Expanding the reach of cat bonds to the world’s most vulnerable: CFGD

The Centre for Global Development (CFGD) has highlighted the growth of the catastrophe bond market as an efficient and “simple” means of insuring natural disasters, but stresses that for the most part, coverage hasn’t reached the most vulnerable and poorest parts of the world.

Despite a slowdown of issuance in the first-half of 2016 the catastrophe bond market has continued to expand in terms of geographical location and risk diversification, offering an efficient source of insurance protection against natural catastrophe events.

However, according to an article on the CFGD website, for the most part, “coverage hasn’t trickled down to the poorer and most at-risk countries – precisely those which are most vulnerable when aid fails to arrive or arrives piecemeal.”

As shown in the above graph, which was produced by the CFGD utilising data from the Artemis Deal Directory, less than one twentieth of the overall value of cat bond issuance since 1996 has protected against exposures in countries considered upper-middle income or below (where income per capita is $12,475 or lower), by the World Bank.

“They have mainly covered risks in the U.S. and other high income countries (HICs),” says the CFGD.

The article continues to note three hindrances on the expansion of catastrophe bonds to vulnerable and poorer regions of the world.

This includes, a need for technical intelligence to produce a contract, the need to pay for advisors and modelling experts in order to develop bespoke products, and the fact that most cat bonds are structured on triggers rather than the actual loss, which creates basis risk.

While the mention of a need to work with potentially costly catastrophe risk modelling experts in order to establish pricing and the terms of a cat bond transaction was noted by the CFGD, it’s important to remember that in order for any form of risk transfer to be successful and affordable adequate modelling capabilities are essential.

Vulnerable regions of the world that are highly susceptible to a range of natural catastrophe events, such as parts of Asia, Latin America, and Africa, lack historical data and advanced modelling capabilities when compared to more mature markets, such as the U.S. and parts of Europe, for example.

As a result, the ability to develop products and solutions of the insurance-linked securities (ILS) market, such as catastrophe bonds, is limited.

Without the ability to adequately and effectively assess the potential frequency and severity of natural disaster events in these parts of the world, it’s far more difficult to design and issue a catastrophe bond to cover the risk in a way that investors will find attractive.

Investor demand for cat bonds remains strong, but the maturity and sophistication of today’s ILS space suggests that capital markets investors require a clearer understanding of the risk, so naturally, modelling and transparency play key roles.

The CFGD highlights that there are some transactions that do protect the more vulnerable and poorer countries, citing the $100 million Bosphorus Ltd. (Series 2015-1) deal from the Turkish Catastrophe Insurance Pool (TCIP), and the MultiCat Mexico Ltd. (Series 2012-1) transaction sponsored by global reinsurer Swiss Re.

Furthermore, the World Bank – CCRIF – 2014-1 transaction, sponsored by the then named Caribbean Catastrophe Risk Insurance Facility (now known as the CCRIF SPC), also provides coverage against natural disasters for member states of CCRIF SPC.

Interestingly, and coming back to a point made by the CFDG surrounding the trigger structure of the catastrophe bonds when compared to more traditional insurance protection, each of the above mentioned deals utilised a parametric trigger structure, which is an important element of the successfulness of such a deal.

Omitting the need to wait for claims assessments post-event, a parametric trigger offers rapid payout post-event as the bond is triggered once a predetermined peril, such as a hurricane, reaches a predetermined intensity in a given location, for example.

Transactions are tailored to individual needs and while an element of modelling is required, a parametric trigger could support and increase protection in vulnerable regions, as shown with the deals mentioned in this article.

“Scaling up this market for lower-income countries would provide better shielding against many risks that undermine development overseas. It would leave more cash in donors’ pockets to tackle the kinds of emergencies that are hard or too expensive to insure against.

“And it would provide the kind of protection to poorer an vulnerable places that rich countries and large firms are choosing for themselves,” said the CFGD.

Catastrophe bonds are just one of a number of ways that insurance solutions can be expanded to those in need in an efficient and affordable manner, something that has been noted by global organisations in the fight to build disaster resilience across the world.

Modelling capabilities continues to advance as technology progresses on an increasing scale, and in turn capacity to better-model and therefore better-understand catastrophes in emerging, vulnerable, and poorer regions, should gain traction also.

Of course, the ILS market is really still in its infancy and the capital was originally seen as needed the most in mature risk markets, where exposures are so great and concentrated that the depth and liquidity of capital markets were seen as vital for peak catastrophe risks.

But ILS and catastrophe bonds in particularly, have now demonstrated that their efficient mechanisms for risk transfer could be brought to bear on risks in regions where vulnerable people need access to financing rapidly after an event occurs. Hence growth is expected  in these regions, especially as the task of sponsoring an ILS or cat bond transaction becomes simpler and cheaper.