Blockchain a potential game-changer, more ILS use-cases to emerge

Blockchain is a potential game-changer for the insurance and reinsurance sector, according to Fitch Ratings, who forecast that the technology will become increasingly embedded in the fabric of the re/insurance market over the coming years and that ILS related use-cases will continue to emerge as well.

Fitch notes that adoption of these technologies should be viewed over the long-term, as transformational benefits won’t be quick to find.

But the rating agency believes that blockchain will bring opportunities for insurance and reinsurance firms to significantly reduce their operating costs, benefit from more accurate customer-specific data, get better risk pricing, and generate improved efficiencies, benefits that will also be available to ILS market participants.

But, still unproven and yet to be meaningfully implemented in the broader insurance and reinsurance market, blockchain is unlikely to show up the true advantages and risks associated with its adoption any sooner than the next three to five years. This means we shouldn’t expect any impacts to re/insurer ratings over the short to intermediate term, Fitch explains.

But Fitch agrees with the hype cycle, that re/insurance is a fertile ground for the decentralised nature of blockchain and distributed ledgers to prove themselves, noting the potential for significant savings around transaction costs, reduction of duplicative effort, faster speed of processing transactions, enhanced underwriting and pricing, as well as reducing fraud.

All benefits the traditional insurance and reinsurance industry would love to realise from its tinkering with the blockchain, but also benefits that can be capitalised on by the ILS fund sector as well and which could ultimately serve to increase the efficiency of ILS capital and the ILS transaction placement and syndication process.

Fitch notes that benefits are most obviously seen in areas such as, reducing the need for reconciliation and audits, automation of processes and improving access to data, while the industry has estimated that expense savings from adopting blockchain could amount to 15% to 30% of annual current expenses.

The ILS market can also stand to benefit in much the same way and while the expense starting point, per dollar of capital, is often much lower across the ILS fund market, any ability to enhance the efficiency of ILS capital even more can only increase the pressure for reinsurers to do so themselves.

Fitch believes that we will see more ILS related blockchain initiatives, highlighting the fact that the technology does lend itself to insurance-linked securities (ILS) and alternative risk transfer structures, including parametric catastrophe bonds and industry loss warranties (ILWs).

Here the potential for smart contracts to represent the risk transfer agreement, the so-called blockchain oracles to represent the trigger inputs, while the capital flows, transaction and trading history is stored on trusted, decentralised ledgers, could make ILS instruments significantly more efficient and the claim process almost automated.

Where such technology may come into its own is in the world of efficient risk placement and trading, as contract structures, triggers and claims could all be coded into transactions, while an open market placement platform would help to match the risks being ceded to the capital providers with the most appropriate risk appetite.

Fitch also highlights the use of the blockchain by Swiss based ILS fund manager Solidum Partners, which has now completed a number of privately placed cat bonds on its own private blockchain settlement platform, the ILSBlockchain.

This initiative is particularly innovative, as it adds efficiency to the placement process in a way that just a few years ago could not have been foreseen, highlighting the fact that blockchain and distributed technology can already make things possible that were previously not even considered.

To us, the use of blockchain technology in ILS can help to make the market even more efficient, reducing its cost-of-capital and provide another lever that heightens the ability of ILS capital to be ever more competitive with the traditional reinsurance market.

At the same time it also promises to help the traditional market enhance its own efficiency, which in turn will raise reinsurers ability to compete back in return.

But blockchain will not be the saviour of traditional reinsurers, or the factor that alone enables the ILS market to further assert its dominance.

The reason we say this is that blockchain initiatives are, so far, relatively closed in nature, created and operated by industry players, and often targeted at very specific parts of the industry. Or very small in nature, focused on a specific goal and lacking the broader automation of other market processes that is required to make the tech into a game-changer in its own right.

This will all change, as progress is made towards re/insurance market automation and we hope to see blockchain initiatives becoming more open in future, encouraging broader market adoption and giving every player the ability to benefit from the efficiencies they will bring.

It remains early days for the InsurTech and blockchain in reinsurance hype cycle, with a long way to go for the market to truly recognise the potential efficiencies these trends will bring.

We hope to see the market adopt open risk placement tools, blockchain playing a part or not, that will enable all parties to leverage the efficiencies of a marketplace and truly put the power in the hands of the customer, in ceding its risks to the most appropriate and attractive form of capital.

The rating agency foresees a period where innovation relies on major players though, saying, “Fitch believes that the ultimate viability of the technology for the insurance industry will depend on a select group of industry leaders adopting blockchain to gain competitive advantages.”

As ever, early adopters and the might of major players will help to drive adoption of technologies like blockchain, but it is to be hoped that efforts involving select groups do not start to look like attempts to create efficiency and increase competitiveness for a select few.

Such efforts may backfire, as has been seen in other industries that faced digital transformation and disruption where market-backed platforms have often lost out to outsiders that saw an opportunity to offer something more open to all.

Fitch says that it expects we will see “additional small test cases” for blockchain based platforms with specific application for the ILS sector. But notes that the transaction mechanics will need to be more widely understood by market participants for broader adoption to occur.

Anything is possible, with the range of technologies now available to reinsurance and ILS market players.

But, for the maximum efficiencies and benefits to be realised, the value chain will need to be upended and intermediation become seamless (and less costly), which all suggests that established players need to relinquish certain roles before the tech-driven fun can really begin.

The real puzzler on blockchain of course, is whether this is a complex and expensive to implement technology desperately looking for a question to solve, or the answer to re/insurers prayers?