Crypto’s Role in Insurance

New solutions for old problems

Daniel Hoover October 2023

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Photo: iStock.com/Floriana

It may seem strange to suggest that cryptocurrency and the blockchain technology upon which it is built may help the insurance industry. The fundamental goal of insurance is to reduce risk, but cryptocurrency is considered a highly volatile digital asset that requires those who engage with it to assume a high level of risk.

Indeed, at first glance, the two would not seem compatible. But cryptocurrency and blockchain may provide organizations operating in the insurance sector with a host of new solutions for old problems.

Reducing Risk With Blockchain Technology

One of the primary goals of cryptocurrency is to provide users with a digital asset that can be transferred without a centralized, third-party intermediary. To achieve this, cryptocurrency leverages blockchain technology to create an ongoing and decentralized record of transactions. Each cryptocurrency transaction adds a new, immutable record—or block—to the blockchain.

The blockchain ledger empowers the secure, verifiable transfer of cryptocurrency without a centralized database. Essentially, it provides those making peer-to-peer transactions with the security that centralized, third-party handlers are meant to provide.^1,23

In the business world, blockchain has become one tool for enhancing trust and transparency in business transactions and increasing security.⁴ Blockchain tools, such as smart contracts that allow transactions to be activated automatically once certain predetermined conditions are met, also may increase efficiency in the business space.

Reducing Fraud in Insurance Claims

Blockchain provides several features that could be used to address insurance fraud. For one, it provides transparency that makes fraudulent claims easier to detect. It also can provide insurance companies with real-time verification tools, allowing for early detection of fraudulent claims.

The most apparent use case for blockchain in reducing insurance fraud involves its role in identity management. Blockchain enhances the ability to establish identity through wallet signing, which involves providing a unique digital signature validated via the blockchain network. Blockchain also allows enhanced transparency in transaction history, which can help identify fraud.^5,6

For example, by recording insurance transactions in a blockchain-based wallet, a carrier could view the pattern of transactions in a given wallet and assign an algorithmic risk score based on that pattern. Wallets showing limited or suspicious activity could be tagged as higher risk and their claims could be escalated for further review.

Adding Efficiency to Underwriting

Perhaps the most significant use case for blockchain technologies lies in the ability to build highly customizable workflows for underwriting. By leveraging the power of smart contracts, insurance companies could automate the underwriting process based on preprogrammed algorithms. This could grant many insurance companies access to the expertise required for more specialized work.

Use cases where smart contracts could streamline insurance underwriting processes may include policy approvals, endorsements, premium calculations and more. Smart contracts could automate the processes, reduce the workload associated with them and cut administrative costs.

Using Cryptocurrency Investment to Fund Future Claims

Cryptocurrency as a general fund investment for insurance carriers is still somewhat new. MassMutual purchased $100 million in bitcoin for its general investment account in 2020.⁷ For now, the volatility that continues to be seen in the cryptocurrency market most likely will keep many insurance companies from following MassMutual’s lead. Still, the combination of increased regulatory clarity,⁸ availability of qualified custodians and service providers, and the need for liquid diversifiers in otherwise increasingly illiquid portfolios appears to have the potential to drive increased use of digital assets in these portfolios in the future.

Another new trend is the emergence of insurance dedicated funds (IDFs), which provide insurance companies access to digital asset markets.⁹ Instead of arranging for specialized custodial, accounting, auditing and tax services before making a digital asset investment, the carrier can buy into a private IDF fund. Insurance companies could use IDFs in different ways, as permitted by their regulators and tax codes, such as direct investment (ICOLI), company-owned or bank-owned insurance (COLI/BOLI) plans, or additions to investment menus inside of privately placed life insurance and annuity products (PPLI/PPVA).

Gearing up for Cryptocurrency Innovations

For insurance companies that want to take advantage of the benefits of cryptocurrency and blockchain, during strategic planning would be a good time to begin discussing potentially incorporating the new technology. In the wealth management space, insurance companies might consider the “buy vs. build” question. Specifically, they might explore whether partnerships with existing market players could be more attractive than trying to force-fit digital assets into an existing business.

On the property and casualty side, insurance companies might consider how existing policies could be affected as policyholders increase their involvement with digital assets. If businesses that accept digital asset payments or partner with higher-risk digital asset businesses are considered a higher insurance risk, underwriting policies may need to be adjusted.

My recommendation to those who remain skeptical about blockchain’s potential for the insurance industry is to stay educated on the latest developments. Some experts predict blockchain will emerge as a disruptive force in several industries—from banking to health care to higher education.¹⁰

Should blockchain prove to be a tool for enhancing insurance processes, those who fail to stay abreast of developments involving the new technology quickly could find themselves struggling to be competitive.

Actuaries, specifically, have the ability to apply their code of conduct and professionalism in the ever-evolving cryptocurrency sector that really needs reliability and trust. For more information on crypto from different perspectives, including the ongoing FTX case, reference “FTX Used Python Code to Fake its Insurance Fund Figure — Gary Wang” and “Cryptocurrency Insurance: Protecting Crypto Assets After FTX Collapse.”

Statements of fact and opinions expressed herein are those of the individual authors and are not necessarily those of the Society of Actuaries or the respective authors’ employers.

Copyright © 2023 by the Society of Actuaries, Chicago, Illinois.