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1Copyright © 2015 Risk Management Solutions, Inc.
CREATING NEW HYBRID PRODUCTS FOR
ADAPTING THE INSURANCE MECHANISM
TO DRIVE RESILIENCE
Robert Muir-Wood
Aug 31st 2016
2Copyright © 2015 Risk Management Solutions, Inc..
WHAT DOES INSURANCE REFUND?
 Intended for restitution to the state that existed before the claim
 Otherwise considered to lead to moral hazard – when the
policyholder is incentivized to cause a claim to raise the value of the
property
 Where new building code requires better standard of construction
than existed previously – compensation is typically only to the old
standard - unless owner purchases additional coverage or buys to a
higher reconstruction value (costing more)
3Copyright © 2015 Risk Management Solutions, Inc..
LONG TERM INSURANCE
 Howard Kunreuther (Wharton Risk Management and Decision Processes Center)
has been a champion of multi-year insurance contracts
 Benefits for the policyholder :
– ensuring they remain insured,
– financial stability,
 Benefits for the insurer,:
– the ability to sustain a stable portfolio of risks and
– avoiding the costs of promoting and signing up annual renewals.
 For the insurer, losing the optionality of annual renewal will also come with a cost
4Copyright © 2015 Risk Management Solutions, Inc..
THE ADAPTATION BENEFITS OF LONG-TERM INSURANCE
 The cost of any action to reduce risk to the policyholder can be compared with how many years it
would take to repay the investment – and the magnitude of the risk reduction
 The premium would then include two components:
– a) the insurance costs and
– b) the annual cost to repay the investment in risk reduction.
 If the payments from the policyholder remain constant while the risk reduction loan is being paid
off, over how many years would the policyholder have to sustain the policy?
– < 1 year would fit within the terms of an annual contract.
– > 10 years likely to be unacceptable to the purchaser
5Copyright © 2015 Risk Management Solutions, Inc..
Original
Insurance
cost
Number of
repayment years
Insurance
cost after risk
reduction
Annualized
cost of risk
reduction
0 n
‘n’ < 10
€
Cost of risk
reduction
6Copyright © 2015 Risk Management Solutions, Inc..
FLIES
Original
Insurance
cost
Number of
repayment years
Insurance
cost after risk
reduction
Annualized
cost of risk
reduction
0 5
€
Cost of risk
reduction
7Copyright © 2015 Risk Management Solutions, Inc..
NOT GOING TO FLY
Original
Insurance
cost
Number of
repayment years
Insurance
cost after risk
reduction
Annualized
cost of risk
reduction
0 15
€
Cost of risk
reduction
8Copyright © 2015 Risk Management Solutions, Inc..
HYBRID CAT RISK AND INFRASTRUCTURE BONDS
Flood Risk
Premium
Flood defence loan interest & capital repayment
Flood compensation capital
Outstanding loan for defense construction
Principal
$
Premium
$
Risk Capital
repaid if no
flood
Year 1 Year 8
Construction of Defense
9Copyright © 2015 Risk Management Solutions, Inc..
INVESTMENTS IN ADAPTATION
 The example of the city protected by a flood defence can be generalized to any
situation where risk can be profitably alleviated by investment in some protective
action: eg. Retrofitting, rebuilding, new protections
 The duration of the product will be determined by the preparation and ‘pay-off’ times
 Where the risk and infrastructure costs are high enough it makes sense to use a
securitization structure
 Hybrid Risk Reduction & Risk Transfer products have the potential to drive
resilience
 Insurers should offer multiyear coverages so as to drive adaptation

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Creating New Hybrid Products for Adapting the Insurance Mechanism to Drive Resilience, Robert MUIR-WOOD

  • 1. 1Copyright © 2015 Risk Management Solutions, Inc. CREATING NEW HYBRID PRODUCTS FOR ADAPTING THE INSURANCE MECHANISM TO DRIVE RESILIENCE Robert Muir-Wood Aug 31st 2016
  • 2. 2Copyright © 2015 Risk Management Solutions, Inc.. WHAT DOES INSURANCE REFUND?  Intended for restitution to the state that existed before the claim  Otherwise considered to lead to moral hazard – when the policyholder is incentivized to cause a claim to raise the value of the property  Where new building code requires better standard of construction than existed previously – compensation is typically only to the old standard - unless owner purchases additional coverage or buys to a higher reconstruction value (costing more)
  • 3. 3Copyright © 2015 Risk Management Solutions, Inc.. LONG TERM INSURANCE  Howard Kunreuther (Wharton Risk Management and Decision Processes Center) has been a champion of multi-year insurance contracts  Benefits for the policyholder : – ensuring they remain insured, – financial stability,  Benefits for the insurer,: – the ability to sustain a stable portfolio of risks and – avoiding the costs of promoting and signing up annual renewals.  For the insurer, losing the optionality of annual renewal will also come with a cost
  • 4. 4Copyright © 2015 Risk Management Solutions, Inc.. THE ADAPTATION BENEFITS OF LONG-TERM INSURANCE  The cost of any action to reduce risk to the policyholder can be compared with how many years it would take to repay the investment – and the magnitude of the risk reduction  The premium would then include two components: – a) the insurance costs and – b) the annual cost to repay the investment in risk reduction.  If the payments from the policyholder remain constant while the risk reduction loan is being paid off, over how many years would the policyholder have to sustain the policy? – < 1 year would fit within the terms of an annual contract. – > 10 years likely to be unacceptable to the purchaser
  • 5. 5Copyright © 2015 Risk Management Solutions, Inc.. Original Insurance cost Number of repayment years Insurance cost after risk reduction Annualized cost of risk reduction 0 n ‘n’ < 10 € Cost of risk reduction
  • 6. 6Copyright © 2015 Risk Management Solutions, Inc.. FLIES Original Insurance cost Number of repayment years Insurance cost after risk reduction Annualized cost of risk reduction 0 5 € Cost of risk reduction
  • 7. 7Copyright © 2015 Risk Management Solutions, Inc.. NOT GOING TO FLY Original Insurance cost Number of repayment years Insurance cost after risk reduction Annualized cost of risk reduction 0 15 € Cost of risk reduction
  • 8. 8Copyright © 2015 Risk Management Solutions, Inc.. HYBRID CAT RISK AND INFRASTRUCTURE BONDS Flood Risk Premium Flood defence loan interest & capital repayment Flood compensation capital Outstanding loan for defense construction Principal $ Premium $ Risk Capital repaid if no flood Year 1 Year 8 Construction of Defense
  • 9. 9Copyright © 2015 Risk Management Solutions, Inc.. INVESTMENTS IN ADAPTATION  The example of the city protected by a flood defence can be generalized to any situation where risk can be profitably alleviated by investment in some protective action: eg. Retrofitting, rebuilding, new protections  The duration of the product will be determined by the preparation and ‘pay-off’ times  Where the risk and infrastructure costs are high enough it makes sense to use a securitization structure  Hybrid Risk Reduction & Risk Transfer products have the potential to drive resilience  Insurers should offer multiyear coverages so as to drive adaptation