Resilience bond approach plausible via Ocean Risk Index: AXA XL’s MacFarlane

As AXA XL continues to support and develop the Ocean Risk Index, Andrew MacFarlane, Managing Director and Head of Pricing & Analytics for London & Bermuda, Reinsurance, explores the thinking behind the initiative and more specifically its use as a risk transfer tool, including the potential for a catastrophe bond type structure linked to resilience and natural assets.

AXA XL operates as the speciality insurance and reinsurance division of the AXA group, and has been involved and interested in the ocean risk space for a number of years, culminating in what will be the world’s first Ocean Risk Index.

The Ocean Risk Index is still very much in development and its initial focus will be looking at the impact of a changing ocean on sea levels and the degradation of marine ecosystems, both now and in the future.

The aim of the Index is to better understand the risk associated with these changes in order to better assess, price and ultimately transfer and trade some of the risk.

In an interview with Artemis, AXA XL’s MacFarlane discussed how the Index might be a useful risk transfer tool for the industry.

“The idea really is that we are able to generate an exceedance probability curve at a reasonably granular spatial scale for coastal areas globally,” said MacFarlane. “We will be aiming to generate these curves now and project what it will look like in the future under different climate change scenarios.

“That will allow us to value or put a price on how the assets in a particular area might be exposed as a result of a change in sea level and what the impact on marine ecosystems might look like and from that, to then think about how we might transfer that risk. It’s as much about understanding what that change will look like and using that to try and think about instruments that we an put in place to try and help transfer those risks.”

For AXA XL, more understanding and better education around ocean risk, which includes partnerships with scientists and academics, as well as conversations with governments around macro level issues, is vital when looking at how ocean changes influence the resilience of coastal communities and the adverse impacts on natural assets, such as coral reefs, mangroves, and coastal marshes.

“We are certainly interested in these types of natural assets,” explained MacFarlane. “Specifically, the impacts those natural assets have on resilience for coastal communities and the impact that the changing ocean is having on those natural assets, those marine ecosystems,” he continued.

With resilience being a key component and risk transfer being the aim of the Ocean Risk Index, Artemis questioned MacFarlane on the potential use of a catastrophe, or resilience type bond structure to transfer ocean risk to the capital markets.

“It is too early to say at this point. We really first need to get the Index up and running. If it is accepted, there are ways that we can potentially use a catastrophe or resilience type bond structure to transfer risk to the capital markets,” he said.

An initiative to develop a parametric insurance solution to protect and enhance the resilience of coral reefs and the communities that rely on them for the four countries of the MAR region was developed recently by The Nature Conservancy (TNC).

It functions as a resilience-linked insurance product. Using this as an example of a similar solution that leverages a parametric trigger, MacFarlane explained that the timescale for such a policy would have to be rather lengthy, something that he’s not sure the market would be able to get its head around to begin with.

“I think it has to be in small increments and at this point in time we are more focused on getting the Index operational and structuring it, and then we would have to investigate what the appetite is out there for those type of considerations. Length of time obviously being an important one,” he said.

Eventually, the Ocean Risk Index will enable trading of ocean risk, and, while this is important, MacFarlane told Artemis that the Index also provides value from a policy and regulation point of view.

“We are also looking to use this to try and help assess and inform policy for governments who have big exposures to these types of components of the Ocean Risk Index as it stands today.

“If we are able to demonstrate which particular assets are exposed to a change in ocean, and, if we are able to put that in front of a government then there is value in that,” said MacFarlane. “There’s value in considering how we are then able to think about some of the work that we are doing with those governments around transferring risk at a macro level as opposed to a particular cedant or a particular company.

“There is a lot of talk about government de-risking, about transferring liabilities into the private sector and this is potentially an area where there is a big opportunity to do that. It’s policy and macro level risk transfer solutions as well,” he explained.

To end, MacFarlane said that while it’s difficult to say if the Index will be picked up quickly once released, there is definitely a rising interest around all things related to climate, with ocean risk just being one part of that.

“If we are able to demonstrate the value in the Index and we are able to demonstrate that it’s a robust metric, objective and is one that can be trusted and is one that we can use to educate and inform policy and in some ways quantify risk, then yes, I think it potentially could be successful and provide good opportunities to transfer risk.

“It depends on the environment we are in when it is ready. We obviously feel there is a real value in it otherwise we wouldn’t be doing it. It is something new, something different and so there will be work that will be required to prove its value,” said MacFarlane.