Gap between economic and insured losses can be narrowed by catastrophe bonds

by Artemis on September 23, 2011

The burden placed on the governments of developing nations after natural disasters and other catastrophe events can be huge. Much of the developing world is particularly exposed to a wide range of natural catastrophes but insurance and reinsurance penetration is low meaning that the government can end up picking up the pieces.

After an event occurs in a developing nation the economic losses can be enormous while the insured loss amount is often insignificant by comparison. This leaves governments with the unenviable task of paying for much of the clean up and reconstruction from their own funds, sometimes damaging the wider economic growth prospects of the nation. Closing the gap between economic losses and insured losses is a hot topic and while increasing insurance penetration helps the uptake is generally slow and governments are seeking other ways to finance disaster recovery.

India is a prime example of a country at risk of natural disaster losses and reinsurer Swiss Re has been promoting risk transfer to the Indian government as a way to help them narrow the gap between economic and insured losses in the country (according to this article from the Times of India). Swiss Re have been suggesting ways that the Indian government can lessen the economic impact of natural disasters.

One of the risk transfer tools suggested by Swiss Re was catastrophe bonds, similar to the MultiCat Mexico 2009 Ltd. transaction which provides FONDEN the Mexican Fund for Natural Disasters with $290m of reinsurance protection against specified natural disasters.

By using catastrophe bonds to narrow the gap between the economic and insured losses caused by natural disasters the Indian government could minimise the effects on the wider economy and secure a multi-year, reasonably priced source of reinsurance protection which pays out quickly in the event of disaster.

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