German-based insurance giant Allianz has announced it has been successfully testing Blockchain technology and smart contracts for the processing of default swaps and bonds.
The company is feeling positive about the potential of technology to increase the competition among financial institutions.
Allianz Risk Transfer, founded in 1997, has been operating as the center of competence for alternative risk transfer business within the Allianz Group offering tailor-made insurance, reinsurance and other non-traditional risk management solutions to industrial and financial clients worldwide.
Applying the Blockchain in insurance services
Allianz is not the first company to test Blockchain technology and research the application opportunities to improve services.
Earlier PwC announced that it will largely support the research of the application of Blockchain technologies in the area of insurance. Insurance provider John Hancock, in collaboration with ConsenSys Enterprise, began working on proof of concept using Blockchain and BlockApps.
Carrying the nontraditional approach to risk management Allianz Risk Transfer and Nephila Capital Limited announced that they have successfully piloted the application of Blockchain smart contract technology for transacting a natural catastrophe swap.
Company’s pilot is one of several tests applications of Allianz’s Disruptive Technologies division. It has demonstrated that Blockchain-based contracts could significantly accelerate and simplify transactional processing and settlement between insurers and investors, and increase tradability of cat bonds. It undoubtedly sets the direction for exploration of more opportunities to apply this technology to other insurance transactions.
What are the ‘cat’ swaps?
Catastrophe or ‘cat’ swaps and bonds are financial instruments which transfer a specific set of risks (e.g. natural disaster risks) from an insurer to investors or other insurers utilizing triggers with defined parameters. Generally, ‘cat’ bonds follow an approach similar to financial ‘cat’ swaps, meaning that if the event occurs and meets the predefined trigger criteria, the third-party is responsible for the pre-agreed financial risk.
‘Cat’ bonds, however, involve multiple parties assuming the catastrophe exposure through a securitized financial instrument in which they invest. What happens when a qualifying cat event occurs? They lose all or part of the principal they have invested. What if the event does not occur? They win and receive interest in the form of a periodic ‘coupon’ payment in addition to the return of their principal investment at the bond’s maturity.
Now what’s there for the Blockchain?
The processing of payments between insurers and investors can take weeks or even months after the event has occurred. Smart contracts based on Blockchain technology are believed to facilitate and accelerate the contract management process. How exactly would it work? Each validated contract on the opened shared infrastructure contains data and self-executable codes inherent to that contract. If, and when, the triggering event occurs, and if it 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 the contract parties.
Richard Boyd, Chief Underwriting Officer of ART explains:
“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 radical effects on the speed and efficiency of the process and, in the case of bonds, on the tradability of such securities.”
Indeed, if automating the process via smart contracts based on Blockchain has such high potential to reduce the time of processing to as low as a few hours (or maybe even few minutes?) why not replace clerks with machines?
Blockchain has been long associated with the Bitcoin digital currency. However, its applications have been explored throughout other industries. For instance, the Blockchain-based smart contracts allow digital execution of contracts with automated and distributed ledgers designed to be incorruptible and to demonstrate high potential to reduce the arbitration and validation functions traditionally performed by independent third-party institutions.
Blockchain can easily eliminate our need for banks, intermediaries and administrators, auditors and clearing houses.
Laura Taylor, Managing Principal at Nephila says:
“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 the Blockchain.”
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