5 Ways Blockchain Could Transform Insurance - Are Actuaries Ready?

November 12, 2024

Estimated Reading Time: 4 minutes

Blockchain technology has the potential to redefine the insurance industry, enabling more efficient operations, innovative business models, and better risk management. Despite the emergence of blockchain-based InsurTechs in 2017, mainstream adoption remains limited, primarily due to its association with cryptocurrencies, funding challenges, and the need for collaboration among insurers. An example of blockchain is Lemonade Insurtech that has backed a DAO (Decentralized Autonomous Organization = no administrator required to manage the pool), and it will roll out weather index insurance to African farmers.

Beyond the volatility associated with cryptocurrency booms and busts, which many mistakenly equate with blockchain technology as a whole, a significant challenge for the industry is the high level of fraud, often resulting in bankruptcies. A recent and notable example is the collapse of FTX, a bankruptcy larger in scale than Enron’s. Opinions on how to address such failures vary. One perspective argues that these issues stem from insufficient regulation and weak corporate governance, suggesting that centralized blockchain platforms should be subject to stricter oversight. The opposing view advocates for true decentralization, where the absence of intermediaries could prevent such failures; proponents point to fully decentralized platforms, like Uniswap, which have demonstrated greater resilience than their centralized counterparts. Both approaches offer valuable insights.

Blockchain allows for plenty of improvements in existing insurance value chain such as:

  • Operational efficiency: Blockchain technology streamlines insurance, making it nearly invisible by creating a seamless, digital process. By connecting mobile and personal data to oracles and generating self-executing smart contracts, it eliminates the need for extensive operational staff to handle forms and manual scrutiny. Smart contracts automatically execute when predefined conditions are met, allowing insurers to scale policy sales without proportionally increasing their workforce—a hallmark of exponential technologies. ZhongAn serves as an example of a traditional yet innovative insurer leveraging blockchain for significant operational efficiency gains.

  • Business model: Blockchain can enhance the mutuality of insurance pools by decentralizing power, giving control directly to pool members rather than placing it solely in the hands of intermediaries. Depending on the desired structure, the pool can operate as fully decentralized or appoint an agent to manage it on behalf of the members.

  • Product development: Blockchain enables the parameterization of risks, allowing for the creation of an infinite variety of parametric insurance products tailored to the specific needs of pool members. This shift removes the need to rely solely on standardized, mass-market products. It's essential to expand index insurance beyond common areas like travel and microinsurance to address standard risks in developed markets as well.

  • Further examples of specific use cases: In pricing and underwriting, a decentralized data lake can offer a diverse and extensive dataset, improving pricing accuracy and reducing underwriting uncertainties through enhanced data quality and coverage. Claim payouts can also be automated using smart contracts. Decentralized digital IDs enable seamless quote generation, allowing personal data to be securely shared across insurers, which fosters industry-wide integration to combat money laundering and improve 'Know-Your-Customer' protocols. Additionally, shared claims databases can help identify high-risk groups or individuals with questionable histories. The greatest potential for these applications lies in motor and medical insurance, sectors often plagued by fraud and waste. Blockchain can also simplify the administration of reinsurance, swaps, and securitizations. While securitization in reinsurance is currently underutilized, streamlined blockchain-based administration could drive broader adoption, leading to more efficient capital optimization.

Transforming Insurance Industry with Actuarial Automation

Embark on a journey with Visionet to transform your strategies and embrace the limitless possibilities of Actuarial Automation. Dive into our white paper and discover how you can embrace efficiency, innovation and ensure adherence to regulatory standards. Download white paper: The Rise of Actuarial Automation Whitepaper - Visionet

Blockchain technology, combined with self-executing smart contracts, has enabled a new peer-to-peer (P2P) insurance model that eliminates traditional premium payments. Instead, each member deposits their premium into a digital wallet that functions as an escrow account, only used if a claim is filed. In this model, no member’s exposure exceeds the amount in their wallet, and if no claims occur, each member retains their funds. Payments are conducted using Bitcoin, further reducing transaction costs. Teambrella, which claims to be the first insurer using this Bitcoin-based model, exemplifies this innovative approach—and it’s not alone.

Administered by the Lemonade Foundation, this project brings together key players including representatives from the Avalanche blockchain; Chainlink, which provides real-world data to blockchains; DAOstack, a developer of DAO software; Etherisc, a builder of decentralized insurance applications; Hannover Re, a German reinsurance company; Pula, an agricultural insurance startup; and Tomorrow.io, a provider of real-time weather information. Another noteworthy initiative is B3i, launched with enthusiasm by multiple global insurers, though it faced bankruptcy in 2022 due to funding challenges.

A successful example of index insurance supporting vulnerable communities in the face of climate change is Swiss Re’s coral reef insurance, designed to protect against hurricane damage. Swiss Re partnered with The Nature Conservancy and regional governments in Mexico to safeguard the Mesoamerican coral reef off Mexico’s Yucatan Peninsula. Research demonstrated a direct link between a healthy coral reef and the region’s economic resilience, as the reef helps prevent beach erosion—a critical factor for local tourism. This innovative insurance model ensures quick disbursement of funds, allowing trained community members to respond to reef damage after severe storms. This marked the world’s first nature-based insurance solution to protect Mexico’s coral reef.

The key question is how insurance professionals—such as underwriters, claims administrators, and actuaries—can adapt to this paradigm shift. Currently, there is little clarity on this front. While InsurTechs are pioneering new approaches, their high failure rates and limited financial compensation often fall short of what traditional insurers offer, leaving little incentive for professionals, such as actuaries, to specialize in this area. However, innovation could thrive if established insurers and blockchain-focused Insurtechs form strategic partnerships, allowing each to leverage the other's strengths in a mutually beneficial relationship.