Interview: Where next for African Risk Capacity, Dr. Simon Young

The latest in our series of interviews features Dr Simon Young, CEO of African Risk Capacity Insurance Company Ltd (ARC Ltd), a catastrophe risk pooling insurer for African states established under the umbrella of the African Risk Capacity (ARC) Specialised Agency of the African Union (AU).

The African Risk Capacity Agency was formed in November 2012 and now has 25 signatory AU States. It has a broad remit of building the capacities of its member states to prepare for and respond to natural disasters.

ARC Ltd launched in May 2014 and is approaching the end of its first year of operations. In the past year it has provided index-based drought insurance to five African nations, making payouts to three for whom the parametric triggers were breached due to poor rainfall last year.

Other initiatives that ARC has been discussing include the potential issuance of climate change-linked catastrophe bonds, an initiative of particular interest to Artemis, the provision of outbreak and epidemic insurance as a response to the Ebola crisis, adding flood and tropical cyclone coverage as well as increasing the number of member countries in year-two and beyond.

With these initiatives in mind we spoke with Dr Simon Young to get some additional insight on ARC’s ongoing initiatives and where it could focus next.

ARC’s first year appears to have been a resounding success in many ways, what has particularly pleased you about it?

The most rewarding aspect of this first year of operations is the proof of concept which it has provided for almost every aspect of the model which was conceptualised and then built with incredible perseverance by a small team under the leadership of Dr Richard Wilcox, the founding Director General of ARC.

The number of firsts that have been ticked off during this first year is too long to list here, but spans a wide range of development objectives from contingency planning and resilience-building through pro-active sovereign disaster risk management to public-private partnerships and commercial risk markets sharing in the financial response to drought in sub-Saharan Africa. Shifting the paradigm on drought response, which has been static for decades, is easy to talk about but to have actually achieved it in the most tangible terms is really notable.

At the UN in New York on 12 February, an appeal was launched to fund humanitarian support in the Sahel; ARC Ltd had already made payouts to the three most-affected countries and peer-certified contingency plans were already being implemented in two of those countries (and about to start in the third). ARC has enabled more rapid action, with greater national ownership and with better oversight on funded activities than ever before.

Establishing a risk pooling insurer is clearly a difficult process. What do you feel other countries or regions could learn from the ARC example?

The insurance piece is actually the easier bit compared to the political considerations that have to go in to putting together a multi-national pool such as ARC. One of the more challenging things on the insurance company side is the ever-changing landscape of donor support for these sorts of public-private partnerships.

Structuring the capitalisation of ARC has broken new ground in finding a compromise between grant funding and commercial investment, to enable the vehicle to be sustainable at premium costs the African nations can afford but with a tangible return for funding agencies – both in terms of return of initial capital but also the development gains achieved.

But I think the main lesson from ARC is the need for a robust political umbrella under which multiple nations and other stakeholders can identify and capitalise on the benefits of risk pooling.

The drought cover appears to have been well-received, resulting in three payouts in the first year. What feedback have you received from members?

I don’t think we’re any different to other insurance companies in respect of what our policy-holders expect of us – they expect prompt payouts when they are triggered, and a good explanation when they are not.

Given that we have made three payouts within 9 months of launching – and within 15 months of having an agreed term sheet as a basis for forming the insurance entity, the members have recognised that the internal systems and controls that have been put in place worked as designed – from both financial and administrative perspectives.

Some things didn’t go quite as planned and we will learn from those, but all in all, I think all the stakeholders have good reason to be pleased at where we are. We’ve also ‘tested’ the participating reinsurance markets, who are sharing in the payouts, and they have responded very positively.

ARC reported that it will look to issue climate linked catastrophe bonds, through a facility called the Extreme Climate Facility (XCF) how is that initiative progressing?

We made the announcement in New York in September at the UN Climate Summit and since then have been tying up the initial funding agreements for the research and development phase of the project. That is kicking off right now and we anticipate being able to share some results later this year.

The critical element we will develop first is the underlying climate index; once we firmly establish that we can do this for Africa and have a model which is acceptable to the global markets then we will start to think about financial structures etc.

So it is early days but we are excited to develop what we think is both a highly innovative climate change financing tool with global application as well as a great addition to the climate change adaptation and resilience armour for African states under the ARC umbrella.

What support, if any, could the insurance-linked securities (ILS) market provide to ARC to assist with the XCF initiative?

The initial announcement certainly generated lots of interest in the ILS market; there’s been talk over many years of bringing the private markets into the climate change financing space but it has been a struggle to do that on the adaptation side in particular.

For XCF to work, our extreme climate index methodology and the model behind it will need to be robust, transparent and acceptable to the markets – so it is in establishing those characteristics that I think the ILS market can play a role – so that when we have the structuring completed in early 2016, we can depend on interest and keen pricing from as broad a range of market players as possible.

The investor interest in ideas like the XCF is enormous. Has ARC got any thoughts as to how this product would be offered to the market in terms of diversification and structure?

It is too early for us to talk in detail about these sorts of aspects of XCF; there is a lot of hard work on developing the extreme climate index which must be completed before we start to think about the deal structuring. However, we know that the XCF issuances will be a diversifier for all ILS investors and will bring new risk into a marketplace which is fully primed to execute such deals.

ARC also reported that it would look to launch an outbreak and epidemics insurance policy, to provide cover for incidents such as the Ebola crisis. How is that initiative progressing?

As has been reported on Artemis, the ARC team received a mandate from its Conference of the Parties and has been encouraged by the African Union Commission to explore opportunities for financing rapid response at the national level to infectious disease outbreaks.

We have looked in some detail at the necessary building blocks for such a solution to be viable and we think they are there. We have also discussed how such a country-focussed programme fits within the broader global response financing that is being developed with the World Bank at the forefront.

We believe that the ARC approach, in working with countries to build their own resilience and response capabilities, while encouraging sovereign state responsibility for management of the risk, is a critical part of any sustainable pandemic response financing mechanism and we are looking forward to developing the partnerships that will be needed to deliver on this initiative.

ARC’s mission has always been to encourage resilience of its policy holders, with cheaper premiums available to those displaying efforts to become more resilient. How has this concept been received by members as it is unlike anything else in insurance?

A key innovation of ARC is the requirement for contingency planning to be in place and of an acceptable standard before the insurance product is even offered and then, in the case of a triggered payout, a further detailed implementation plan is required, again to meet a pre-agreed benchmark standard, before the payout is made.

This implementation plan is a detailed budget of how the payout will be spent, with the aim of getting as much of the payout to food-insecure individuals as quickly as possible via mechanisms that are known to work. The process is audited so that lessons can be learned and to ensure funds are used in the proscribed way.

Putting these kinds of constraints in place for an insurance programme in which the states are largely paying their own premium (only about 20% of 2014/15 premium is donor-funded, and then only indirectly) is challenging to say the least, but that has always been ARC’s ultimate aim and the proof of concept with payouts this year will certainly help in growing the programme over the coming years.

If one considers that drought response in sub-Saharan Africa has traditionally been funded almost entirely by donors, it is actually quite remarkable that countries are willing to both meet our contingency planning and other requirements and pay a premium from their own budgets – but that is what is happening and it really demonstrates the commitment of African nations to step up to the plate in building resilience against climate hazards, in the face of increasing uncertainty due to global climate change, a phenomenon in which they have played almost no role in causing.

What other products might ARC look to launch in the future?

We have plans for both Flood and Tropical Cyclone coverage in the next couple of years; the modelling has started for flood and will soon start for tropical cyclone, and we will be starting our country outreach on both in the coming months, which will include contingency planning, capacity building around the modelling technology, participation in model validation, and engagement on risk management and risk transfer (for those countries who are not participating in the drought coverage.)

The recent floods in southern Africa and Madagascar have again reminded us all of the urgency of these products and we have keen interest from countries to participate.

The risk modeling and science is key to ARC, can you tell us a little about the latest developments and technologies being employed?

While we are keen to employ the best and latest technology to improve our products and therefore our service to member states, we are also committed to ensuring that participating countries and their officials fully understand the technical aspects of the models we are deploying to underpin the parametric insurance contracts.

We think that this is critical in developing a sustainable solution, and believe that it will have a catalytic effect across the continent in further improving the landscape for implementation of index-based insurance products.

So we are looking for a balance; in many regards, we must use the latest technologies because they are the ones that are generating the data we need for Africa, but we also need to be able to generate a robust and defendable historical time series to ensure fair insurance pricing to policy-holders and competitive pricing from international markets. For example the flood modelling will utilise the latest space-based technologies because that is the only cost-effective way of mapping flood impacts across the continent.

Where would you like to see ARC in five years time?

ARC is such a multi-faceted entity that there will be a whole host of activities over the next 5 years, driven by the needs and desires of ARC’s Member States which the staff across ARC Agency Secretariat and ARC Ltd serve. We are excited to have Mohamed Beavogui take on the role of Director General of ARC Agency later this year, and look forward to helping him to implement the vision and mission of ARC.

For ARC Ltd, we want to keep growing the insurance pool by having more sovereign clients and offering coverage for new climate perils and, assuming we can raise additional capital, coverage for infectious disease. We anticipate XCF being up and running and having issued the first tranche of bonds.

But most of all, I hope that the paradigm shift in management of disasters across Africa which ARC represents will be seen to have acted as a catalyst to crowd in both the traditional donor community and the private sector to provide cost-effective and sustainable mechanisms to build resilience, which is a critical underpinning of sustained economic development for so many African countries.

This in turn, I hope, will lead to increased quality of life for millions of Africans and, 30 years later, finally move the images of famine that those of my generation so vividly remember from the front pages to the history books.

End.

Our thanks go to Dr Simon Young for this insight into the progress made and plans for the next year at the African Risk Capacity.

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