Asian risk and insurance market embraces the blockchain

Sompo, one of japan’s leading multi-line insurance groups, has become the latest major insurer to wake up to the transformational potential offered by the blockchain. Blockchain is a form of distributed ledger technology that enables data to be distributed across computers in multiple locations while also synchronising it to maintain a single ledger. This technology could transform the insurance and reinsurance industry by rapidly speeding up the agreement and distribution of contracts, payment of claims and enabling underwriters to more accurately analyse and price risks in real time.hideIt could also accelerate the arrival of wider capital markets into the industry as it enables risk transfer contracts to be written on a parametric trigger basis, rather than the traditional indemnity basis. This technology potentially offers the answer to many of the complaints that risk managers in Asia and worldwide have about the insurance industry: its apparent inability to deliver innovative and bespoke risk transfer solutions in a painless, transparent and rapid manner and respond as and when required. Applying the blockchain Risk managers in the Asia-Pacific region should therefore be delighted to hear that one of the region’s leading insurance groups is actively pursuing the application of this new technology, as well as insurers and reinsurers in Europe, Bermuda and the US. Sompo announced towards the end of September that, in collaboration with Soramitsu Co, the Japanese fintech company that has developed an open-sourced code for Iroha, an open source distributed ledger (blockchain) project, it has begun trailing the use of blockchain technology for derivative products. Sompo pointed out that Japan suffers many natural disasters, including earthquakes, typhoons and volcanic eruptions, and “in readiness for such risks there is a rapidly growing need for products such as climate derivatives”. The Japanese insurer explained that similar products are also now being sold outside of Japan in emerging countries that face natural disaster risks such as drought, especially in the agricultural sector. “In response to the needs of this fast-growing domestic and international market, Sompo Holdings has teamed up with Soramitsu to start developing systems (currently in a beta version for user trials) that utilise blockchain technology to provide customers with highly convenient derivative products and efficient services,” states the company. The derivative system that will use blockchain technology, which Sompo Holdings and Soramitsu have begun jointly developing, 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”, explains Sompo. This single sentence offers a solution to many of the problems currently identified by risk and insurance managers and highlighted in Commercial Risk Asia’s ongoing survey of risk and insurance managers, to be published at the Pan-Asia Risk and Insurance Management Association’s conference in Hong Kong in November. “Since the 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,” adds Sompo. The rapidly expanding Japanese insurance company, which has just announced a $6.3bn acquisition of Bermuda-based Endurance Specialty, says it will devise and develop products and services that use the latest digital technologies, including blockchain, to contribute to the “safety, security, and health” of its customers. Soramitsu, created in February 2016, also contributes to the development of blockchain technology through its participation in the Hyperledger Project, a global open source project established by the Linux Foundation, a non-profit organisation. As noted above, Sompo is not first off the blocks with its investment in blockchain and other new technologies to develop creative new solutions to customers’ evolving risk transfer needs. In May, for example, Allianz Global Corporate & Specialty’s specialist unit Allianz Risk Transfer (Bermuda) (ART) announced that it had developed a risk management solution for hedging wind volume risks for wind farms. In its debut deal, ART executed a ten-year proxy revenue swap with US-based Capital Power’s Bloom Wind Farm, to be constructed near Dodge City, Kansas. This new tool for the wind power industry was created and commercialised through a partnership between ART, Nephila Capital, the specialist investment manager, wind power broker REsurety and Altenex, the network that procures renewable energy for companies and government bodies. The ten-year agreement will secure long-term predictable revenues and mitigate power generation volume uncertainty related to wind resources for the 178 MW Bloom Wind Farm, explains ART. Karsten Berlage, managing director of ART, says the high upfront cost of modern utility-scale wind projects means that it is important for investors in such projects to be able to secure long-term stable revenues to underpin the investment. He says that, up till now, traditional price-focused hedging solutions have been commonly used to try to address this risk. But this proxy revenue swap offers an entirely new form of revenue risk management for the wind power industry. “Similar in concept to a tolling agreement or capacity payment, this novel structure swaps the floating revenues of a wind farm – those driven by the hourly wind resource and power prices – for a fixed annual payment. This transaction is the first in a robust pipeline of future wind financings and would also be feasible in other wind farm markets globally beyond the US,” says ART. Mr Berlage says the “unique” swap has been made possible by new technology that is being harnessed for the benefit of customers in a challenging area. He adds that recent advances in data availability for the US wind market as well as in risk assessment and modelling allowed this “unprecedented” scope of risk transfer within a single product. “In contrast to more short-term and price-focused hedging approaches, for the first time price and wind volume risks of a wind farm have been managed at the tenor needed to support a project’s capital structure and balance sheet. The result is a level of revenue certainty never before available to the wind industry,” explains Mr Berlage. Teaming up One of the key factors in this development is partnership with other expert firms. Allianz, as with Sompo, is a huge insurance group but it does not have all the expertise needed to structure such solutions and needs to work with partners. This is a consistent trend. When insurers come up with truly innovative solutions nowadays, they work with other firms just as Sompo is working with Soramitsu. In this case, ART and Nephila leveraged their collective weather risk transfer expertise, risk capacity and credit strength. REsurety provided the specialised risk analysis needed to structure the proxy revenue swap and delivers ongoing services as the calculation agent for the transaction. Altenex supports the management of power price-linked risk as part of the structure. ART also recently announced that it had worked with Nephila to pilot the use of blockchain technology for the transaction of a natural catastrophe swap. The insurer says the test run demonstrates that transactional processing and settlement between insurers and investors could be significantly “accelerated and simplified” by blockchain-based contracts. It also says the deal shows other benefits, such as increased tradability of cat bonds and wider opportunities to apply this technology in other insurance transactions. ART explains that so-called catastrophe, or ‘cat’, swaps and bonds are financial instruments that transfer a specific set of risks, typically natural disaster risks such as hurricanes or typhoons, from an insurer to investors or other insurers, using triggers with defined parameters. In the case of a financial cat swap, the insurer pays a third party to assume the financial risk of a defined catastrophe event such as a Florida hurricane in exchange for a payment or series of payments. If the event occurs and meets the pre-defined trigger criteria, the third party is responsible for the pre-agreed financial risk, says ART. Cat bonds follow a similar approach but with multiple parties assuming the catastrophe exposure through a securitised financial instrument in which the parties invest, continues the Bermuda-based insurer. If a qualifying cat event occurs, the investors lose all or part of the principal they have invested; if not, they receive interest in the form of a periodic ‘coupon’ payment, as well as the return of their principal investment at the bond’s maturity. ART says blockchain-based smart contract technology has the potential to facilitate and accelerate the contract management process of such cat swaps and bonds. Each validated contract on the open-shared infrastructure contains data and self-executable codes inherent to that contract. When a triggering event occurs that meets the agreed conditions, the blockchain smart contract picks up the predefined data sources of all participants, and then automatically activates and determines payouts to or from contract parties, explains ART. “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,” explains Richard Boyd, Bermuda-based chief underwriting officer of ART. “By replacing the human interventions that 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,” he adds. “The smart contract technology allows digital execution of contracts with automated and distributed ledgers, which are designed to be incorruptible, thus having the potential to significantly reduce the arbitration and validation functions traditionally performed by independent third-party institutions such as banks, intermediaries and administrators, auditors and clearing houses,” says ART. Captive development ART and Nephila say they have worked with a number of firms to develop the “proof of concept” and, as with Sompo, see extensions of this technology across the insurance industry, not least in fronting for captives. “One example that will interest corporate risk managers is the potential to improve the payment processes involved in international fronting for captives, where multiple process steps are involved in the transfer of premium from a corporate to its own subsidiary,” says Mr Boyd. “Often, client captives retain licences in a single country where domiciled and rely on insurers to front for them in other countries. Insurance premium paid by a subsidiary would typically flow from the subsidiary to the fronting insurer and then onward to the captive often through an intermediary at each step. Within each of the parties, multiple processing and reporting procedures also occur before the premium can flow through. Each of these internal steps and external transfers takes time and can result in errors or disagreements,” he adds. Mr Boyd explains that this technology can be used to “optimise” or minimise these steps and also expenses. “A unique feature of the blockchain is the concept of a ‘distributed ledger’ that allows each party in the insurance chain the exact same information instantaneously. This real-time transparency, combined with the notion of a ‘smart contract’ that has the ability to execute pre-approved and agreed actions automatically, will optimise the speed and accuracy of transactions while minimising human errors and intervention. Premium cashflows can reduce from days or weeks to a few minutes without error,” he says. Claims application Another potentially highly beneficial application of this technology is in the critical area of claims, Mr Boyd explains. “As a scenario, the real-time transparency of blockchain technology could also apply to claim notifications and, once claims are adjusted, the execution of payments could happen with the same speed and accuracy,” he says. Also, late last month New York-based blockchain startup Symbiont demonstrated to a group of insurers, reinsurers and investors a system of smart contracts integrated with its assembly blockchain to show how it can facilitate the automatic dispersal of funds via catastrophe swaps. Ron Papanek, the company’s head of product, told specialist digital currency and blockchain reporting service CoinDesk that it has built a mature platform that is capable of conducting 80,000 transactions per second. He gave an example whereby an insurance company could propose a swap by inputting details into the insurance smart contract. This would include the covered event threshold, the fixed-rate payment, the currency, the floating rate, the effective dates and the payer (the reinsurance broker). The smart contract would then be uploaded to the private blockchain and become visible, almost instantly, for the reinsurance broker that would approve the contract. After approval, a PDF of the ISDA version of the contract could be downloaded, with all the data being tracked via the blockchain. “Both parties now have complete documentation of the existence of this contract,” Mr Papanek told CoinDesk. The high interest in this technology and its potential applications is underlined by the fact that a total of 81 investors and insurance industry executives attended the demonstration, from the US, Europe and Asia, according to CoinDesk. Caitlin Long, recently hired president and former Morgan Stanley managing director, told the reporting service: “It’s literally a who’s who of the insurance industry, from all around the world – property/casualty insurers, life insurers, reinsurers, and several investors in insurance-linked securities too.”

Asian risk and insurance market embraces the blockchain

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