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Innovation in the Insurance Industry: What to do About Blockchain?

By David Luce, Co-Chair of Fintech, Partner, DLA Piper And Jeff Aronson, Partner, DLA Piper

David Luce, Co-Chair of Fintech, Partner, DLA Piper

When you consider the major U.S. companies which disappeared in the recent past as a result of their failure to innovate and adapt to the next big change, the list is staggering—record stores, video rental shops, cell phone manufacturers, instant camera makers, toy stores and book stores—all have been disrupted by rapid changes in technology leading to market failures for Fortune 500 companies. Moreover, we have seen entire industries such as the taxi cab, hotel and men’s razor industries get disrupted by innovators not even seen as attackers (i.e., ride sharing companies; online bed and breakfast marketplaces; Internet razor subscription clubs). The messages here are clear. First, innovate and adapt—or disappear. Second, the attack may come from a non-traditional technology competitor that is not on your radar.

We know the insurance industry is not immune to changes caused by technology. We counsel numerous insurers on corporate venture investing, digital innovation and intellectual property matters. The number and variety of business strategies and tools coming to market in the insurance industry is staggering. Besides blockchain, sensors, satellites, drones, machine learning and AI claims handling and processing, “selfie” underwriting, telematics and cyber-and robo-advisers are but a few of the new ideas that may disrupt the insurance industry.

"Blockchains use encryption and it is nearly impossible to alter their existing data illicitly, the ledger creates a trusted, immutable record"

With this background in mind, let’s consider blockchain.

Blockchain is a digital ledger technology on which transactions are anonymously recorded. (A ledger is a collection of transactions.) It is implemented in a distributed fashion for a community of users. Users can be the general public or private parties (i.e., your business partners). Each transaction (a “block”) is added to the ledger (the “chain”) once approved through an automated process. When a new “block” becomes part of the “chain,” it is timestamped and the transaction is irrevocable and irreversible. With a distributed ledger, there is no single point of failure. Blockchains are updated in near real-time as transactions are approved. Because blockchains use encryption and it is nearly impossible to alter their existing data illicitly, the ledger creates a trusted, immutable record. Thus, a blockchain is really a shared digital ledger technology that allows participants to securely transact directly, with accountability and a high resistance to malicious tampering.

Jeff Aronson, Partner, DLA Piper

However, vulnerabilities can be introduced if additional coding complexity is added to meet new requirements. To avoid defeating the security of the ledger, customers may need to forego custom developments and modifications, while vendors may be required to design both the solution and necessary back-up protocols.

The shared digital ledger contains a continuous and complete record (the chain) of all transactions performed which are grouped into blocks: a block is only added if the nodes, which are members in the blockchain network with high levels of computing power, reach consensus on the next ‘valid’ block to be added to the chain. A transaction can only be verified and form part of a candidate block if all the nodes on the network confirm that the transaction is valid. A block generally contains four pieces of information: the ‘hash’ of the previous block, a summary of the included transaction, a timestamp, and the proof of work that went into creating the secure block. Once information is entered on the blockchain, it is extremely difficult to alter: a blockchain network lacks a centralized point of vulnerability for hackers to exploit and each block includes the previous block’s ‘hash,’ so any attempts to alter any transaction with the blockchain are easily detectable.

Blockchain is thus a self-maintaining database which typically has a “functionality wrapper”, or app development platform, on top. Blockchain can be thought of as an operating system for which useful applications (“smart contracts”) can be written. Assets and information about transactions can be stored and tracked without the involvement of a typical intermediary, such as a bank, central authority or other trusted third party.

A blockchain network may be public and open (permissionless) like the Internet or structured within a private group like an intranet (permissioned). The blockchains that have captured the imaginations of financial institutions are known as “private” or “permissioned” blockchains because only preapproved participants may join them. These blockchains use different means to ensure the identity of parties to a transaction and achieve consensus as to the validity of transactions. The entities creating the “private” blockchain agree on rules governing how entries are recorded and under what circumstances they can be modified. Only authorized participants are given access and are known within the network.

Blockchain makes possible the use of so-called “smart contracts.” Smart contracts are blockchain-based contracts which automatically execute upon certain specified criteria coded into the contract being met. Execution over the blockchain network eliminates the need for intermediary parties to confirm the transaction, leading to self-executing contractual provisions. This may decrease cost and increase efficiency. Smart contracts raise intricate legal issues beyond the scope of this article, often in multiple jurisdictions at once.

Initial coin offerings (ICOs), Bitcoins, Ethereum and other cryptocurrencies are among the first well-known applications to use blockchain technology. Lost in the attention those have received is that blockchains—as distributed ledgers—have really enabled them to exist and thrive. While cryptocurrencies and ICOs create fascinating legal issues for lawyers, the hype may have obscured blockchain’s true potential as middle and back office software. Just as open source and middleware changed the way companies do business (and dramatically changed the jobs of CIOs), blockchain applications could ripple across the insurance industry.

With new blockchain applications for the insurance industry now debuting regularly, insurers should consider a blockchain initiative that involves having a team catalog the most manual processes in the organization and assess where a blockchain solution may be reasonably deployed, and then prioritize the opportunities based on savings to be achieved and implementation time and costs. If blockchain is not appropriate for those manual processes, machine learning, AI and bots may still offer cost savings. Conventional wisdom is that market leaders can miss one big wave of innovation, but two big waves may sink the ship. Insurance CIOs should pay attention to blockchain and the other disruptive technologies and innovation coming at the industry, even if they don’t yet adopt them wholesale.

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