World Economic Forum eyes risk sharing with catastrophe bonds: Davos 2020

A World Economic Forum (WEF) initiative focused on responses to humanitarian risk is investigating areas where catastrophe bonds may prove valuable tools for risk sharing with private markets and investors, according to a United Nations representative.

The World Economic Forum (WEF) is an international organisation focused on public-private cooperation. Its annual meeting is approaching fast, held in Davos, Switzerland next week and as a result discussion of risk related issues, from disasters to humanitarian catastrophes, are front and centre once again.

In advance of the WEF’s Davos 2020 meeting, United Nations representative Mark Lowcock, the Undersecretary-General for Humanitarian Affairs and Emergency Relief Coordinator, at the UN Office for the Coordination of Humanitarian Affairs (UN OCHA), raised catastrophe bonds and risk transfer to private or capital market investors as a key route towards sharing (transferring) risks.

Discussing how anticipatory action is required for the humanitarian system, in order to deliver what the world’s poorest need in terms of financing and support, the UN’s Lowcock explained that insurance and reinsurance markets and structures will need to be utilised, as well as structures such as cat bonds.

“The traditional approach to dealing with humanitarian crises has been to watch disaster and tragedy build, then decide that we need to respond, then mobilize money and organizations to help, and only then to start to get help to the people who need it,” Lowcock explained.

This reactive approach has saved many lives, he further explained, but anticipatory methods can either negate the crises in the first place, or at least mean the response is ready to go, including the necessary financing and capital.

“By taking an anticipatory approach we can have a better, faster and cheaper solution to humanitarian needs. One that is more dignified. One that protects hard-won development gains. And one that deals with problems before they arise and where they arise,”Lowcock said.

This can involve forecast based financing and other solutions where capital can be disbursed in advance of the disaster occurring, or immediately it occurs.

Clearly insurance and reinsurance solutions using parametric triggers can be calibrated to provide much more immediate sources of financing, with insurance-linked securities (ILS) such as catastrophe bonds a way to sell that product into private market investors and tap the capital market to fund humanitarian response financing vehicles.

By spotting the early warning signs related to disasters that can causes humanitarian crises, risk transfer solutions can be structured utilising triggers that provide a more responsive solution, getting the necessary capital and financing to where it is required at the right time.

Lowcock laid out a vision for insurance and reinsurance being more anticipatory, saying, “The first thing we need to do is to make much greater use of disaster risk insurance. This kind of insurance is taken for granted in wealthy countries, where almost half of natural hazard costs are covered by insurance. That is not in the case in poorer countries, which on average have just 5% coverage.

“With climate change, natural disasters are becoming more frequent, more intense and more destructive. Expanding coverage can make a huge difference in preventing shocks from becoming humanitarian crises. Insurance provides fast, predictable payouts. It also makes people more aware of risk.

“I want to see progress made by applying principles of anticipatory approaches to insurance so that they pay out earlier, possibly even before a predictable disaster, and incentivize policyholders to reduce and manage risk.”

In addition, he highlighted contingent financing sources, such as the World Bank’s Deferred Draw Down Options for catastrophe risk, as another way to secure capital that can pay-out more readily to help nations response better to crises.

In addition, the capital markets has a role to play in providing private capital to underpin risk financing for humanitarian disaster related needs.

“We should share more risk in humanitarian settings with the private sector, in addition to insurance. Catastrophe Bonds are another instrument that provide cash to governments immediately after a disaster. If things go the investors’ way, they recover their capital in full, plus the interest generated, plus the government’s premium. If a disaster happens, investors lose their capital, which goes as an instant payout to the government.

“The World Economic Forum’s Humanitarian Investing Initiative is seeking to identify the areas where risk sharing between humanitarian and development agencies and corporates and investors is possible,” Lowcock said.

With an increasing number of lives facing humanitarian crises every year and issues such as climate change set to drive more crises and disasters, the world needs to get to grips with developing financial tools to support adaptation, prevention, response and recovery.

By keeping risk transfer anticipatory in nature, working to ensure the coverage is responsive to the needs and conditions in question, a better financing solution backed by the depth of capital markets is possible, somewhere the ILS market and catastrophe bonds uniquely sit.

The need for solutions is clear, Lowcock said, “We have no choice but to make every donor dollar go further and faster. I believe the answer to achieving this lies in an anticipatory approach.

“But we must go into this with our eyes wide open. As we innovate more, and use data to anticipate problems before they occur, we need to remain clear-minded and analytical. Some of these innovations will work brilliantly, others will not. Together, we must confidently scale up the successful experiments and ruthlessly abandon the others.

“An anticipatory approach requires a degree of boldness, maybe bravery, to challenge the status quo. It requires a leap – not of faith, because this is data-driven – but of confidence. The human and financial gains of this work are too valuable to squander.”