Governments encouraged to look to ex-ante risk financing such as catastrophe bonds

by Artemis on June 8, 2012

Governments should seek to avoid becoming the insurers of last resort when disaster strikes by choosing to buy protection through ex-ante risk financing mechanisms offered by the insurance and reinsurance markets. Despite a trend towards more catastrophe insurance coverage, the increasing uptake is not keeping pace with the growing amount of uninsured losses and this gap looks set to widen as the developing nations of Africa and Asia modernise and economic loss exposures grow.

In this article from the Bangkok Post, Martyn Parker, the chairman of Swiss Re’s Global Partnerships, refers to the recent flooding in Thailand and says the growing size of the potential uninsured losses governments could face is forcing them to look to new forms of ex-ante risk financing to secure cover before disaster strikes.

These pre-disaster (ex-ante) risk financing mechanisms could include risk retention, contingent credit lines, or public-private risk transfer transactions where the risk is transferred to third parties such as the capital markets or re/insurers. Of course he highlights that risk transfer to third-parties, particularly to the capital markets, can take the form of insurance-linked securities or catastrophe bonds. He highlights one of the benefits to governments who seek out this kind of cover as being the swift payout that can occur if the agreed triggers of a cat bond or parametric insurance policy are met. This can assist a government in its relief efforts and make recovery from disaster swifter.

Parker from Swiss Re says that governments ought to be thinking about whether these types of ex-ante risk financing are right for them and that they believe it should be in their consideration set for disaster financing and risk management solutions. Parker said; “Such solutions could also prevent the government from having to do something unpleasant such as raise taxes or divert budgets from other areas.”

With the positive publicity that the catastrophe bond sector is receiving this year it should help to raise its profile to governments around the world and particularly in developing nations where catastrophe risks are large. Will 2012 see the next MultiCat cat bond from a government somewhere around the world? We’ll have to wait and see but it is encouraging that market participants like Swiss Re continue to push the possibility.

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Kiffmeister June 8, 2012 at 1:48 pm

That’s a point that we (at the IMF) made in a 2006 working paper on the “limits of market-based risk transfer” (http://www.imf.org/external/pubs/cat/longres.aspx?sk=19916.0). Basically the idea was for either governments to prefund or donors to in effect make ex-ante donations.

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