Catastrophe insurance schemes can help disaster aid/recovery: Report

In the wake of a natural disaster event in an emerging, vulnerable region of the globe disaster aid, while important, often takes time to reach those in need and in some cases is far from enough to meet the needs of those affected.

This underlines the importance of expanding catastrophe insurance schemes and ventures to reach all corners of the world, according to the Center for Global Development.

It also underlines the importance of a functioning and efficiency global market for reinsurance capacity, as so many of these catastrophe pools and schemes require access to the most efficient reinsurance protection possible, in order to keep their costs down and the product viable.

Theodore Talbot and Owen Barder of the Center for Global Development have produced a comprehensive report on how catastrophe insurance can improve the financing of disaster aid and the coverage of a range of perils, while supporting the development of improved disaster resilience.

Interestingly, this comes as the London Market Group (LMG), a taskforce that is currently working on the development of London as an insurance-linked securities (ILS) hub with the UK Government Treasury, recently launched a white paper to develop a Foreign Aid catastrophe bond (FAB).

Unfortunately, poorer regions of the world often experience some of the most devastating natural catastrophe events, highlighted by the Nepal earthquake, drought conditions in part of Africa and India, and extreme weather events in parts of Asia.

Owing to a lack of insurance protection in these parts of the world, which is a result of a lack of insurance awareness and education combined with limited modelling capabilities and resulting inadequate, and unaffordable solutions, when disaster strikes a large portion of the costs is borne by the local governments, or foreign governments providing disaster relief.

While foreign aid is welcomed and important to the rebuilding of lives and economies of those affected, it can often be too little too late, something that the report highlights as an area where catastrophe re/insurance pools and schemes can mitigate the impact and improve the rebuilding and refinancing efforts.

The LMG’s recent white paper on the establishment of a FAB is an example of a new, innovative approach to using catastrophe insurance mechanisms to better finance foreign aid. Instead of using the UK’s foreign aid budget, a catastrophe bond that will be fully collateralised by third-party investors, will be issued that covers certain peril regions, and which member countries will pay a risk premium in return for payout post-event.

The LMG’s proposal, along with plans from the World Bank and other global, public and private sector organisations to improve global resilience all highlight the benefits of ILS features such as parametric triggers, and the wealth of capital markets capacity, in improving global resilience and recovery efforts.

It also supports removing some of the financial burden from local and foreign governments, and should help vulnerable countries improve their own resilience to global catastrophe events, something the Center for Global Development highlights in its report.

In contrast to financing a disaster post-event, a catastrophe insurance model for tackling natural catastrophe events and improving resilience would help spread the cost of disasters, “lifting the burden from the poorest people and countries,” says the report.

While it would also serve to “provide predictable payouts, thereby enabling faster disaster responses which limit the overall losses, and align incentives to invest today to reduce risks (where possible) and limit losses tomorrow,” says the report.

Regarding the point raised on predictable payments, the report highlights parametric triggers as a sound approach to catastrophe insurance schemes, as they ensure rapid payout post-event and the predetermined specifics of what parameters will trigger a payout post-event, offers a better idea of the amount of funding a country will get and when it will receive it.

This helps to eliminate some of the uncertainties with current disaster aid financing, providing countries with a clearer understanding of the amount they will receive post-event and when they will receive it.

While it’s extremely difficult to reduce the actual risk of many hazards, the use of catastrophe insurance schemes to speed up recovery post event and ensure needed finance is available can mitigate the impact somewhat. But the report also highlights that it’s important regions have incentives to improve resilience efforts, ultimately reducing the need for foreign aid and catastrophe schemes.

The report, titled ‘Payouts for Perils: Why Disaster Aid is Broken, and How Catastrophe Insurance Can Help to Fix it,’ explores the use of catastrophe insurance and features such as parametric triggers, catastrophe bonds and other solutions in great detail, providing an holistic view of the benefits.

Building global resilience is at the forefront of global public and private sector goals, and reports like this along with discussions from the World Bank and the UN, continue to underline the important role insurance, reinsurance, and ILS capacity and features can play in protecting against future disasters in vulnerable regions.