Olivier Rikken is manager, public speaker and thought leader on digital disruption, blockchain and business process management at AXVECO, a boutique consultancy firm headquartered in Amsterdam.
In this opinion article, Rikken discusses how the insurance industry could persue a true peer-to-peer (p2p), crowdfunding model by leveraging blockchain technology.
There is a shift going on in the financial sector.
The steep rise of the FinTech industry, where investments went up eightfold in the past 5 years to almost $20bn is causing unrest within traditional companies. One of the most interesting developments in the FinTech industry is without a doubt blockchain.
There are already many examples of how blockchain could impact the banking industry, especially payments services and security and commodity trading. In the insurance industry it is Internet of Things, big data and crowdfunding that are widely described.
Perhaps because of this, the impact of blockchain on the insurance industry hasn't been a strong point of focus for new innovators. Some papers, like the Ethereum white paper and “Chain of a lifetime” do describe examples of new products that could result from blockchain technology, but these focus less on new possible business models.
But that's not to say there's no conversation on this topic. A report from the Dutch National Bank of March 2016 put sustainable future business models within the insurance branch on deep red. The urgency for new business models is high, although it looks like the sense of urgency is not always present within the traditional insurance companies.
There, the focus is more on incremental change of the current model instead of disruptive change or even green field set up of a new model.
Benefits to gain
So, what could be a new model and how could this model be executed? Blockchain, especially smart contracts, could be the enabler for a true P2P or crowdfunded insurance model.
In the new business model, the focus of the insurers would shift away from asset management and instead would focus on matching supply and demand and to risk calculation research. The insurer would provide a marketplace-like platform where customers can post their insurance demand, which could be either a standardized product or even a specific demand.
The insurer then would use its "risk intelligence" and risk models, based on their historical data, to perform a premium calculation to post the expected return, after subtracting their margin off course.
Posting this premium calculation, interested investors can bid or subscribe to the demanded insurance. This can either be done as a group through crowdfunding, or by individuals in a P2P way. This could depend on the kind of insurance request, the available resources of the investor and his or her risk appetite.
So far, this model looks much like the one Lloyd's already has in the insurance market or the ones companies like Funding Circle have set up in the P2P lending market.
And here is where blockchain will play a vital role.
Besides the administration being done in a decentralized ledger, with the use of smart contracts, one could guarantee the payment from the investor to the customer in case the event for which the customer posted their insurance demand happens. The smart contract is thus programmed as a traditional guarantee, but without the need of a bank.
By doing this in a blockchain, the administration and execution processes are simpler, almost fully automated, transparent and cheaper than in a traditional set up. Besides that, the investors know their maximum exposure as the amount defined in the smart contract.
The insurer can also fulfill the role of assessor of the damage to verify the validity of the insurance claim. But this could as easily be outsourced to a third party and by connecting the blockchain to other ledgers. This validation can then be verified automatically.
In this model, the use of smart contracts in the insurance market would not have to be limited to the example of P2P types of insurance, but could virtually be used for all kinds of insurance. Especially if one will be able to pool the amounts individual investors are willing to invest in the crowdfunding model to minimize the impact per investor in case of a major event happening.
Dividing essential tasks
This new business model has benefits for all parties involved, the insurers, the investors and of course the customers.
By acting as the provider of the marketplace and the risk intelligence, insurers gain a number of benefits. The capital needed to insure the customers remains at the investors, so the insurer, in turn, can operate with minimal levels of capital or even become completely capital-free.
With regards to regulatory licenses, similar models in the P2P lending business don't need a full license or even a license at all, just an exception from the regulators. As for the development of the platform, this could (and should) be outsourced to a third party on a pay-per-use basis, making the company even more "capital agile".
The end result could be a very lean, agile and cost-efficient organization.
On the investors side, this brings a new opportunity for investments in leaner organizations, and as a result, the potential for higher returns. Private investors with less to spare could also join the market, and there will be clear insight into the maximum financial risk exposure for investors.
Finally, for the customers, because there would be multiple investors bidding and subscribing and low operational costs, the insurance can be cheaper.
This model could give the customer the possibility to post demand for very specific insurances in an easy way, and the payment of the insurance can be guaranteed due to the smart contracts.
Of course, there are various challenges in this model, some of the most urgent would be whether regulators allow the market to operate with these new efficiencies.
Insurers also need to create critical mass on the investor side in order to spread risk in case of larger payments to customers, and flexibility would be needed on the demand side in the case of very specific insurances.
With regards to the risk calculation, due to the nature of very specific insurances, an insurer would need to have the right capability to make a risk-return calculation that is attractive to both customer and investor.
Customers would play a vital role as well, as they would need to put their trust in a system in which there is no third party with capital reserves.
But, all in all this business model could be very interesting, and it could bring multiple benefits, creating a true P2P, crowdfunded insurer. One can even argue that, should this model develop fully, we might no longer have a traditional insurer, but instead, an intelligent capital trading house that fulfills this essential market role.
Peer to peer visualization via Shutterstock