Navigating blockchain opportunities in Insurance
Unifying Insurance and Blockchain has so far been the most difficult task of my entire career. On one hand, those two concepts should work well together: Insurance and Blockchain belong to the financial services family, it’s basically a lot about money flows in both cases, and both can hedge your loss in case something bad happens to your assets.
Yet, there are big hurdles to more collaboration between the 2 worlds: Blockchain technology, cryptocurrencies and Decentralized Finance are very new while actuarial work implies benefiting from long historical series to take a risk, crypto-ventures are eager risk takers whereas Insurance companies resell most of the risk they underwrite, Blockchain developers start from a green field whereas Insurance has a lot of legacy systems to cope with, Blockchain companies invent unregulated business whereas large insurance companies need to be very attentive to regulation compliance, and last but not least: insurers thrive on customer trust (that they will be compensated in case of loss) whereas Blockchain’s motto is “don’t trust, verify”.
Blockchain is full of opportunities for the Insurance industry but selecting the best ones and how to tackle them is a difficult task for insurance decision makers. Indeed, great opportunities are most of the time the riskiest, the less regulated ones and/or the most difficult to implement. Before dwelling on opportunities, I want to start with some mistakes I witnessed while seeing “Blockchain projects” being developed, boosted or stopped in the Insurance industry.
Mistakes the Insurance sector should avoid regarding Blockchain
Mistake #1: “Yes” to blockchain, “No” to tokens
Bitcoin was created to exchange value with no central party. The very objective of Bitcoin was to create a digital asset and enable its uncensorable exchange. It is therefore in principle doubtful that “blockchain technology” would serve well objectives that are too far away from the principle of distributed digital value exchange. And indeed, when there is a project with blockchain but no token, the value-add of the blockchain is most of the time at least subject to debate and finishes with a technical scrutiny of the differences between a private blockchain and a shared database. In other words, you start with a will to leapfrog to modernity with Blockchain and finish with a technical discussion on how to marginally improve your IT.
Mistake #2: Add blockchain but leave the rest unchanged
Blockchain is new and therefore not adapted or easily pluggable to legacy systems. One can even add that Blockchain’s ethos is even to disrupt legacy systems. And it needs a lot of efforts of talented people (exchange owners, service providers, even some regulators) to link the “cypher world” with the legacy world and bring additional value to the latter, sometimes under the criticism of the most adamant and radical crypto defenders. If you want to extract value from the blockchain, you need to adapt to it. Therefore thinking that an insurer can whistle for blockchain help, and a wizard would jump from the bush and magically improve insurance processes is just a pipe dream. You cannot get blockchain value if you want to keep all your legacy systems, all your processes, all the complexity you should get rid of.
Mistake #3: Ignore the most obvious opportunities
The Insurance industry will soon understand that the most immediate opportunities are not related to how Crypto can support Insurance but how Insurance can support Crypto. The cryptocurrency sector is now a real one, with billions of dollar value being exchanged every day. This sector needs wallet and custodian insurance and has seen products emerge at high prices. Insurance will for sure end up doing its usual job (risk assessment and risk coverage) on this new surface (Bitcoin and all cryptocurrencies). Some brokers (Marsh, AON) and insurers (Arch Insurance) have engaged in this first step, and will be able to bootstrap an activity around Blockchain insurance. The more knowledge these players get, the more difficult it will be for followers to catch up.
Mistake #4: Refuse cryptocurrencies their status of financial assets
Insurers invest the proceeds of insurance premiums on financial markets. They will do it cautiously and invest in not too risky assets, typically sovereign bonds or defensive stocks, in order to be able to compensate insurance claims (compliance to Solvency II regulation also leads them towards that direction). As the modern portfolio theory of Markowitz instructs to never “put all your eggs in one basket” in order to decrease risk for the same ROE expectation, insurance companies Treasury teams diversify between Sovereign bonds of different countries, long and short-term bonds, add corporate bonds and other asset classes.
My personal take is that they also would be wise to invest a tiny share of their funds in a “new” asset, called bitcoin, today:
- Investing a small bit of insurance premiums in bitcoin enables to hedge against fiat hyperinflation in case of sovereign credit default or banking collapse (don’t forget that insurers don’t only indemnify in cash, sometimes it is with services that can be subject to strong price increase in case of hyperinflation)
- Committing part of their reserves in bitcoin as a store of value, as Microstrategy decided to do a few weeks ago¹, is a hedge against sovereign currency turmoil
Michael J. Saylor, CEO, MicroStrategy Incorporated: “This investment reflects our belief that Bitcoin, as the world’s most widely-adopted cryptocurrency, is a dependable store of value and an attractive investment asset with more long-term appreciation potential than holding cash”
Mistake #5: Assume you can catch up later
One thing that is certain about Blockchain is the speed of change of the industry. Forks, ICOs, stablecoins, DeFi, flash loans: each quarter brings a new topic and it is more and more difficult to catch up for lost knowledge. What’s more, Blockchains are giving birth to projects that don’t mix well with the idea that “insurers will invest later when the sector is stabilized”. It will not be possible for insurers to “buy the winning blockchain” because it will be much too expensive, it will not be possible for insurers to eliminate liquidity pools as they are decentralized, it will not be possible for insurers to insure the crypto sector when smart contracts fed by decentralized capital will do it autonomously. The risk for insurance is not only in terms of lost opportunities but also in terms of threat to the current business.
Blockchain opportunities in Insurance
1. New insurance opportunities: insuring the crypto world
Wallets, smart contracts, ICOs, custodians, security solutions, tokenized assets… The beauty about insurance is that any new sector or activity created in the world will often be a new surface for insurance. The need for insurance is all the stronger with cryptocurrencies, as any theft cannot be “overwritten” by a governing central party.
The good news for Insurance is that insuring supposes a first step of crypto risk assessment, which itself already provides a lot of “Blockchain knowledge” to an insurance company. Then comes insurance, and the hit suffered on the first covered hacks enables insurers to 1. finetune their risk assessment and adapt covers 2. identify weak points of the crypto sector that could be new business opportunities for insurers.
2. New investment opportunity: hedge against fiat fall
While insurance premiums invested in financial markets used to make a large part of insurers’s profits in the good old days, this is not any longer the case in a context of low to negative interest rates. What’s more, the expected post-COVID economic recession combined with sharp quantitative easings might lead to episodes of hyperinflation, potentially boosted by investor defiance towards Sovereign and Corporate debt. This is a risk that insurers could hedge by investing in hard money: they can follow Bershire Hathaway² and invest in gold, or follow Austrian economists like Saifedean Ammous³ and invest in Bitcoin.
Even if there is no complete collapse of the sovereign currencies systems, the structure of Bitcoin (programmed issuance, issuance reduction over time, fixed max supply) will reassure that it is an asset that has a power to hold more value in the mid- to long-term than fiat assets, hence being a clear hedge against falling sovereign currencies values. Whatever critics say about “Bitcoin volatility”.
The logic behind such a move is threefold:
1. Increase diversification (therefore lower the risk for a target ROE)
2. Reset allocation risk in a world where the US, German or Swiss Sovereign credit risks may not anymore be considered as the lowest risks
3. Be able to survive in a world where sovereign currencies plummet
3. Reshaping Insurance… and finance
The idea that insurance can only be provided by insurers is more and more disputed by new technology and digital disrupters. Traditional barriers to entry to the insurance sector are falling: actuarial expertise is challenged by new armies of data scientists, claims management is becoming useless with parametric insurance and IoT, public smart contracts eliminate the need to trust a big financial brand on the promise of a future payment, capital can be accumulated through liquidity pools and regulation is becoming irrelevant and powerless to regulate decentralized protocols and money flows. Under this new context, the Insurance sector has to reinvent itself, disrupt itself before being disrupted, and find new areas where it can bring value.
If we look back, what are the opportunities insurers have already left to others: being an oracle (Chainlink), being a custodian (BitGo), insuring exchanges (Binance’s SAFU), inventing distributed insurance protocols (Etherisc), creating decentralized liquidity pools (Uniswap), insuring DeFi / hedging in DeFi (Nexus Mutual, Opyn)…
It’s of course debattable how close those opportunities are to the insurance business today but they might be the building blocks of the next generation of Insurance.
The same applies for Finance. Whether insurers will be able to seize opportunities of Decentralized finance does not depend on whether banks or other financial institutions will let them do it (note that only new players are mentioned in the list above) but whether or not insurers are able to provide decentralized services cryptofans are looking for. Everything is possible for insurers, as long as they comply with “crypto principles” (open source, decentralization, trustlessness, transparency and privacy to some extent). It’s not so much about knowing if insurance firms have the resources to contribute but whether or not their culture will let them contribute, and contribute the right way.
4. Process opportunity. More timestamping in insurance processes
Bringing insurance processes to modernity implies an addition of simple yet difficult-to-implement decisions: shifting processes from mails and phone calls to software, digitizing and tracking. In the tracking part, whether it is insurer/reinsurer commitment, fronter/risk carrier relationship, corporate contract terms or freight checking, Blockchain can bring some value through the timestamping of actions and the automated reconciliation of events. This is for sure not the most disruptive way to leverage Blockchain for insurers but a timely one as post-COVID insurers will need to eliminate frictions, costly litigations and time lost in manual reconciliation. Acknowledged: timestamping is an exception to Mistake #1 described above.
