LMG puts forward ILS solution for catastrophes
The London Market Group (LMG) has released a white paper to discuss the creation of a foreign aid catastrophe bond (FAB) at a roundtable in the House of Commons.
FAB would use the upcoming UK ILS regime to address the risk of natural catastrophes in under-insured emerging markets to provide a more cost effective approach to catastrophe relief backed by commercial capital.
The proposal put forward suggest the government sponsor the issue of an insurance policy to cover the risk of catastrophes in a specified country or region.
According to LMG, the risk premium would be paid by the protected countries and the Department for International Development’s (DfID) overseas aid budget would underwrite the bond issue. Countries protected by the bond would be selected from those currently receiving development aid from DfID.
Any capital raised from sophisticated investors via the issuance of a bond, would be placed in a trust account to secure the maximum level of risk in the policy.
Investors would receive the risk premium as a yield to compensate investors for the modelled level of risk within the policy. Capital, minus any payments triggered by the policy, would be returned to investors at the end of the policy.
The FAB would be distributed by a specialist investment advisory firm then managed by a professional administrator/management firm.
Malcolm Newman, chief executive officer of SCOR’s London and Paris hub, and leader of the LMG work stream, said: “The idea behind the FAB is a joint initiative between the Government and LMG to provide a cost effective response to catastrophes currently supported by the UK foreign aid budget.
“We are looking to emulate other government-led forms of insurance which already exist in areas such as Mexico and the Caribbean to cover damage from the major natural perils of windstorm and earthquake. The LMG envisages a similar form of insurance to improve resilience in developing countries or regions which are under-insured against similar catastrophes.
“The Nepal earthquake is a recent example where a FAB could have provided a more cost effective approach to catastrophe relief backed by commercial capital. It is also in line with recent innovations in the market, such as the Pandemic Emergency Financing Facility sponsored by the World Bank.
“There are some clear benefits from this proposal, for example the government could provide a more predictable and transparent source of funding for short term disaster relief and potential longer term resilience against climate change. It also reduces the amount spent on short term disaster relief, while freeing up funds for longer term development as the bond will replace post disaster aid.
“Ultimately it could allow developing countries to fully take over the premium payments as their economies develop and underlying insurance penetration grows, linking to initiatives that may come from the new Insurance Development Forum.”
