A new report just released by the Milken Institute (an independent economic think tank) discusses the issues affecting the insurance marketplace regarding the difficulty in finding ways to cover disaster prone areas. The report shows that with a little bit of innovative thinking, and some help from capital market innovations, insurance companies could cover catastrophe risks and ensure that homeowners, businesses and communities are covered in case of a disaster. The key, the report states, is decreasing barriers in the emerging market of insurance-linked securities.
The report, “Financial Innovations for Catastrophe Risk: Cat Bonds and Beyond,” is based on a Milken Institute Financial Innovations Lab attended by representatives from the insurance, reinsurance, and bond ratings industries, along with practitioners in finance, law and government regulation. This Financial Innovations Lab and the report were supported by Allstate Insurance Company.
The report offers several key solutions:
- Decrease fees and standardize transactions through a variety of measures that include eliminating the need to conduct transactions offshore by establishing special purpose vehicles (SPVs) onshore and by standardizing loss warranty documents, issuance structuring and documentation.
- Attract large institutional investors by increasing the amount of investment-grade cat bond issuances.
- Securitize a wider range of risk (currently the majority of bonds are for wind and earthquake risk) and geographic distribution (including fast-developing regions, such as India and China) to increase diversity in the market.
- Educate investors and, more important, asset allocators, to enhance legitimacy and further establish the bonds as an asset class.
- Improve risk management tools for investment professionals, develop appropriate benchmarks that address risks in other parts of the world, increase market transparency and accessibility of the asset class, and issue more collateralized debt obligations (CDOs) to target investor preference.
- Increase liquidity and transparency in the secondary market by issuing larger transactions.
- Increase participation by the rating agencies to achieve more than a single rating, currently the norm, to attract more traditional fixed-income investors.
All great suggestions for ways to increase usage of cat bonds and to encourage greater participation in the marketplace. The best thing to come out of this report is the clear signal that cat bonds and insurance linked securities are seen as the best way to secure an insurable future for hard to insure areas.
The full report can be downloaded as a PDF or ordered in print from this page.