Web 3 technologies, which include decentralised networks and blockchain, are designed to be more secure, transparent, and more open than previous generations of the internet. This opens up endless opportunities for insurers, by offering fast, secure, and cost-effective ways to eliminate friction, frustrations and delays surrounding information exchange and validation. Insurers will need to be ready to respond to shifts in the competitive landscape brought on by a decentralised financial system. Decentralised finance (DeFi) aims to make finance more open and transparent by reducing reliance on centralised authorities and intermediaries.
Insurance has many compelling use cases for DeFi technologies, including increasing consumer trust and automating operations. As a result, the entire ecosystem, from brokers to risk modellers, should be aware of how these technologies might impact them.
What are the key applications of Web 3 in insurance?
The innovations likely to have the most significant impact on the insurance market include blockchains, smart contracts and zero-knowledge proofs, also known as ZK protocols.
- Blockchains are decentralised databases (distributed ledgers) of transactions hosted on peer-to-peer networks. Since these databases are immutable and cannot be changed, they act as trusted and transparent information stores.
- More sophisticated blockchains can run code to create smart contracts, with a wide range of possible insurance applications, from payments to collateral management and claims handling. Smart contracts are self-executing contracts with the terms of an agreement written in lines of code. They work with services called oracles that can provide information from outside the blockchain to the smart contract. Third parties will also be able to audit the publicly available contract code providing greater certainty on when the contract will do what the creators claim.
- Zero-knowledge proofs can mathematically confirm whether a data set is true or false without providing a third party with any underlying information. These are already being used to improve the scalability of blockchain networks, and insurers could use the technology to share information securely such as when processing claims.
Gauging the potential across your value chain
We highlight the strategic and operational considerations across the five links in the insurance value chain, from product development to customer service.
1. Product development
Smart contracts unlock the potential for new kinds of insurance products. Self-executing contract code that third parties can validate will help to create products with greater payment certainty and reduced delays. Businesses, such as ACRE Africa, have already begun to test smart contracts in parametric insurance, compensating farmers against the effects of extreme weather. Smart contracts automatically pay policyholders as soon as defined conditions are met, such as a period of low or excess rainfall.
ACRE's first-year trial reached more than 12,000 farmers with more than 500 payments. The primary benefits this would offer insurers are increased product flexibility and speed to market, which is achieved by simplifying key elements like claims handling.
While the initial use of smart contracts in parametric insurance is for simple claims triggers, developments in AI-powered claims assessment will facilitate more complex use cases.
Providing cover for digital assets and cryptocurrencies opens up further market opportunities for insurers who have the expertise to understand and price these risks. Lloyds has experimented with crypto insurance policies as part of its Future at Lloyds programme, while insurers such as Nexus Mutual offer coverage against smart contract failure and exchange hacks. But still, as much as 99% of the $900 billion digital asset market remains uninsured. To address this gap, insurers should identify possible partners to model blockchain and smart contract risks. Greater insurance protection for digital assets could help build consumer confidence against risk from exchange collapses, cyber-attacks or lost and stolen wallet keys.
Web 3 offers new ways to distribute insurance products. Decentralised insurance platforms could lower the barriers for non-insurers to offer and invest in customised micro-insurance products.
For instance, a community group could launch a product built on an insurance blockchain where group members manage and approve claims. By using their knowledge of their community's risk profiles, they can more accurately assess and price individual risks than a traditional underwriter.
In this ecosystem, insurers will help manage digital infrastructure, provide capital, set up agency agreements and ensure regulatory compliance.
Embedded insurance offered through non-insurance apps, like a digital wallet, is likely to provide the primary route to market. Users could then receive tailored prompts, such as through a web browser extension, offering insurance cover when using DeFi applications, and protecting them against unexpected losses.
3. Underwriting and risk
Web 3 technologies will create both challenges and opportunities for insurers in risk management and underwriting. Understanding the risks associated with smart contracts and DeFi platforms will be crucial for accurate pricing and exposure management. Insurers should leverage partnerships with exchanges, protocols and insuretechs to model and assess Web 3 technology risks.
But insurers can benefit from using Web 3 technologies in risk assessment, by adopting ZK protocols to speed up due diligence, allowing secure information sharing between counterparties. For example, insurers could benefit from cross-industry information sharing without giving up proprietary datasets that help to give them a competitive edge. Insurers could use these to monitor information that otherwise would not be accessible, to better understand individual and corporate risks, including solvency or customer behaviour. In addition, insurers could share risk information in real-time with businesses and individual customers to help guide behaviour, such as modelling smart contract execution.
4. Claims management
Claims decision-making through Web 3 could simplify governance processes, support regulatory reporting, and broaden data access.
Smart contracts can enhance the claims experience and strengthen policyholder confidence that their insurer will pay out valid claims. An example of this would be when an insurable loss is detected, a smart contract could act as a virtual intermediary validating the claim and authorising the payment. As the Internet of Things, which connects objects and devices to the internet, becomes increasingly ubiquitous and computer vision technology develops, smart contracts will be capable of validating a broader range of claim types. By using a blockchain oracle service, smart contracts can access real-world data to confirm information unavailable on the blockchain. For example, a smart contract could use an oracle to check and confirm weather data to decide whether to pay a natural catastrophe claim. Tokenomics and decentralised autonomous organisation (DAO) insurance companies could take this further by transforming claims governance. For example, where the oracle cannot check information automatically, token holders who provide insurance collateral could vote on whether they should pay a claim. By becoming involved in the insurance process consumers could learn more about how the sector works and supports them. Insurers could benefit from simplified and accelerated dispute resolution.
5. Customer service
Using Web 3 technologies to improve clarity and transparency over claims will enhance customer experience and help to address customer complaints. This could also spur a shift towards a more transparent operating model by providing customers with greater clarity over insurance costs and how much of their premiums are paid out in claims.
Despite these benefits, insurers need to consider the customer servicing implications of building blockchain and smart contract products. While blockchain technology has the potential to make the insurance industry more efficient and transparent, it could make it more complicated for customers. It would require customers to adapt to new and possibly complex technologies, such as decentralised networks and smart contracts. This could equally introduce new risks and challenges for customers, such as the need to protect against potential security breaches. Responding to these requirements will require clear considerations of customer needs and how to make Web3-enabled products understandable. At the same time, insurers will still need to meet the requirements of customer conduct regulation, including protecting vulnerable customers and adhering to the FCA's Consumer Duty requirements.
So while advanced blockchain users could benefit from the ability to view and audit transaction flows, it will be necessary for insurers to provide simplified information to customers to make sure they are clear about their coverage and how they will be paid.
Realising the benefits of Web 3
How can you respond effectively to the challenges and opportunities that Web 3 offers? Drawing on our work with both insuretechs and established insurers, three key priorities stand out:
1. Build the foundations
You can already take proactive steps to prepare for Web 3 technologies. Work with systems providers and advisors to find out what's available and how your business could benefit.
Investing in digitising your products and services, increasing organisational agility, and improving in-house technology capabilities will help you develop Web 3 applications and put you in the best position for the transformation ahead. Further foundations include support for research, analysis and modelling, either through hiring or acquisitions and partnerships.
2. Design solutions across your value chain
One of the attributes marking out the Web 3 frontrunners is their ability to design and implement end-to-end solutions. This includes developing products that increase transparency and enhance service rather than focus on single components of the value chain in isolation.
3. Take your customers with you
It's important not to undermine the benefits of Web 3 by making it hard to interact with Web 3 products - or going back on recent progress in improving accessibility and simplifying products. Instead, build understanding and trust in Web 3 delivery. Focus development on helping customers achieve better outcomes.
The full impact of Web 3 is yet to be felt. But the possibilities are increasingly evident, and the opportunities to lead innovation remain open. Building Web 3 into ongoing digital transformation can help to lay the foundations for change. The danger is allowing legacy systems, culture and thinking to hold you back from embracing the potential. Moving now to prepare for the shake-up ahead will help your business to get ahead of the curve, enrich customer experience and boost business value.
To help you understand how Web 3 will impact the insurance business, please get in touch with Benedict Altier.