Blockchain: Accessing Its Value

Current blog posts and business journals contain active discussions on blockchain concepts, offering varied views about its impact and sustainability. These published pieces are creating confusion for business leaders due to an apparent lack of agreement on the impacts of the blockchain process and, more importantly, uncertainty about blockchain's complex association with bitcoin.

Many perplexed readers may be inclined to ignore blockchain concepts or defer consideration until clearer information and evidence are available. However, disregarding blockchain rather than actively understanding it could put an organization, including captive insurers, at a competitive disadvantage compared to others who move to embrace its full context. With or without blockchain, fundamental changes in business processes and value propositions are rapidly underway. Business paradigms are important frameworks, but operational processes and practices, along with enabling technology, are being implemented in quests for efficiencies and value creation.

Business is often conducted through a series of activities or processes to acquire or modify an asset(s), forming a transaction network. These activities are performed by separate and distinct parties, entities, or departments. Blockchain is a methodology to document the financial value of the acquisition or modification activities associated with both tangible and intangible assets. The network participants consist of parties who have an economic stake in the transaction outcomes. This process can all be accomplished using a distributed or shared ledger, facilitated by technology and controlled by security protocols for authorized parties. Others, such as regulators, may be given visibility into the proceedings. Network participants approve the progress of the various steps in the execution of the transaction, forming chain-like documentation of the business activities from their beginning to completion or delivery. Through this process, blockchain ensures that the asset transaction is secure, timely, accurate, and auditable.¹

Bitcoin, on the other hand, is a cryptocurrency whose exchange and trade are conducted via a blockchain network, which is described above. It can be compared to cash and is used to complete buying/selling events or currency trading. Both buying/selling events and currency trading are currently being conducted without the benefit of some critical elements of monetary policy and regulatory oversight, generating significant market volatility in bitcoin value. Its freewheeling nature creates concern for many. In contrast, the technology-enabled blockchain processes are attracting significant interest for applications in business transactions within many industries and settings.

Blockchain was designed to enhance business transactions. It was developed as a process to address the need for an improved, efficient, cost-effective, trusted system for conducting and recording the financial and contractual aspects of business. In operational terms, these transactions are commonly called value streams. The centerpiece of the blockchain methodology is the recording of the financial or accounting impacts associated with the transfer of an asset and the value added to the asset as it moves through the acquisition or modification steps. As an asset moves through the business transaction, the aggregation of steps form a chain of custody and actions, completing the entire process.

Blockchain enables the building of trust among business participants as the asset moves through the transaction chain. Participants are typically given a view of where the asset is at any point. The blockchain process can reduce the cycle time, resulting in efficient and effective translation completion. With blockchain, the business transaction is also considered to be trusted because it provides the ability to audit the entire transaction from end to end. Network participants can rely on the integrity of the process, as each participant approves the completion of each chain link in the process.²

The business benefits of blockchain can be consolidated into three major categories: time savings, cost savings, and tighter security. Other benefits that can be derived from these include enhanced privacy, improved auditability, and increased operational efficiency.³

A focus on cost savings and increased operational efficiencies allows the benefits of and interest in blockchain to become clearer and better understood. At the Connecticut Captive Insurance Association Collaborative on October 26, 2017, keynote speaker Glenn Finch, vice president and cognitive innovation officer at IBM, discussed "process reimagination." This practice looks at fragmented business transactions (or value streams) to identify opportunities for improving business outcomes. Essentially, process reimagination examines both tangible and intangible assets through the lens of technology. It identifies opportunities to enhance the ability to manage (or move) an asset, add additional value, and make better decisions. Mr. Finch stated that, according to a recent survey, a significant number of responding chief financial officers (66 percent) have established key objectives for improving operational efficiency.⁴ In this context, the growing interest in enhanced, economical outcomes associated with blockchain can be understood.

Certain business transactions lend themselves better to the benefits derived through using blockchain processes. Inspired industries appear to share some common attributes: a high degree of regulation, a reliance on cost estimates in completing asset transactions, and a dependency on value-added production in the delivery of products and services. Specific industries that come to mind include insurance, reinsurance, risk management, health care, retail, construction, and component aggregators (e.g., aerospace).

Interest in and the promise of blockchain are growing, and we will undoubtedly see its application in many settings. However, one key aspect that must be remembered is that blockchain exists at the intersection of process and technology—its full value lies with evolving processes that impact how business transactions are facilitated and conducted, in addition to determining how the value stream is measured as the assets move through the transaction process. Blockchain offers great potential benefits to prospective users if the elements of process improvement, capital management, and technology are all considered in structuring and adopting an enhanced business model. Blockchain will almost always enhance the value stream, but redesigning operational processes and organization around blockchain increases the value outcomes further.

At a December 2017 New York City Bar Association event, a panel discussed blockchain within the financial services sectors. Paul Meeusen, the head of distributed ledger technology at Swiss Re, Ltd., in Zurich, was quoted as saying, "If there is one industry where the time value of money is key, it's insurance." Mr. Meeusen went on to say, "… there's a lot of frictional costs lost across the [insurance] value chain."⁵

The insurance and reinsurance industries utilize complex business processes. A risk transfer process, for example, involves multiple parties or participants who assess risk, determine how much risk they will retain, assume that risk, and then transfer unretained risk to other parties or risk takers. The completion of these steps involves multiple transactions, complex accounting ledger entries, and extended time lines. The risk asset is valued in the form of risk premium calculations or estimates. Only a portion of the premium is allocated to the payment for contractual obligations associated with damages to an insured asset or damages to a third party.

A widely held consensus is that between 25 and 40 percent of risk premium charges or estimates are associated with expenses. These are frictional costs; therefore, as little as 60 percent of the risk premium may be associated with risk acceptance and available for paying potential claims. The complex process of risk transfer and acceptance is an example of a business transaction that may be improved through the adoption of enhanced business processes like blockchain. Process improvement may be seen in both efficiency (process cost) as well as improved precision in setting risk premiums.

At an annual EY insurance executive forum held in New York City in December 2017, several key trends were cited regarding the convergence of technology, business acumen, and risk management. The speakers and panelists noted that all segments of the insurance and reinsurance value chain are being reevaluated. Opportunities are being sought to enhance current business practices in order to improve efficiencies and execution and ultimately enhance operating returns for an industry that is considered "highly refined and remarkably well capitalized." All areas are under review, including distribution, underwriting, claims, and operations.⁶

How do this potential transformation and its expected benefits play out? As noted, transformation is occurring in many places, with a focus on various aspects of the insurance and reinsurance value chain. Perhaps one of the most interesting areas is the captive insurance arena. Captive insurance programs are complex insurance/reinsurance structures that apply additional key work steps for risk and asset management. They introduce more interfaces, handoffs, and accounting (ledger) entries into the value stream. With the observed frictional costs in these transactions, blockchain appears to be particularly well suited for bringing increased value, efficiency, security, and customer satisfaction.

Leading risk consultants, captive managers, insurance brokers, and their clients are already at work applying the principles of blockchain to these programs. Expect to see interesting innovations that go well beyond distribution and accounting. Exciting opportunities are emerging as new transaction parties join the blockchain network. Existing roles and responsibilities may be redistributed or reassigned. What appears to be disruptive and painful on the surface may very well provide enhanced financial returns for captive insurance and risk management stakeholders. Interesting times lay ahead for those committed to process improvement and value creation. They stand to reap the benefits associated with these enhanced business practices, facilitated by technology.

1. Manav Gupta, Blockchain: IBM Limited Edition (Hoboken, NJ: John Wiley and Sons, Inc., 2017) pp. 3–11.
2. Ibid.
3. Ibid.
4. Glenn Finch, Connecticut Captive Insurance Association Collaborative on Captive Insurance and Alternative Risk Transfer (Stamford, CT, October 26, 2017).
5. Matthew Lerner, "Insurance Well Suited to Blockchain, Speakers Say," Business Insurance, December 12, 2017.
6. "Observations on Insurance Industry Innovation Journey," Six Things Blog, Insurance Thought Leadership.com—A Catalyst for Transformation, December 19, 2017.