Mobilising capital after disasters is key to economic recovery: Report

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Disasters, be they natural in nature and caused by weather or other catastrophes, man-made such as terrorism, cyber and industrial catastrophes, or others such as health-related, like pandemics, can all have the effect of denting economic, social and political resilience and as a result mobilising capital swiftly after the event is critical.

Mind the Gap sign (Source: Autoprotect)Of course we’ve been writing about the so-called protection gap for years, explaining the need for risk pooling, risk transfer and access to efficient risk capital to support risks in areas of underinsurance, or even for risks where there is no insurance available at all.

One key component of the structures already in place to support recovery from disasters is the protection gap entity, by which is meant the likes of Pool Re for terrorism, Flood Re for flood risks, CCRIF SPC (Caribbean Catastrophe Risk Insurance Facility) and insurers such as the California Earthquake Authority (CEA).

Our coverage is typically focused on these entities need for reinsurance capital to backstop the risks they assume or pool, as well as the potential for the capital markets to act as reinsurer or capital provider, letting the entities leverage the efficiencies and liquidity of capital markets to finance risk.

But there is much more to this issue, including the socio-economic reasons these entities have come into being and also the question of whether they all adopt the best possible structure to deliver the help that is required.

A newly published report from Cass Business School seeks to dive into this issue in far more detail than we can.

The report, titled “Between State and Market: Protection Gap Entities and Catastrophic Risk” looks at different Protection Gap Entities (PGEs) from around the world in both developed and developing economies, examining their role, their effects and their limitations in managing risk and helping to relieve the financial consequences of disaster.

The report finds that the mobilising of capital is essential to aid economic recovery from disasters, with the short-term financing immediately after disasters seen as critical, while in the longer-term we’d suggest that protecting inflows of capital (donor, corporate, sovereign, etc) is absolutely key to assist in reconstruction and recovery.

Insurance products, structures using parametric triggers, reinsurance capital to underpin this, as well as the tools of the capital markets and insurance-linked securities (ILS) all provide mechanisms to alleviate some of the impacts and ease the recovery, but the report finds that the protection gap entities themselves need to continue to evolve to better meet the needs of stakeholders.

The evolution of protection gap entities is key, as they need to keep pace with developments in private markets to ensure they are utilising the latest financial technology and most efficient mechanisms for accessing capital, in order to provide the best services possible.

In many cases protection gap entities can be held back by politics and the inability of the state to move quickly enough to provide enhanced and improving coverage, hence the report discusses the fact these entities sit between state and market.

Hence, one of the conundrums of narrowing the protection gap is marrying the objectives of the state with those of the marketplace, not always the easiest task.

Getting shareholder equity backed insurance and reinsurance firms to align with the objectives of the state is never easy and often ends up being an industry sponsored public relations initiative, of which we’ve seen many in recent years.

However recent initiatives appear to be offering better solutions and methods of engagement, so it is to be hoped that the marrying of state and market can become more fruitful over time.

One point worth mentioning here is that the motivations of the capital markets is a little different from re/insurers, as the investors simply seek a reasonable risk-adjusted return for assuming catastrophe and disaster risks, where as a re/insurer has operational overheads and shareholder demands to support as well.

Here, the combination of risk markets and capital markets can perhaps provide a better solution for working with the state, as the availability of the capacity comes down to the returns being reasonable, while the risk market expertise can originate, analyse, structure and assist in transferring that risk.

In this way we feel the protection gap entities and their efforts could become another glimpse of the future of re/insurance, with the traditional market expertise becoming more important than its balance-sheets, while the capital market offers the depth and liquidity necessary to assume such vast volumes of risk.

This is where cost comes in though, as in developing economies the ability to pay enough for risk transfer is not always evident, leading to donor involvement, subsidisation and other factors required to support the protection gap entities and sometimes even the local market insurers.

Which makes using the most efficient forms of capital essential of course, but even the capital market investors have a minimum return requirement.

As a result it’s hard to offer many solutions and the report does not come to any dramatic conclusions, as we can’t, about how to narrow the protection gaps. Neither does it define ways forwards to improve the situation.

But it is clear from our experience that in order for the protection gaps to begin to narrow, the risk and capital markets need to come together to develop, provide and support a tiered infrastructure for disaster risk transfer, involving the efficiencies of the capital markets, alongside the expertise of the risk markets, to support sovereign, state, commercial, and personal risk transfer.

It is usually impossible for a microinsurance initiative to survive in a country where there is no higher level risk transfer for sovereign, state and government entities, infrastructure and capital, as when disaster strikes the country suffers such severe levels of economic impact that the micro entities struggle to continue to exist.

Hence the higher-level risk transfer to support the capital flows into and out of an economy are absolutely key, needing reinsurance and capital markets expertise and support.

At the same time though, the micro level is vital to expand risk transfer to the masses, protect lives and livelihoods and help people recover from disaster.

The protection gap entities perhaps need to sit in between, in some cases, supporting the middle layer as well as back stopping the micro providers and pooling risk for the macro risk transfer efforts.

It’s a complex problem and one that is going to take the efforts of all parties to solve, although we do need a realistic approach to sourcing capital for these efforts and to make sure the role of re/insurers is the most appropriate one, making the most of the significant expertise they offer.

The report provides a good discussion piece to get the industry thinking about the role of the protection gap entity and could stimulate some ideas for better ways to structure the market, if the market is indeed really serious about the mission to narrow the protection gap. You can find a copy of the full report here.

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