Risk model expansion to support growth of catastrophe risk transfer

In order to expand the reach and capabilities of parametric insurance solutions, catastrophe risk insurance pools, and catastrophe bonds across emerging regions in the fight to improve global disaster resilience, risk modelling must be expanded, says a recent report by the Center for American Progress.

Following talks last year among world leaders and global organisations, the need to improve global disaster resilience via insurance and reinsurance solutions was emphasised, following the potential for increased economic and insured losses as a result of more frequent and severe natural catastrophe events.

Underlining the vast cost of natural disasters across the world, reinsurance broker Aon Benfield revealed that in the first half of 2016 economic natural disaster losses totalled $98 billion, of which the re/insurance industry shouldered $30 billion of the cost.

This means that a staggering $68 billion of the overall loss caused by natural disasters in the first six months of 2016 alone, wasn’t covered by any form of insurance and that this would have to be paid by governments, and ultimately taxpayers.

With a wealthy of insurance, reinsurance and institutional or capital markets money seeking out risk, the opportunity to mobilise this in order to make the world better protected against catastrophe and weather risks is huge, but the need for analytics to underpin this is becoming increasingly clear.

Further highlighting the vast and expanding global protection gap (difference between economic and insured losses post-event), an article by the Center for American Progress states that in 2015 more than 1,000 natural disasters incurred losses of roughly $100 billion, of which just 30% was insured.

Furthermore, the report explains that emerging regions such as parts of Asia and Africa, which are highly susceptible to natural disaster events, have dangerously low insurance penetration rates, so when disaster strikes they heavily rely on foreign and local government aid to recover, which can take far too long and sometimes be inadequate.

In an effort to improve disaster resilience in both mature and emerging markets, and in light of the expectation that climate change is contributing to an increase in the severity and frequency of nat cats, catastrophe risk insurance pools, parametric insurance solutions and catastrophe bonds, have been touted as viable and important approaches to boost global protection and resilience.

The report, which is produced by Pete Ogden, a Senior Fellow at the Centre for American Progress, Jerusalem Demsas, an intern with the Energy Policy team at the Centre and Ben Bovarnick, a former Research Assistant with the Energy Policy at the Centre, highlights the opportunity and need for the expansion of parametric insurance, catastrophe risk pools and also cat bonds to more parts of the world.

“Since 2003, 43 countries have secured parametric coverage or begun to develop their own parametric risk insurance programs. Fortunately, increased political attention is being paid to the positive role such insurance can play in helping the most vulnerable countries better cope with the effects of climate change,” says the report.

However, in order for the expansion of such solutions to happen, and in particular with emerging regions, risk-modelling capabilities must be expanded and improved, explains the report.

“But one thing that can and must be addressed immediately is the shortage of adequate risk modeling in developing countries—risk modeling that is a prerequisite for scaling up climate-related risk insurance system globally,” says the report.

“Data on natural disasters and disaster risk reduction are still severely lacking at the local level, which constrains improvements to reduce local vulnerabilities to extreme weather.

“Spatial coverage and database resolution are typically global and only retain state-level information, meaning that local levels lack specific data, which creates a wide degree of variation between loss estimates among subnational regions,” the report continues to explain.

In order to develop adequate and effective solutions, whether this be a catastrophe risk pool, catastrophe bonds, or other forms of parametric insurance protection, risk data is vital.

The better understood an exposure the better-equipped insurers, reinsurers, and also insurance-linked securities (ILS) players will be to assess and price the risk, ensuring that which ever type of solution is established is able to serve its purpose adequately, effectively and efficiently.

“Expanding modeling to cover new geographic areas or new risks in a given area not only is a precondition to providing climate-related risk insurance to populations in those areas but also is critical to diversifying risk on the global scale, which would allow for expansion of coverage in areas where headway has already been made,” says the report.

Schemes such as the African Risk Capacity (ARC), the CCRIF SPC (formerly known as the Caribbean Catastrophe Risk Insurance Facility), and the Turkish Catastrophe Insurance Pool (TCIP), are examples of how a catastrophe insurance pool that utilises both traditional and alternative reinsurance capital and features can improve the resilience of vulnerable regions against natural disasters.

Clearly for such schemes to be replicated and expanded across the world it’s going to require a concerted effort from both public and private sector entities, to ensure the risks are properly understood and that any developed ventures are work in an efficient and effective way.