Asia lags on reinsurance, capital market solutions to disaster risk

by Artemis on April 29, 2014

A new report from the Asian Development Bank (ADB) highlights that Asia is lagging behind the rest of the world when it comes to developing insurance, reinsurance and capital market solutions which enable workable disaster risk transfer markets.

The Asia-Pacific region remains significantly underinsured for catastrophe risks, according to the report. The lack of insurance, reinsurance and capital market solutions to transfer disaster risks to parties better able to assume them leaves the regions GDP seriously at risk in the face of disaster.

The gap between the total amount of economic losses from catastrophe or disaster events and insured losses can now be so wide that the ability of governments in the region to step in as insurers of last resort may not be relevant anymore as even they cannot finance the gap without a hit to the countries GDP.

Because of this widening gap and its potential to set back any gains that Asia-Pacific nations make in terms of GDP, effectively setting back the countries economic resilience each time major disaster strikes, the Asian Development Bank is calling for the region to put in place insurance and reinsurance mechanisms that can respond to catastrophes more readily.

Just 7.6% of natural disaster losses in Asia in 2013 were insured, compared to 67% in the United States. In the last twenty years Asia has borne almost half of the global economic cost of natural disasters, almost an estimated $53 billion annually.

The ADB says that given the concentration of catastrophe risks in the region, and the expected increase in frequency and severity of climate related disasters, developing workable solutions to disaster risk transfer must become a key policy priority.

The ADB favours ex-ante financing, including insurance, reinsurance and capital markets risk transfer tools, as it allows the capacity required to pay for disasters to be secured before the disaster strikes. The ADB highlights that immediate liquidity is vital for emergency response, recovery and reconstructions, here the parametric trigger is a particularly vital tool, along with weather indices, which allow for prompt payouts to be defined and made after catastrophe strikes.

As you would expect the ADB report discusses catastrophe bonds and insurance linked securities (ILS) and where they can fit into a more robust disaster risk financing framework for the Asia-Pacific region. There is significant commercial interest in developing risk transfer mechanisms for the Asia-Pacific region, says the ADB report, something that the reinsurance and ILS markets would readily agree with in the current pricing environment.

Accessing more of the disaster risk in Asia is a key priority for the majority of large, global reinsurance firms as well as for many ILS managers and specialist ILS investors. With the reinsurance and ILS markets still softening in terms of pricing, accessing new sources of yield by developing risk transfer markets in regions such as Asia is only going to grow in priority over the coming years.

The ADB report notes that a lack of robust historical loss data is one factor that can hold back development of risk transfer markets in Asia, along with the high cost of, often proprietary, risk modelling. The report also notes that governments in the region need to take a leading role in promoting the use of innovative disaster risk financing tools as well as developing the necessary legal and regulatory frameworks to support their introduction.

The ADB advises that governments could help by putting in place regulation to support parametric products, micro-insurance schemes or catastrophe-linked securities (so catastrophe bonds), bring in a system of tax incentives for private insurance coverage and also enable the use of insurance as a risk management tool for public entities.

The report also notes the importance of the public private partnership in bringing disaster insurance cover to new communities and supporting the development of private markets. The creation and support of private markets in insurance and disaster risk transfer is key, without them the introduction of often subsidised micro schemes can be doomed to failure as the interests of the local communities can be forgotten in favour of the interests of those seeking to profit. There will be plenty of time for all to profit from providing disaster risk financing mechanisms but to do so they must be implemented in a sustainable and market-supporting manner.

The ADB also calls for a regional catastrophe risk pool or facility to be created, mentioning the Caribbean Catastrophe Risk Insurance Facility and the Pacific Catastrophe Risk Insurance Pilot as examples. These parametric based insurance pools allow countries to buy cover that responds to specific disaster metrics while pooling the risk to get better pricing in the global reinsurance market.

However the ADB notes that achieving a regional catastrophe pool would be a difficult task, given the scale of the region, the economies and the exposures within it.

Other areas that require focus are on the collection and availability of data on hazards, exposures, vulnerabilities and losses in the Asia-Pacific region. ADB proposes the development of a regional platform for collecting and disseminating data on assessing and modelling risks.

Finally, the ADB stresses that in any initiative to develop disaster risk financing or transfer key priorities should include; business continuity planning, enhancing technical and institutional capacities, and coordinating various governmental authorities across all levels.

A holistic approach to creating disaster risk financing and transfer markets is certainly required in Asia-Pacific. The involvement of the global reinsurance market as well as capital markets investors will also be key, if any initiatives are to have the capacity and scale to really make a difference.

Once again though, it does have to be stressed, that the goal of any initiatives in disaster risk financing and transfer have to be focused on enabling the creation of, and supporting, local markets, with local insurers and reinsurers, with the protection afforded by the risk transfer facilities in place.

Moving into Asia and seeking to dominate the provision of catastrophe or weather insurance, reinsurance and risk transfer capacity, without thinking about how the necessary insurance markets beneath it continue to exist and develop after a truly major catastrophe strikes, is simply a short-sighted approach to solving what is a very complex problem.

You can access a copy of the ADB’s report here.

Also read:

2013 insured catastrophe losses hit $45Bn, protection gap widens.

Reinsurance, capital markets should lead way on loss & damages.

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