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The risk transfer industry understands that more could be done to close the protection gap, and more risk pools linked to governments could help solve this problem, argues Laurent Montador of French reinsurer CCR, which is backed by the French government.
Re/insurance pools, whether governmental or private market-driven, are usually created involving public and private stakeholders either to resolve disruption in the re/insurance supply or to mitigate the threat of unaffordable insurance, especially for complex or high-value perils, such as natural catastrophes, terrorism, war, aviation, pollution, nuclear or energy, for commercial lines and personal lines in P&C, but also in the life, and accident & health sectors.
What is at stake? Obviously, the protection gap, but also a recognition of the potential inefficiency of the market. Competition drives forces to innovation for the benefit of customers, but there are cases where insurability also can have its limit, but not only after a crisis, as in 2008.
As situations, knowledge and behaviour evolve, alongside the scope of perils and covers, expectations of different stakeholders in pools as well as how pools might be structured could evolve as well. The time element is also important as such structures could be set up on a temporarily basis or with a more permanent status.
The way they have been structured depends not only on their objectives but also on the risk-reward culture of the country involved (state interventionism versus market-driven) and the intentions of the law makers. Public or governmental-structured, with private players involvement as important stakeholders (as seen in Spain, France, Switzerland, Japan and India), or privately driven with strong sponsorship from the state ( as seen in the UK, the US and CEA) are common examples.
It would, however, be an error to oppose those two sides, as we can see by the existence of many public-private partnerships, in one form or another that we will summarise as pools.
A framework for classifying pools
The notion of protection gap entities (PGEs) allows us to attribute a ‘public’ or a ‘private’ characteristic, depending of the risk-reward culture of a country.
In their report Between State and Market: Protection Gap Entities and Catastrophe Risk, Paula Jarzabkowski et al from Cass Business school propose a framework of classification of these schemes, depending on (i) type of market intervention; and (ii) the position in the insurance value chain.
Type of market intervention
- Removing the risks: for risks that are seen as too volatile or extreme for the market to take, such as multiple large terrorism attacks (including chemical/biological/radiological/nuclear) or extreme nat cat events such as earthquakes.
- Redistributing risk: taking the risks of highly exposed groups of policyholders (homeowners, commercials, industrial or municipalities, but also some specific industries of national importance such as agriculture) for which the ‘actuarial’ premium would be too large to be affordable, and subsidising them either by paying directly a part of the premium by the state (or at a higher international level such as the EU) or by increasing the actuarial premium to be paid by lower-risk policyholders.
- Combining risk removal and risk redistribution: usually, this is a result of an evolution of the pool—either after a full removal, gradually return risk to the market or gradually reduce risk redistribution as protection measures in highly prone areas progressively make insurance premiums affordable.
All these three types of market intervention have the same goals: providing sustainable coverage to the largest number of insureds possible and maintaining affordable supply. Then, after an event or crisis that provokes a market player’s withdrawal, removing the most volatile risk allows the market to return in a less volatile area, restore the supply and bring back stability and security.
Positions in the value chain
- The insurer: the PGE insurer develops its own insurance policies for specific perils, with its tariff (or percentage of premium), limits, deductibles and wording and offers them using private insurers as distributors and service contractors to pay the claims. Sometimes, the private insurers act altogether as ‘public’ insurers when specific perils within their policies are mandatory and highly regulated by law.
- The reinsurer: the PGE reinsurer can supply failure by removing risks or to gather a share (up to 100 percent) of all the risks from the insurance market or only the considered most highly exposed risks, and then keep them, partly when it is possible to cede them to the reinsurance market at an affordable price.
- Government body: the private market is not used as primary insurer or primary reinsurer, sometimes used as distributors and collectors, but potentially using reinsurance and the financial market on a secondary step.
Learning from experience
There are organisations that bring the stakeholders and managers of pools together to meet regularly, to discuss technical issues with lively discussion and views that can be shared under the strict ‘Chatham House’ rule. Public communications and conferences can follow for the benefit of all.
The International Forum of Terrorism Reinsurance and Insurance Pools (IFTRIP) and the World Forum of Cat programmes (WFCP), the latter dedicated to nat cat, are two good examples, which allow circulation of ideas about evolvement in the scope and structure of these pools, especially with the sharing of experience after a large event or a recognition of a new demand to fulfil.
The sorts of questions discussed include how to treat cyber in terrorism risk, limited to physical damage as already in place in several countries or extending to non-physical damage.
A particular peril that is also worth mentioning is nuclear risk. The development of commercial nuclear reactor installations in the 1950s made it necessary for national authorities and insurers to meet to enhance their knowledge about the consequences of failure to control the nuclear fission chain reaction causing damage to the installation and also more serious events causing radioactive contamination of third parties and installations.
Nuclear liabilities principles are based on international conventions—Vienna, Paris, and Brussels—and laws (the Price-Anderson Act in the US). There is a strict and exclusive liability, with mandatory financial coverage for the operator in place for potential victims minimum compensation, a lex loci principle and a limited liability principle where beyond a certain level (recently increased from Ä91 million to Ä700 million) the responsibility is passed from the individual operator to the state and then up to another threshold (Ä1.2 billion) up to Ä1.5 billion to a pool of states which signed the Paris Convention, the eventual shortfall going back to the state involved.
Nuclear pools (and mutuals) were created allowing an industry to be insured with an architecture involving many stakeholders from many countries with a proven track record, enhancing the knowledge and prevention of an exceptional risk—a risk that could be seen before as totally uninsurable.
Newcomers and pioneers
There are other existing protection gaps that do not receive a full answer: the demand for non-damages business interruption is enormous, for corporates and for small businesses.
At the moment, only a small part of these could eventually find such a cover with limitations. Limit of access due to a security cordon following a terror act is not seen as something impossible by the potential insureds.
Why does the market not provide enough capacity in this field? Information data, statistics and geo-modelling are often missing and if a deterministic model (delivering a ‘what-if’ approach) could be available, a proper probabilistic (delivering a 1:200 years return period in occurrence or aggregate basis) is sometimes just impossible.
Nowadays the financial and reinsurance market needs to be fed with probabilistic models. The ‘old-fashioned’ PML approach with less granularity is no longer sufficient and the risks seem to be too complex and intercorrelated to rely only on this approach. The work of shaping an appropriate cover that fits part of the demand as well as the financial capacity of the provider cannot be made properly due to this lack of models.
This is where modelling agencies could enter the circuit, providing more and more accurate models that bring confidence for the players to enter the arena of risk providing. That’s also where re/insurtech could bring innovation with other than traditional insurance data and models.
The internet of things will open up new sectors to be used for new indicators of risks, helping to prevent and mitigate them but also helping to resolve bridging the gap in uninsured or underinsured areas.
We can already see initiatives for risks such cyber emerging in the modelling industry. This brings some confidence in putting capital at risk with a possible decent return, but the accumulation control of a such diffuse peril with heterogeneity in loss definition needs to be increased.
A greater supply could emerge responding to the enormous demand of security. But, where initial models fail, if losses emerge far above expectations, with significant capital losses provoking eventual bankruptcies, there will be a brutal stop in the supply.
That’s eventually where states and market will gather together again to create a new protection gap entity.
Laurent Montador is deputy chief executive of French reinsurer CCR. He can be contacted at: lmontador@ccr.fr
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