Bernard Lunn
Almost all the early stories about Blockchain adoption were about Banks. Blockchain platforms and solutions providers are now seeing even more interest from Insurance. This research note looks into the reasons why and analyzes the second order impact of this change which will dramatically change Insurance & Reinsurance as well as the Wealth and Asset Management business and Marketplace Lending.
The Provenance use case for Blockchain
The use case for Insurance that has been understood for some time is Provenance. This affects assets such as jewelry, art and antiques where it is critical to know that the "asset is what the customer claims it is". An immutable blockchain is the obvious solution. An early pioneer in this use case is Everledger (our note on Everledger from July 2015 is here).
However this is a) a niche within Property & Casualty and b) one can easily envisage this being deployed by Insurance companies in a way that is more incremental than revolutionary.
The separation of insuring & investing
This is the radical and disruptive idea that is being discussed and developed currently. In our note on Lemonade, we wrote about the 3 layer stack of insurance:
- Layer # 1: Brokers. Their job is to gather premiums from customers.
- Layer # 2: Insurance Companies. Their primary job is claims processing. They take in premiums via brokers, invest the cash flow and pay out claims when needed.
- Layer # 3: Reinsurance Companies. They are the payers of last resort. They insure the insurance companies. Their job is to have enough capital to pay out claims, even if the models did not predict the volume of claims.
The change that is being discussed is using Blockchain to totally separate Layer 2 and 3. For a great explanation of how this could work please see this post by Olivier Rikken where he writes:
"In the new business model, the focus of the insurers would focus on supply / demand matching, to risk calculation research and operations and shift away from asset management. The insurer would provide a market place like platform where customers can post their insurance demand, which could be either a standardized product or even a specific demand.
Olivier Rikken goes on to explain:
The insurer then would use their “risk-intelligence” and risk models, based a.o. on their historical data, to perform a premium calculation to post the expected return, after subtracting their margin off course. Posting this premium calculation, interested investors can bid/subscribe to the demanded insurance. This can either be done as a group in a crowdfunding way, or as an individual in a p2p way, depending on the kind of insurance request, the available resources of the investor and his or her risk appetite. So far this model looks much like Lloyd's already has in the insurance market or as companies like Funding Circle have set up in the p2p lending market."
Networks always win in the end, but it can take a long time.
Marketplace Lending is scaling fast and creating a new asset class. Networks and markets always win in the end. The question is how long it will take. There are two reasons to think this will take a long time - customer confidence and regulation. The hurdle to customer confidence in Insurance is very high. We might experiment buying some loans on a lending marketplace and "put it down to experience" if the investment goes wrong. That is quite different from paying premiums for decades and not being 100% confident that the cash will really be there if disaster hits.
This is where customer confidence intersects with regulation.
Solvency 2 on the Blockchain
Solvency 2 regulation is designed to ensure that insurance companies have enough capital to pay claims.
What if the model shifts to a marketplace on the Blockchain as Olivier Rikken posits? He articulates the logic of using smart contracts to:
"guarantee the payment from the investor to the customer in case the event for which the customer posted their insurance demand happens (the smart contract is thus programmed as traditional guarantee, but without the need of a bank!). By doing this in a blockchain, the administration and execution processes are simpler, almost fully automated, transparent and cheaper that in a traditional set up. Besides that, the investors know their maximum exposure (being the amount defined in the smart contract)."
The issue is how much capital the investor has to put at risk. Will it be back to the future where the equivalent of Lloyds Names agree to unlimited liability? These issues will take time to play out, but I am convinced we will move to a marketplace model. This is one of those inevitable but not imminent changes like the move to real time clearing & settlement in capital markets.
Second Order Impacts
Here is is our Cui Bono and Cui Amisit analysis.
When this change does happen it will totally reshape the insurance value chain:
- Insurance companies who are losing out on layer 3 of stack will work harder to take over Layer 1 by selling direct.
- Asset Managers & Marketplaces will thrive from the inflow of investing opportunities.
- Reinsurance companies will thrive as the deepest pools of capital around.
- New Insurance companies will be created that are born-on-the blockchain with a radically lower cost base.
- Incumbent Insurance companies will work hard to transform their core operations to become agile and low cost and customer centric. Some will meet a Blockbuster/Kodak type fate by failing to transform properly. Those that succeed in their transformation will have both scale and agility and will thrive.
The Provenance use case for Blockchain
The use case for Insurance that has been understood for some time is Provenance. This affects assets such as jewelry, art and antiques where it is critical to know that the "asset is what the customer claims it is". An immutable blockchain is the obvious solution. An early pioneer in this use case is Everledger (our note on Everledger from July 2015 is here).
However this is a) a niche within Property & Casualty and b) one can easily envisage this being deployed by Insurance companies in a way that is more incremental than revolutionary.
The separation of insuring & investing
This is the radical and disruptive idea that is being discussed and developed currently. In our note on Lemonade, we wrote about the 3 layer stack of insurance:
- Layer # 1: Brokers. Their job is to gather premiums from customers.
- Layer # 2: Insurance Companies. Their primary job is claims processing. They take in premiums via brokers, invest the cash flow and pay out claims when needed.
- Layer # 3: Reinsurance Companies. They are the payers of last resort. They insure the insurance companies. Their job is to have enough capital to pay out claims, even if the models did not predict the volume of claims.
The change that is being discussed is using Blockchain to totally separate Layer 2 and 3. For a great explanation of how this could work please see this post by Olivier Rikken where he writes:
"In the new business model, the focus of the insurers would focus on supply / demand matching, to risk calculation research and operations and shift away from asset management. The insurer would provide a market place like platform where customers can post their insurance demand, which could be either a standardized product or even a specific demand.
Olivier Rikken goes on to explain:
The insurer then would use their “risk-intelligence” and risk models, based a.o. on their historical data, to perform a premium calculation to post the expected return, after subtracting their margin off course. Posting this premium calculation, interested investors can bid/subscribe to the demanded insurance. This can either be done as a group in a crowdfunding way, or as an individual in a p2p way, depending on the kind of insurance request, the available resources of the investor and his or her risk appetite. So far this model looks much like Lloyd's already has in the insurance market or as companies like Funding Circle have set up in the p2p lending market."
Networks always win in the end, but it can take a long time.
Marketplace Lending is scaling fast and creating a new asset class. Networks and markets always win in the end. The question is how long it will take. There are two reasons to think this will take a long time - customer confidence and regulation. The hurdle to customer confidence in Insurance is very high. We might experiment buying some loans on a lending marketplace and "put it down to experience" if the investment goes wrong. That is quite different from paying premiums for decades and not being 100% confident that the cash will really be there if disaster hits.
This is where customer confidence intersects with regulation.
Solvency 2 on the Blockchain
Solvency 2 regulation is designed to ensure that insurance companies have enough capital to pay claims.
What if the model shifts to a marketplace on the Blockchain as Olivier Rikken posits? He articulates the logic of using smart contracts to:
"guarantee the payment from the investor to the customer in case the event for which the customer posted their insurance demand happens (the smart contract is thus programmed as traditional guarantee, but without the need of a bank!). By doing this in a blockchain, the administration and execution processes are simpler, almost fully automated, transparent and cheaper that in a traditional set up. Besides that, the investors know their maximum exposure (being the amount defined in the smart contract)."
The issue is how much capital the investor has to put at risk. Will it be back to the future where the equivalent of Lloyds Names agree to unlimited liability? These issues will take time to play out, but I am convinced we will move to a marketplace model. This is one of those inevitable but not imminent changes like the move to real time clearing & settlement in capital markets.
Second Order Impacts
Here is is our Cui Bono and Cui Amisit analysis.
When this change does happen it will totally reshape the insurance value chain:
- Insurance companies who are losing out on layer 3 of stack will work harder to take over Layer 1 by selling direct.
- Asset Managers & Marketplaces will thrive from the inflow of investing opportunities.
- Reinsurance companies will thrive as the deepest pools of capital around.
- New Insurance companies will be created that are born-on-the blockchain with a radically lower cost base.
- Incumbent Insurance companies will work hard to transform their core operations to become agile and low cost and customer centric. Some will meet a Blockbuster/Kodak type fate by failing to transform properly. Those that succeed in their transformation will have both scale and agility and will thrive.
Bernard Lunn
Founding Partner, Daily Fintech Advisers
www.dailyfintech.com
Bernard Lunn is a serial entrepreneur, senior executive, adviser and a strategic dealmaker. He worked in Fintech before it was called that with startups, growth stage and turnaround ventures (incl. Misys, Temenos, IMS, ITRS). He has lived and worked in America, India, UK & Switzerland and is adept at cross border deals.
Founding Partner, Daily Fintech Advisers
www.dailyfintech.com
Bernard Lunn is a serial entrepreneur, senior executive, adviser and a strategic dealmaker. He worked in Fintech before it was called that with startups, growth stage and turnaround ventures (incl. Misys, Temenos, IMS, ITRS). He has lived and worked in America, India, UK & Switzerland and is adept at cross border deals.
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Le quotidien Finyear :
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La newsletter quotidienne :
- Finyear Newsletter
Recevez chaque matin par mail la newsletter Finyear, une sélection quotidienne des meilleures infos et expertises en Finance innovation, Blockchain révolution & Digital transformation.
Les 6 lettres mensuelles digitales :
- Le Directeur Financier
- Le Trésorier
- Le Credit Manager
- The Chief FinTech Officer
- The Chief Blockchain Officer
- The Chief Digital Officer
Le magazine trimestriel digital :
- Finyear Magazine
Un seul formulaire d'abonnement pour recevoir un avis de publication pour une ou plusieurs lettres