In order to close the insurance protection gap the world’s oldest insurance and reinsurance market, Lloyd’s of London, says that capital market investment, channeled through insurance-linked instruments, is going to be a key tool to help achieve this.
Lloyd’s notes in a release today that efforts to close the disaster protection gap are not going well, with an estimated $163 billion of assets left underinsured in the world today and this gap having only closed by less than 3% in the last six years.
You’d think that Lloyd’s would be extolling the virtues of its marketplace and traditional insurance and reinsurance syndicates, as the mechanism for closing these gaps.
But actually, even the world’s oldest insurance market is aware that without the support of the capital market the task of narrowing this gap is going to be incredibly slow and that borrowing concepts from financial market structures and insurance-linked securities (ILS) is likely to have greater effect in a shorter period of time.
Insurance penetration rates remain significantly higher in developed nations compared to in emerging economies, but the insurance industry on its own is not making the headway required to meaningfully close this gap, it appears.
As a result, research from Lloyd’s, alongside the Centre for Global Disaster Protection, Risk Management Solutions (RMS) and Vivid Economics, lays out some details on four financial instruments that the group say could be used to incentivise investment in resilience.
All four are more akin to capital markets tools than insurance or reinsurance, borrowing heavily from some of the concepts developed in the insurance-linked securities (ILS) and development finance markets.
The instruments the report describes are: insurance-linked loans (infrastructure loans with an insurance component; resilience impact bonds (a type of impact or social bond, but specifically for resilience); resilience bonds (the catastrophe bond like resilience bond concept that has been broadly discussed for the last few years); and resilience service company (ReSCos) (a funding mechanism that would be linked with insurance).
While all four are insurance-linked, none of these would really require a traditional insurer or reinsurer to be able to get them off the ground and in fact may even be more efficiently delivered as pure capital market instruments.
Lloyd’s did of course also explain the important role that risk financing can play, by providing liquidity immediately after a disaster strikes, protecting government capital and buffering taxpayers from the loss.
But even here Lloyd’s highlights the Indonesian governments interest in sponsoring catastrophe bonds as evidence of this.
It’s clear that ILS has a vital role to play in disaster risk financing and resilience building, with the investor base having the ability, appetite and capacity to take the natural catastrophe risk on its shoulders, while also providing innovative financing techniques.
Clearly the global insurance and reinsurance market is going to be instrumental in making this happen, as the depth of expertise is required to facilitate meaningful transfer of these risks. But the capital markets working alongside appears to be an accepted fact now, with even the most traditional of re/insurance players recognising the need for the depth and liquidity of financial markets to support these goals.
Bruce Carnegie-Brown, Chairman of Lloyd’s, commented, “Insurance is a major contributor to disaster recovery often providing the quickest financial crisis relief available. The terrible earthquake and tsunami disaster on the Indonesian island of Sulawesi underlines the important role that insurance can play by increasing financial liquidity in catastrophe affected areas. Innovative insurance solutions can provide governments with access to financial relief rapidly after a disaster strikes, easing the burden on them and tax payers. If insurance is not available catastrophes can have a much greater impact on economies and lives.
“The insurance sector wants to work with government to help people understand the insurance products that are available and to provide improved access to those products. Together we can help tackle the crippling underinsurance crisis and give people in the world’s most exposed economies the security they so desperately need.”
Daniel Stander, Global Managing Director, RMS, added, “Those who can’t afford the additional costs of building resiliently are even less likely to be able to afford to rebuild after a disaster. Being able to quantify accurately the benefits of investing in resilience is therefore fundamental. The four products have been designed with this in mind. The objective is twofold: to reduce the initial costs of building resiliently and to finance the residual risk. In this way the benefits of insurance can be enjoyed by those who need it most.”