced placed insurance.

See also: Is P2P a Realistic Alternative?  

It appears that we are observing in the risk markets that the insurance industry has been behaving in a way that can be described as: “If all you have is a hammer, everything looks like a nail.” Great, but just be sure you insure the risk exposure.

There are new tools available to the risk markets, along with new behavioral patterns, and we should not be a surprised when we see new methods — P2P and otherwise — emerge to employ these new tools for the benefit of society.

In the next section of this series, I will dive into one of those tools: blockchain, a.k.a. distributed ledger technology.

It’s Time to Accelerate Digital Change

For global insurers, digital transformation and disruptive innovation have gone from being vague futuristic concepts to immediate action items on senior leaders’ strategic agendas. New competitive threats, continuing cost pressures, aging technology, increasing regulatory requirements and generally lackluster financial performance are among the forces that demand significant change and entirely new business models.

Other external developments — the steady progress toward driverless cars, the rapid emergence of the Internet of Things (IoT) and profound demographic shifts — are placing further pressure on insurers. A common fear is that new market entrants will do to insurance what Uber has done to ride hailing, Amazon has done to retail and robo advisers are doing to investment and wealth management.

Yes, “digital transformation” has become an overused term beloved by industry analysts, consultants and pundits in the business press. Yes, it can mean different things to different companies. However, nearly every insurer on the planet — no matter its size, structure or particular circumstances — should undertake digital transformation immediately. This is true because of ever-rising consumer expectations and the insurance sector’s lagging position in terms of embracing digital.

The good news is that many early adopters and fast followers have already demonstrated the potential to generate value by embedding digital capabilities deeply and directly into their business models. Even successful pilot programs have been of limited scope. By addressing narrowly defined problems or one specific part of the business, they have delivered limited value. Formidable cultural barriers also remain; most insurers are simply not accustomed or equipped to move at the speed of digital. Similarly, few, if any, insurers have the talent or workforce they need to thrive in the industry’s next era.

Because the value proposition for digital transformation programs reaches every dimension of the business, it can drive breakthrough performance both internally (through increased efficiency and process automation) and externally (through increased speed to market and richer consumer and agent experiences). Therefore, insurers must move boldly to devise enterprise-scale digital strategies (even if they are composed of many linked functional processes and applications) and “industrialize” their digital capabilities — that is, deploy them at scale across the business.

This paper will explore a range of specific use cases that can produce the breakthrough performance gains and ROI insurers need.

From core transformation to digital transformation

Recognizing the need to innovate and the limitations of existing technology, many insurers undertook core transformation programs. These investments were meant to help insurers set foot in the digital age, yet represented a very first step or foundation so insurers could use basic digital communications, paperless documents, online data entry, mobile apps and the like. These were necessary steps, as the latest EY insurance consumer research shows that more than 80% of customers are willing to use digital and remote contact channels (including web chat, email, mobile apps, video or phone) in place of interacting with insurers via agents or brokers.

More advanced technologies, which can enable major efficiency gains and cost improvements for basic service tasks, also require stronger and more flexible core systems. Chatbot technology, for instance, can deliver considerable value in stand-alone deployments (i.e., without being fully integrated with core claims platforms). However, the full ROI cannot be achieved without integration.

For many insurers, core transformation programs are still underway, even as insurers recognize a need to do more. Linking digital transformation programs to core transformation can help insurers use resources more effectively and strengthen the business case. Waiting for core transformation programs to be completed and then taking up the digital transformation would likely result in many missed performance improvement and innovation opportunities, as well as higher implementation costs.

One key challenge is the industry’s lack of standardized methodologies and metrics to assess digital maturity. With unclear visibility, insurance leaders will have a difficult time knowing where to prioritize investments or recognizing the most compelling parts of the business case for digital transformation.

But, because digital transformation is a long journey, most insurers are best served by a phased or progressive approach. This is not to suggest that culturally risk-averse insurers be even more cautious. Rather, it is to acknowledge that complete digital transformation at one go can’t be managed; there are simply too many contingencies, dependencies and risks that must be accounted for.

See also: The Key to Digital Innovation Success  

Insurers must be focused and bold within their progressive approach to digital transformation, as it is the way to generate quick wins and create near-term value that can be invested in the next steps. Each step along the digital maturity curve enables future gains. Rather than waiting to be disrupted, truly digital insurers move boldly, testing and learning in pursuit of innovation and redesigning operations, engaging customers in new ways and seeking out new partners.

Digital transformation across the insurance value chain: a path to maturity and value creation

Digital transformation delivers tangible and intangible value across the insurance value chain, with specific benefits in six key areas:

It’s important to emphasize speed and agility as essential attributes of the digital insurer. Even the most innovative firms must move quickly if they are to fully capitalize on their innovations — a concept that applies across the entire value chain. The idea is to launch microservices faster and embrace modernized technology where possible. For instance, deploying cloud infrastructures will enable some parts of the business to scale up and scale down faster, without disrupting other parts of the business with “big dig” implementations.

The dependencies and limitations of legacy technology are also worth reiterating. Insurers that can integrate process innovations and new tools with existing systems — and do so efficiently and without introducing operational risk — will gain a sustainable competitive advantage.

The following digital transformation scorecards reflect how the benefits apply to different technologies and initiatives.

Omni-channel

Today’s consumers are naturally omni-channel, researching products online, recommending and talking about them with friends and contacts on social media and then buying them via mobile apps or at brick-and-mortar retail locations. Basically, they want a wide range of options — text, email, web chat, phone and sometimes in-person. A better omni-channel environment may also enable insurers to place new products in front of potential customers sooner and more directly than in the past.

Insurers must look beyond merely supporting multiple channels and find the means to allow customers to move seamlessly between channels, or even within channels (such as when they move from chatting with a bot to chatting with a human agent). It is difficult to overstate how challenging it is to create the capabilities (both technological and organizational) to recognize customers and what they are seeking to do, without forcing them to re-enter their passwords or repeat their questions.

There are many other subtleties to master, including context. For example, a customer trying to connect via social media to voice concerns is not likely to respond well to a default ad or up-sell offering. Omni-channel is increasingly a baseline capability that insurers must establish to achieve digital maturity.

Big data analytics

The application of advanced analytical techniques to large and ever-expanding data sets is also foundational for digital insurers. For instance, predictive analytics can identify suitable products for customers in particular regions and demographic cohorts that go far beyond the rudimentary cross-selling and up-selling approaches used by many insurers. Big data analytics also hold the key for creating personalized user experiences.

Analytics that “listen” to customer inputs and recognize patterns can identify opportunities for new products that can be launched quickly to seize market openings. Deep analysis of the customer base may make clear which distribution channels (including individual agents and brokers) are the best fit for certain types of leads, leading to increased sales productivity.

The back-office value proposition for big data analytics can also be built on superior recognition of fraudulent claims, which are estimated to be around 10% of all submitted claims, with an impact of approximately $40 billion in the U.S. alone. Reducing that number is an example of how digital transformation efforts can be self-funding. Plus, the analytics capabilities established in anti-fraud units can be extended into other areas of the business.

Big data is also reshaping the risk and compliance space in important ways. As insurers move toward more precise risk evaluations (including the use of data from social channels), they must also be cognizant of shifting regulations regarding data security and consumer privacy. It won’t be easy ground to navigate.

Internet of Things (IoT)

The onset of smart homes gives insurers a unique opportunity to adopt more advanced and effective risk mitigation techniques. For instance, intelligent sensors can monitor the flow of water running through pipes to protect against losses caused by a broken water pipe. Similar technology can be used to monitor for fire or flood conditions or break-ins at both private homes and commercial properties.

The IoT clearly illustrates the new competitive fronts and partnership opportunities for insurers; leading technology and consumer electronics providers have a head start in engaging consumers via smart appliances and thermostats. Consumers, therefore, may not wish to share the same or additional data with their insurers. Insurers may also be confronted by the data capture and management challenges related to IoT and other connected devices.

Telematics

Sometimes grouped with IoT, data from sensors and telematics devices have applications across the full range of insurance lines:

  • Real-time driver behavior data for automotive insurance
  • Smart appliances — including thermostats and security alarms — within homeowners insurance
  • Fitness trackers for life and health insurance
  • Warehouse monitors and fleet management in commercial insurance

The data streams from these devices are invaluable for more precise underwriting and more responsive claims management, as well as product innovation. Telematics data provides the foundation for usage-based insurance (UBI), which is sometimes called “pay-as-you-drive” or “pay-as-you-live.” Premium pricing could be based on actual usage and driving habits, with discounts linked to miles driven, slow or moderate speeds and safe braking patterns, for instance.

Consider, too, how in-vehicle devices enable a fully automated claims process:

  • Telematics data registers an automobile accident and automatically triggers a first notice of loss (FNOL) entry.
  • Claims information is updated through text-based interactions with drivers or fleet managers.
  • Claimants could be offered the opportunity to close claims in 60 minutes or less.

Such data could also be used to combat claims fraud, with analysis of the links between severity of the medical condition and the impact of the accident. Some insurers are already realizing the benefits of safe driving discounts and more effective fraud prevention. These telematics-driven processes will likely become standard operating procedure for all insurers in the near future.

Voice biometrics and analysis

Audio and voice data may be the most unstructured data of all, but it too offers considerable potential value to those insurers that can learn to harness it. A first step is to use voice biometrics to identify customers when they call into contact centers, saving customers the inconvenience of entering policy numbers and passwords, information that may not be readily at hand.

Other insurers seeking to better understand their customers may convert analog voice data from call center interactions into digital formats that can be scanned and analyzed to identify customer emotions and adjust service delivery or renewal and cross-selling offers accordingly. The manual quality control process checks for less than 1% of the recordings, which is insufficient. Through automation, the entire recording can be assessed to identify improvement areas.

See also: 4 Rules for Digital Transformation  

Drones and satellites

Early-adopting insurers are already using drones and satellites to handle critical tasks in underwriting and claims. In commercial insurance, for instance, drones can conduct site inspections, capturing thermal imagery of facilities or work sites. Their reviews can be as specific as looking for roof cracks, old or damaged boilers and other physical plan defects that can pose claims risks.

Within homeowners lines, satellites can capture data to analyze roofs, chimneys and surrounding terrain so that insurers can determine which homeowner they want to add to underwrite, as well as calculate competitive and profitable premiums. When linked to digital communications tools, drone and satellite data can even trigger notifications to customers of new price options or policy adjustments.

Within claims, drones and satellites can handle many tasks previously handled by human adjustors across all lines of business. Such remote assessments can reduce claims processing time by a considerable degree. This method is particularly effective in situations such as after floods, fires and natural disasters, where direct assessment is not possible.

While many transformation programs that use drones and satellites remain in the experimental stages due to operational challenges, it is possible that they can improve the efficiency and accuracy of underwriting and claims information gathering by 40%.

Blockchain

Blockchain provides a foundation for entirely new business models and product offerings, such as peer-to-peer insurance, thanks to its ability to provide virtual assistance for quoting, claims handling and other tasks. It also provides a new level of information transparency, accuracy and currency, with easier access for all parties and stakeholders in an insurance contract. With higher levels of autonomy and attribution, blockchain’s architectural properties provide a strong digital foundation to drive use of mobile-to-mobile transactions and swifter, secure payment models, improved data transparency and reduced risk of duplication or exposure management.

Insurance companies are interested in converting selected policies from an existing book to a peer-to-peer market. A blockchain network is developed as a mechanism for integrating this peer-to-peer market with a distributed transaction ledger, transparent auditability and “smart” executable policy.

E-aggregators are another emerging business model that is likely to gain traction, because it is appealing to both insurers and the customers. Insurers can offer better pricing due to reduced commissions compared with a traditional agent-based distribution model, while customers gain freedom to compare different policies based on better information. Of course, e-aggregators (whether fully independent or built through an existing technology platform) will require a sophisticated and robust digital platform for gathering information from different insurance companies to present it to consumers in the context of a clear, intuitive experience. It is also important for insurance companies to transfer information to e-aggregators rapidly; otherwise, there is the risk they will miss out on sales opportunities. This is why blockchain is the right technology for connecting e-aggregators and insurers.

To see the full report from EY, click here.