The first catastrophe insurance pool for African nations has been launched today by African Risk Capacity (ARC), a specialised agency set-up by the African Union to help member states become more resilient to extreme weather events and to protect food insecure populations.
The catastrophe insurance pool has been established to enable parametric insurance policies to be sold to African countries, providing them with post-disaster event financing which is predictable and has a rapid payout mechanism due to the parametric nature of the policies.
The ARC Agency has created a specialist hybrid mutual insurance company, ARC Insurance Company Limited (ARC Ltd), which is initially domiciled in Bermuda. ARC Insurance will issue parametric disaster insurance policies to a group of African governments, starting with Kenya, Mauritania, Mozambique, Niger and Senegal. The initial capital behind the insurer has been provided by Germany and the United Kingdom, who are also founding members of the mutual.
To begin with ARC has issued parametric insurance policies with a value of approximately $135m. The policies will cover drought and each has been tailored to meet the needs of the covered African country. In addition to its own capital, ARC Ltd has secured reinsurance capacity totaling $55 million the international reinsurance and weather risk markets in order to cover the parametric risks it is taking on from the participating countries.
By pooling the risks from the group of African countries it enables the reinsurance protection to be secured at a cheaper cost, making the whole project feasible. By pooling risk across countries within a region, the reinsurance market will typically give a better price than reinsuring the countries individually.
It’s interesting that there is an element of weather risk cover included. We could make an educated guess as to who may be involved on the other side of that portion of the reinsurance cover. Using weather risk transfer products to provide some of the hedging makes sense as the covered peril is drought risks. There are markets which can provide this cover more cheaply than traditional reinsurers which may have helped to keep the costs of risk transfer down.
“The creation of the first ever African catastrophe insurance pool is a transformative moment in our efforts to take ownership and use aid more effectively. It is an unprecedented way of organising ourselves with our partners, with Africa taking the lead – taking our collective destiny into our own hands, rather than relying on the international community for bailouts,” commented Dr Ngozi Okonjo-Iweala, Chair of the ARC Agency Board and Nigeria’s Minister of Finance.
The ARC catastrophe insurance pool aims to help governments’ in Africa to reduce their reliance on external aid in the event of natural catastrophes. At the moment international assistance is secured through an appeals system and then allocated on a largely ad hoc basis after a disaster strikes. As a result, African governments affected by disasters can be forced to reallocate funds from essential development projects to crisis responses, which can create funding problems in other areas of their economies and negatively affect GDP.
Kenya’s Cabinet Secretary for the National Treasury, Henry Rotich, explained; “Droughts undermine our hard-won development gains, just as Africa is beginning to realise its vast potential. ARC will help us build resilience among vulnerable populations, protect our agriculture investments, thereby increasing productivity, as well as promoting fiscal stability by preventing budget dislocation in a crisis.”
“I’m proud to have overseen the establishment of ARC Ltd, and am pleased to acknowledge the financial support of US $200 million by the UK and German governments through DFID and KfW respectively,” noted Chairman of the Company Board of Directors and former head of the International Finance Corporation, Dr. Lars Thunell. “ARC Ltd’s insurance programme goes a step further than previous sovereign risk pools thanks to its close ties with ARC Agency. Through the development of contingency plans linked to rapid payouts under the parametric insurance policy, the benefits of ex ante sovereign risk financing will flow directly to the most affected food insecure populations.”
ARC Ltd utilises a new software application called Africa RiskView developed by the UN World Food Programme to estimate crop losses and drought response costs before a season begins and as it progresses, triggering insurance payouts at or before harvest time if the rains have been poor. A cost-benefit analysis performed by ARC Ltd estimates that spending one dollar on early intervention through parametric insurance from ARC could ultimately reduce the potential economic impact by as much as four and a half dollars.
The launch of the risk pool is timely given recent global warnings about the adverse consequences of a changing climate and the potential impact on continental Africa, as Dr Richard Wilcox, Director General of the ARC Agency noted; “ARC is a critical instrument for countries to manage their risks as they experience the consequences of climate change.”
“ARC is a breakthrough in disaster risk management in Africa, a win-win for governments and their partners alike. By putting their political legitimacy and technical skills together, the African Union and WFP have created a game-changer,” added Nobel Laureate Professor Robert Shiller.
The drought protection provided through ARC is likely the starting point for this project and we could see additional covers become available in the future. As these catastrophe insurance pooling facilities emerge in developing economies it brings new risks to the international reinsurance market and also educates emerging economies in the benefits of risk transfer and reinsurance. As a result these efforts should be supported as one day they could result in more diversifying risks becoming available to reinsurers and the capital markets.