The End of Insurance as We Know It

by Rob Galbraith

  STUFF INSURANCE

  Another important consumer need is to cover a wider variety of items that go beyond what has traditionally been considered “valuable items.” In today’s world, there is very limited need for personal articles coverage for fur coats, rare coins or silverware. Instead, coverage for mobile phones, gaming consoles and pets are much more in demand. Yet, coverage for these items is often limited or non-existent for existing insurance products. Instead, there has been an explosion in the amount of extended warranties (also known as service contracts) and other non-traditional products that I call “quasi-insurance” that are subject to little to no regulation. These extended warranty products are generally not sold by insurance agents or brokers. Rather, most often these products are sold by the same retailers which sell the high-end consumer electronics, appliances or other items that consumers are seeking to protect from damage and loss.

  Recent research has estimated that the compound annual growth rate or CAGR for extended warranties of consumer electronics will be 6.2% from 2018-2026 and result in a market size from $30B today to over $50B[174] by 2026. Mobile phones and tablets account for roughly 50% of the overall value in the market today. The growth in extended warranty products has been fueled not only by consumer demand but also by strategic alliances with retailers, allowing retailers to offer products that go beyond the limited manufacturer’s warranty and engendering a longer-term relationship with customers,[175] making it a win-win-win scenario for providers, retailers and consumers alike. The most notable of these is the recent partnership between Walmart and Allstate that was announced in August 2018[176] where Walmart Protection Plans are now “powered” by the insurance giant. Extended warranty providers are able to make a nice profit margin with limited downside risk from these products, all without generally being subjected to the watchful eye of insurance regulators.[177] Global competition and the decreasing prices of electronics has put downward pressure on premiums for extended warranty providers but the outlook for continued growth in the market is higher than for traditional P&C products.[178]

  SURVIVAL OF THE NIMBLEST

  The rapid and accelerating pace of change in technology is leading to a broader acceleration of change in our lives. This has profound implications in many different ways for traditional players because the insurance coverage needs for our society are rapidly evolving from the traditional product suite and divide between personal and commercial lines. The Venn diagram below shows how the P&C insurance landscape is changing with arrows representing directional movement within the ecosystem.

  Traditional insurance has never covered all exposures to financial loss, so the market share the represent in the above diagram is a subset of the broader market for “risk avoidance” products that consumers and businesses desire. The standard division between personal and commercial lines has also seen some blurring. Indeed, carriers who target small businesses also seek to write the personal lines exposures that come with it. For instance, a farm and ranch policy is often paired with the personal lines auto and homeowners coverage to fully meet the consumer need, as well as provide some diversification of risk and increase in revenue for the account. Some personal lines policies such as homeowners insurance also covers a limited amount of business property, depending on the carrier, without requiring a full-on business policy to be issued. However, the product lines historically have not had much overlap. Finally, some insurtech startups are betting on changing consumer desires, behaviors and tastes towards more flexibility in how they use their insurance product by quickly adding or removing items on demand or being charged for usage-based insurance rather than a standard fixed time-length policy term.

  It is up for intense debate which insurtech startups offering products designed for the gig economy, on-demand insurance and “stuff insurance” will survive and which ones will go belly up. The key point is that consumer needs and desires for insurance-style protection against loss to valuable assets - whether their auto, home, stream of income and/or prized possessions - are evolving rapidly. If traditional carriers are unwilling or unable to move quickly to take advantage of these market opportunities, insurtech startups and non-traditional players such as extended warranty firms have shown the ability to move into the market void left by traditional players to seize upon this rapidly growing opportunity.

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  CHAPTER 19 - THE POTENTIAL AND PERIL OF BLOCKCHAIN

  BLOCKING AND TACKLING

  A lot of business press that covers financial and insurance technology has been devoted in the past few years to blockchain, the foundational technology that underlies Bitcoin and many other cryptocurrencies. With the possible exception of artificial intelligence, no technology is harder to separate fact from fiction than blockchain. Explanations of how the technology works for non-geeks are exceedingly dry and tedious, but digging into the details is critical for understanding what is hope and what is hype. With so much press already devoted to blockchain, it is tempting to ignore all of it as chasing a fad that will fade away with time. However, with so many potential use cases and a foundational need to develop superior trust mechanisms in a digital age, blockchain is worth investing time and resources in to learn how it can be harnessed as a powerful disrupting technology in P&C insurance.

  At its core, blockchain has the potential to be deployed for any transactions (processes) which occur today that require a mechanism to ensure trust. This can be between two insurance carriers, an agent and a carrier, an agent and a customer, a customer and a carrier, or a claimant and a carrier. It can also be between two individuals seeking to participate in a decentralized risk pool as an alternative to traditional insurance. Julian Hillebrand, a blockchain consultant, writes in Medium that blockchain provides the potential to build up existing processes in insurance more efficiently and design entirely new products. The potential for new development using blockchain in insurance is quite large, according to Hillebrand, and in particular the role that intermediaries play in insurance will undergo significant changes over the next few years.[179] As with most new technologies, blockchain itself is agnostic as to who derives benefits and leverages the technology most effectively for financial gain between traditional players and startups.

  Blockchain is intended to be a fail-proof way for two or more parties to guarantee trust in any transactions between them purely through a tamper-proof coding algorithm. Perhaps the easiest analogy where the benefits can be envisioned most clearly is when using your credit card at the grocery store. Today, you purchase the items in your cart by inserting or swiping your credit card into a payment terminal so that the exchange of funds can be facilitated from your bank account to the merchant. For this process to work, there are centralized intermediaries between you and the merchant: the bank whose credit or debit card you are using, the payment network such as Visa, Mastercard, American Express or Discover and the terminal device itself which consists of hardware and software. While there is strong encryption built all throughout the process, the possibility of having your credit card information hacked is quite real, as evidenced by the massive Target data breach that occurred in 2013 and affected 41 million customers.[180]

  In today’s world, most trust mechanisms are developed by institutions that are highly centralized. So two or more parties who do not inherently trust each other can use a centralized institution, like a bank or an insurance carrier, that they mutually trust to facilitate a transaction between them. Sometimes multiple institutions are involved: for example, two banks may interact with each other on behalf of their customers seeking to facilitate a transaction, often with an intermediary such as the Federal Reserve in between. In insurance, it is common for two or more parties to be involved in a transaction, ranging from relatively simple - like resolving a claim - to more complex transactions - like purchasing reinsurance cover. These edifices that are created to build trust to facilitate transactions and economic activity come at a high cost - billions in the case of credit card fraud[181]
alone.

  Blockchain seeks to create trust between parties in an entirely new way. Blockchain is “an incorruptible digital ledger of economic transactions that can be programmed to record not just financial transactions but virtually everything of value”, according to Don and Alex Tapscott,[182] authors of Blockchain Revolution. How does blockchain accomplish this? At its core, blockchain technologies create an immutable digital ledger that records transaction details through the use of strong encryption technology that (at least conceptually) is immune from corruption or manipulation. The mechanism for how this works in practice is complex and varies based on the specific implementation.

  One critical component is that the digital ledger is decentralized; that is, the database of blockchain transactions is stored on multiple computers which must authenticate any changes to the ledger based on complex algorithms. If one or more of these distributed computers does not “agree” to the change, the database is not updated and the transaction is rejected. Since the computers are distributed, in theory, it is not possible to simultaneously hack all of them in the same manner to corrupt the blockchain and erode trust in the system. In practice, the theoretical immutability of blockchains has not worked out as promised as there have been several instances of notable hacks[183] which have required modifications (known as “forks”) in the ledger. These sorts of breaches call into question whether these blockchains are truly as secure and immutable as advertised by proponents. While early blockchain implementations have proven to be less secure than proponents have claimed,[184] the promise of blockchain as a technological alternative to current (and costly) systems that provide trust in financial transactions is large enough to justify further exploration by players in the insurance ecosystem.

  TALES FROM THE CRYPT

  The invention of blockchain is associated with the creation of Bitcoin, the most well-known cryptocurrency, in 2009. Some experts, such as Professor Campbell Harvey of the Fuqua School of Business at Duke University, see lots of potential for cryptocurrencies[185] while others, such as Warren Buffett, think they are worthless.[186] However you personally feel about cryptocurrencies, the underlying technology - blockchain - has far more potential use cases than just cryptocurrencies.

  New technologies like Ethereum use blockchain technology to enable smart contracts. Why is this relevant? Most of the existing constructs in insurance are mechanisms to enforce the core transaction of charging an amount up front (premium) in return for the promise to pay later (loss) if damage occurs to an exposure due to a covered peril. Think about legal contracts, regulation, agent and claims licensing, loss reserves, bad faith, material misrepresentation clauses, Special Investigations Units (SIU), etc. According to the RiskBlock Alliance, the following areas have the potential to benefit from blockchain technology:[187]

  •Proof of insurance and certificates of insurance

  •Real-time fraud and regulatory monitoring

  •Tokenization of titles, deeds and liens

  •Digital inspections of physical assets

  •Agent and broker licensing

  •Policy cancellation and non-payment

  •Any transaction involving multiple payees

  •Technical accounting

  •Salvage and subrogation processes

  •Commercial liability

  •Enabling secure exchange of data for Internet of Things (IoT) enabled devices

  •Any process that requires exchange and verification of third-party data

  A simple early application for blockchain in insurance is to provide proof of insurance for auto coverages. While traditionally two parties exchanged copies of their auto insurance identification cards to confirm coverages (which may or may not truly be in force), the use of blockchain allows for the possibility to exchange information on auto coverages through mobile phones to instantaneously confirm coverage in a secure manner.[188]

  INSURING THERE IS TRUST

  If many of the problems of trust - broadly defined - could be reduced or eliminated between the policyholder (insured) and the carrier (insurer) through a magical technology (blockchain), expenses could be greatly reduced[189] as well. This can result in multiple benefits to both parties. From the perspective of customers, components of the value proposition include:

  •Less underwriting questions at time of quote on the application

  •Less need for verification of ownership and valuation at claim time

  •Reduced time for claims handling, resulting in faster resolution (and payment) of a claim

  •Greater certainty that the insuring party (likely a carrier, but could in the future be simply another party - think peer-to-peer insurance) will pay when a loss occurs and not defraud the insured

  •Less reliance on technical contractual language (legalese)

  Robert Cummings, a contributor writing in CIO, argues persuasively that blockchain will not just save expenses but also improve customer satisfaction for those who adopt blockchain in the insurance ecosystem due to its accountability, transparency and superior security. [190]

  From the perspective of insurance carriers, there are also attractive components of leveraging blockchain technology which could include:

  •Reduced expenses to acquire a policy

  •Reduced expenses to handle a claim

  •More confidence in accuracy of rating and exposure data for underwriting

  •More confidence that an insurable interest exists

  •Reduced expenses due to fraud and investigation of suspicious claims

  •Faster verification of information with 3rd parties, especially claimants and their insurance carrier as well as landlords, lenders, servicing providers, etc.

  In order to realize the potential of blockchain in the insurance space, there are corporate entities and consortiums seeking to facilitate the development of solutions for a wide array of use cases. Some companies are implementing blockchain solutions that can be leveraged by insurers and other parties. APIs are a great way for insurers and others to access blockchain technology and its benefits. One example is a project by ANZ to leverage IBM’s blockchain solutions to ease the transfer process of payments between brokers and insurers to make the process faster and more transparent.[191] While there are real-world examples of proprietary blockchain solutions deployed for multiple use cases, some feel that proprietary approaches are inherently limiting and that a consortium approach is needed.

  Consortiums help solve the problem of getting different blockchains to “talk” with one another, and this integration is key for driving industry-wide adoption. A neutral and trusted party is seen as critical for successful adoption of blockchain technology by competing carriers, which would likely bring in many other parties that are integral to the insurance ecosystem. RiskBlock Alliance and b3i are two examples of consortiums that are working to bring together a diverse group of interested parties. The Institutes, best known as a professional education non-profit that administers the Chartered Property Casualty Underwriter (CPCU) designation along with many others, has recently entered the blockchain space with their RiskBlock Alliance for exactly this reason. Many of the largest US-based carriers are members of The Institutes board of directors representing a large percentage of P&C premiums written in the United States. If most of these market participants were to support a single blockchain platform (rather than several competing ones), the industry as a whole could see large returns.

  b3i is a European-based consortium that hopes to accomplish something similar to what the RiskBlock Alliance is hoping to achieve. The consortium has been working on their first blockchain-based product offering[192] which currently exists as a prototype handling certain reinsurance contracts between, cedants, brokers and reinsurers. The architecture combines solutions which are private to individual entities as well as shared across multiple parties. As you can see, the industry is already looking for ways to leverage this technology.

  THE BUZZ ABOUT BLOCKCHAIN

  In addit
ion to consortiums that are working with traditional players to leverage the benefits of blockchain, insurtech startups can also leverage blockchain technology to create value propositions that compete against existing firms. Nick Lamparelli, host of the insurance podcast Profiles In Risk and an Insurance Nerds principle, wrote an article on five ways that blockchain will revolutionize the insurance ecosystem.[193] Lamparelli cites the following examples as being low hanging fruit for blockchain applications in insurance:

  1.The complete elimination of all applications in insurance - insureds will simply push or share their blockchain with agents and insurers.

  2.No need for repetitive verifications such as inspections. For example, if an insured gets a new roof put on, all of the information will be verified by blockchain including not just the shingle materials and manufacturer but also full information about the contractor who performed the installation.

  3.The end of certificates of insurance: all verification of coverage will be performed via blockchain.

  4.No more need for audits of items such as payrolls, sales records, inventories, etc.

  5.All claims will be embedded in blockchain, discontinuing the need for loss runs and making salvage and subrogation a snap.