On the very last day of 2016 and shortly after the creation of B3i, I wrote a blog on the use of blockchain in insurance. The many reactions that followed showed an
appetite for discussing the actual benefit, i.e. the business case of distributed ledger technology (DLT) in insurance, which is the topic of this blog.
Minimum Viable Product
Now that the B3i group of companies has started developing a first minimum viable product ("MVP") to transact a reinsurance contract on blockchain, we can start assessing the benefits. The potential lies in improving today's outdated segregated views of separate insurance company ledgers, considering the fact that the counterparties often co- or reinsure the same underlying risks and hence have mutual interdependencies on the quality of loss reserving, financial and accounting data.
The challenges to overcome when digitising the re/insurance process are relatively small, whilst the positive economic effects could be considerable. For example, the
reinsurance and commercial insurance industry has a fairly low number of players, with an easier task to agree on common standards and terminology compared to a highly diverse and fragmented retail consumer market. A slight improvement to the expense ratio of B3i members could generate saving substantially above the investment that blockchain would require.
The core focus of the B3i work currently undertaken, is to assess benefits at the micro-economic or corporate level for the member firms, meaning the positive impacts that should materialise among insurance providers and their policyholders. We see these benefits in the following areas:
- Working capital savings
- Foreign exchange efficiencies
- Operational efficiencies and risk reduction
- Data integrity improvements
Working capital savings
In its pursuit to deliver a service and create value for a customer, every business activity requires working capital, which in insurance essentially is: cash. Good management of working capital requires efficient processes and controls over premium collection and claims reimbursement. We intend to measure this by timeliness of claims payment from point of settlement, speed and automation of pairing of incoming cash and, as a result, reduced operational risk and improved quality of cash flow forecasts (the replicating portfolio that also forms the basis for asset-liability management and the baseline cash flows for any accounting valuation).
The relevance and materiality of efficient management of operational insurance cash flows can differ depending on the level of interest rates and height of the combined ratio. Nonetheless, we believe that the essence of "time value of money" is pervasive and crucial for our industry and a matter of basic discipline. We can only be a reliable custodian of assets and prudent provider of risk cover, if we also demonstrate operational efficiency in managing the cash originating from our policies. These benefits of improved working capital efficiency, combined with stronger cash and credit risk management form a first pillar of the B3i MVP.
Foreign exchange efficiencies
Reflecting the international nature of our business, we also expect significant benefits from improved foreign exchange handling and valuation. Our performance metrics
will include the payment transaction costs, as well as speed and effort of settling such cross-currency and cross-border transactions. Beyond administrative efficiency, settlement speed reduces credit and foreign exchange risk exposure. Within main jurisdictions and currency zones, such as ACH for USA, SEPA for the Euro-zone, and GBP within the UK, great improvements have been made already, leading to quasi same-day settlement. As business growth increasingly comes from high-growth markets outside these common currency zones, there is still an untapped potential for improvement. Such improvements can also be enabled by intelligent banking solutions, such as for example the use of virtual bank accounts. Hence a DLT solution will need to include an effective counterparty data management and be able to integrate with such solutions. Our current scope is limited to using normal "fiat" currencies, but, as we gain experience, over time we may explore options to use certain forms of crypto-currency as a way of settling balances between re/insurance counterparties, in particular between counterparties with long duration and recurring transactions. Reducing settlement latency mitigates currency and operational risk associated with open or unreconciled foreign currency positions.
Operational efficiencies and risk reduction
As a result, we expect to reduce the administrative and reconciliation effort in managing re/insurance placement and post-placement processes. The current practice of managing policy and claims data in separate ledgers, with redundant and potentially inconsistent master and transaction data, leads to erroneous, inconsistent and
duplicated data and in turn to time lost in reconciling and correcting these data. This process repeats between insured, insurers, brokers, reinsurers and retrocessionaires. This is an accumulation of industrial waste. It not only slows down the process but forms a source of contract uncertainty or leads to erroneous or – worst case – fraudulent application of contract terms. We expect a DLT solution to bring significant efficiencies to the process. It will also help accelerate the dematerialization of the process, which today is still largely paper-based in the (re)insurance industry.
Data quality improvement
We expect all this to be underpinned by a significantly improved data quality and integrity. By using an established insurance data language - Acord - and streamlining the insurance contract execution on a DLT, we aim to reduce the time and cost per transaction (contract, claim, settlement), shorten contract negotiation lead time, reduce contract uncertainty (signatures missing post inception date), improve referential integrity across all policy master data, reduce disagreement over application of contract
conditions, and accelerate the exchange and acknowledgement of policy and claims related messages. This is not only an information technology undertaking, but equally a cultural shift towards stronger adherence to industry taxonomies and good practices. Beyond testing the suitability of blockchain, including smart contract functionality, we will therefore test our ability to establish a common language across our member firms. The best technology still requires us to express business terms,
conditions, rules, events and valuations in a universal and clear language. We are in the business of managing risk, hence we should as well reduce uncertainty in the basic interpretation and execution of our contracts.
All combined, this should bring a better experience for the ultimate customer, the policyholder. It is the nature of reinsurance and large commercial risks to have multi-party relationships: multiple reinsurers with each a share on a primary insurance's cession, one insurer leading or co-insuring a programme with multiple other parties, or a broker leading a placement on behalf of multiple parties. The focus of all parties should be on the pricing, modelling and management of the underlying risks and exposures, managing the policyholders' interests and honouring obligations, not on re-processing and reconciling ill-structured data. A better customer experience will be our ultimate measure of success.
There is a saying that "what you measure, is what you get". Therefore, over the next months, the B3i group will, alongside the development of its MVP, design a set of performance metrics and assess the benefits described in this article. As a result, by mid of 2017, the findings of the initiative's joint work will not only address the technical, but as well the economic viability of the newly proposed platform.
In my next blog, I will address the macro-economic, regulatory and policy making challenges and benefits of Blockchain in insurance. Stay tuned!
Acknowledgements: Sincere thanks to the following B3i friends and colleagues for their editorial reviews and contributions: Alessandro Spadoni (Zurich Insurance), Carolyn Pike and Phil Hunt (Swiss Re), Manuel Stagars (Author of the "Blockchain and Us" documentary); Régis Delayat (SCOR and Chairman of Acord Ruschlikon), Yoshi Hashimura (Sompo Japan Nipponkoa Insurance)