I struggled with the headline for this post because the news connects to so many different themes we cover on Daily Fintech:
- Real use cases for Blockchain.
- Catastrophe Insurance and Climate Change.
- Financial Inclusion.
- Innovation by Incumbent Financial Services.
- The new global back office.
- The unbundling of vertically integrated Insurance.
We will explore how the story illustrates all those themes.
What is a Catastrophe Swap?
A catastrophe swap is a financial instrument traded in the over-the-counter derivatives market. Insurers need protection after a large natural disaster because numerous policyholders will file claims within a short time frame. A catastrophe swap helps insurance companies transfer some of the risk they’ve assumed through policy issuance and provides an alternative to purchasing reinsurance or issuing a catastrophe bond.
In a catastrophe swap, two parties, an insurer (Allianz in this case) and an investor (Nephila Capital in this case), exchange streams of periodic payments. The insurer’s payments are based on a portfolio of the investor’s securities, and the investor’s payments are based on potential catastrophe losses as predicted by a catastrophe loss index (created by third party firms to quantify the magnitude of insurance claims expected from major disasters).
Real use cases for Blockchain.
To avoid getting caught up in the Blockchain hype cycle, we use this handy decision tree to evaluate whether a use case really warrants Blockchain technology.
Catastrophe Swaps seem like a good fit.
Catastrophe Insurance and Climate Change.
A few months ago we looked at Big Data ventures working on catastrophe modelling and Meteo which is focused on weather related risk. Risk modelling is key to Insurance. Risk modelling gets a lot more complex if Climate Change is real – the historic models simply don’t apply any more.
For the billions living on $1 or $2 per day, Climate Change is not just an inconvenience, it is life threatening if their crops fail. Anything that makes crop insurance easier and cheaper will change the lives of billions. Any innovation at the risk modelling and financing level that helps is to be greatly welcomed.
Innovation by Incumbent Financial Services.
This story has a traditional Insurance Company (Allianz) and a traditional investment firm (Nephila Capital) using radical new technology for breakthrough innovation. It is possible that Insurance companies were able to spot disruption coming sooner than their banking colleagues because the banking disruption came first. As the famous book by Lou Gerstner about the transformation of IBM asks – Who Says Elephants Can’t Dance?
The new global back office.
The BPO (Business Process Outsourcing) industry turned India into the back office of the world by taking basic clerical jobs and shifting them to a cheaper location and applying a rigorous approach to process optimization.
Call that global back office version 1.
Version 2 is much more radical. This is when business processes are not optimized – they are eliminated. Call this Business Process Elimination (BPE). Blockchain is critical to this. We looked at this in the context of Real Time Equities Settlement. When that goes mainstream, whole swathes of processes that we now call Post Trade Processing will be eliminated.
Delaware clearly wants to be the new Global Back Office based on Blockchain. It makes sense if they can address the thorny jurisdictional issues around Smart Contracts.
The unbundling of vertically integrated Insurance.
In the end, we used this theme for our headline. Unbundling is what digitization does to Incumbents. This has been going on for some time in Banking, but is only now starting to happen in Insurance. We move from vertical integration to a stack with different companies offering different services and combining through partnerships.
The insurance industry works through a 3 layer stack:
- Layer # 1: Brokers. Their job is to gather premiums from customers.
- Layer # 2: Insurance Companies. Their primary job is claims processing. They take in premiums via brokers, invest the cash flow and pay out claims when needed.
- Layer # 3: Reinsurance Companies. They are the payers of last resort. They insure the insurance companies. Their job is to have enough capital to pay out claims, even if the models did not predict the volume of claims.
This Catastrophe Swap using Blockchain technology unbundles the link between Insurance Companies and Reinsurance Companies. Now any investor can be a Reinsurer.
The company providing the technology for this Catastrophe Swap, Symbiont, raised a $7m Series A in January. Blockchain often starts by mimicking existing processes – in this case an Industry Loss Warranty (ILW) using an industry-loss trigger. It is possible that Symbiont technology will enable a more sophisticated alternative using a parametric trigger (explained here). This is what could facilitate microinsurance type policies such as crop insurance.
At the investor end of the stack, Symbiont technology can transform insurance risk into a security, thus making it simpler for investors. This is what will drive the unbundling of Insurance and the democratisation of Reinsurance.