Using Blockchain for Climate Insurance

The power of using crypto within insurance to combat climate risk

Sho Tsuchiya
April 8, 2022
Financial Services

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Why are climate risks and insurance historically a bad match? 

When your livelihood depends on something as unpredictable as the weather—such as relying on agriculture—climate insurance is a must, but insurance coverage for something like mother nature can be a challenge. However, here’s what full-stack insurance company, Lemonade announced—an offering, involving a blockchain-based insurance solution, to help more than 3 million small farmers in Africa who are facing climate risks, such as floods and drought.

Lemonade’s approach to this challenge involves 3 straightforward steps:

  1. Identifying risks (used to price policies and pay claims)
  2. Automating claims assessment
  3. Funding its capital pool (through tokenization)

What this means is that you could account for and anticipate calamities, such as storms, using predictive technology, from accurate data gathering.

You can combine this data with smart insurance assessment metrics and automate the claims processes.

Finally, a layer is added by tokenizing the weather risk to digital assets, which allows the transfer (financial) of funds between investors and the insured, smoothly.

Multiple companies pool their resources to offer this three-part solution using cutting-edge technology. We are focusing on the third today.

Let’s dive into blockchain (via Tokens) in insurance

What is Tokenization?

A crypto token is a digital asset issued on a blockchain. 

In Wall Street terms, this process is similar to traditional securitization, but with a blockchain twist. Tokenization is the process of issuing a token (typically on the Ethereum blockchain) that represents the value of a single or a collection of an actual physical asset.

Just like issuing new shares in a company, owners of assets, such as real estate, can carry out a security token offering (STOs) to fractionalize ownership and generate liquidity from their assets from qualified investors (who pass KYC/AML checks).

the tokenization process

Why do blockchain-based Tokenization and Insurance match?

Blockchain use cases are diversifying with steady acceptance. We discuss a few of its applications in-depth in our insight; one of which is insurance.

As builtin explains, how Tokens work is roughly analogous to how a Google doc is distributed—it is “widely shared, not copied nor transferred,” has an “immutable record”, is “decentralized and transparent”, and therefore secure. It functions as digital codes with identifiable numbers encrypted and assigned to one owner. 

These features combine to make it difficult to forge or steal. 

Another benefit of blockchain use is automation; it executes smart-contract terms automatically, so processes are streamlined.

If hard-to-predict catastrophes leave a gash in the insurance market, a blockchain-based insurance solution could be one avenue to use to glue the gap; it offers security, transferability, and transparency while being conducive to automation and can offer broader insurance covers.

More specifically, Tokenizing insurance can offer the following:

  • Tokens can also be used as a way to tokenize and transfer the risks of an existing pool—replacing traditional reinsurance, or raising capital to launch new insurance products. 
  • The tokens can be structured similarly to traditional insurance-linked securities (ILS), where token holders are entitled to a return that is derived from the premiums paid by the insured and have set issue and maturity dates. 
  • At maturity, if a risk event doesn't occur, an investor will recover both the principal and the interest from the investment. However, they also risk losing the entirety of their invested amounts if a risk event occurs and the capital is required to meet claims.
tokenization visual

In conclusion, what can we learn from Lemonade’s efforts?

Incalculable risks and insurance coverage don’t synthesize well, but it’s worthwhile exploring Lemonade-like work because it connects crypto investors with climate risk and insurance—including players from both the insurance and blockchain ecosystems.

By offering automated claims processes, combined with the use of parametric methods to distribute insurance at cost, it covers communities that have long been susceptible to weather risks and unable to afford indemnity coverage.

As blockchain lends itself to automation and is a secure way of risk transfer, it seems that leveraging it to automate claims payouts while tokenizing its capital pool can help bridge the gap and fulfill unmet needs.

If you’re curious about new insurance methods, blockchain-based use cases, or want to understand more about companies doing more good work, book a demo to chat with our team!