The insurers Standard Chartered, Zurich and Zurich UK said they would begin to pay digital currency companies for claims processing. Last week, British utilities E.ON agreed to do the same for Bitcoin futures.
The first-time acceptance of digital currency by the insurance industry, hailed by the head of a state-backed pension fund, casts a spotlight on one of the Internet’s biggest marketplaces: the open-source protocol known as blockchain, which supports digital currencies.
It is used to both transfer data and record transactions between computers. Transactions are verified by thousands of digital code miners around the world, who verify the authenticity of transactions with a distributed ledger: Blockchain is not directly owned by any of the participants; instead, it is stored on computers around the world.
It offers enormous potential for regulation. Governments and businesses around the world are in the midst of wrestling with how to regulate the cryptocurrency, as more and more uses of it emerge.
One of the big problems insurance companies face when dealing with digital currencies is the fact that, unlike financial instruments such as stocks and bonds, their profits come through algorithms, not sales of goods or services. So, however benevolent it may seem to some, financial transactions with digital currencies are now also subject to regulatory oversight.
But, as with any new technology, far less is known about the regulatory risk than about the upside.
Over the past few years, insurance companies have increasingly been facing cyber-attacks as their computers are hacked. Hackers’ aim is not to steal corporate secrets or separate businesses but to steal identities: They know that banks, governments and companies use specific terms to define their customers, and so identify themselves to premium-paying companies. As more hospitals switch to using electronic medical records, cyber-hackers are taking advantage of that.
In 2013, for example, a hacker used stolen U.S. Social Security numbers to impersonate Obamacare enrollees and “register” for healthcare benefits. Such incidents raise questions for health insurers, who use the credentials of people who have taken out insurance. These types of episodes may not directly bring fraud charges but insurers are still concerned about claims fraud and the possible loss of reputation.
Digital currencies such as Bitcoin provide many opportunities for using insurance to keep fraud at a minimum.
Yet, what is remarkable is the relative ease with which insurance companies and banks have leapt into this market. For much of the past year, executives at large financial institutions have been skeptical about cryptocurrencies and expressed concern that their merchants could suffer from low payment volumes or excessive regulation.
The blockchain protocol works by creating an ongoing shared database of every transaction. If you are an insurer and you know your customers’ names, you could create a digital wallet that keeps track of them. You could then log into a website, scan their digital identity, and then process the transaction automatically. That way, your company can reduce the risk of fraud and also receive better service from customers.
Bank and insurance executives are focused on “reputational risk” because they know that bad press is almost always followed by complaints and lawsuits. Getting caught up in a bitcoin scandal, on the other hand, is almost impossible. Though Bitcoin hackers did spend millions to break into Mt. Gox, the largest Bitcoin exchange, a journalist could publish a scathing article about Bitcoin in a British newspaper and it would not affect the value of the currency.
Insurance companies are also concerned about regulatory scrutiny — which may include monitoring their clients’ investments or limiting their access to banks. Bitcoin-related lawsuits have cost insurers significant amounts of money. And the more niche digital currencies become, the less insurers can rely on issuers for similar digital guarantees. The most popular cryptocurrency, for example, is not regulated by anyone.
But for now, the Digital Asset Exchange, the largest marketplace for bitcoins, has turned down multiple insurance offers because the type of business it does is not regulated.
For now, insurance companies and banks are wading into a sea of opportunities.
But cryptocurrencies may not be the only digital assets that emerge. Analysts are forecasting the expansion of “cryptos” (such as virtual currencies and blockchain technology) to myriad industries, including agriculture, music, and finance.
So for now, insurance and banks are just dipping their toes into the Bitcoin market. But their approaching of digital currencies may help clarify how best to regulate the technology in the long run.
Andrea Miteski, PhD and MD in the field of reinsurance. Long term senior insurance executive with specialization of reinsurance optimization.