Blog: The insurance-linked securities education gap

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It is vital that the education gap around insurance-linked securities is addressed, say Phoenix C Retro CEO Kirill Savrassov and Axa XL assistant underwriter Toby Pughe.

The protection gap, the difference between economic and insured losses, is a damning reflection on both the insurance market and those responsible for managing risk. Protection gaps exist in both developed and emerging markets, but Swiss Re estimates that where catastrophe risk coverage is around 35% in developed markets, it is 6% in developing countries. According to Aon, 2020 saw $268bn of economic losses from natural disasters. Just $97bn was insured, and developing countries suffered a disproportionate share of the uninsured losses, which are only increasing following a decade-long rise in natural catastrophes linked to climate change.

When a natural disaster strikes, immediate steps need to be taken to provide temporary shelter, food, and water. In developed nations, government bodies such as the Federal Emergency Management Agency in the US typically provide these things. However, the same cannot be said for less developed markets. For example, when Hurricane Maria struck the island of Puerto Rico in 2017, its people were without clean food and water for more than six months, while 98% of buildings were either damaged or destroyed.

With inadequate insurance market development and a lack of alternatives, vulnerable countries rely on handouts from multilateral agencies and global development aid in the aftermath of natural catastrophes. However, such aid is usually reactive by nature, and payments can be slow to materialise. Since hurricanes Harvey, Irma, and Maria, the limitations of traditional indemnity insurance have also started to surface. Confusion around policy wordings and legal disputes has delayed disaster recovery, further impacting vulnerable groups.

Pooling regional risk

Government pools such as the Caribbean Catastrophe Risk Insurance Facility and Africa Risk Capacity have illustrated the benefits of pooling regional risk, but such risk pools are not viable options for Eurasia transit countries. This is because the region’s geopolitical fragmentation, underdeveloped insurance markets, low insurance penetration, and protectionism (restricted market access for international players) make insurance placements a challenge at the macro level.

The validity of traditional insurance is not being questioned here, but its suitability on a macro level in developing countries is. Insurance-linked securities, in the form of parametric catastrophe bonds, can help to minimise the impacts on economic growth and productivity and help countries with a low credit rating to source capital.

The Chinese Belt and Road Initiative is another example where ILS could help transfer industrial and sovereign risk to the capital markets. China, through loans, has invested tens of billions of dollars in infrastructural development in Central Asia and neighbouring regions. Despite these regions having significant exposure to natural disasters (predominantly earthquakes and floods), most of these new developments are not adequately insured. Historically, nearly a third of the capitals in BRI transit countries have, at some point, been devastated by earthquakes and/or floods.

A better understanding of ILS can help traditional markets and governments transfer risk more efficiently. However, the lack of government understanding around ILS creates an issue, so bridging the education gap is vital for all stakeholders: potential sovereign sponsors, International Financial Institutions and the ILS community.

Multinational agencies like the World Bank and the United Nations Development Programme are doing an excellent job promoting parametric insurance and instruments that transfer risk to the capital markets. However, their involvement alone is not enough. Industry participants, associations, and, more importantly, academia need to join forces in a dedicated effort to educate local market participants, opinion leaders, and government officials on how to transfer their risk more efficiently.

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