This article explores why Blockchain, a technology barely eight years old, is set to have a profound impact on the reinsurance market. The application of this technology will both change the way reinsurance markets conduct business and the financial dynamics of that business. This disruption is approaching very quickly; we will start to see its impact in 2018 and can expect significant change within five years.
It takes a UK/London perspective within a global context. It uses the active North America Property Cat reinsurance market as an example because, in London, this is one example of a line of reinsurance business where the bulk of the capacity is provided by a small group of reinsurance carriers and brokered through an international distribution chain. We think that it is in just such lines that compact, small consortiums where we will see the early leaders of blockchain enabled reinsurance business.
The fundamental issues facing the London reinsurance market
Global reinsurance markets have been attractive in a climate of low investment returns. Alternative capital including Insurance Linked Securities (ILS) has made a significant inroad into this market; particularly in global property catastrophe where it now accounts for approaching 15-20% of this market compared to, our estimate, of London’s 11-13%.
London’s reinsurance GWP has remained relatively static at around £15bn (32% of the whole London Market) annually but this masks the effect of downward pressure on pricing and a growing overall market. In practice, London has lost overall market share while also suffering reduced underwriting margins and investment returns. The market may look stable but it is under significant strain.
London suffers some particular operating issues that affect other reinsurers but are magnified here:
• Additional brokerage / acquisition overheads. Almost all business is double intermediated through local and London brokers and this results in a penalty of doing business of an estimated 13%. A pressure that is borne by increased pricing to the outward insurer or reduced margin to the reinsurer.
• High operational costs in the chain from insurer through brokers and into reinsurers. This is exacerbated by the layers of intermediation, the syndicated nature of doing business across many reinsurer counterparties and the high costs of shared administration in London. These costs are apparent across all aspects of business from placing, into finance accounting and reconciliation, and the whole claims process. The basic inefficiencies in administration and quality of information are further magnified by regulation that requires prudent positions to be taken on any uncertainty. There are indicators in expense ratios that London (and other geographies) that operational costs are at least 20% too high because London’s expense ratios are, on average 9pp higher than non-London peers.
In short, London risks becoming a market of last resort for reinsurance and is already showing signs of this as its share declines. New sources of reinsurance capital appear to now be well established and part of the business landscape; and this is also affecting the proportion of reinsurance business written into London. Underwriting skills remain very strong in London but these do not guarantee long term health of the market. London’s future in reinsurance equally rests as much on its ability to compete efficiently with other markets and new capital products to both retain its share and challenge for an increased share of business.
Looked at across the London Market with, we estimate, around $33bn of Property Catastrophe business reinsured through about $3.3bn GWP, insurers are taking a cost penalty estimated to be approaching a conservative 25% of operating costs or £0.23bn ($0.35bn). For reinsurers, that is typically now more than current realised underwriting margins. Addressing this gap needs new tools to substantially streamline operations across the reinsurance distribution chain.
Why blockchain and why is this particularly applicable to the reinsurance market
Blockchain and its associated supporting technologies allow us to build a different type of business application that could, on a realistic basis of reducing costs and using that efficiency to compete more effectively for market share, allow London to reduce expense ratios by at least 8% and provide better service and experience to customers.
These new Blockchain based business applications are different because they are decentralised and distributed across the participants who use the system:
• Each participant organisation (e.g. cedants, brokers, reinsurers) has their own copy of the same business application and stores their own copy of their business data within their organisation and under their control.
• There is no central or third party that stores or becomes the defacto owner of everyone’s information. Instead, the common application, spread across each participant automatically ensures everyone’s individual records are synchronised, cannot be surreptitiously or accidentally altered (i.e. are records are ‘immutable’).
• Only the direct participants to a transaction (e.g. an insurance contract between two parties, a financial transaction for a premium instalment, or a claim) can ever see the data relating to that transaction. Other organisations using the same shared application cannot access that confidential data.
These features which are largely enabled and automatically managed by security protocols and encryption technologies that underpin the internet have a profound impact on the types of systems that will underpin the way we operate in business.
• These are systems that support complex collaboration between trading counterparties. They are particularly suited to business to business interactions between organisations and they create new marketplaces where we can completely reliably and provably transact business on a mutual, peer-to-peer, basis. They consequently are not just transactional but reinforce and enhance business relationships.
• These systems ensure that the information I see about a transaction is exactly the same as you see. This new transparency means we both see exactly the same status for a trade (e.g. ‘claim agreed’ or ‘claim queried’). Further, these records can never be altered without the counterparty being aware of this and being able to prove the original version. This is completely different to any other electronic/digital or paper exchange.
• The information shared between parties can remain confidential to the parties of a transaction. This is absolutely essential in any competitive marketplace and is typically a fundamental requirement.
• The technology frameworks that support these systems mean that business applications can, compared to large centralised systems, be relatively quickly built and deployed across collaborating organisation and run at a substantially lower cost.
The reinsurance market is a particularly strong candidate because we have established wide networks of counterparties. The counterparties undertake complicated (contractually based) trades requiring lots of dialogue between the individual counterparties. Furthermore, information is subject to negotiation and alteration over the course of the contract; the accuracy of this information is paramount to ensuring enduring trust between the trading counterparties. The impact of such Blockchain based collaboration systems will significantly alter the way we can transact reinsurance business:
• Every operational process step in insurance organisation is driven by interaction with a counterparty outside the organisation. This happens in contract placement, financial and operational administration and claims administration. Individual organisations cannot unilaterally drive great operational efficiency without working with its counterparties. These distributed systems are the platform for that collaborative efficiency and a true shift to automated straight-through-processing where that is appropriate. A 25% reduction in operating costs (about an 8pp reduction in Expense Ratios) should be a minimum goal for each organisation using these systems.
• These systems shift the whole collaboration process away from burdensome administrative activity (creating documents, entering data, finding data, checking, rechecking, reconciling information and creating audit trails to prove actions) to real business collaboration of understanding and analysing information, negotiating, assessing risk and commercial decision making. Reinsurance will see a change and refocussing towards the high skill, truly underwriting value led capabilities that centres like London can excel at.
• Reducing the administrative burden will also speed up processes at every stage through placing, finance and claims administration. This directly improves the service to the client and addresses one of the key issues the market faces. This is particularly true for London market that operates at a geographic and intermediated distance. Providing faster and more transparent business makes a market more attractive to work with.
• The information and quality of the information by all participants in these systems about contracts and claims affords new ways of shaping reinsurance products that simply cannot be achieved at this time. It is likely that the mutual sharing of this information will itself lead to the emergence of new business models between participants that are not even readily predicable at this time.
• The mutual and collaborative nature of these platforms mean that it is likely that consortia will form around natural and existing trading relationships (i.e. the companies you do 80% of your business with already in a particular line). These will reinforce and improve those relationships to the mutual benefit of parties.
The combination of reduced costs, a focus on underwriting and client service that is supported by the transparency of information shared by transacting counterparties (reinsured, broker & reinsurer) should allow London to grow its share of the Property Catastrophe business by at least 5%. The impact of this would amount to a retained 40% to 100% improvement in underwriting profits for participants and better, more keenly priced reinsurance for clients and insurance for the insured.
Conclusion and a Call to Action
Blockchain based distributed collaboration systems provide to tool for radically altering the way reinsurance business works. Such is the potential capability for realising operational efficiencies in this complex set of marketplaces around the globe that this presents both an opportunity and threat. The opportunity is to be a leader and embrace and benefit from the change; the threat is that, even if there is resistance from established players, new entrants will seize the chance to build on these new models to provide very competitive offerings against established players.
The speed of experimentation and adoption is itself a threat. These technologies, when appropriately designed and managed, can be deployed inside a few months and allow participants to gain experience and benefits quickly. At ChainThat we have an established and demonstrated an ‘Insurance Blockchain Framework’ that allows a consortium to quickly build, experiment and evolve trading relationships using these new technologies. We predict that 2017 to 2018 will see the advent of multiple consortia that will operationally benefit from early adoption. Blockchain use does not need complete market adoption to benefit the individual participant and individual participants will benefit greatly in experimenting early. This is an area where slow adopters will struggle to catch up because of the knowledge that will be gained from the new ways of working in each enterprise.
The potential benefits are substantial for those active in reinsurance markets who embrace these innovations. This is a path to achieving deep operational efficiency savings and using that to both secure and then win market share. Becoming part of a, small value focussed, consortia in an active sector also affords an element of protection; it guards against new entrants and should afford a better, longer term, competitive position than less active organisations who wait and watch.
For more information, contact ChainThat here.
(Note: Figures are primarily drawn from ‘London Matters Factbase’ & associated sources – LMG with additional ChainThat analysis. )