Using smart contracts to underwrite climate risk
By: Oliver Johnston-Watt
Tags: Blockchain, Insurtech, Smart Contracts, Climate Change, Risk Management

Using smart contracts to underwrite climate risk

How The Demex Group is helping enterprises weather climate change by building climate resilience into their business models Oliver Johnston-Watt Follow Nov 19, 2020 · 6 min read

Climate risk

In 2020 for the first time the Global Risks report produced by the World Economic Forum included three climate-related factors in their top 5 global risks. These are (1) extreme weather events (2) natural disasters and (3) failure to mitigate and adapt to climate change.

The WEF therefore is predicting that, over the next ten years, businesses will need to be well equipped to combat negative weather-related effects on their business model. Winter-related businesses — snow-removals, property managers and ski resorts, for example — are well accustomed to the risks associated with climate volatility. Heavy snowfall can result in high profits for snow removers, high costs for property managers, who need to clear snow, and a successful season for the ski resorts. However, as weather becomes increasingly unpredictable, companies of all shapes and sizes are under pressure to offset climate risk to maintain, at a bare minimum, break-even revenues to cover fixed costs.

The Demex Group

Enter The Demex Group, an insurtech startup which traces its roots to Munich Re, one of the world’s largest reinsurers and one of their financial backers. Demex’s mission is to pre-empt the volatility of climate change by enabling businesses to develop ‘climate resiliency’ through the delivery of risk management tools.

The Solutions Center

Demex provides their platform The Solutions Center which onboards the various parties required in a transaction to supply businesses with affordable financial risk management.

These parties can include:

The risk providers (companies with large balance sheets who can absorb the downside) Modelling partners (firms with analytics platforms who provide weather sensitivity data) Distribution channels (third party firms who have access to specialized markets or large-scale brokerage networks) Platform partners (firms who have risk carrying capacity who may want to license the platform)

These parties may rely on data populated by the modelling partners across a multitude of sites, depending on the scale of the client’s operations. For example, a snow-removal company may operate hundreds of snow-ploughs across multiple states. Rather than taking an average of snowfall across a wide area, data can be extracted from each location to identify specific nuances in the distribution.

What The Demex Group therefore provides is the ability for multiple parties to transact together to deliver a meaningful risk management tool or product for businesses whose operations may be impacted by weather volatility or extreme weather events.

Enabling a trust architecture to deliver multi-party value

Business is inherently multi-party: organisations are made of actors (human and machine) that follow processes or workflows that use or modify data to achieve a certain business objective. Typically we have relied on the written law as our primary trust architecture to enable good business. The rules and conventions of a business transaction are expressed in a legal contract, agreed and signed by the parties, who must follow the rules or expect legal action.

The development of trust and consensus between parties in a transaction is a costly process in terms of time and capital, relying on paper trails, both digital and physical. Paperwork requires manual intervention, intermediaries and can be open to fraud. However, until recently, this has been the high cost of doing valuable business.

Smart contracts — delivering multi-party trust

Parties require:

Consensus regarding the rules and conventions of a business transaction

The knowledge that these rules and conventions are stored securely, agreed up and cannot be fraudulently changed by a bad actor

These two problems are solved by smart contracts — a digital expression of a contract between parties whereby the rules and conventions have been agreed and verified by a consensus algorithm, stored on a cryptographically secure blockchain which ensures that each party has an immutable and verifiable single copy of the truth.

Smart contracts in their nature constitute a future trust architecture for multi-party businesses, particularly with the increasing importance of data.

Smart contracts and climate risk

A company underwriting climate risk may engage in a relatively simple contract. Take a snowplough provider for example operating across 24 sites in a north-eastern state.

This snowplough company has fixed costs — employees, equipment, offices, leases and supplies — which must be covered each year at a cost of $1.5 million.

In the case that there is a downturn in snowfall, particularly across more than one season, this business suffers. Its financial viability teeters on the vagaries of the weather forecast, which is out of their control.

However, with The Demex Solutions Center, this company can participate in a transaction with a risk provider who based on snowfall data in each of the 24 sites can offset the downside to ensure they meet their $1.5 million breakeven each year. A risk provider can provide a policy for a fixed, affordable price.

This process is made more efficient through the deployment of smart contracts which as part of this trust architecture can automate outcomes and ensure that the snowplough operator is paid on time with no quibble. The modelling partner’s data is trusted, the rules and conventions of the policy are agreed upon and stored security and no parties can without consensus alter the rules.

The result is parties without trust can transact together and create value.

The risk provider relies on third party data which is trusted and cannot be tampered with.

The customer is secure in the fact that their policy will pay out when the conditions of their policy are met.

Enter DAML — the leading smart contract for business

Smart contracts require standards to ensure scalability, efficiency and interoperability. The clean frontrunner as the enterprise/business standard for smart contracts is DAML, created and open sourced by Digital Asset.

The value of DAML is that the language is designed to abstract multi-party distributed applications and is engineered to be written once and deployed anywhere. Therefore, businesses can write their business logic in DAML and then choose the underlying network infrastructure they wish to deploy on.

The Demex Group chose DAML as it enabled them to develop their multi-party processes rapidly with each party expressed clearly. Additionally, DAML is designed to preserve privacy — a powerful combination when paired with an underlying blockchain infrastructure which enables each party to transact based on an immutable single source of truth.

Focus on application, not blockchain and smart contract infrastructure

The Demex Group employed DAML for its low-code, natural approach to expressing business logic. However, in order to program a distributed application in DAML, The Demex Group needed to deploy the DAML runtime engine onto a persistence layer that suited their use case, be it a blockchain or centralised database.

In this case, The Demex Group’s use case lent itself perfectly to blockchain.

Not wanting to expend valuable resources on deploying and managing blockchain and smart contract infrastructure, The Demex Group recently announced that they had selected Sextant for DAML, the management platform provided by Blockchain Technology Partners (BTP) who are also a partner of Digital Asset.

Sextant for DAML enables the DAML runtime engine to run on either Hyperledger Sawtooth, Hyperledger Besu (two blockchain frameworks) as well as Amazon QLDB and Amazon Qurora (two centralized database offerings).

Sextant for DAML automates the deployment and management of the network infrastructure which enabled The Demex Group to focus on developing their business application and shipping their product to market sooner.

Summary

The Demex Group is addressing the pressing issue of ensuring that enterprises can navigate the resulting volatility due to extreme weather events financially and building climate resilience into their business model. Effective climate resilience is just as important for an enterprise weathering climate change as building long term sustainable value through ESG initiatives, such as carbon credits.