Sompo Japan trials blockchain for catastrophe & weather derivatives

Japanese and global property & casualty insurance group Sompo Japan Nipponkoa Holdings Inc., is the latest to embrace use of blockchain technology for risk transfer as it trials the technology for catastrophe and weather linked derivative transactions.

Blockchain, the distributed ledger technology which was originally developed for cryptocurrency bitcoin but has now been seen to have much wider uses, is gaining traction in insurance, reinsurance and also insurance-linked securities (ILS) markets, as participants look to insurance technology (insurtech) to modernise risk transfer, while making processes more transparent and efficient.

Sompo Holdings is the latest to identify blockchain’s potential in catastrophe or weather risk transfer, teaming up with a Japanese fintech startup named Soramitsu to create derivative insurance contracts using blockchain technology.

The company says it began trialing the products this month (September 2016) saying that given Japan’s exposure to natural disasters such as earthquakes, typhoons and volcanic eruptions, there is a “rapidly growing need for products such as climate derivatives.”

Sompo notes that products such as these are already sold overseas in emerging economies as well, where drought risks have been transferred using derivatives in the agricultural sector. Other weather-index related insurance products could also be simply transacted in derivative form, we presume.

Hence, Sompo Holdings says it has joined forces with fintech startup Soramitsu to develop blockchain technology that will enable the insurer to “provide customers with highly convenient derivative products and efficient services.”

Sompo Holdings says it aims to:

“Create a service that simultaneously shares data such as contract details on the blockchain to accurately and swiftly carry out every step in the insurance process, from managing risk aggregation for derivative products to determining whether or not to pay out on claims and implementing procedures to pay compensation.”

Catastrophe or weather derivatives are simpler in transaction form, scope and process than indemnity insurance and can also be automated using inputs of data which feeds the trigger. They can also be either insurance or reinsurance contracts, providing transfer of risk with little difference in form (just scope) no matter the size of the contract.

By using the blockchain to issue and sell derivative insurance products, Sompo Holdings could provide a fully automated product that paid out based on the input parameters specific to the catastrophe or weather peril covered.

Blockchain insurance and reinsurance derivatives could also feature industry loss triggers, providing a way to take the global market in ILW’s and other industry loss based reinsurance and retrocession contracts onto technology platforms.

Many blockchain and other insurtech startups (as technology other than the blockchain does exist) have targeted risk transfer through financial structures that more easily create bilateral transactions, such as swaps and derivatives.

It’s interesting that the focus areas are often transaction structures and risks that the ILS fund market would be happy to get behind, and a number of insurtech startups are actively targeting securitisation platforms to enable direct transfer of insurance or reinsurance risk to the capital markets.

Allianz Risk Transfer and the world’s largest ILS fund manager Nephila Capital have already piloted and completed a catastrophe swap transaction using blockchain technology and others are looking at similar use-cases.

Sompo Holdings is targeting the derivative as the financial technology to enable the insurance risks to be structured and transferred. ILS funds already invest in derivatives, from weather derivatives based on temperature to catastrophe derivatives often in industry loss warranty (ILW) form.

Hence Sompo Holdings could easily leverage blockchain technology, insurance derivatives and the ILS market to help it to share risk automatically, or even just transfer the entire risk to the ILS market and ILS investors, placing Sompo as the originator, analyst and pricing agent, earnings fees from every transaction, while the capital market provides the capacity behind the system.

We’re sure that’s not the plan though. As the majority of insurance and reinsurance company run insurtech or blockchain projects are about increasing efficiency, rather than finding a way to transition out of the old re/insurance business model into one that wholeheartedly embraces the capital markets as the best destination for risk.

Sompo Holdings explains the rationale:

Since use of blockchain technology has the potential to enable provision of highly secure financial services and improve service efficiency while controlling system investment costs, Sompo Holdings and Soramitsu will also examine broader application of the technology to new insurance products.

The trial from Sompo Holdings is another encouraging sign that capital markets convergence in insurance and reinsurance is set to drive at least a portion of the insurtech wave, with risk transfer products on platforms such as the blockchain set to be suitable for capital market and ILS fund investment.

While incumbents look to technology for efficiency, the real promise of combining insurtech and ILS is in accelerating the transfer of risk to capital and making that process (or the risk-to-capital value-chain) as fast, smooth and direct as possible.

A footnote (and looking to the future):

Importantly, the trial undertaken by Sompo Japan uses a blockchain technology platform which is being open-sourced. Iroha, the distributed ledger technology platform developed by Soramitsu has been built using the Hyperledger Fabric architecture, a collaborative blockchain project from the Linux Foundation.

We say importantly, as we believe interoperability should be a key trait of systems developed by and for re/insurance players using the blockchain. Developing closed or non-compatible systems, could hamper companies with a similar range of problems that many are dealing with from their legacy systems today, including becoming locked-in to vendors and technology stacks.

The ultimate insurtech solutions should aim to provide markets in risk transfer, enabling any originator to bring insurance or reinsurance risk to the platform and any capacity or capital provider to connect to the platform to assume that risk. For insurance risk transfer to become as efficient as possible you need markets and exchanges, not closed systems (we believe).

Also read:

– Blockchain tech could improve efficiency of risk capital: BDA.

– On accelerating the transport of risk to capital (ILS + Insurtech).

– Blockchain is “made for reinsurance”, a $10 billion opportunity: PwC.

– Blockchain catastrophe swap platform ready, shows insurtech potential.

– Samir Shah to lead insurtech risk securitisation start-up Ledger Investing.

– How Blockchain Could Really Change the Insurance Industry.