Reinsurance, capital markets should lead way on loss & damages

by Artemis on November 21, 2013

The United Nations conference on climate change continues in Warsaw, Poland this week. A key topic of discussion is what to do about the growing loss and damages from climate and natural disasters, particular losses being suffered in the developing world.

This has become a core focus of the UN’s Conference of the Parties (COP 19 / CMP 9) climate talks and has led to a symbolic walkout by a number of developing nations in protest at what they see as the failure of wealthier nations to provide financial support to enable quicker recovery after disaster strikes.

The talks have seen calls for a disaster, or loss and damage, mechanism which would support the developing world and be subsidised to some degree by the developed. The call is for the core UN Framework on Climate Change to be amended to include details of a disaster risk financing facility, with disasters that are made worse by climate change financed by a global facility, largely funded by the richer nations which are seen as largely causing global warming.

The New York Times reports that a group of developing nations and China has walked out of the talks, symbolically, demanding that an agreement on a loss and damage (or disaster risk financing) facility must be reached before the end of this years talks. The focus on this discussion has grown since the recent super typhoon Haiyan disaster in the Philippines, which as with most natural disasters in Asia sees economic losses far outweight those which can be recouped from insurance, reinsurance and risk transfer.

The current set of talks in Warsaw aimed to lay out the foundations for a proposal to create such a facility, to provide disaster risk financing for developing nations largely supported by capital from the developed, richer nations of the world. The requirement for such a facility is clear, but the question which remains unanswered is whether this should be a subsidised facility provided by the governments of the developed world or a facility which aims to become a functioning, private risk transfer market over time.

Insurance and reinsurance companies have been represented at the current round of UN climate talks, with 100 companies submitting a proposal for ways to improve disaster risk financing for the poorer nations of the world and to enable post-disaster recovery. Microinsurance, weather-index insurance, parametric insurance facilities and examples such as the Caribbean Catastrophe Risk Insurance Facility, have all been cited as examples of ways the insurance and reinsurance market can help to support the needs of developing nations.

The question lies in how to make these fully sustainable, functioning private markets, which allow for accurate pricing of risk and will support the creation and ongoing development of local insurance and reinsurance markets, rather than the permanent establishment of subsidised global facilities.

The World Bank published a report earlier this week which looks at the growing amount of loss and damage from weather, climate and natural catastrophe events around the world. The annual average losses and damages from weather related events has risen from $50 billion in the 1980’s to close to $200 billion over the last decade, according to data in the report from reinsurer Munich Re.

As the global climate continues to change, be that from warming, patterns or other phenomena man-made or otherwise, the cost and damages associated with weather and climate level catastrophe events are rising rapidly. All countries are impacted by these events but it is the developing nations of the world which are worst affected, bear the brunt of disaster losses and also find it the hardest to recover post-disaster event.

“Typhoon Haiyan, the most powerful typhoon ever to hit the Philippines, has brought into sharp focus how climate change is intensifying the severity of extreme weather events, which hurts the poor the most,” commented Jim Yong Kim, World Bank Group President. “While the immediate relief effort must be front and center of our attention today, such tragic events show that the world can no longer afford to put off action to slow greenhouse emissions, and help countries prepare for a world of greater climate and disaster risks.”

The report titled ‘Building Resiliance: Integrating Climate and Disaster Risk into Development‘ shows that weather-related financial losses are concentrated in middle-income, fast growing countries, where increasingly high-asset values are becoming more exposed. These nations are also typically low from an insurance and reinsurance penetration point of view, meaning that post-disaster risk financing is often low.

The average impact to these middle-income developing countries from weather disasters equaled 1% of gross domestic product (GDP) between 2001 to 2006, a percentage which is ten times higher than the average for higher income countries.

While these middle-income countries are currently bearing the financial burden, it is the lower-income developing countries which find it hardest to cope with and recover from weather disasters. It is these poorer countries which find weather, climate and natural disasters the most crippling, according to the report.

“Over the last 30 years, the world has lost more than 2.5 million people and almost $4 trillion to natural disasters. Economic losses are rising – from $50 billion each year in 1980, to just under $200 billion in 2012. And three-quarters of those losses are a result of extreme weather”, said Rachel Kyte, the World Bank Vice-President for Sustainable Development. “While you cannot connect any single weather event to climate change, scientists have warned that extreme weather events will increase in intensity if climate change is left unchecked.”

According to Munich Re data, total reported losses from disasters are estimated at $3.8 trillion since 1980 with 74% due to extreme-weather. This huge economic toll demands the assistance of the global insurance, reinsurance and capital markets to help find a sustainable and ongoing, market-based, solution to disaster risk financing and contingent disaster recovery funding. This is where the reinsurance and capital markets must take a lead role in any efforts to mitigate and protect against weather or natural catastrophe loss and damages.

Identifying any linkage between our changing climate, warming of the climate and the rise in weather-related disaster losses is fraught with difficulty, but the clear evidence that losses and damages are rising is enough to trigger the conversations at the climate talks. It is clear however that climate related impacts will continue to grow while countries in regions where natural and weather disasters are prevalent develop further and GDP grows.

Given the trend of increasing disaster economic losses and damages, mechanisms to mitigate the impacts of disasters are as important now as the initiatives to increase disaster resilience. How we create these mechanisms is just as important as creating them though, they have to be sustainable, have to result in functioning markets and have to support creation of local financial markets as well.

A holistic approach to building resilience and the ability to recover post-event is required, with insurance, reinsurance and capital markets more than able to lead the way on financing and protecting against economic loss and damages. This is a key piece of the demands being made at the climate talks and the role that reinsurers and capital markets, in the form of third-party reinsurance capital, can play is vitally important.

The report from the World Bank proposes greater use of insurance, reinsurance and instruments such as catastrophe bonds, at the relevant levels of risk severity and frequency, to provide a framework of financial instruments to assist with climate and disaster resilience.

Parametric insurance, catastrophe bonds, catastrophe swaps, weather derivatives, indemnity insurance, microinsurance and weather-index covers are all cited in the report, demonstrating the range of instruments available to help in disaster risk financing. The World Bank has experience in these tools and they all have a role to play in realising the demands of the developing nations of the world who are in most need of protection.

One of the problems that needs to be overcome is how to make efforts to provide financial instruments to insure against and transfer disaster and weather risks sustainable. Subsidies are inevitable to get such mechanisms off the ground, but the ultimate goal must be to create new private markets, which are self-financing, sustainable and benefit the countries they target by helping local companies and finance to get involved.

Purely launching an initiative to transfer disaster risk in a developing nation with subsidies and no plan for how to transfer the initiative to the private market is not sustainable. This is why the private reinsurance, insurance and capital markets investors in ILS and reinsurance need to come together to establish new markets.

There is evidence from some microinsurance and microfinance schemes that when the subsidies are removed the price rises and the products become less sustainable. New models to launch these schemes must be thought through, perhaps seeking to bring protection in at the GDP level first, allowing insurance to be introduced afterwards once GDP level risk transfer is secured.

Pricing of risk is vital and this means better risk models are required, to allow reinsurers and the capital markets to accurately price risk within these new and developing regions of the world. If reinsurance and high severity, low-frequency weather and disaster risks can be priced and sold to the private markets, then we can hope to see top down growth of risk transfer and insurance markets underneath.

Given the focus in the reinsurance sector on finding new growth opportunities, vitally important for an over-capitalised market, as well as the focus among ILS markets on getting access to sufficient risk to soak up investor interest, these markets should be taking a lead role in provision of weather and disaster risk transfer capacity.

The capital markets is the one source of capital large enough to provide the capacity required for this initiative. Working alongside reinsurers to create new risk transfer markets, with the vision to support insurance markets beneath them, is within the natural remit of reinsurance and ILS markets looking to grow.

A resolution appears to be required at the UN climate talks in Warsaw this week, in order to progress all-inclusive discussion of how to provide financing for disaster and weather events at the next meeting and beyond.

It is to be hoped (in Artemis’ opinion) that any such resolution is not purely focused on subsidies from developing nations to the developed. Rather Artemis hopes that a resolution is focused on how functioning developed risk, reinsurance and capital markets can be leveraged to build sustainable, global disaster risk financing facilities, which in turn encourage and support development of local insurance market security as well as GDP growth.

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