Indonesia cat bond possible, as World Bank lends for disaster insurance

The World Bank has approved $500 million of funding for Indonesia to help the country enhance its financial response to natural disasters, climate risks, and health-related shocks, with the use of risk pooling, and insurance or reinsurance instruments at the heart of the plan.

Between 2014 and 2018, the central government of Indonesia has spent between US$90 million and US$500 million annually on disaster response and recovery, the World Bank explained, while Indonesia’s local governments spent an estimated additional $250 million over the same period.

With the cost of natural disasters and severe weather events expected to keep increasing further due to climate change and also urban growth, the World Bank notes that these costs will pressure Indonesia’s government public spending.

Add to this the additional pressure of the COVID-19 pandemic and it’s clear risk financing and risk transfer to remove some of these fiscal and financial pressures would benefit Indonesia going forwards.

A new World Bank project aims to support the Government of Indonesia’s National Disaster Risk Finance and Insurance Strategy, with this $500 million loan expected to fund a significant amount of work.

The goal is to strengthen Indonesia’s fiscal and financial resilience by putting in place a risk Pooling Fund for Disasters, which will be backed by insurance and reinsurance instruments from international markets.

Commenting on the loan provision from the World Bank, Sri Mulyani Indrawati, Minister of Finance of the Republic of Indonesia said, “Financial preparedness for disasters, climate shocks, and health crises such as COVID-19 is increasingly important for Indonesia. This support will help the government deliver a more targeted and timely response, reducing the impact of disasters and helping to protect Indonesia’s development progress.”

The World Bank project will seed fund the Pooling Fund for Disasters, which in future will utilise a range of financial instruments to ensure it has sufficient resources to pay out for disasters.

These are likely to include insurance and reinsurance market based instruments, but also pre-arranged financial market instruments that can provide contingent sources of capacity.

The risk pool will, “Leverage domestic and international insurance and reinsurance markets to support more efficient disaster response through providing financial capacity to backstop the fund in severe disaster years and by drawing on expertise and technology for managing payouts,” the World Bank said, while the precise financial instruments to be used are as yet undecided.

Which is where catastrophe bonds and insurance or reinsurance risk transfer to the capital markets comes in, as one viable option for securing the necessary capacity to underpin Indonesia’s disaster risk pooling facility.

The World Bank’s strategy for this Indonesia project is, “Identifying contingent liabilities in advance, pre-arranging a combination of financial solutions including leveraging financial markets, setting clear public financial management rules for use of these resources, and linking these funds to clear disbursement channels so they reach beneficiaries efficiently.”

While the amount of insurance and reinsurance protection the new Indonesia risk pool will need is as yet unspecified, the World Bank believes that, “Markets are expected to play a catalytic role in expanding protection coverage over time.”

This likely includes the capital markets, which again brings the catastrophe bond forwards as a potential risk transfer mechanism that could secure the capacity needed to support Indonesia’s disaster risk pool in an efficient manner.

As the Indonesian government looks to build on its National Disaster Risk Financing and Insurance (DRFI) strategy, with this risk pooling initiative seen as a key component, the use of risk transfer to financial markets is expected to play an important role.

Purchasing insurance or reinsurance protection for the Indonesia Disaster Risk Finance Pooling Fund that will channel capital to support the risk pooling initiative is seen as vital for its sustainability.

The subject of catastrophe bonds and disaster risk transfer to the capital markets has come up previously and Indonesia’s government has had discussions regarding the use of catastrophe bonds as a disaster risk financing tool before.

Importantly, the World Bank sets out its goals for how disaster risk capital would be used, which is critical for such a project.

Saying that “effective and transparent” flow of funds is critical, to ensure money gets to the right people and places quickly after disasters strike.

All of which goes to say, that accessing efficient forms of capital, using structures that can be triggered transparently and quickly if disasters occur, should put the catastrophe bond at the heart of discussions to protect Indonesia’s risk pooling facility once it’s up and running.

Satu Kahkonen, World Bank Country Director for Indonesia and Timor-Leste, commented, “The improved availability and flow of funds will ultimately support the population of Indonesia who will benefit from faster and better targeted response to disaster and health shocks. This will particularly benefit the poorest and most vulnerable, who are most affected by delayed disaster response and often lose their livelihoods and incomes, which keeps them in poverty.”