Cat bonds key to closing protection gap
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Multi-cat bonds or other ILS solutions are the only viable solution for coping with natural disasters in the Eastern European and Commonwealth of Independent States region, and Bermuda could have a big role to play in making this happen, says Kirill Savrassov, chief executive of Bermuda-based Phoenix CRetro Reinsurance.
The human cost of natural disasters is measured not just in the deaths and injuries they cause, but also in terms of their lasting economic impact on survivors and countries. Natural disasters don’t just destroy homes and fields; they can altogether annihilate years of economic growth.
This is even more important for developing countries and regions, where insurance has not yet developed into a reliable help on the macro level. For example, during the period of 2005–2014, the region of Eastern Europe and the Commonwealth of Independent States (ECIS) faced 314 disasters, resulting in more than 60,000 people being killed and 11 million people affected, with more than $25 billion worth of damage.
The region of the Balkans, Caucasus and Central Asia has always been exposed to a big earthquake threat, and this has now, due to climate change, been joined by a huge flood exposure, whereby extreme weather events are fast becoming normal in the Balkans. Some of the events that have hit the region are:
- The 1948 Ashgabat earthquake in Turkmenistan which killed almost 10 percent of the population;
- The 1966 Tashkent earthquake which destroyed most of the buildings in the city, killing between 15 and 200 people and leaving 300,000 homeless;
- The 1988 Spitak earthquake in Armenia which killed nearly 50,000 people with another 130,000 injured and 517,000 homeless. On a macro level, with halting 170 industrial enterprises, it destroyed over 40 percent of the country’s manufacturing capacity;
- The 2014 Balkan floods which caused damage and losses equivalent to nearly 5 percent of Serbia’s GDP and nearly 15 percent of Bosnia and Herzegovina’s GDP, with recovery needs straining government resources; and
- Macedonia: in 2015 and 2016, 30 people died and more than 170,000 were affected by heavy flooding that caused major damage to roads, bridges and water management infrastructure, interrupting transport and economic activities across the nation. The extensive damage caused to private as well as public property meant that some communities are still coping with the impacts.
With insurance penetration between a fraction of 1 percent and 2 percent, and the politics of unnecessary intermediaries in the form of local “national” reinsurers, the governments must definitely look into more helpful and established ways of disaster risk finance.
The way ahead
If we look for solutions for this issue, as of 2018 there are three options available: (i) catastrophe deferred drawdown option (CDDO) arrangements by the World Bank; (ii) pooling schemes equivalent to the Caribbean Catastrophe Risk Insurance Facility or African Risk Capacity; and (iii) multi-cat bond arrangements following successful examples created in Latin America.
It’s true that the World Bank’s CDDO solution is the most rapid of these, but it is basically still a loan. It may stretch over many years, for a low interest rate, but a loan brings up issues involving the question of sovereign debt, something that many governments might have a problem with.
Pooling schemes are a better and more practical solution. However, the ECIS region is too fragmented and overloaded with geopolitical issues for these to be practical in this region, as there is no way for regional pooling to occur. As a result, straightforward parametric cat bonds, an important part of the ILS market, seem to be the best solution for the region in current circumstances.
When disaster strikes, immediate steps must be taken to protect survivors and provide temporary shelter and emergency food and clothes. In the medium and long term, homes will need to be rebuilt, places of employment reconstructed and infrastructure of the area re-established. Ideally, this will be done in a manner that is resilient to future disasters. All this costs money.
It is easier to inject money into a devastated area if those affected are insured. However, the example of Superstorm Sandy in the US in 2012 demonstrates the weakness of that approach. Even though Sandy struck one of the most economically developed areas of the world, only 50 percent of the overall economic loss there was insured. In developing economies, the insurance penetration is a mere fraction of that amount.
Increasing insurance penetration is a good goal, but it’s not enough over the long term.
If there is to be a solution that benefits everyone, it is likely that the solution will have to be organised by the government, whether on a national or a local level. Such a solution cannot take the form of insurance, as insurance requires an interest rate.
A state sponsor will not own all the property that is destroyed. In addition, insurance requires proof of loss and the resulting payments are made only on an indemnity basis. The adjustment process can be time-consuming and delay the payment of funds.
If the ILS market seeks new opportunities, the creation of multi-cat bonds for this region might well meet the demand.
ECIS, multi-cat bonds, disasters, earthquakes, economic losses, Eastern Europe, Commonwealth of Independent States
Cat bonds key to closing protection gap