Public sector use of reinsurance, collateralized & cat bonds growing: Guy Carpenter

The use of risk transfer solutions, including reinsurance, collateralized reinsurance arrangements and ILS or catastrophe bond issuance, is rising among the public sector, as entities look to better manage and mitigate their loss exposures, according to Guy Carpenter (GC).

“Insurers and public sector buyers are benefiting from the increased supply of catastrophe capacity from reinsurers and are also turning to capital markets and convergence capital solutions to supplement their traditional reinsurance placements,” explains reinsurance broker GC in a report.

GC states that between 1970 and 2014, $2.7 trillion of global natural catastrophe losses, or roughly 73% were uninsured, leading private and public sector risk leaders to seek a reform of the roles and responsibilities through “which societies can better manage these complicated risks.”

This $2.7 trillion figure represents a huge protection gap, and as public sector entities seek to better manage their financial and economic exposure to natural disasters, the use of alternative risk transfer tools and capital market capacity has increased.

The capital base in the global reinsurance market has witnessed impressive growth in recent times, aided by the persistent influx of alternative reinsurance capital from institutional investors, such as pension funds and family offices.

2014 was a record breaking year for ILS as catastrophe bond issuance reached its highest ever level, as recorded by the Artemis Deal Directory, and so far in 2015 issuance levels have remained strong, and could again break the $8 billion mark by year’s end.

And, according to GC 30% of the currently $22 billion, that GC counts, in outstanding catastrophe bonds were issued by public sector entities, such as the Texas Windstorm Insurance Association (TWIA), Florida Citizens, and the California Earthquake Authority (CEA).

“Catastrophe bonds have provided new sources of risk capital where traditional reinsurance markets were not positioned to increase the capacity commitments they made,” highlights GC in its recently published report, ‘Partnerships: The Way To Public Sector Risk Financing.’

What’s more, the report underlines the fact that many public entity cat bond sponsors have returned to the market for a repeat sponsor, and a wave of potential new entrants are in the pipeline, implying satisfaction of the benefits and workings of alternative risk transfer solutions to protect against catastrophe exposures as a supplement or addition to their traditional reinsurance programmes.

“The fact that significant market capacity now exists to shift the burden from taxpayers to diversified markets is a welcome option to the politically unpalatable post-event scenarios faced by many public entities,” notes GC.

A goal and struggle for public entities globally is to reduce public debt and increase economical and financial security, an area the reinsurance and ILS landscape can really help with.

Transferring risk via the use of traditional risk transfer structures, like reinsurance, or to the capital markets using alternative risk transfer mechanisms, such as sidecars, collateralized reinsurance and cat bonds, alleviates some of the financial burden placed on governments post-event, and can also ensure a speedier recovery and rapid payout.

A notion highlighted by GC, which states that by utilising reinsurance and ILS, public entities “gain enhanced flexibility to finance economic and social development and build infrastructure, reducing the likelihood of increased taxation and/or assessment/surcharges as a result of the adverse event. These solutions also allow local economies to recover more quickly.”

The ability of public entities to adequately and successfully transfer catastrophe risk to the capital markets has been aided by the growing presence and force of the convergence markets, offering organisations multiple avenues and structures to adopt, which best suits their individual needs.

“The use of risk transfer capacity is instrumental in many ways. It provides significant savings to public sector entities in years with outsized loss activity and it supplements and protects loss reserve funds/surplus built in years where losses have not exceeded retained premium,” concludes GC.

With global organisations and regional insurers, reinsurers and the wider risk transfer world stepping up commitments to build global disaster resilience efforts, it’s likely that risk transfer will become an increasingly larger slice of the pie.

And, as the use of cat bonds, collateralized reinsurance structures and alike are more widely used, accepted and understood, combined with successful application, it would be expected that public entity utilisation of ILS to manage catastrophe exposures and mitigate losses will continue to rise also.

Read our series of articles focused on the insurance protection gap – under-insurance in emerging and developing economies, the gap between economic and insurance losses, and transferring risk from public sector to private – the opportunity that is on every reinsurance CEO’s lips and which presents the largest opportunity to put excess risk transfer capital to use, requiring both traditional and capital markets support.