Blockchain’s Benefits for Insurers Begin Planning for The Next Blockbuster Technology

February, 2017 Gil Maletski, CTO, Gil.Maletski@sapiens.com Zvika Delman, Marketing Strategy Director, Zvika.Delman@sapiens.com

Blockchain’s Benefits for Insurers

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Table of Contents

1. Executive Summary ............................................................................................................................... 1

2. From Bitcoin to Blockchain ................................................................................................................... 2

3. Defining and Explaining Blockchain ...................................................................................................... 3

3.1 How It Works ........................................................................................................................ 3

3.2 Public vs. Prvate Blockchains ................................................................................................ 4

3.3 Blockchain’s Advantages ....................................................................................................... 5

4. Initial Challenges ................................................................................................................................... 6

5. Blockchain’s Potential for the Insurance Industry ................................................................................ 7

5.1 Smart Contracts .................................................................................................................... 7

5.2 Blockchain-Backed Mutual and Peer-to-Peer Insurance ...................................................... 8

5.3 Internet of Things (IoT) ......................................................................................................... 9

5.4 Fraud Detection .................................................................................................................. 10

5.5 Improved Underwriting Process ......................................................................................... 10

6. Trusted Advisor ................................................................................................................................... 11

7. About Sapiens ..................................................................................................................................... 11

Blockchain’s Benefits for Insurers

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1. Executive Summary

Bitcoin has changed the money transfer process, but it’s likely that the technology behind the currency,

blockchain, will have the greater impact. Blockchain is basically a data structure that enables the

creation of a digital ledger of transactions and the ability to share them among a distributed network of

computers. This new technology offers many business advantages, including simple and fast

transactions, full transparency and security, constant accessibility, reduced cost and a single point of

truth.

Despite the inevitable and initial hurdles, blockchain possesses great potential for insurers. In fact, a few

insurers have already formed a group “aiming to explore the potential of distributed ledger technologies

to better serve clients through faster, more convenient and secure services,” according to Munich Re.

Insurers who successfully harness blockchain technology can reap tremendous benefits from smart

contracts, the Internet of Things (IoT), improved fraud detection and enhanced underwriting.

This white paper aims to provide a brief but clear overview of this nascent technology, as well as to help

insurers understand how they can utilize blockchain to improve their business.

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2. From Bitcoin to Blockchain

Most people have probably heard the term “bitcoin.” It’s a digital currency created in 2009 that is based

on a set of algorithms and protocols. This cryptographic (code-based) payment mechanism is exchanged

for goods and services and can be stored in online “digital wallets.” By enabling citizens around the

world to exchange digital money without the intervention of banks or governments, this decentralized,

non-hierarchical application has begun to disrupt financial and trade markets. Unfortunately, the lack of

regulation means that many black market money exchanges – illegal drugs, web extortion, prostitution,

etc. – are conducted via bitcoin.

Bitcoin’s “miners” solve math problems to approve transactions. What motivates them? They are

awarded with bitcoins in transaction fees.

Bitcoin’s value (based on supply and demand, and trading) has fluctuated throughout the years. From

2009- 2012, the infancy of the currency, the value of bitcoin was very low: between a penny to $13. In

2013, the value rose 5-10 percent every day until it reached a high of $1,108.80. It’s worth eventually

fell to $600, rebounded to $1,000, and then dropped again to the $500 range. Between 2014-2015, the

value bounced between $200-$700. By the beginning of 2017, the bitcoin’s worth again rose above

$1,000.1 The value fluctuations in 2013 can be seen in the chart below.2

Figure 1: Bitcoin Value Fluctuations in 2013

Bitcoin has undoubtedly been a breakthrough application for money transfer. It’s likely, though, that

bitcoin’s real and long-lasting value isn’t the currency itself, but the technology behind the currency.

The foundational technology, which is called “blockchain,” has the potential to transform the way we

live.

1 “History of Bitcoin,” Wikipedia. 2 “Charts,” Coinbase.

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3. Defining and Explaining Blockchain

Blockchain is a data structure that enables the creation of a digital ledger of transactions and the ability

to share them among a distributed network of computers. Using cryptography, blockchain enables

network participants to make changes to the ledger securely, in the absence of a central authority

(blockchain is decentralized).

Leading analyst firm Novarica explains the four distinguishing properties of blockchain:3

Distributed: databases are usually hosted centrally (a “top-down” structure). Blockchains are hosted on networks and administered by the participants.

Permission-less: all users are treated equally, with full read and write access.

Immutable: old records cannot be reversed. A blockchain implementation provides no way to correct errors or redact private information sent by accident to the wrong recipient.

Trusted: blockchains are based on mathematics, not relationships. Because scripts are open to all for review, these contracts themselves are trustless.

3.1 How It Works4

“Digital records are lumped together into ‘blocks’ then bound together cryptographically and chronologically into a ‘chain’ using complex mathematical algorithms. This encryption process, known as ‘hashing’ is carried out by lots of different computers,” according to a BBC news article on how blockchain technology may change how we do business. Once the data is hashed, it cannot be converted back into the original data (and each block receives a unique digital signature, which is also used as the block’s unique identifier). When there is a need to change information in the chain – for example, a money transfer from A to B, as depicted in the image below – an automatic broadcast is sent to every member of the database. Approval requires majority agreement. If someone wants to attack or hack the chain, s/he would have to obtain access to the majority of copies (millions) in the database simultaneously to be successful. Perhaps an analogy can better explain how blockchains are structured and how individual blocks relate to each other. “With books, predictable page numbers make it easy to know the order of the pages…With blockchains, each block references the previous block, not by ‘block number’, but by the block’s fingerprint, which is cleverer than a page number because the fingerprint itself is determined by the contents of the block.”5

3 “Blockchain in Insurance,” Novarica, November 2016. 4 “How Blockchain Tech Could Change the Way We Do Business,” BBC, January 22, 2016. 5 “A Gentle Introduction to Blockchain Technology,” Digital Currency Insights.

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Figure 2: The Blockchain Sequence6 (from Reuters)

3.2 Public vs. Prvate Blockchains7

The “public vs. private” distinction is important when it comes to blockchain.

Despite our earlier descriptions of blockchain as being open, participants can decide to establish a

private blockchain network with only known and vetted members. This may be the ideal option for a

group of subsidiaries opened by the same conglomerate, for example.

Public blockchain networks enable anyone, without needing permission from an outside authority, to

read and write data. This is the more common type of blockchain and the type we have mainly been

referring to in this white paper.

Blockchain, particularly public blockchain technology, is based on a peer-to-peer (P2P) model. As

opposed to a server that can offer limited access, each network participant can read and view all of the

data, and updates are open and shared.

6 “All You Need to Know about Blockchain, Explained Simply,” World Economic Forum, June 17, 2016. 7 “A Gentle Introduction to Blockchain Technology,” Digital Currency Insights.

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3.3 Blockchain’s Advantages

Blockchain offers many benefits, including:8

Simple and fast transactions – participants can transfer information or data without third party intervention. Banking institutions, contrarily, often involve several institutions and international money transfers systems around the globe for such a transaction, which may take up to a week.

Fully transparent and secure – users control the transactions. When a user wants to add or

change information, the request is broadcasted to all participants holding copies of the existing

blockchain. Each participant’s system automatically checks if the information matches the

blockchain’s history. If the majority of participants agree that the transaction is valid, the new

transaction will be approved and a new block is added to the chain.

24/7 accessibility/availability – data can be expediently transferred via the system 24 hours a

day, seven days a week, without delay.

Reduced cost – one ledger, controlled by secure and transparent technology, reduces mediators

and costs to a minimum.

Single point of truth – because blockchain is reliable and durable – an “unhackable” network – it

can be used as a single point of truth.

8 “Blockchain Technology: 9 Benefits & 7 Challenges,” Deloitte.

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4. Initial Challenges

Despite the tremendous potential for insurers, it would be naïve to pretend there aren’t initial

hurdles as the industry works out how best to deploy this potential game-changer. Current

challenges include:9, 10

Consumer and Organizational Confidence – even though blockchain’s defining feature is

security, the psychological barrier is still there (as with anything new) and potential users are

still waiting for additional proof in terms of cyber-attacks.

Technical Understanding – the fundamentals of blockchain are difficult enough to grasp, and

even more so is the technical application behind the theory. The ability to practically implement

the infrastructure “falls outside of the traditional IT development skill-set,” said Vijay Michalik,

research analyst from Frost & Sullivan.

Legacy Systems – blockchain applications require its users to upgrade or, in some cases, replace

their platforms. As with any system transition, the migration process must be carried out

carefully and efficiently.

High Entry Fee – blockchain transactions are both cost and time savers, but due to the bullet

above and other factors, the costly initial investment could be a deterrent.

Current Computing Power –a great deal of computer power is required to enable blockchain to

flow continuously. To put the amounts of energy needed into perspective, blockchain

mathematical solutions are occurring at a pace of 450 thousand trillion per second.

Complete Shift – to meet its full potential, the entire ecosystem of blockchain users and

operators must shift to a decentralized network. In the process, they will face internal and

external cultural adoption struggles.

9 Ibid. 10 “The Challenges of Using Blockchain Technology,” CNBC, February 29, 2016.

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5. Blockchain’s Potential for the Insurance Industry

The use of blockchain in the insurance field is still in its infancy, but insurers increasingly understand the

tantalizing potential. Unlike banking and money transfer applications, which have attracted much of the

early focus, insurers are still pondering how to best use blockchain technology to maximize existing

advantages and strength. As with other new developments, the insurance industry is largely proceeding

cautiously, although some insurers are already actively exploring blockchain.

Aegon, Allianz, Munich Re, Swiss Re and Zurich have launched the “Blockchain Insurance Industry

Initiative B3i, “aiming to explore the potential of distributed ledger technologies to better serve clients

through faster, more convenient and secure services.”11

These pioneer insurers are collaborating in an experimental project in the reinsurance field. “If

Blockchain technology proves viable, it could well streamline paper work and reconciliations for (re-)

insurance contracts and accelerate information and money flows, while greatly improving auditability,”

according to a Munich RE press release. 12

Insurance Networking News reported in the winter of 2017 that the consortium was looking to add

“several new members” and would soon test its databases. The outlet quoted the B3i as saying it would

"co-produce a pilot project, using

anonymized transaction information and

anonymized quantitative data, in order to

achieve a blockchain proof of concept for

inter-group retrocessions."13

In terms of public vs. private, the insurance

industry is looking at both types. As of today,

there are a few promising areas that are

drawing interest from insurers…

5.1 Smart Contracts

“A smart contract is a digitally signed,

computable agreement between two or

more parties. A virtual third party, a

software agent, can execute and enforce at least

some of the terms of such agreements,” according to PwC.14 Smart contracts are of course digital and

11 “Insurers and Reinsurers Launch Blockchain Initiative B3i,” Munich RE, October 19, 2016. 12 “Insurers and Reinsurers Launch Blockchain Initiative B3i,” Munich RE, October 19, 2016. 13 “Insurance Blockchain Alliance in Europe to Grow This Year, Insurance Networking News, January 27, 2017. 14 “Blockchain and Smart Contract Automation Introduction and Forecast,” PwC.

Figure 3: Traditional vs. Smart Contracts13

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written using programming code languages. This code establishes the rules and consequences, similar to

a regular contract, and can be automatically executed by a distributed ledger system.15

Smart contracts powered by a blockchain technology could provide customers and insurers with the

means to manage claims in a transparent, responsive and trusted manner.

“Contracts and claims could be recorded onto a blockchain and validated by the network, ensuring only

valid claims are paid…smart contracts would also enforce the claims – for instance, triggering payments

automatically when certain conditions are met (and validated),” according to a Deloitte report.16

In addition to being more reliable and significantly reducing fraud, smart contracts have the potential to

dramatically expedite onboarding and other insurance processes, enabling insurers to provide a unique

customer experience.

5.2 Blockchain-Backed Mutual and Peer-to-Peer Insurance

The insurance industry, like most industries, is shifting towards greater transparency and trust. Mutual

and peer-to-peer (P2P) insurance are gaining in popularity because they can offer these qualities. Using

the smart contracts described above, insurers could use blockchain to succeed in the P2P and mutual

markets.

“Blockchain technology could empower people to manage (some of) their risk more directly, with peer-

to-peer and mutual insurance platforms based on blockchains,” according to Long Finance, as quoted by

PwC.17

An interesting article by Olivier Rikken, manager at AXVECO, a consultancy firm in Amsterdam, examines

the possibilities.18

Insurers can provide a marketplace-like platform where customers post insurance demands. These could

be for traditional products, or specific demands. By using historical data and applying risk models and

analytics, a premium calculation would be performed to post the expected return (after subtracting the

insurer’s margin), according to Rikken.

Once the premium calculation is available, interested consumers can subscribe via a peer-to-peer

system, or via crowdfunding. Blockchain would guarantee the payment from the investor to the

customer base (when necessary).

15 “Smart Contracts Explained,” Blockchain Technologies. 16 “Blockchain Applications in Insurance,” Deloitte, 2016. 17 “Blockchain in the Insurance Sector,” PwC, 2016. 18 “Why Blockchain Could Enable a True P2P Insurance Model,” CoinDesk, April 23, 2016.

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“By doing this in a blockchain, the administration and execution processes are simpler, almost fully

automated, transparent and cheaper than in a traditional set up. Besides that, the investors know their

maximum exposure as the amount defined in the smart contract,” writes Rikken.

Some insurers would balk at giving up control of the insurance process and their customers, for fear of

turning into a mere “pipe” or conduit. This is certainly a legitimate concern and challenge, but as P2P,

mutuals and blockchain technology gain wider acceptance, it is wise to begin exploring their potential

now.

5.3 Internet of Things (IoT)

The Internet of Things (IoT) is the connection of devices to the Internet via software, sensors and

network connectivity. This connection enables these objects to collect and exchange data. Smart homes,

car telematics and wearables are hot IoT areas for insurance companies.

IoT is shifting insurers to a more proactive way of interacting with their customers. They are able to

reduce costs by accurately assessing clients' risk levels and then adjusting premiums. By offering

discounts and rewards for safe behavior and improved habits, insurers can help change customer

behavior and offer a more personalized, tailored customer experience.

Where does blockchain fit in?

If the smart contract (from the previous sub-section) is merged with IoT smart devices and backed by

blockchain, synergy will be achieved. This new combination will enable the IoT devices to communicate

with the insurance smart contract automatically, with transactions and contract validations taking place

in real time. Reduced insurance costs will result from this minimization of error. The following are two

theoretical examples of this synergy:

Claims management driven by IoT – property and casualty (P&C) insurers could collect claims

data from connected cars, smart homes and other assets and analyze it in real-time for more

accurate claims management, reinsurance transactions and lower capital costs. Auto insurers

could use data such as vehicle damage or accident metrics (speed, brake pressure, airbag status,

etc.) to inform claims processing.

For example, the IBM Watson IoT platform blockchain integration enables IoT devices to engage

in transactions. Leveraging this platform, it is possible for information from devices – such as

RFID-based locations, barcode-scan events, or device-reported data – to be passed on and

stored on a private IBM blockchain ledger.

Devices will also be able to communicate to blockchain-based ledgers to update or validate

smart contracts. For example, as an IoT-connected package moves along multiple distribution

points, the package’s location and temperature information could be updated on a blockchain.

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This would allow all parties to share information and the status of the package as it transfers to

multiple parties, to ensure the terms of the contract are met.19

Instant funds disbursement – the interaction between insurers and customers will be made

more direct during disbursement. In theory, insurers will transfer claim proceeds directly into

customers’ digital wallets when signaled to do so by smart contracts or connected devices.20

5.4 Fraud Detection

One of blockchain technology’s best features and value propositions is the level of trust it fosters. It will

practically eliminate fraud, due to the ability to validate authenticity, ownership, and provisioning of

goods, as well as the authenticity of documents. By connecting to external databases, Blockchain

enables scanning of police theft reports, and can detect patterns of fraudulent behavior related to a

specific identity (via claims history). Blockchain can also prove date and time of policy issuance, or

purchase of a product, and confirm subsequent ownership and location changes.21

“Blockchain has great potential to eliminate error and detect fraud by providing a decentralized digital

repository. It may independently verify the veracity of customers, claims, and policies and provide a

complete transaction history. This prevents transaction duplication, displaces the roles of a trusted third

party, and provides a verifiable public record of all transactions. In addition, blockchain can store

encrypted personal data and a public ledger. Many insurers are already applying it for reducing fraud

and liability associated with immediate payments across borders and multiple currencies,”22 according

to N-iX, an outsourcing provider based in Europe.

Everledger23 is already being used to combat insurance fraud. This digital, global ledger tracks and

protects items of value by using blockchain as a platform. Their initial software is related to diamonds.

Previously, diamond assessments varied depending on the different stages of the trade chain, and price

estimates, shipping and insurance were often recorded separately. Blockchains, contrarily, are

immutable, tamper-free and trusted.

5.5 Improved Underwriting Process

Today’s underwriting process is still highly dependent upon reams of paper forms, with minimal online-

enabled applications, and email communications between the underwriters, broker and client, including

documentation in the form of email attachments. When claims are filed, there is often disagreement

19 “Explore Watson IoT with Blockchain,” IBM. 20 “Digitizing Processes End-to-End with Blockchain,” Accenture. 21 “Blockchain Technology as a Platform for Digitization: Implications for the Insurance Industry,” EY, 2016. 22 “Top 5 Implementations of Blockchain in Insurtech,” N-iX, October 31, 2016. 23 “Diamonds, Blockchain and Banks: The Story of Everledger,” BBVA, April 12, 2016.

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about which information was shared, by whom and when. These disagreements can ultimately lead to

lengthy litigation and cause problems for underwriters and their clients.

Blockchain can resolve these difficulties by facilitating a more transparent, simplified and faster process.

A McKinsey report offers a real-life possibility:24

“Dynamis is one of the blockchain start-ups innovating in the area of smart contracts for insurance

products. The company is developing a P2P supplemental unemployment insurance and uses social

network profile data for verification of the employers’ status. In this case, the smart contracts are

automating the underwriting of policies and claims handling – combined with approvals/verifications

from other policyholders, who serve the role of evaluators.”

6. Trusted Advisor

As discussed in this white paper, blockchain offers tantalizing potential to insurers, but also poses some

hurdles. Sapiens is following the latest developments closely and is engaging in industry discussions with

our strategic customers in different regions. While we are still gathering information on this emerging

technology, Sapiens is confident that our experience in helping guide insurers through previous industry

disruptions can be of help to today’s insurers as they begin this new journey.

7. About Sapiens

Sapiens International Corporation (NASDAQ and TASE: SPNS) is a leading global provider of software

solutions for the insurance industry, with a growing presence in the financial services sector. Sapiens

offers core, end-to-end solutions to the global general insurance, property and casualty, life, pension

and annuities, reinsurance and retirement markets, as well as business decision management

software. The company has a track record of over 30 years in delivering superior software solutions to

more than 200 financial services organizations worldwide. The Sapiens team of approximately 1,900

professionals operates through our fully-owned subsidiaries in North America, the United Kingdom,

EMEA and Asia Pacific.

24 Blockchain in Insurance – Opportunity or Threat? McKinsey&Company, July, 2016.

Contact us

For more information, please visit us or contact us at:

www.sapiens.com

info.sapiens@sapiens.com

Tel: +972-3-790-2010

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