Capital markets ideally placed to meet emerging ECIS demand: RMS

by Artemis on October 19, 2018

Insurance-linked securities (ILS) are well positioned to meet emerging demand from the ECIS region (Western Balkans, Southern Caucasus, Eastern Europe and Central Asia), although certain challenges must be addressed in order to stimulate issuance, according to global catastrophe risk modeller, RMS.

Artemis recently spoke with RMS’ Global Managing Director, Daniel Stander, and a consultant in RMS’ Capital and Resilience Solutions Practice, Conor Meenan, on the sidelines of the recent UNDP disaster risk financing conference in Istanbul. The focus: the potential for and the benefits of disaster risk reduction (DRR) and disaster risk financing (DRF) across the ECIS markets.

“The region stands to benefit from ILS like any other. ILS investors tend to be region-agnostic. As long as the modelling is trusted and the trigger mechanism transparent, capital will be interested. Then, like other regions, cat bonds can be tailored to provide capital for any disaster need, from immediate response to longer-term reconstruction,” said Stander.

Meenan added that the ECIS region is highly exposed to both the frequency and severity ends of the risk spectrum, driven by significant seismic and climate hazards.

“The Caucasus, the Balkans and Central Asia will each profit from any measures that help to transfer some of this risk. The Bosphorus issuances demonstrate that there is appetite and capacity for both ILS and sophisticated parametric triggers,” continued Meenan.

Catastrophe bonds Bosphorus 1 Re Ltd. and Bosphorus Ltd. (Series 2015-1) were both issued by the Turkish Catastrophe Insurance Pool (TCIP), offering a combined $500 million of parametric reinsurance protection against Turkey earthquake risks. As shown by the Artemis Deal Directory, RMS was instrumental in the design and delivery of these facilities.

Catastrophe bond issuance across the ECIS region has struggled to expand, however, and Meenan explained that ILS and collateralized sources of reinsurance capacity must be demand led.

“Sovereign-level cat bond issuance will only be sustainable over the long-term if the ministries of finance want to transfer their disaster risk.

“UNDP has a vital role to play in stimulating demand. The agency can convene stakeholders, ease communication and catalyse action across national borders. This type of regional collaboration can be crucial, especially when countries face potential disasters – like the 2014 Southeast Europe floods – which pay no heed to geopolitical boundaries,” said Meenan.

Stander, added: “Two actions will catalyse cat bond issuance in the region above all. First, countries need to invest in quantifying their risk so that they can confidently describe their need. Second, donor nations need to embrace the countries’ intent by offering premium financing.”

Alongside regional collaboration, the pair noted certain political, economic, financial and social constraints that must also be addressed.

“There is a role for disaster risk financing at all scales – from the farmer to the finance minister,” said Stander. “The nature of challenges varies by scale. One constraint, however, exists at all scales: cost. The long-term affordability of a risk financing instrument must be considered if the solution is to be sustainable. This is as true for the farmer and the finance minister as it is for the fund manager.”

Meenan added: “Another criterion is fitness for purpose. This means the overarching need must be clearly identified and articulated. Then the instrument can be built around a specific purpose. For example, disaster risk financing that aims to support emergency response might look very different from one designed to support, say, the reconstruction of public infrastructure. Any financing scheme that isn’t sensitive the constraints of its purpose will be unsustainable.”

Despite the challenges, Stander believes that the capital markets are ideally placed to meet the emerging demand. He cited three reasons.

“First, collateralized risk transfer offers sovereign sponsors a high level of certainty and simplicity. Second, large-scale risk transfer in the region will initially be on a parametric basis – an approach which suits capital markets investors. After all, sponsors and investors alike want rapid post-event processes. Finally, the region is effectively uncorrelated, so we can expect good appetite amongst ILS investors.”

DRR and DRF efforts in other parts of the world, such as regional risk pools in the Caribbean and Africa, and CDDO arrangements by the World Bank, are an example of effective risk transfer schemes that leverage the capital markets and bring collateralized sources of reinsurance capital to solve these disaster funding issues.

Stander told Artemis that lessons learnt in other parts of the world can be brought to bear in the ECIS region.

“Perhaps the most obvious lesson from the sovereign-level financing schemes implemented to date is that single-peril, parametric triggers offer a good first step into large-scale risk transfer. From relatively simple beginnings, trigger sophistication and peril scope can evolve as required over time. The take-away: don’t let aspirations of perfection prohibit the successful delivery of ‘good enough’ solutions. Given the sheer scale of the resilience gap, municipalities can do a lot with a little,” said Stander.

“Another valuable lesson is that packaging up regional exposure within a pooling scheme can offer an efficient approach to begin modelling and transferring risk.

“Of course, the heterogeneity between countries – in underlying risk, government capability and regulation – presents a challenge to sovereign risk pooling. Yet, while no two countries are the same, risk pools can be structured with sufficient flexibility to accommodate country differences. Indeed, experience has taught us that disaster risk financing facilities are more likely to get off the ground when municipalities which share similar risks, needs and capabilities collaborate.

“A further lesson is self-evident: the quantification of catastrophic risk is fundamental to developing effective disaster management strategies. This is as true for DRR as it is disaster DRF. Simply put, DRR financing cannot get out of the blocks without an initial appreciation of the frequency-severity distribution of the potential impacts of acute shocks.

Meenan concurred: “Central European and Eurasian governments stand to benefit greatly from techniques developed for more developed markets. They can leverage tried and tested risk transfer mechanisms pioneered in the developed markets, as well as the cat models methods that supported the design of those mechanisms.”

Challenges of course remain, said Stander, referencing how a lack of awareness and a lack of incentives hinder the development of national and regional financing tools.

“In many parts of the world, homeowners and government officials alike are simply not aware of the potential human and economic impacts of probable shocks. Equally they are often unaware of what existing solutions cover and what innovative solutions are available.

“And even where such understanding exists there is rarely sufficient alignment of interests to drive behavioural change. In principle, this is not very difficult to solve. It’s a case of identifying the stakeholders, surfacing their objectives and structuring solutions that deliver the desired outcomes for each beneficiary. In practice, though, this takes time.”

RMS seems unwavering in its commitment to lead this agenda. Stander certainly is, reflecting on the sense of purpose which motivates him: “Since its founding in the 1980s, RMS’ mission has remained constant: to make communities and economies more resilient to disasters through a deeper understanding of catastrophes. There is arguably no better way for RMS to fulfil its societal mission than by pioneering sovereign-level disaster risk financing for developing regions.

“After all, fit-for-purpose analytics play a critical role in designing and implementing effective strategies for economic and social resilience. They help define the problem, set realistic targets, prioritise mitigation initiatives and structure financing solutions. This is no less the case for the developing communities across central Europe and Eurasia. The type of risk analytics which have underpinned DRR financing in developed markets can be harnessed to stimulate the prudent management of disaster risk in developing ones.”

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