From Idea to Proof of Concept: Realising the Potential of Distributed Ledger Technologies in Insurance
For much of the past year, Swiss Re has been working on proving if blockchain technology could be viable for the insurance industry.
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It has been a year full of belief, promises and hands-on experience, which has enhanced our perspective and enabled us to be ready at every stage of this evolving and promising technology. Needless to say, this would not have been possible without the dedication of many in the company and strong collaborations with leading thinkers outside the company. Leadership commitment has also been a key success factor.
In many ways, what blockchain does is to provide "consensus-as-a-service". Consensus is at the heart of blockchain operations and forms the first layer of decentralised architecture. Consensus in today's world is driven by legal contracts – each organisation has its own internal state, its own ledgers and its own view of the world, all of which need to be reconciled. Settlements, for example, are done through a series of contracts between organisations. These contracts affect the consensus, and if one party deviates from the consensus, another party – through legal recourse – can bring the first party back to consensus. What is now done via legal means will be offered as a service through blockchain in a systemic way (ie., an 'in-band' system), and not in an out-of-band legal way. This builds blockchain's credibility as a "digital trust machine".
What was the trigger behind this invention?
Blockchain as a technology is an answer to the post 2008 legal, contractual and regulatory overhead built up in the financial services sector. Blockchain enables the removal of contractual and legal overhead (eg oversight and audit) from above and replaces it with systemic overhead from below. Blockchain seeks to flip the original problem on its belly by building a system that provides the same level of guarantee, while admittedly slower than traditional databases. Put differently, blockchain technology potentially transforms the financial services universe by disintermediating and liberating the trust from outside, and building trust from within. That is why blockchain makes sense in this era of financial services, and would not have been feasible before 2008.
Asset tokenisation and data mutualisation
There are typically two kinds of solutions that we see with blockchain. One is "asset tokenisation", where the ownership of valuable assets, represented as tokens on the blockchain, is tracked and traded, and the other is "data mutualisation", where blockchain's primary function is to enable the choreography of business process between market participants – both regulating and regulated entities – where data is mutualised to improve coordination between actors with benefits such as data lineage, data quality, immutability and controlled access to same data. Bitcoin is a good example of the former. However, the insurance industry can benefit from both. Blockchain's ability to send, receive and store information as well as its ability to enable transaction flows across multiple layers of counterparties – from Insured to Primary Insurer to Reinsurer to Retrocessionaires to Capital Markets – could potentially redefine the standard for digital transaction processing. Whether it is simple contract automation or parametric products or digital risk marketplace, blockchain can extend the industry's options and possibilities. Justifiably so, the insurance industry is keen to test the value of this promise.
Swiss Re's journey
About a year ago, Swiss Re began thinking aloud about practical applications of this technology and how it could benefit our customers. We realised quickly that the post placement claims processing value chain could significantly be improved by using this technology. Once clients place business with us, many see the process of reinsurance accounting as a somewhat necessary evil. It can be cumbersome for them to exchange data with us, and periodically settle on what they owe us and what we owe them. Anything we can do to make this process easier would be appreciated. Most of our clients work with multiple reinsurers, and all parties stand to benefit if processes are simplified and streamlined, versus every reinsurer inventing its own wheel.
With this in mind, Swiss Re began scouting for a good testing ground, and decided to focus on improving its Intra Group Retrocession (IGR)  business process. Our internal contracts and the challenges to settle them quarterly are quite similar to those we have with clients. Our focus was on the business problem, rather than on the technology - to check how we could make the quarterly IGR process faster, leaner and more transparent.
The IGR process, which takes about two months to settle, absorbs quite some time and effort, as well as working capital. The IGR proof of concept (PoC) gave us the practical test case to put insurance contracts on a blockchain wherein business logic can self-execute in a digital form, and results are validated by counterparties and notarised on the mutual distributed ledger. Starting off with IGR as the first PoC for validating this technology hypothesis was challenging, but in hindsight, it turned out to be the perfect launching pad and even formed the basis for the first PoC of the Blockchain insurance industry initiative (B3i), an industry-wide engagement for blockchain experimentation. B3i is a significant step forward in driving standards for faster blockchain adoption in the industry and for realising business value.
The blockchain is not a panacea, and the technology and business applications are still evolving in areas ranging from pre-placement to post placement to settlement. Unique properties of the blockchain and smart contracts could deliver significant efficiency gains across the re/insurance value chain. Expected benefits such as reduced cycle time, cost and friction, and enhanced transparency could ultimately create savings that could be passed on to the insured, helping to make insurance more affordable and accessible for all. Swiss Re is leading among re/insurers in this experimentation journey with this technology and deeply values the opportunity to collaborate closely with its peers in the industry to drive successful business change.
#1: Blockchain is easy
The simplest first: the beauty of building something block by block. Our children do it with building blocks like Lego or dominos. In insurance, we often work with multiple versions of contracts. They form the basis to collect premium payments and reimburse claims after loss events. We use account statements to exchange information about what happened. These are our "building blocks". Each block only makes sense if connected to another. When you have built a giant block castle, you cannot take out any block in the middle of it and try to replace it without being noticed. Blockchain works in a similar way and that is a good thing, especially in insurance, which relies on trust and truth around events, properties or people. An immutable mechanism to trace and manage authenticity and versions of data can be a breakthrough, as it will eliminate inefficiencies, reduce fraud, mitigate operational risk and strengthen contract certainty.
#2: Latency is legacy
Executing an insurance contract or settling a claim can take time, a lot of time, with limited overview of a payment’s status until it has fully traversed a cross-border chain. The so called "batch processing" leaves parties unaware of the settlement while the beneficiary receives the credit only after a delay. Reducing this latency, not only of payments but the entire upstream contract and settlement cycle, mitigates risk, improves liquidity management and reliability of financial reporting. Rather than being in the dark, it will be much clearer when transactions settle. This can be a "what's app" moment for insurance, enabled by Blockchain's smart contract handling on a distributed ledger.
#3: Omnipresent means sharing
Underwriting or claiming insurance often involves agreeing on different versions of the truth, as it relates to assumptions, scope, cover, facts or circumstances. Is the claimant really the owner, does the property really exist, what is the industry consensus on the large loss event? Shared ledgers with shared logic, covering the same events and actions recorded at the point of occurrence, provide an instantaneous and shared view of status. Sharing data in a trusted central place makes the management of authenticity and identity much easier.
#4: Consensus can be efficient
Judgement or plausibility checks can be required for contractual parties to reach agreement. If such consensus is found between contractual partners, without relying on a central authority or intermediary, things can really get efficient. This does not mean a fully machine driven process. Human interaction will still be key (eg for underwriting and claims adjustment sanity checking or auditing) and a blockchain signature authority mechanism can process such human approval steps. The overall process of reaching consensus will become leaner. Insurers then use their reserves primarily to compensate for losses, rather than to fund disproportionate administrative, transaction or legal fees. It may not be intuitive, but law and computer science are quite natural partners, or with a quote from Nick Szabo, the man widely credited with inventing the smart contract concept itself: "Traditional law is manual, local and often uncertain. Blockchain smart contracts are automated, global and predictable in their operations."
#5: Kata – when we collaborate, we make things better
This lean mindset advocated by Toyota relentlessly pursues continuous improvement in cost, quality and service. Processes typically improve when people collaborate. That is why you see teams huddling together on lean managed factory floors. Insurance dearly needs this, to address the cash and paper flow trapped across its value chain. The insurance industry now has a unique, common platform to jointly run such improvements and make insurance more accessible and affordable to all.
#6: Cash is king
Time value of money is key to insurance, surely in times of low interest rates with high opportunity cost. It further increases the pressure to improve the cash conversion cycle and optimise asset-liability management. This requires reliable cash forecasts from re/insurance operations. The engine for such forecasts are quarterly settlement processes, which can take many months to settle, leading to credit risk, unreliable forecasts and inefficient usage of liquidity. A distributed ledger, combined with latest payments message standards can bring a breakthrough in the payments and cash management cycle. Why can we transmit a private video message across the globe in seconds, but need several days for a payment? This is the "last mile" that needs to be solved to address the latency issue described above. There are examples already that prove this use case, even if they may only leverage particular parts of blockchain technology, such as cryptography and instantaneous settlement, which add most value to payments.
#7: Holistic vision rather than proprietary
Insurance participants handle massive amounts of data via various platforms. The industry has already developed partial e-admin solutions, taxonomies or exchanges, but with adoption limited to certain portfolios, segments or markets. The industry needs to depart from its proprietary legacy towards a holistic solution, much like what SWIFT became for banking and preferably even more courageous, more efficient and open source.
#8: Actors not just altruists
Is it a too simple and altruistic view that the industry actors can come together for something that may not bring competitive advantage to any single participant? Insurers, brokers and reinsurers will have to choose their act in this play. Standards exist already that can be leveraged. Unlike banking however, the insurance industry does not have an industry-wide network to operate messages with this standard. Blockchain could fill this gap. It will reduce time for shuffling cash and paper around, and free up time to manage risk and portfolios.
#9: Immutable means "first time right" thinking
In large-scale insurance contracts, parties self-declare how their portfolios have developed. They reveal facts about business development, exposures, losses or reserves, yet without running competitive risk. It is good to apply a "first time right" mindset to such reporting, with a clear audit trail of every change to the initial declaration. This will eliminate much reprocessing and reconciliation work that adds no value. A distributed platform for estimates where updates are traceable, auditable and most of all immutable is new and powerful for the insurance industry and can dramatically improve its business processes.
Insurance implies periodically reporting mutual obligations. Parties run these data through the terms and conditions of the contract that binds them. The outcome should be the same, only with reverse signs. Yet a lot of time is spent performing separate calculations, hoping to arrive at the same result. When multiple parties share the same contract logic, the benefit of executing the contract in a shared, neutral ledger is obvious.
 Retrocession is the practice of one reinsurance company providing services to another by insuring the activities of another reinsurance company. This is done by accepting business that the other company had agreed to underwrite.