Cat bonds, risk pools, parametric triggers key to risk mitigation: Aon

Innovative insurance and reinsurance mechanisms such as catastrophe bonds, risk pooling facilities and parametric triggers are all key ways that risk mitigation can be improved in the world’s most vulnerable areas, Aon said today.

The insurance and reinsurance broker highlighted the continuing issue of the protection gap and the need for society to build greater resilience against catastrophes.

Just in the last decade, natural catastrophes have driven global economic losses amounting to US $2.98 trillion, Aon’s data shows.

But only US $845 billion of this figure was covered by insurance or reinsurance, resulting in a very significant protection gap of 72%.

The broker hosted an event in London today, where public and private sector figures and organisations came together to discuss ways to collaborate and close the insurance protection gap.

There is a need for the insurance and reinsurance industry, as well as the insurance-linked securities (ILS) market, to work closely with governments, humanitarian and non-governmental organisations to achieve this goal.

The goal is to create solutions that can scale and deliver the necessary protection at all levels of society to narrow the gap between insured and uninsured catastrophe losses.

Greg Case, CEO of Aon plc, explained, “The protection gap places an immense financial strain on governments, businesses, communities and individuals. Yet, financial impact is only one aspect of the toll these disasters inflict. We also must consider the profoundly troubling humanitarian and social impact – lives lost, communities compromised and businesses, as well as individual livelihoods, disrupted.

“Considering the magnitude of the challenge, a solution is beyond the ability of any individual, organization or even sector. We have absolute conviction, though, that, collectively, we can make a difference. Our hope is that we will forge a shared commitment to new ways of collaborating that will allow us to build resilience at scale.”

Asia is highlighted as the region with the largest protection gap, as just 12% of economic losses, US $151 billion out of US $1.23 trillion, were covered by insurance and reinsurance in the last decade.

In Latin America and Africa too, insurance take-up rates sat in the low single-digits over the last ten years, meaning the majority of losses went uninsured and government or international financial support was required to help communities recover.

In order to combat the protection gap, the use of innovative and advanced risk transfer tools and structures is required.

So too is access to capital and naturally the insurance-linked securities (ILS) market is an area where significant focus is placed, as a conduit for taking the world’s catastrophe risks to the deepest and most liquid pools of capital available.

Aon highlights in particular the use of catastrophe bonds, as well as catastrophe risk pooling facilities and parametric triggers in insurance or reinsurance, as “important new ways to improve risk mitigation in the most vulnerable areas.”

The British Red Cross participated in today’s event and as we’ve documented the organisation is already working on a volcanic risk catastrophe bond and has ambitions to broaden their use to cover other humanitarian risks such as refugee and migration financing.

Simon Meldrum, Innovative Finance Specialist, British Red Cross, commented, “Our vision is of a world where every community is resilient to the impact of the climate crisis, both today and in the future. With a presence in almost every country in the world, we see first-hand the humanitarian impact of increasingly volatile weather. We are also one of the biggest organisations in the world responding to natural disasters and people in crisis. In addition, we are working in disaster risk reduction through our Climate Centre and other specialists across the Red Cross.

“We are now starting to explore new ways of working with private sector partners and pilot some exciting initiatives such as insurance linked securities or catastrophe bonds because we believe that cross-sector collaboration with governments, the insurance sector and non-governmental organisations will be critical to shifting the dial in the humanitarian response.”

The protection gap has been a constant source of discussion in the insurance and reinsurance industry over the last decade. In fact, I first wrote about the concept back in 2011 and it’s become a topic of discussion we cover here at Artemis at least once a week.

Progress has been made in some areas, but still the percentage of global catastrophe and weather losses that are uninsured keeps rising, especially in emerging economies.

The tools and techniques to transfer these risks are now abundant, as too is the capital and capacity to support their transfer. But issues surrounding understanding of insurance, government buy-in, furthering education at all levels continue.

At it’s most basic level though, there is a need for the world’s corporate actors and governments to take greater responsibility for protecting their communities, workers, their infrastructure and also their asset flows around the world.

This top-down approach could reap significant benefits, if only these players were encouraged (in some cases mandated) to buy more protection, to the benefit of the people who’s lives their operations and decision-making touches upon.

While at the same time expanding insurance penetration at the micro-level will also help to make communities more resilient from the ground up. From individual protection for the poorest, to small businesses having greater access to responsive risk transfer tools that help them deal with and trade through disasters, this tier is essential to community life.

In the middle sit the actors such as the Red Cross, who can bolster their ability to do their work more effectively through the use of innovative insurance based risk financing and other tools such as insurance-linked securities (ILS) and cat bonds.

It’s a tiered approach, but the holistic protection that could result from it would be a great contributor to the closing of the protection gap.

The insurance, reinsurance and ILS industry is putting significant effort into these protection gap initiatives, but with our changing climate time is running short and the industry needs to prioritise and accelerate its work in this area.

An unpopular thought may also be the industry’s cost-base and the expense of accessing insurance and reinsurance capital, as a factor that is holding back these efforts.

More efficient risk syndication will help and placement of programs needs to be made seamless, with technology leading the way here, to ensure that affordability is high for those seeking protection at all tiers of society.

So too is making the industry’s risk models available to actors in society and helping them understand their exposures and how risk transfer can be structured and placed in modern, lower-cost ways, to deliver the access to risk bearing capacity that is necessary.

It’s encouraging to see the discussions still taking place, but the time for action is now and making use of the available modern tools and efficient capacity together is key to delivering societal benefits that could last for generations.