Sustainability, local markets key to G7 goal to grow disaster insurance

A further 400 million people in regions of the globe vulnerable to the perils of climate change related hazards are to have access to catastrophe or disaster risk insurance by the year 2020, according to G7 leaders.

Leaders of the G7 met in Elmau, Germany recently to talk global economic issues and part of the discussions focused on the need for greater insurance penetration and awareness, in relation to climate and catastrophe risks, most notably in developing, vulnerable countries.

“We will aim to increase by up to 400 million the number of people in the most vulnerable developing countries who have access to direct or indirect insurance coverage against the negative impact of climate change related hazards by 2020 and support the development of early warning systems in the most vulnerable countries,” state the G7.

In order to reach its goal, the G7 said it “will learn from and build on already existing risk insurance facilities such as the African Risk Capacity, the Caribbean Catastrophe Risk Insurance Facility and other efforts to develop insurance solutions and markets in vulnerable regions, including in small islands developing states, Africa, Asia and Pacific, Latin America and the Caribbean.”

The African Risk Capacity Ltd, or ARC, launched in May 2014 with five policy holding members, being Kenya, Mauritania, Mozambique, Niger and Senegal, but following the success of its first operational year the organisation recently said that it hoped to grow its members to 12 countries in its second-year.

An announcement that came shortly after ARC made its first payout to three of its member countries, which totalled $25 million and was awarded as a result of severe drought experienced during 2014.

The ARC catastrophe insurance pool is a solid example of how to provide catastrophe and climate-related financing to poorer, vulnerable regions of the globe, while also serving to build members’ resilience to catastrophe events and leveraging international reinsurance capacity to do so.

While participating countries pay a premium to secure their place as a member of ARC, they must also ensure they are making efforts to strengthen their resilience to future events, thus diminishing the need for risk transfer solutions in the future.

And this is clearly the ultimate goal of G7 leaders, and rightly so too. There’s little to be gained over the longer term from throwing money at post-event reconstruction efforts if nothing is to be done to encourage or incentivise vulnerable nations to mitigate the social and economic impact pre-event.

This was highlighted by the G7 leaders who stressed the need for advanced early warning systems in the most vulnerable countries of the world. Signalling again that mitigation is paramount, but clearly the need for sufficient funds and post-event capabilities must also be made available.

It also seems detrimental to efforts at improving the world’s resilience to the negative impacts of climate and catastrophe-related events if countries assume they will just receive a large payout after an event.

So resilience is the key, but that doesn’t come over night and in order to ensure maximum protection for vulnerable regions in the future, the use of sophisticated, comprehensive risk transfer tools, such as catastrophe bonds and the wider ILS sector will likely prove invaluable.

In fact, ARC announced last year that it had established the Extreme Climate Facility (XCF), a tool that will use catastrophe bonds for financing the risk of climate change, although this is still a work in progress.

Furthermore, as the intensity and frequency of severe weather events is widely predicted to increase, along with asset values and a dangerous level of coastal migration to areas susceptible to issues like water stress, particularly in Asia, the potential losses from natural events increases also, further emphasising the need for sufficient, affordable risk transfer mechanisms.

It seems that world leaders are on the right track regarding catastrophe, weather and climate-related risk transfer products for vulnerable nations, but as well as the efforts of leaders and governments, it must be a concerted effort by the insurance, risk and capital markets in support.

The G7 describes its Climate Risk Insurance Initiative as the following; “Effective climate risk management that aims to build resilience to the impact of climate change especially for poor and vulnerable people in highly exposed and low-income countries needs to encompass disaster risk reduction, adaptation to climate change and insurance to cover a portion of the residual risks that arise from natural hazards and extreme weather events.”

One issue that will have to be addressed is economic viability and also the future self-sustaining nature of catastrophe, weather and climate-linked risk transfer and insurance products.

The development of risk transfer pooling facilities and the ground-level, often weather index based, microinsurance programs required to actually deliver insurance to the most exposed people in some of the poorest countries could not have happened without subsidy.

The question is how does the world get beyond subsidy, or at least minimise the requirement for subsidy, as expansion of risk transfer facilities and weather or catastrophe-linked microinsurance continues.

The ultimate goal must be to develop facilities that provide the ultimate back-stop for local insurance economies and markets. The plans must aim to support and encourage the development of local markets, rather than involve subsidised international players taking shares in new markets.

This is not an easy task, but there are initiatives and start-ups in the insurance, reinsurance and also ILS space, looking to find sustainable ways to deploy their capacity into emerging economies as a way to encourage the development of local insurance markets.

One thing is certain, capacity is not an issue currently.

The traditional reinsurance, insurance-linked securities (ILS) and catastrophe bond market participants are all ready to support initiatives that give them opportunities to put their excess capital and capacity to work.

There is without doubt a key role for the capital markets and ILS fund investors to play in expanding insurance coverage and better financing the risks associated with the impact of major disasters.

In fact, for ILS investors such as the world’s largest pension funds, providing risk transfer solutions to aid the resilience of developing and developed areas of the world to the perils of climate related weather and extreme, adverse catastrophe events, is seen as socially responsible investing.

But encouraging the reinsurance world’s excess capital into supporting these initiatives is no good without a clear plan for how to make the resulting insurance schemes and risk pools ultimately self-sustaining, in as far as that is possible. No easy task.

While the ultimate goal is clearly to build societies and economies’ resilience to extreme weather and climate-related events, risk transfer is an important aspect of the process, one that can help to ensure steady and hopefully sustainable progress.