IFC developing index-based earthquake insurance product for Indonesia

International Finance Corporation (IFC), part of the World Bank Group, is developing an index-based insurance product to protect banks in Indonesia that provide loans to individuals and micro, small and medium enterprises from losses following earthquakes and other disasters.

The IFC has signed a cooperation agreement with specialist reinsurance company PT Asuransi MAIPARK Indonesia to work on the development of the new parametric insurance products. Supported by the IFC, MAIPARK will work with local insurance companies and banks to develop and distribute a new earthquake-index insurance product. The earthquake product may be followed by one targeting protection from typhoons and tropical rains we understand.

Over 12 million Indonesians live and work in earthquake exposed regions, with an estimated $79 billion of economic exposure. Should a major earthquake strike a population centre such as Yogyakarta or Padang, it is estimated that the worst-hit banks could lose as much as 35% of their income, eroding the banks’ capital reserves and compromising their ability to lend.

Banks are an oft forgotten user of catastrophe and natural disaster insurance product and in many areas of the world are drastically underinsured, particularly for the inability of their customers to repay loans. This issue is even prevalent in the U.S., where homeowners in California, for example, do not have to take out earthquake protection despite having large mortgage loans to banks.

The IFC is trying to help Indonesian banks in two ways with this product. One; by protecting the loans they give out it means banks can still expect to receive payment even after major disasters strike their customers. Two; providing disaster risk financing for banks enables them to keep lending after disaster, thus helping the population to keep businesses running, which in turn keeps the banks cash flow active.

Therefore the index-insurance for earthquakes will help banks to hedge their exposure to non-performing loans and other potential post-disaster scenarios, such as mass savings withdrawals. The IFC says that this can in turn support better financial performance, lower interest rates, reduce volatility in access to credit, and expand banking services.

“Indonesia’s earthquake hazard exposure is among the highest in the world, both in terms of human mortality and economic losses,” said Frans Sahusilawane, president director of MAIPARK. “Our cooperation with IFC allows us to provide protection for banks against financial risk due to earthquakes.”

Index-insurance, or parametric, based on the actual measurements of an earthquake or other natural disaster, is an effective way to provide this protection, particularly in economies which are still developing. It enables insurance to be offered to the poorest communities, without the need for time-consuming and expensive claims processes. Index triggers also make it very easy to sell the insurance as customers can identify with the benefits of being protected much more readily and the products are simple to explain.

“Insurance protection for banks that provide loans to small and medium enterprises is important in maintaining business sustainability,” said Sarvesh Suri, IFC’s country manager for Indonesia. “This is IFC’s first insurance project in Indonesia and underlines our commitment to fully support sustainable economic growth providing protection to all key players.”

This project comes under the remit of the Global Index Insurance Facility and is funded by the Japanese government. The facility’s objective is to expand the use of index insurance as a risk management tool in agriculture, food security and disaster risk reduction.

The use of index or parametric triggers in disaster insurance for developing economies continues to flourish around the world. Of course, the largely subsidised nature of these products will one day have to give way to commercial ventures and at that point the responsibility for transfer of the risks involved will move to the global reinsurance and capital markets. With so much risk being index based it makes the use of instruments such as parametric catastrophe bonds suitable for reinsuring these projects.