The integration of blockchain to the financial sector will do a lot of good. Blockchain technology is uniquely outstanding for financial transactions, settling disputes and ultimately establishing trust between different parties. All of these are day-to-day occurrences in the financial industry. However, what is less known is the significance of using blockchain technology for reinsurance.
WHAT IS REINSURANCE?
Reinsurance simply put, is insurance for insurers. Reinsurers are distinct companies that underwrite the insurance of policies that another insurance company, known as the cedent, have already sold. For example, let’s say that Insurer A has insured a business against all possible damages it incurs. In the case of a natural disaster such as landslide or an earthquake, the business might incur great losses in millions of dollars. Most times Insurer A may not have the liquidity or assets to cover this cost without going bankrupt. In order to still maintain this insurance while also avoiding bankruptcy, they result to paying another insurer(probably specialist reinsurer) to carry on some of this liability. Now this sort of practice, enable smaller insurers to increase their revenue without actually risking any form of lofty financial collapse in the event of such a claim.
USE OF BLOCKCHAIN
The industry strongly believes that blockchain could aid make very vital cost savings, lower settlement times, increase transparency and also add a layer of security that was initially impossible. As a matter of fact, PwC estimates that blockchain could save the industry between $5-10 billion.
Let’s uncover some of the areas that blockchain could help.
Blockchain is particularly significant at automating tasks initially done by human beings. It would be possible to use smart contracts as a replacement in place of the tedious high cost existing paperwork in the industry. PwC analysis has concluded that blockchains could drastically reduce about 15-25% of expenses. This reduction would easily be accomplished by automated data processing and automatically leading to a reduction in fraudulent and malicious activities, resulting in cost savings.
If companies would implement a consortium blockchain, they would be able to store the information contained to only those with permissions. Also, they would be confident, that all parties would gain complete transparency over smart contract executions and transactions.
As the reinsurance grows, it becomes more difficult for the original insurer to keep track of which parties hold a particular liability or liabilities. By partaking in a shared blockchain, all the parties can see how and to whom risk is distributed. When the insured then sets in a claim, both the claim and the settlement between all parties can be resolved faster and with low disputes. As a result of this outstanding transparency and freedom to reliable data means that all parties can keep track of more accurate risk models.
As we know, blockchain is immutable, which means it’s data cannot be altered or manipulated maliciously, it provides authentic high-level security for reinsurers. Industry leaders believe that it could drastically reduce fraud internally and between companies.
A more centralized consortium blockchains have the capabilities to achieve significant throughput and speed because they consist of very fewer nodes. By using such a blockchain the reinsurance industry could allow for very high speed up settlements between parties. This should without any doubt lead to higher standards and ultimate improvements in the entire industry. Bockchain would not only provide a faster settlement layer but also removing the need for human interaction, payments could eventually be automated between participating companies.
AN APPROPRIATE TYPE OF REINSURANCE BLOCKCHAIN
A lot of the benefits we have discussed so far somewhat depends on the type of blockchain that companies uses. It is very uncommon that reinsurance companies will choose to function on a public blockchain such as Ethereum. However, if this were to be the case, they would not only be limited to operating with the native asset of the blockchain, but all transactions would be publicly displayed. Rather, it is very likely they will use a federated or consortium blockchain. This approach means that only approved companies can fully partake both in terms of inputs of new data and in reading the blockchain. This shows that only partaking companies have access. The risk here is that it is more centralized design that eventually leaves open the door for some nodes to conspire with each other and manipulate the blockchain, undermining the security and immutability desired by the industry.
THE B3i CONSORTIUM
Blockchain adoption is being led within the reinsurance industry by a consortium known as B3i. They were founded in 2016 and currently hold a number of 38 members from around the globe. Their major aim is research applications of blockchain for reinsurance.
By joining as one group, the purpose is to harmonize upon a common standard that can be used by all companies with ease. It would be almost impossible to collaborate with multiple different blockchain methods.
However, B3i is working on it’s prototype product, which they expect to move into complete production in the future. The product handles all settlements, calculations and reporting via a hyperledger design. It functions on three distinct blockchain levels. And every party has it’s own private blockchain on which it saves it’s contract data. There is also a master data blockchain that secures the company’s information and general contract clauses. Lastly, the shared communication blockchain contains the communication that confines and validates the state of each private blockchain.
This enables all parties, including reinsurers and cedents, to properly execute their contracts and encrypts all communication between the parties. Additionally, the cedent can request quotes to all the parties and carry out communication until all parties agree on and sign the contract.
B3i products without a doubt is intriguing and we will have to wait to gauge it’s success until it is released for full implementation. Also, without the game theory consensus mechanisms like Proof-of-Work and Proof-of-Stake, it is difficult to see how it can guarantee the level of security and immutability seen on public blockchains.