More detail on the Pacific Islands parametric catastrophe insurance facility

Further details have emerged on the new disaster insurance facility which launched last week to provide parametric insurance cover for tropical cyclone and earthquake risks to a group of Pacific Islands. The parametric catastrophe facility has been set up by the World Bank and the Secretariat of the Pacific Community (SPC) Pacific Catastrophe Risk Assessment and Financing Initiative (PCRAFI) team with financial support from the Japanese government.

We now have more technical information regarding the facilities underlying structure, how the parametric payouts will be effected and how the underlying reinsurance pool will operate. Read our article on the launch of the facility from last week for background information.

The pilot project aims to answer two important questions about supply and demand for catastrophe risk transfer products in the Pacific. On the supply side the pilot aims to test the underlying risk models and the appetite of international reinsurers to underwrite Pacific catastrophe risk with parametric triggers. On the demand side the project aims to demonstrate the willingness of the Pacific Islands to buy catastrophe risk cover and demonstrate the benefit that the payouts will bring to the region.

The facility offers parametric earthquake and tropical cyclone (typhoon) coverage to each country on an annual basis. Each country can select per-peril coverage and can choose what return period of catastrophe events they’d like to cover; 1 in 10, 1 in 15 or 1 in 20 years catastrophe events. A less frequent attachment return period can be selected if desired. Losses up to the attachment return period provide the deductible for which the country is responsible. The parametric policies provide coverage from the attachment return period up to the 1 in 150 year loss level. For catastrophe events above that exhaustion level the country would receive the full payout possible under the terms of its policy.

The parametric policies do not pay on actual losses incurred, rather a modelled loss approach based on the parametric measurements of the severity of the catastrophe event will calculate the attachment return period and how much payout is due. Catastrophe risk models have been developed to create event footprints which will enable calculation of losses. A risk modelling firm will be expected to undertake a calculation within 10 days of receiving a calculation notice.

Technical parameters of a catastrophe event will be used to denote severity and whether the parametric triggers are breached. Wind speed measurements will be used for tropical cyclone and ground motion readings for earthquake risks. Risk modelling firm AIR Worldwide have developed a catastrophe risk model which will be used to calculate estimated losses against which payouts will be calculated and made. This will enable quick payouts which can be used directly for disaster recovery purposes. The World Bank said payouts could be as quick as two to three weeks after a catastrophe event strikes.

The portfolio of catastrophe risk transfer policies of the five Pacific Islands have a maximum aggregate limit of $45m for the 2012-2013 pilot season. The portfolio has an annual expected loss of $1m and there is a 54.5% chance of a payout being made to at least one participating country. The aggregate portfolio losses is estimated to exceed $10m once every 100 years.

The risk has been pooled from the five participating Pacific Islands and have been reinsured as a single, diversified portfolio. The World Bank said that by pooling the risks, simulation shows that the catastrophe load can be reduced by as much as 70% and this enables a better reinsurance rate-on-line meaning the facility can reduce the premiums. The risks were placed with four international reinsurers; Sompo Japan Insurance, Mitsui Sumitomo Insurance, Tokio Marine & Nichido Fire Insurance, and Swiss Re.

In the first year each of the five participating Pacific Islands is paying an annual premium of $400,000, with the Japanese government paying the first years premiums, and this drops in the second year of the pilot to $200,000.

Reinsurer Swiss Re released the following about their role and the benefits of this modelled loss approach to triggering payouts from the facility:

Natural disasters, such as Tropical Cyclone Evan that made landfall in December last year causing widespread destruction of infrastructure and loss of property in Fiji and Samoa, are an impediment to economic development. The cost of relief, recovery and reconstruction efforts is a major financial strain for governments.

Through the pilot catastrophe risk insurance programme, Swiss Re and other insurers support the public sector to reduce its contingent liabilities. If a natural disaster strikes any of the five countries, a modelled loss approach will be used to quickly approximate the damage on the ground and trigger the payout under the programme. The project is currently in its pilot stage and will expand to include more Pacific Island States as it grows.

The support of this transaction by Swiss Re reaffirms its long standing commitment to help the public sector build resilience through the use of innovative insurance solutions and the public-private partnership model.  It is also the first sovereign catastrophe risk transfer programme in Asia Pacific.

Read our article on the launch of the facility from last week for additional background information.