The Smart Insurance Contract on Blockchain - hype or reality?

An insurer once asked me: "Rick, will the blockchain replace insurance as we know it?". My tongue-in-cheek answer was "No, not entirely!". The truth is that nobody yet really knows how far insurance can go with blockchain technology, but that doesn’t stop it being one of the hottest topics for the industry right now. 

Hype or reality? First, some context...

Last September, the World Economic Forum published a report entitled, “Deep Shift – Technology Tipping Points and Societal Impact”. The report is based on surveys with over 800 executives and experts about new technologies and innovations. The point of the report is to identify deep shifts in society that result from new technologies. These include areas such as 3D printing, driverless cars, wearables and artificial intelligence.

I was drawn to shift number 16, simply called “Bitcoin and the blockchain”. By 2025, 58% of these experts and executives believed we would hit the tipping point for Bitcoin and blockchain. This was defined as;

“10% of global gross domestic product will be stored on blockchain technology”

To put that into context, the total worth of Bitcoin today in the blockchain is circa 0.025% of today’s $80trillion global GDP.

Also of interest, especially given that it looks like Tunisia will be the first country to issue a digital currency on a blockchain, shift number 18 was called “Governments and the blockchain”. Here, almost 3 out of 4 of the survey group expected that “Governments would collect tax via a blockchain by 2023”.

It’s a reality then!

It’s certainly looks that way. And $500m of VC money in 2015 can’t be wrong, can it?

The prospect of a seismic shift on a par with the impact of the Internet is massively compelling. Which explains all the attention, predictions and excitement about blockchain. But, if we use the evolution of the Internet as a benchmark, the development of blockchain today for commercial use is equivalent to the Internet in, say, the mid 1990s’ at best.

The debates on with or without Bitcoin, private or public blockchains, Sybase vs Oracle (oops, wrong century) are yet to play out. The ability of the Bitcoin blockchain to scale to handle massive volumes at lightening speed remains unproven.

Now, just as it was in 1995, blockchain technology is at an embryonic stage. Still finding its way; yet to prove it is a viable, industrial strength, large-scale technology capable of solving world hunger.

Which is why I am going to focus on the use case for insurance, rather than the technology itself. (For one explanation of how Blockchain works, go to Wired, here.)

The Smart Insurance Contract

This is getting most attention right now. The notion of automating the insurance policy once it is written into a smart contract is compelling. The idea that it will pay out against the insurable event without the policyholder having to a make a claim or the insurer having to administer the claim has significant attractions.

First, the cost of claims processing simply goes away. Second, the opportunity for fraud largely goes away too. (I hesitate on this one simply because it is theoretical and not yet proven). Third, customer satisfaction must go up!

One example being used to illustrate how these might work came from the London Fintech Week Blockchain Hackathon last September. Here a team called InsurETH built a flight insurance product over a weekend on the Ethereum platform.

The use case is simple. In the twelve months to May 2015, there were 558,000 passengers who did not claim for delayed or cancelled flights in and out of the UK. In fact, less that 40% of passengers claimed money back from their insurance policy.

They built a smart contract where the policy conditions were held on blockchain. Using the Oraclize service to connect the blockchain with the Internet, publicly available data is used to trigger the insurance policy.

In this case, a delayed flight is a matter of fact and public record. It does not rely on anyone’s judgement or individual assessment. It is what it is. If the event occurs, the smart contract gets triggered and the pay out is made. Automatic and immediate, with no claims processing costs for the insurer and satisfaction for the customer.

Building on this example and applying it to motor, smart contracts offer a solution for insurers to control claims costs after an accident. The trigger that there has been an accident would come from a smartphone app or the connected car via the Internet to the blockchain. Insurers are always frustrated when customers go a more expensive route for repairs, recovery and car hire. So, with a smart contract, insurers could code the policy conditions to only pay- out to the designated third parties (see related article by Sia Partners).

So long as the policy conditions are clear and unambiguous, and the conditions for paying out are objective, the insurance can be written in a smart contract. When the conditions are undeniably reached, the smart contract pays out. As blockchain startup SmartContract put it, “Any data feed trusted by a counterparty to release payment or simply complete an agreement, can power a smart contract.”

To understand this better, I asked Joshua Davis, the technical architect and co-founder at blockchain p2p InsurTech Dynamis to explain it to me, “you need well qualified oracle(s) to establish what “conditions” exist in the real world and when they have been “undeniably reached”.  An oracle is a bridge between the blockchain and the current state of places, people and things in the real world.  Without qualified oracles there can be no insurance that has any relation to the world that we live in.   

“As far as oracles go you can use either a single trusted oracle, who puts up a large escrow that is lost if they feed you misinformation, or many different oracles who don’t rely on the same POV or data sources to verify that events occurred.

“In the future social networks will be the cheapest and most used decentralized data feeds for various different insurance applications.  Our social networks will validate and verify our statements as lies or facts.  We need to be able to reliably contact a large enough segment of a claimant’s social network to obtain the truth.  If the insurance policy can monitor the publishing or notification of our current status to these participants and their responses accurately confirm it, then social networks will make for the cheapest most reliable oracles for all types of future claims validation efforts.”

Is this simply too good to be true?

Personally, I don’t think it is. Of course, a smart contract doesn’t have to be on the blockchain to deliver this use case.

However, what the blockchain offers is trust. And it offers provenance. The blockchain provides an immutable record and audit trail of an agreement. The policyholder does not have to rely on the insurer’s decision to pay them damages because they’ve broken their promise to keep them safe from harm. As the WEF report states, this is an “unbreakable escrow”. The insurer will pay out before they even know about it.

There’s another reason for going with the blockchain – cybersecurity!

With the blockchain sitting outside the corporate firewall and managed by many different and unconnected parties, the cyber criminal no longer has a single target to attack. As far as I’m aware, blockchain is immune to all of the conventional cyber threats that corporations are scared about.

What happens when you put blockchain and P2P Insurance together?

In December, I published a 2-part article on Peer 2 Peer Insurance (here are the links to Part 1 and Part 2). When you bring the P2P model together with the blockchain, this creates the potential for a near-autonomous self-regulated insurance business model for managing policy and claims.

Last year, Joshua Davis wrote an interesting white paper called “Peer to Peer Insurance on the Ethereum Blockchain”. In the paper, he presents the theory behind blockchain and the creation of Decentralized Autonomous Organizations (“DAO”). These are corporate entities with no human employees.

The DAOs would be created for groups of policyholders, in a similar way to the P2P group model of the likes of Guevara and Friendsurance. No single body or organization would control the DAO; it would be equally “controlled” by its policyholders within each group. All premiums paid in would create a pool of capital to pay claims.

And because this is a self-governing group with little or no overheads, any float at the end of the year would be redistributed back amongst the policyholders. Arguably, this makes the DAO a non-profit making organization and materially increases the capital reserve for claims costs.

The big question mark for this model is regulation. Who will maintain the blockchain code with in each DAO when regulations change does not yet have an answer. But, what does seem a dead cert is that someone, somewhere is figuring out how to solve this.

Blockchain offers the potential for new products and services that have never existed before in a P2P insurance model. It should also open up insurance to whole new markets, especially those on or near the poverty line.

For now, we watch to see what comes from the likes of Dynamis who are using smart contracts to provide supplementary employment insurance cover on Ethereum.

Innovation will come from new players

It has been my belief for some time that, in the main, incumbent insurance firms will not be able to materially innovate from within. Like Fintech, the innovation that will radically change this industry will come from new entrants and start-up players, such as;

Dynamis

SmartContract

Rootstock

Everledger (see previous article on Daily Fintech here)

Tradle

Ethereum Frontier

Codius (Ripple Labs) (update: Codius discontinued)

This is particularly true with blockchain in insurance. These new age pioneers are unencumbered by corporate process, finance committees, bureaucracy and organisational resistance to change.

Besides, the incumbent insurance CIOs have heard this all before. For decades, software vendors have promised nirvana with new policy admin, claims and product engines. So why should they listen to the claims that blockchain is the panacea for their legacy IT issues. Which is a subject for another post… watch this space!

This article was first published at www.dailyfintech.com on Thursday 14th January 2016. Daily Fintech Advisers provide strategic consulting to organizations with business and investment interests in Fintech. 

The author, Rick Huckstep is an InsurTech thought leader with www.the-digital-insurer.com.