EIOPA calls for capital markets capacity for pandemic NDBI insurance

There is a clear role for risk transfer to the capital markets in the provision of capacity to address pandemic related non-damage business interruption risks, according to Europe’s insurance and reinsurance sector watchdog, the European Insurance and Occupational Pensions Authority (EIOPA).

The Authority has published a new staff working paper that lays out ideas for improving the insurability of business interruption in light of pandemics.

EIOPA’s staff have analysed a range of potential options relating to prevention measures to increase resilience and to reduce losses, sourcing much needed insurance and reinsurance capacity with capital markets risk transfer a recommended option, and also multi-peril solutions for broader coverage of systemic risk.

The paper also looks into some of the challenges related to modelling and structuring triggers for claims in the context of pandemics as well.

Prevention is placed up front, but following behind is the need for capacity and the awareness that traditional insurance and reinsurance market sources alone will not be able to provide this, even if the models and triggers are constructed to support risk transfer.

“To improve society’s capacity for bearing business interruption risk beyond traditional insurance mechanisms, capital markets can be an additional layer of risk transfer and diversification,” EIOPA explains.

Further stating that, “Designing new and successful capital markets instruments for financing business interruption risk in a pandemic crisis pose challenges, and require legal certainty, predictability and swiftness in the payment of claims.

“Progress on pandemic risk modelling and pricing is needed, where possible incentivizing risk prevention through relevant claim triggers.”

In a letter to the European Commission’s Commissioner for Financial Services, Mairead McGuinness, EIOPA explains that getting investor buy-in for covering pandemic non-damage business interruption will not be a simple task.

“There are challenges to involving investors in financing business interruption risk in a pandemic crisis, in particular where their risk appetite is limited,” the letter explains. “Public-private solutions for a pandemic financing facility may be relevant to consider in a shared resilience solution. But further work is also needed to improve legal certainty, predictability and swiftness in the payment of claims, and to incentivise risk prevention through relevant claim triggers.”

Interestingly, EIOPA identifies the significant coverage gap that exists for business interruption and in particular non-damage business interruption.

Our regular readers will already be aware that a new startup, OTT Risk, has launched specifically to address this gap, using advanced technology such as machine learning, financial structuring and insurance-linked securities (ILS) techniques to tap into capital market investors as a source of reinsurance capacity.

EIOPA’s work on this paper will have been underway prior to OTT Risk coming to light. We interviewed the founders Chamath Palihapitiya and David Soloff as part of our ILS NYC event, which you can watch here.

Particular challenges that are expected, when trying to transfer these pandemic business interruption risks to ILS and capital market investors, include “generating enough return and diversification for investors, to designing parametric triggers that are both objective (to counter moral hazard) and relevant (to limit basis risk),” EIOPA explains.

In addition they noted that public-private solutions to create a “leveraged pandemic fund” may be a relevant option to consider, in order to get investor buy-in for a shared resilience solution.

The paper also discusses the potential benefits of pooling multiple risk types, focusing on systemic risks.

This also closely matches the OTT Risk business model, as the team there have a desire to provide capacity to support a wider range of non-damage business interruption risks than pandemic-related alone.

EIOPA said, “Multi-peril solutions can provide opportunities for addressing the systemic risk of ‘following’ events. While pandemic-specific schemes are being discussed today, the option to introduce future-focused multi-peril pools should be considered going forward. This could support the development of common prevention measures, as well as address the opportunity cost of separate peril solutions.”

Adding in its letter to the EU Commissioner, “The next crisis is unlikely to be the same as today’s, so we should improve our tools having in mind future challenges ahead.”

The topic of economic business impacts from unexpected events (essentially interruption, but also intangible hits to value, economic drivers etc), and how to financially protect against them or transfer the risk of them occurring, is a very hot subject right now.

While the insurance and reinsurance industry has been excluding some of these exposures from its products, where they were never designed or expected to be covered, others are looking at new ways to put understanding and analytics around these exposures, with the aim being to facilitate risk transfer.

It’s good to see these discussions at high levels in European politics, we suspect similar discussions are ongoing elsewhere around the world.

Deep reinsurance capacity is required to support functioning insurance systems to support the world’s businesses, as these systemic level and largely intangible risk exposures from interruptions to economic activity become increasingly important.

The global capital markets are the ideal source for that and insurance-linked securities (ILS) provides the structures that could channel that capital to risk.

Watch our video interview with OTT Risk founders Chamath Palihapitiya and David Soloff, which was part of our ILS NYC event.