Global reinsurance (and ILS) capital strengthens disaster risk resilience

by Artemis on September 23, 2014

According to a new report, global reinsurance capital plays a key role in absorbing the impact of disasters, by providing predictable financial relief and strengthening societal resilience. We would add that ILS capital and catastrophe bonds do the same.

The report from a consortium of 12 reinsurers, called the Global Reinsurance Forum, says that insurance and reinsurance is one of the main financial tools which can help to strengthen disaster risk resilience.

The report states:

Large, unpredictable, and costly disasters are inevitable – but global reinsurance provides a mechanism to compensate insured parties for their losses, using the premiums they and others have paid beforehand under an agreed contract. Global reinsurers are able to offer this service to insurers because they pool their risks and capital globally and thus gain the benefits of diversification.

Reinsurance and insurance (collectively, “re/ insurance”) and other pre-paid risk-financing mechanisms are widely recognised as a critical part of any comprehensive disaster risk management strategy. The re/insurance industry has expertise in risk prevention and absorbs disaster shocks by providing predictable financial relief. Timely payouts enable rebuilding and recovery, which helps to reduce indirect losses.

Interesting to us is the lack of discussion of collateralized reinsurance, insurance-linked securities (ILS) and catastrophe bonds in this report. It does make one mention of reinsurers ability to transfer risks to the capital markets through ILS, but that is all.

It’s perhaps not surprising given the current reinsurance market environment, that reinsurers might want to focus in on the insurance and reinsurance business model and contract, and why this is good for building disaster risk resilience. We cannot disagree, insurance and reinsurance plays a vital role in this, but the report feels like it is missing something given the clear role that the capital markets have to play in enabling those seeking protection to access diversified capacity if they choose or to directly access capital market sources of risk bearing capacity.

In fact reinsurers have an opportunity to help those in need of disaster resilience to access the capital markets if they choose, acting as transformers of risk or simply by helping them to structure direct access to the capital markets, leveraging reinsurers deep modelling and structuring expertise.

In the current pressured market environment it would seem an opportunity missed, not to have explained how the convergence of reinsurance and capital markets increases the usefulness of reinsurers in these efforts and the options available to those seeking to transfer risk.

The report is excellent, in terms of content on the role reinsurers play in helping to build financial resilience to disaster and other emerging risks. It’s clear that reinsurers have a key job in moving forward the climate and disaster risk agenda, which is receiving so much attention this week and with opportunity to expand at the core of these efforts it will benefit them to promote their role.

However, it does feel like this report could have been more all-encompassing on risk transfer, risk capital with a little more agnosticism as to the source, the structure and how it is facilitated. It’s understandable that reinsurers want to promote their role and service offering, but sometimes it does feel like market-share is more of a driver than actually providing the most efficient and, importantly for many emerging economies, cost-effective solutions. We hope to be proved wrong and expect that as convergence continues to deepen that reinsurers will find they cannot take on these new risks and regions without the support of efficient capital and ILS.

The importance of capital to provide contingent catastrophe, disaster and extreme weather relief and to boost resilience is clear and initiatives such as the climate change catastrophe bonds for Africa announced this morning demonstrate the direction this is going in.

Accessing the capital markets for contingent disaster capital, using parametric and index triggers, is perhaps the most efficient way to provide risk transfer for sovereign facilities, governments, countries and direct to large corporations, especially those with supply-chain or facility exposures in disaster prone regions.

That takes the ‘indemnity’ concept out of the chain of risk transfer and enables direct access to the capital markets, something that was a topic of broad discussion in Monte Carlo this year. It is expected that this will be a growing trend in years to come and we believe reinsurers need to embrace this trend, perhaps even to use it as a way to access risk capacity to further their own growth and expansion aims, or risk being disintermediated (to a degree) in favour of a more efficient route to capital.

This would not mean reinsurers suffer, in fact it could be a trend which supports the growth and establishment of local insurance and reinsurance markets, thus stimulating more indemnity premiums while efficient structures transfer peak risks to the capital markets. That could add a layer of protection at the GDP level in emerging economies, allowing local, sustainable insurance markets to emerge and flourish, a vital and key piece of the puzzle to expanding insurance penetration around the world.

You can access the report, titled ‘Global reinsurance: strengthening disaster risk resilience’, in PDF format here.

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