This is the second part in our series on the potential of blockchain technology for the takaful industry. In the first part we introduced the concept of the blockchain and mentioned one of the more interesting examples of blockchain being used in the UN World Food Program for Syrian Refugee camps which resulted in a 90% reduction in administration costs. We also listed some the interesting aspects of blockchain technology. Among them were faster transactions at significantly reduced costs and immutable record keeping (Meaning that once a record is placed in the blockchain, it can no longer be tampered with afterwards).
So how does a blockchain work?
For the purpose of this article, a conceptual understanding would be sufficient to understand how a blockchain works. For those that are more technically inclined, there are numerous resources available online that explain how a blockchain works. The level of technical detail that these resources go into varies and all one needs is do an online search to find out more.
As an analogy, take for example the emails we send out on a daily basis. We use our email software every day to send messages, but do we really understand how the technology and protocols like TCP/IP behind it work?
What happens in a blockchain transaction?
A Blockchain, in most cases, is public, meaning that the entire transaction happening in the blockchain are visible to anyone and everyone. This provides a level of transparency that has previously never existed (there are also private blockchains as well).
As an example of a transaction on a blockchain, let’s say someone wants to send cryptocurrency or a token halfway around the world to another country. For a transaction to be successfully recorded in the blockchain, four things must happen:
-A transaction must take place
The user must broadcast his/her attempt to send a certain value of a cryptocurrency or token to someone else.
-The transaction must be verified by the network.
A Blockchain runs on a network of computers known as nodes, provided by volunteers all around the world (even you can join the network). A Blockchain network may consist of thousands or even millions of nodes with no central database. Each node has a local copy of the blockchain, ensuring the availability of the data. So, if one or two of these nodes are down, there will be thousands of other nodes that have local copies of the ledger. The network will then verify the validity of the transaction according to the blockchain history. The transaction needs no government, bank or any other middleman for verification, (this means that blockchain a decentralized technology).
-The verified transaction must be added to a block.
The verified transaction is then stored in a block. A block is basically a record or a file that stores the data. However, the block must be given two cryptographic hash codes – one is from the preceding block and another one is its own. A hash code is a string of letters and numbers which is generated using an algorithm. This algorithm transforms digital information into a hash code in a process known as hashing.
-The block is added to the blockchain.
Matching hashes connect the blocks together, thus forming the blockchain. Once connected, it will be extremely hard to change or alter the recorded transaction. For instance, if a hacker attempts to make changes to a transaction, the hash of the block needs to be changed as well, as well as the hashes of other connected blocks. Changing the hash code means breaking down the blockchain since the hash is no longer matched with the preceding and following blocks. Attempting to recalculate the hashes for other blocks as well to restore a chain is nearly impossible.
Blockchain and Smart Contracts
One of the features about blockchain is that it can also store pieces of code and programming, enabling what is known as a smart contract.
A smart contract is a computer program that consists of “if-then” statements which runs on a blockchain. If a specific condition is fulfilled within the smart contract, the next step will be automatically executed.
To create a smart contract, one needs to encode the terms, predetermined rules, or restrictions on the blockchain. When (or if) these terms are met, the code executes on its own. The smart contract also interacts with the data from the real world.
Vitalik Buterin, co-founder of the Ethereum blockchain, defines a smart contract as “A mechanism involving digital assets and two or more parties, where some or all of the parties put assets in, and assets are automatically redistributed among those parties according to a formula based on certain data that is not known at the time the contract is initiated”.
Implementation of Blockchain in Insurance Products
Implementing smart contracts in insurance products can significantly reduce friction in the customer experience, especially when dealing with claims. Imagine when a policyholder is eligible for a claim, a payout will be made automatically without the policyholder needing to do a single thing. Thanks to a smart contract, automated claims can now become a reality. This greatly reduces the claim processing time as well as the claims expenses. As it is on a shared ledger, insurers can record any transactions permanently and can avoid processing multiple claims from the same accident thus preventing insurance fraud. The following are examples blockchain technology currently being used in the insurance industry:
Fizzy is automated insurance using a smart contract for delayed flights developed by AXA. When a person purchases a Fizzy policy, their purchase information is recorded in a smart contract which is connected to global air traffic databases. In the event of a flight delay for two or more hours (regardless of what the cause is) the compensation is triggered automatically and there is no need to report the claim.
LumenLab, MetLife Asia’s Singapore-based innovation center has begun testing automated insurance using a smart contract providing gestational diabetes protection for expecting mothers. The experimental product is known as Vitana. Customers download the Vitana app and the underwriting is done on customer’s mobile phone within 2 minutes. The smart contract is used to automate not only a claim, but also underwriting.
B3i Property Cat XoL Contract
B3i started as a collaboration of insurance and reinsurance companies aiming to explore the potential uses of Distributed Ledger Technologies within the industry. It has now become B3i Services AG, which is an independent entity. In 2017, B3i launched a blockchain prototype platform for Property Cat XOL contracts. The prototype enables a cedant to request a quote and allows the cedent, broker and reinsurer to interact on the platform until an agreement is reached. All communication is encrypted so only the relevant party can access and read what it should. The same process applies for settlement of contracts.
Implementation of Blockchain in Takaful Products
At the time of writing, there are currently no known examples of takaful products which are utilizing blockchain technology. Among the reasons for this could be due to the following:
- Adaptability challenges – some takaful operators may face difficulty in the integration of systems. This is especially true of large operators with legacy systems.
- High operation costs – using and running blockchain technology may consume substantial computing and processing power, which may lead to higher running costs.
- Lack of talent – there are still not enough developers with experience in blockchain technology and cryptography.
Potential Blockchain Takaful Products on horizon?
To give some ideas of blockchain takaful products that could be developed in the future, here are two ideas:
- Hajj/Umrah Blockchain Product
Several takaful operators have offered Hajj/Umrah products with benefits such as Personal Accident, Accidental Death or emergency medical expenses. Most of these products work on a reimbursement basis where the participant needs to file a claim upon return to their home country and wait for the claim to be processed. If this type of product was developed on the blockchain, a smart contract could be developed which would automatically disburse the benefit amount. Cross border payments could also be done instantly as there is no need to go through banking networks such as SWIFT.
- Surplus Distribution Using Smart Contract
Most takaful products will have surplus sharing between the operator and the participant which is according to a ratio stipulated in the contract. A smart contract could be developed that enables automatic sharing and disbursements of surplus. Within the smart contract conditions can be set such as whether to distribute the surplus on a yearly or monthly basis, or if the participant decides to donate the surplus directly to a charity or other beneficiary. Once the smart contract is finalized then it will automatically distribute the payments without any additional paperwork needed.
With the concepts presented above, it is hoped that Takaful operators will soon consider the application of blockchain technology in future product developments. Takaful operators should be aware that the rate of change due to technology is happening at an exponential rate and for those willing to innovate and take bold steps, will gain first mover advantages.
Ultimately, is it the takaful participant that stands to gain the most from this innovation as he or she will be able to reap the benefits from greater efficiency and peace of mind. The days of filling out tedious claims forms and constantly chasing claim pay-outs may soon be a thing of the past.