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Nephila & Allianz work on blockchain catastrophe risk trading


The world’s largest insurance linked investment manager Nephila Capital and insurance giant Allianz are working together on blockchain technology for catastrophe risk trading, betting on the ability of insurance technology (insurtech) to make underwriting and investing in catastrophe risk more efficient.

Demonstrating just how important technology (insurtech) is going to be in the next wave of disruption facing the risk to capital value-chain in insurance, the pair have worked on a pilot or proof-of-concept using a natural catastrophe swap transaction.

A catastrophe swap is about as simple a transaction as you could hope to find for a pilot of a relatively new technology such as blockchain, which is the technology that lies beneath the bitcoin crypto-currency, providing a perfect use-case for the transfer of risk from one party to another.

One of the elements of blockchain technology that insurance and reinsurance markets have been exploring is its ability to act as a distributed ledger, enabling transactional history, contracts and integrity to be maintained and stored for any party in the transaction chain to interrogate.

Another is the promise of smart contracts, where blockchain technology is utilised to allow contracts or even securities to be created, stored, verified and even transferred between parties.

A combination of these two elements of blockchain technology is currently being put to work by a number of start-ups and incubators targeting the insurance and reinsurance sector, with some focused on insurance risk, and others on so-called micro-securities, which would enable risk to be more easily and efficiently packaged, sold and transferred or invested in. We’ve even come across a start-up looking to embed a special purpose vehicle SPV type arrangement into the blockchain in the last year.

As you’d expect, Nephila Capital and Allianz have clearly been keeping pace with the development of this exciting technology and have been participating in a pilot.

The pair are hoping to encourage use of the technology for catastrophe bond trading, although at this time it seems a single type of catastrophe swap has been used for the proof-of-concept. They see possibilities for facilitation and accelerated triggering for catastrophe swaps and bonds.

Allianz said that use of the blockchain and smart contracts could help to speed up catastrophe bond payments, as the details of a smart contract including a trigger for an insurance transaction can be automated using this technology.

Of course the type of trigger used would define the speed of payment to a degree, an indemnity cat bond is never going to be as fast to pay out as a well designed parametric trigger, but with technology a ceding insurers reported claims experience could be logged programmatically allowing the smart contract to ‘know’ when it reaches an attachment point and is time to pay out.

Allianz and Nephila said that the proof-of-concept showed that the processing and settlement of payments under a catastrophe swap could be faster using blockchain technology.

Richard Boyd, Allianz Risk Transfer Chief Underwriter, commented; “Blockchain technology would increase reliability, auditability and speed for both cat swaps and bonds as less manual processing, authentication and verification through intermediaries is required to confirm the legitimacy of payments/transactions to and from the investors.

“By replacing the human interventions which are currently embedded throughout the entire risk transfer process, frictional delays and the risks of human error are completely removed – with a radical effect on the speed and efficiency of the process and, in the case of bonds, on the tradability of such securities.”

This is an important point for insurance-linked securities (ILS). Blockchain, and this chain of trust and verification that it provides, could enable ILS transactions to be automated in terms of settlement, payment and also invested in electronically as well.

Add in other technology that is in development, around robo-advisers (automated investment scripts that could manage diversification), feeds of catastrophe and weather data, as well as integration with risk modelling tools, and it’s easy to see that the future of the ILS market could become automated or programmed, to a degree.

Allianz said that blockchain could also boost public catastrophe bond trading, as smart contracts can ensure integrity of securities and ownership, as well as keeping the transparent ledger of trades, prices and history of each deal.

The insurer said it is going to carry on this work, develop a more detailed business case and bring in other financial partners, as it continues to look to blockchain as a platform for risk transfer and risk trading.

Allianz also said that regulation would be key. Regulators are already assessing the ramifications of contracts being held virtually, but there may be work required in re/insurance as domicile becomes less apparent once transactions are entered into in the cloud.

For the catastrophe bond market and ILS investors blockchain technology has the potential to be truly revolutionary.

Laura Taylor, Managing Principal at Nephila, stated; “We believe technology will drive the future of insurance. We have invested a great deal accordingly and are pleased to extend our long-standing strategic partnership with ART to use of the Blockchain.”

It’s not just the ability to track and trace transactions, automatically trigger and settle, as well as structure as digital smart contracts. It is the potential for insurance risk to be broken down into ever more granular and understandable chunks, transferred or invested in digitally, traded between parties, a transparent store of value or price be held, plus all the structural, trigger and transaction integrity that is getting the reinsurance market so excited.

It’s encouraging to hear that Nephila has participated with Allianz in this pilot. The next phase could be fascinating and has ramifications for other insurance or risk linked assets such as weather derivatives and ILW’s as well, where a parametric trigger could be automated or an index trigger activated electronically.

Insurance technology (insurtech) will change insurance and reinsurance markets forever.

The announcement from Allianz and Nephila says that the pair are working with a number of partners on the application of blockchain into insurance and reinsurance. They see potential for many uses, including such areas as the optimisation of the payment process in international fronting for captive insurers, where transferring premium from a corporate to a subsidiary can involve multiple process steps.

For ILS, the promise of even more efficiency being added to its capital and the process of making investments in catastrophe and other insurance risk could ramp up the adoption of the capital markets as source of underwriting capacity once again and could stimulate another phase of ILS market growth.

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