Catastrophe protection gap needs capital market support: Bernardino, EIOPA

Gabriel Bernardino, the soon to retire Chairman of the European Insurance and Occupational Pensions Authority (EIOPA), has highlighted the capital markets role in delivering catastrophe insurance that has fewer protection gaps.

In an interview with Brink News, Bernardino explained the need for multi-peril catastrophe insurance and reinsurance coverage that protects against the uncovered portion of risks, such as non-damage business interruption related to a pandemic or other peril, just as much as physical property damage.

“I think there is a clear recognition from all parties, that the current situation — when we look at the coverage of business interruption — is far from optimal. It creates risks for the companies and reputational risks for the insurance market,” Bernardino explained.

Adding that, “I think we can do better collectively as a society to deal with these risks. There are different views, but I think that there is a high level of support for an approach that would combine public and private engagements in order to maximize the COVID-19 agenda and to have a better management of these risks out there.

“There are solutions in the form of insurance and reinsurance mechanisms. What is needed at the end of the day is political willingness and political decision to move ahead.”

Discussions about insurance backstops for pandemic and other systemic risks are rife and Bernardino boils it all down to a need to redesign catastrophe insurance for the current moment.

“Non-damage business interruption is a quasi-systemic risk. It is impossible for these risks to be dealt with by the insurance sector alone. What we propose are three elements for this shared resilience solution to work. One is to really have better risk assessment,” he explained.

“Secondly, the role of prevention and mitigation is crucial. And when we’re talking about that, it’s prevention and mitigation that can, and should, be put out there not only by governments, but also by different companies in the economy and by insurers.”

A four-layer solution to provide risk capacity for risk transfer has been proposed by EIOPA.

Bernardino laid this out as, “Firstly, direct insurers will need to have a role because insurance companies need to have some skin in the game. So there needs to be some coverage done by the insurance sector to participate in its common effort. It’s the role of the insurance that should go beyond just the role of conveying money from the public side to the policyholders.

“A second layer is for the reinsurance market to have different elements; it can be pools that we have seen that developed in some countries, but also some alternative risk transfer mechanisms.

“Thirdly, there will be a role for governments at the national level in excess of the private market capacity.

“Finally, a fourth layer should be an EU-level support mechanism that could have different nuances. One possibility could be to have a new reinsurance solution on top of what is insured by the other layers.”

It’s easy to see opportunities for the capital markets as provider of deep capacity to support this, at the reinsurance layers, or even in supporting the EU-level support layer.

Asked whether there is a role for the capital markets and insurance-linked securities (ILS), Bernardino said, “Of course, alternative risk transfer mechanisms and the capital markets are quite relevant in terms of transferring risks — and we have seen that in different types of situations with other types of risks. Now, is it an easy solution? No.”

He went on to explain the need to simplify the risk and related triggers, in order to get the capital markets onside.

What this boils down to, in our view, is putting sufficient understanding around the exposures, in the form of data and then designed triggers, to allow the risk to be adequately priced by ILS funds and capital markets players.

Even with the more correlated nature of the risk, if there is sufficient transparency around pricing and risk metrics, there is almost certain to be a capital market for some of them.

How much capacity that could bring to bear remains to be seen, but initiatives elsewhere believe that the capital markets could be a significant supporter of these kinds of risk pooling structures.

Bernardino continued, “Usually capital markets prefer to have a role in risks that are completely uncorrelated from an economic perspective or from a financial market perspective. This is not the case with this risk, but if we avoid complexity — if we can reduce the moral hazard in the way that we define the risk in the way that we define the transfer and the coverage — then I think these will all help to have more standardized risk coverage, which is much more suitable to be placed in the capital markets.

“We need to have something standardized and simple enough with simple trigger mechanisms in order to make sure that it is sufficiently transparent to be funded on the capital market side.”

Bernardino sees the potential for this kind of multi-country, multi-peril, risk pooling and risk transfer solution to have broader application to a wider range of risks as well, including climate related exposures.

“As you know now, everything related to climate change is a hugely important and central element of EU politics. The green agenda is one of the main objectives of the European Commission. So I really hope that this can also contribute to having this discussion at the political level and to take decisions going forward,” he said.

Adding, “That’s why we have been looking at the possibilities of having multi-peril approaches because we have come out with this proposal specifically for the pandemic, but these are solutions that can also be applied in other types of risks.

“In order to deal with this properly, we need to have a combination of EU and national implementation. If we just have one of the legs, I don’t think that this will change the picture very much.

“Our key contribution for this is to try to bring these two elements together in a comprehensive framework that will make this situation in the future managed much better.”

Also read: EIOPA calls for capital markets capacity for pandemic NDBI insurance.