20 December 2019Analysis

Waiting for the revolution

There are few corners of the financial industry, or any other industry for that matter, that have been untouched by the excitement generated by distributed ledger technology (DLT), aka blockchain. Its advocates insist this technology has the power to transform processes in banking, fund management and, of course, insurance.

The insurance industry as a whole is ripe for precisely the efficiency gains that DLT promises to deliver, with customer data and payments two areas in particular that could be handled much more efficiently on a distributed ledger.

John Carolin, chief executive officer of B3i, the blockchain company focused on the insurance industry, notes that the insurance industry has got away with being inefficient for a long time. Insurers have papered over combined ratios of 100 percent with healthy returns on their investment portfolios, he says.

“Can you imagine a bank telling a customer that 15 percent of their money was going to be used as an administration cost for doing business?” says Carolin.

“There is a deep vein of potential for disruption in the insurance industry. It has been resistant to change for a long time.”

Captives have as much to gain from the proliferation of DLT through the industry as any other insurer. DLT is in its element where large, disparate groups collaborate and share information. It could therefore be a game-changer for captives that rely on relatively large groups of service providers, all of which need to share and access information in a timely manner.

As one of the global captive insurance capitals, and a hotbed of technology innovation, the Cayman Islands would seem a logical place for the revolution to be incubating.

In reality, however, there is little going on in Cayman directly related to the application of DLT in the broader insurance industry, let alone the captives sector.

Gary Markham, chairman of the Cayman Islands Blockchain Foundation (CIBF) and chief executive officer of aXpire, which provides digital technology and advisory services, says Cayman’s progress in the DLT space has been glacial.

“There is theoretically an opportunity here for captives to use DLT to streamline the way they insure risk, but there is little happening in that space—in Cayman or in the insurance market generally for that matter,” says Markham.

He adds: “We are pushing hard for the Ministry of Finance and Cayman Finance to recognise the potential benefits of DLT. We want them to create an attractive regulatory framework to bring more business to Cayman, or create a regulatory sandbox, or anything that is going to stimulate innovation.

“Other jurisdictions, particularly Bermuda, are out there promoting themselves as DLT hubs, and Cayman should also be doing that.”

Markham is careful not to blame the Cayman Islands Monetary Authority for Cayman’s inaction in this area.

“There are no laws in place for them to enforce,” he explains. “We asked the ministry to launch a blockchain exchange but that was apparently impossible because the law says there can only be one exchange on the islands.

“There was no flexibility on that, so that was the end of that idea.”

Do as the SEC does

Markham says the problem for Cayman is that it wants to wait and see how the US Securities and Exchange Commission (SEC) engages with DLT, and follow its lead. However, the SEC has not made its mind up how it wants to engage with DLT.

“The UK Financial Conduct Authority has made more progress in this area than the SEC but that doesn’t matter, Cayman wants to follow the US’s lead. On the other hand, when the US does make a decision Cayman will probably move quite quickly,” he says.

The regulatory limbo that DLT finds itself in due to US and SEC ambivalence has wide-reaching implications.

“Businesses don’t bank in Cayman because of the DLT companies based here, even if they are based here themselves,” says Markham.

“Even the DLT companies themselves bank elsewhere, in places such as the Bahamas. Cayman is very protective of its correspondent banking relationships, they are the foundation of everything this island has built, so it is understandable why Cayman is reluctant to diverge from the US in its approach to DLT.”

All that means that, for now at least, most DLT-related activity in Cayman involves technology companies developing it, or hedge funds trading it. Numerous technology companies in Cayman, many of which are subsidiaries of groups based in San Francisco, New York or London, are developing DLT such as Etherium, or their own proprietary ledgers.

Brad Kruger, lead partner in Ogier’s Cayman corporate team and member of its digital, blockchain and fintech group, says software companies are drawn to Cayman for the same reasons hedge funds and other businesses are: tax neutrality and business-friendly regulation.

Kruger estimates that around 200 technology companies have established some form of presence in Cayman in the last two or three years. That has created an opportunity for Cayman’s insurance community: disruptive technology companies often find it a challenge to get insurance, and Cayman’s DLT developers have been no exception.

Markham says: “One company in Cayman providing e-billing services, and another developing DLT solutions for hedge funds, were being quoted rates five times the normal market rate. So there is an opportunity for captives there.”

Kruger says some Cayman-based technology companies have expressed interest in buying insurance, whether that is D&O liability or other coverage, from local players.

Captive interest

A look beyond the regulatory impasse around DLT reveals some evidence of interest bubbling below the surface, especially among captives. Carolin notes that captives have been among the most receptive to DLT among all insurance players which, he says, is because in many cases captives owners have already started applying it in their core businesses.

“The large industrial captives in particular have owners that have already looked at digitising their assets,” he says.

In Cayman specifically, this effect is evident in the progress DLT has already made infiltrating the healthcare industry, says Kruger.

“Blockchain has had a big impact on the global healthcare industry, so there is a significant insurance aspect,” he adds.

“Blockchain technology can help with record-keeping and payment processing. Cybersecurity and data protection are huge issues
for healthcare and DLT could become a part of the solution for those issues too.”

Carolin is not surprised that DLT’s spread into the insurance industry is taking time. “DLT can radically transform the insurance industry,
but it will not happen overnight, the improvement will be incremental,” he says.

There is still much work to be done to win hearts and minds among executives. Many still worry about the security of data held on a distributed ledger, and feel instinctively that it is safer locked in their own vaults.

A further issue is whether DLT can be made compatible with data protection laws. In Europe, the General Data Protection Regulation requires that records are destroyed after a certain period of time if they relate to people who are no longer customers. This would prove a
problem on ledgers where information is stored forever and cannot be destroyed.

But Kruger does not believe this issue will derail DLT’s progress in insurance or other financial markets.

“This looks like a technical problem and a solution will surely be found,” he says. “Ultimately, if there is no technological solution then regulation may need to adapt to new and future realities.”

DLT will need more time to prove itself, and for these lingering problems to be resolved, before technology companies start to tackle the last problem, which will be to navigate insurance companies’ procurement processes. Insurers need to find a way to move past their legacy IT systems.

“Captives have an advantage here because they are smaller and making decisions is easier,” Carolin says.

More broadly, for DLT to make an impact in the insurance industry, processes and practices must be codified so that it can be shared. That is less a problem of technological innovation and more one of cooperation. The evidence of DLT’s progress in other areas, such as R3’s work with banks, is that this problem can be overcome when institutions believe they will benefit.

Carolin believes DLT can have an impact on the insurance industry similar to the one security certificates had on e-commerce.

“It would be impossible to buy things on the internet without security certificates,” he notes. “B3i and DLT can bring that same level of comfort to administration in the insurance industry.”