Indonesia urged to use cat bonds to back disaster insurance scheme

The idea of using catastrophe bonds as a tool to provide access to the capital markets for risk capital to support government backed disaster or natural catastrophe insurance schemes continues to gain acceptance, with Indonesia the latest to be urged to follow this route.

Catastrophe bonds have been utilised by a number of countries as a mechanism to secure reinsurance capacity or risk capital to support a state-backed scheme designed to provide some financial protection against natural disasters to local residents.

In a recent lecture Kornelius Simanjuntak, President Director of local Indonesian insurance group PT Asuransi Himalaya Pelindung and Chairman of the Indonesian Earthquake Reinsurance Pool, called for a public-private partnership approach to disaster insurance and risk transfer.

Simanjuntak discussed a government-backed disaster fund, with insurance industry participation and the potential for the capital markets to be one source of reinsurance capacity, through the issuance of catastrophe bonds.

Putting in place such arrangements for risk financing disasters in the country could help the Indonesian government to provide greater ability for its people to recover post-event, greater liquidity of capital for reconstruction efforts, while transferring some of the cost burden to the reinsurance and capital markets.

Government support and international aid alone cannot hope to enable the population to rebuild their lives, should the worst happen such as a major earthquake in a densely populated city in Indonesia. Access to outside risk capital, such as from the reinsurance market and insurance-linked securities (ILS) investors could be a vital source of liquidity when disaster occurs.

The Indonesian government has historically thought the concept of launching a national disaster insurance scheme too costly and as a significant proportion of the population would be unable to afford private insurance cover, it seems any effort in this area will have to focus initially on sovereign risk transfer, to provide risk capital for government reconstruction and immediate post-disaster recovery costs.

But with risk transfer becoming increasingly efficient, particularly parametric protection which is benefiting from technology and big data innovation, and reinsurance capital increasingly efficient thanks to capital markets participation, Indonesia may find protection is more affordable than ever right now.

Simanjuntak said that as government funds are limited it would be preferable to work on public-private initiatives, where mutual cooperation can reduce costs and leverage the liquidity of private markets for risk transfer.

He cited the example of countries such as Taiwan, Japan and Mexico, which all see disaster risks transferred to the capital markets via catastrophe bonds.

A consortium of insurance companies could pool the risks between them, with the government supporting the insurance premiums of the poorest who cannot access the scheme, and reinsurance capacity provided by global reinsurers and the capital markets through catastrophe bond issues. An approach like this would help to narrow the disaster insurance protection gap in Indonesia.

This model has been followed in some countries, such as Mexico, where the World Bank and other agencies have helped the country to access the capital markets for reinsurance to back a disaster insurance facility.

It has also been implied the current disaster insurance available in Indonesia is constrained by legal and regulatory issues, and Simanjuntak suggested that changes to laws may help to make disaster insurance more available.

Indonesia is one of the most exposed countries to earthquake and volcanic eruption risks, both exposures that ILS and cat bond investors are familiar with. It seems likely that if the country can overcome regulatory and legislative issues, work closely with organisations such as the World Bank and get local insurers onside, it would be feasible for catastrophe bonds to back any disaster insurance scheme that was launched.

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