Demand for flood catastrophe bonds could grow: Swiss Re

A new report from Swiss Re finds that flood insurance losses are growing rapidly while the insurability of flood as a peril continues to prove difficult for the insurance and reinsurance sectors. No other natural catastrophe impacts as many people on an annual basis, with floods impacting an estimated 500 million people per year. Back in 1970, insured flood losses only amounted to $1 billion to $2 billion, in 2011 that figure had leapt to $15 billion.

Recent flood events like the Queensland, Australia flooding, Thailand and the Philippines show that flood events have the potential to be as damaging and costly as major hurricanes. To that end, Swiss Re’s report “Flood – an underestimated risk: Inspect, inform, insure” discusses the challenges that the insurance and reinsurance sector face in adequately pricing flood risk and covering it.

Awareness is also an issue and Swiss Re hopes the publication will help. Matthias Weber, Swiss Re Group Chief Underwriting Officer, says; “With this publication we want to raise greater awareness of floods, their risks and the role of insurance in addressing them. We show what it takes to tackle the challenges in flood insurance and what successful solutions might look like for homeowners and companies.”

Exposure to flood events is growing all the time, with exposures in developing nations now rapidly increasing. Swiss Re said that population growth, demographic change, a higher concentration of assets in exposed areas, greater vulnerability of insured objects and climate change are all contributing to rising flood losses and exposures. The rising exposure and losses are a challenge for insurers and the economic viability of flood insurance is an issue under scrutiny.

Jens Mehlhorn, Head of Flood at Swiss Re and the report’s key author, said; “2011’s USD 12 billion insured losses in Thailand really highlighted the potential for flood to cause extreme losses. The insured losses corresponded to 1800% of the country’s total annual property premium – and this emphasises the difficulties the industry faces in creating an economically viable approach to flood insurance.”

The report looks at how you can build adequate flood insurance markets in order to sufficiently share the risk and how insurers can help in advising on risk mitigation strategies such as urban planning. The report also looks at some of the government backed, nationalised flood programmes and discusses their issues. The report also looks at the existence of flood hot spots, with Thailand being a prime example where a cluster of globally relevant industries can be impacted by flooding, thus causing greater losses and supply chain business interruption.

The report looks at the U.S. National Flood Insurance Program and decides that the NFIP is not sustainable in its current form. The NFIP has debts of $18 billion after years of premiums not truly reflecting the risks being covered. The NFIP system has also been underestimating storm surge leaving it with excess claims to pay. The reform of the NFIP is a hot topic and there are efforts underway to try to move more U.S. flood risk into private reinsurance markets.

Swiss Re notes that alternative forms of insurance and reinsurance have a role to play in flood risk transfer, citing parametric insurance, microinsurance and catastrophe bonds (or insurance-linked securities) as solutions that could be leveraged.

They note that while parametric solutions are much easier to manage from a claims perspective, setting up parametric flood triggers is complex since flood has so many facets. For example, rainfall as a parameter may not account for a burst dam or river flood. Similarly rainfall may be responsible for flooding that occurs many miles from where the actual downpour occurred making it hard to create true parametric triggers. Because of this solutions will often need to be custom designed to fit each use case.

Swiss Re notes the challenges with parametric re/insurance solutions includes basis risk, where the payout may be much lower or greater than the actual loss that occurred. They note that using flood footprints, which outline those geographic areas
that are actually inundated, through remote sensing can improve this and is becoming more advanced.

On microinsurance Swiss Re highlights their work in Haiti with MiCRO where they have a solution in place which provides parametric and basis risk insurance cover for micro-entrepreneurs. The policy uses satellite data to cover rainfall and has been triggered twice for rainfall, and once more recently for losses from hurricane Isaac’s winds and rain.

On catastrophe bonds, Swiss Re notes that demand for ILS based flood solutions has so far been limited, but they say that this could change. To date, only one flood catastrophe bond has been issued. Swiss Re structured and placed on behalf of  Allianz $150m of insurance-linked securities in a deal called Blue Wings Ltd. covering flood in Great Britain and earthquake catastrophe events in Canada and the U.S. This was the first attempt to cover flood as a distinct peril via ILS and cat bonds.

Blue Wings was cleverly structured to use UK Environmental Agency designated flood warnings as a trigger. To calculate river floods, at least 50 reference locations across Great Britain were used to measure flood depth. For an event to trigger the cat bonds, river segments connected with at least four of the reference locations must be designated a “severe flood warning” area by the UK Environmental Agency.

Swiss Re says the demand for flood cat bonds might increase in the future since PERILS AG started giving market loss estimates for UK flood risk. Cat bonds may be based on this data in the future and PERILS hope to broaden their flood estimates to cover more European countries in the future.

Swiss Re notes that there is strong demand from governments for innovative solutions to flood risk, such as catastrophe bonds, as they look for cost-efficiencies, quick payouts and solutions to moral hazard risk.

You can access Swiss Re’s publication here.