Allianz Risk Transfer AG (ART) and Nephila Capital Limited have successfully completed several tests using the blockchain technology to transact a natural catastrophe swap.

In finance, a catastrophe swap is an instrument traded in the over-the-counter market which allows insurers to prevent potential losses developed from natural disasters by reinsuring against catastrophic events that often occur with high severity.

During the settlement process of a catastrophe swap, an insurer establishes a deal with an investor by issuing a set of securities in exchange for their payments. Securities issued by the insurance company through a special purpose vehicle (SPE) come with a principal and interest payment.

When the investors receive the securities, they deposit their cash payments to a trustee, usually a third party organization, which releases the deposit to the insurance company in an event of a severe catastrophe.

There are a few key events which happen when a natural disaster occurs and the pre-defined criteria is met. The trustee first withholds the principal and interest payments and then releases the cash payment to the insurance company.

Smart Contracts

Allianz Risk Transfer AG’s smart contract-based decentralized settlement platform eliminates the need for a third party organization to step in and oversee this process of catastrophe swap settlement.

Smart contract application built on a blockchain network act as the trustee and the special purpose vehicle which the insurer uses to issue securities and interest payments. Allianz’s smart contract platform can be efficiently used to replace these mediators because the entire settlement process depends on several triggers including indemnity, index, parameter, and model.

Like any other corporate bond or derivatives, a catastrophe swap relies on a pre-defined set of criteria or triggers which decides whether an interest rate payment should be paid to an investor or a cash payment must be paid to the insurer.

As an example, let’s assume that the state of Florida is hit by a severe typhoon and an insurance company X is expected to pay its clients that lost a majority of their properties during the natural disaster.

If both parties agree that the triggers have been met, the smart contract application autonomously decides whether to release the payment to company X and withhold the interest payments.

Since the payment is already held by the smart contract platform and both parties are registered to the contract, the application then sends the payment to company X, which will then use the cash payment to assist its clients.

Benefits

By implementing a smart contract application to replace the conventional special purpose vehicle and trustee, both insurance companies and investors will save be able to save a lot of time and money involved in the settlement process.

Furthermore, the elimination of a third party organization enhances security protocols, because the platform is decentralized and the cash payment is not held by a centralized entity.

“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,” states Richard Boyd, Bermuda-based Chief Underwriting Officer of ART. “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.

Although Allianz’s smart contract-based catastrophe swap settlement platform is still being integrated into existing financial systems and markets, the impact of the platform to the entire market will be huge, considering the percentage of payments it will save for both the investors and insurers.

“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,” explained Nephila managing principal Laura Taylor. “In our journey to become more digital, Blockchain promises to help us create more transparent, more convenient and faster services for our customers,” added Solmaz Altin, the Chief Digital Officer of Allianz.

Image Source: Allianz