Presented by David Simmons, Managing Director: Capital, Science and Policy Practice Willis Towers Watson at the Pacific Regional Dialogue on Financial Management of Climate Risk
(26-28 June 2017, Apia)
'The role of insurance and reinsurance in disaster risk management'
1. The Role of Insurance and Reinsurance in
Disaster Risk Management
David Simmons
Managing Director:
Capital, Science and Policy Practice
Willis Towers Watson
Pacific Regional Dialogue on
Financial Management of
Climate Risks
26/28 June 2017
2. Introduction
Catastrophe re/insurance is an established, proven product
For example 2011, an “annus horribilis” for Asia/Pacific Catastrophes
§ Christchurch Earthquake(s): Economic Loss $ 18bn, Insured Loss $14bn
§ Bangkok/Thai Flood: Economic Loss $ 30bn, Insured Loss $12bn
§ Japanese Earthquake/Tsunami: Economic Loss $210bn, Insured Loss $35bn
The global reinsurance market for catastrophe risk is strong
§ Huge inflows of capital from pension funds (over $50bn) seeking return
§ Established reinsurers are seeking new sources of income from markets
where they have little current exposure
§ Catastrophe Modelling techniques are well established and well understood
But the benefits are more than just financial restoration
§ Recent schemes focus upon speedy cash injection to facilitate immediate
post-disaster response
§ The value is far more; greater risk awareness, better risk management,
planned disaster response
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3. Most existing schemes protect domestic property
§ Catastrophic risks can be too large for local insurers to bear
§ A national scheme provides basic property insurance coverage to the population
§ Commercial property generally covered in the open insurance market
§ Governmental property mostly self insured
Most share similar characteristics:
§ Indemnity-based but with limited coverage and with features to speed up loss
settlement
§ Mostly compulsory, can be politically unpopular but else suffer adverse selection
§ Governments may guarantee the fund, else risk fund exhausts after a major loss
§ Almost all schemes use global reinsurance markets to gear up fund
§ Vast majority buying reinsurance does uses a reinsurance broker, who help design,
model and place the optimal reinsurance at best possible terms
§ Coverage is often limited but can be “topped-up” by local insurers
§ Most rates are risk-adjusted to encourage good risk behaviour/building standards
§ However, some (e.g. France) have flat pricing regardless of risk, following principle of
solidarity
National Catastrophe Schemes
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Existing Schemes
4. National Catastrophe Schemes
Sub-National
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Disaster relief/governmental assets
Fonden (Mexico) - example of a scheme covering government assets and disaster response
§ Provides property cover to federal agencies and state governments in Mexico
§ But also included a catastrophe bond to provide near instant event response funding
Regional schemes harder to put into place
§ CCRIF in the Caribbean was the first one in 2007
§ Followed by Europa Re (Balkans) in 2010, PCRIP (Pacific) in 2013 , ARC (Africa) in 2014 and CCRIF
Central America in 2015
§ Must be fair to all parties, with no hidden cross-subsidisation
§ Need strong sponsor(s); e.g. the World Bank and CARICOM for CCRIF
The Insurance Development Forum (IDF) aims to make it easier to create new schemes
§ A new insurance industry/World Bank/UN body
§ Aims to provide technical, modelling and legal support to help create new national and regional schemes
§ Likely to include creation of a Technical Advisory Facility to augment work of World Bank and others
A regional or national scheme can support local initiatives
§ CCRIF, directly or indirectly, has spawned a number of micro insurance initiatives
§ Similarly, modelling undertaken for e.g. a cities/municipalities scheme can be the basis for a later national
and/or series of local schemes or vice versa
5. National Catastrophe Schemes
A potential scheme structure
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Structure and Design: Example
Management Board
Representatives of Local
Government, National
Government, Local Insurance,
Experts
Scheme built around
a Catastrophe Fund
Local and National
Government
Premium
City/Municipality
City/Municipality
City/Municipality
City/Municipality
Trigger + State of
emergency
declaration
Insurance payout
Reinsurance
CapacityTrigger payouts
External
DonorsPremium
Risk
Monitoring
and
Evaluation
Reinsurance
premium
Policyholder
of parametric
insurance policies
6. Structure and Design
Or Something in Between
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Parametric vs Indemnity
•Scheme pays on actual loss
•No basis risk
•But high cost of loss adjustment
•Loss adjustment also results in payment delays
Indemnity
•An event occurs, payment is made
•Simple, easy to understand
•Event definition made by a verifiable independent agency (eg USGS)
•But high basis risk: smaller events may cause a large loss, a large
event conversely may cause few losses
Parametric
Basis Risk
Complexity
7. Structure and Design
Or Something in Between
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Parametric vs Indemnity
•Scheme pays on actual loss
•No basis risk
•But high cost of loss adjustment
•Loss adjustment also results in payment delays
Indemnity
•Model pays based on estimated loss from a catastrophe model
•Basis risk should be low but still real
•Requires time and expense to build the catastrophe model
•Catastrophe models are good for homogenous exposures (i.e.
domestic property), less good for complex risks
Modelled Loss
Basis
•Essentially a simplified version of a modelled loss
•Formulae estimate hazard at certain reference points (e.g. wind
speed, ground shaking, rainfall)
•Additional formula estimate the loss resulting from this hazard
•Lower basis risk than pure parametric, but higher than Modelled Loss
Parametric
Index
•An event occurs, payment is made
•Simple, easy to understand
•Event definition made by a verifiable independent agency (eg USGS)
•But high basis risk: smaller events may cause a large loss, a large
event conversely may cause few losses
Parametric
Basis Risk
Complexity
8. Structure and Design
Parametric or Indemnity (or both?)
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Parametric vs Indemnity
It is important to decide what is most important
§ Speed: speed of payment or speed of set-up
§ Basis risk: i.e. accuracy of loss payment
If speed of payment is important, a form of parametric cover makes sense
§ Both CCRIF and ARC promise payment within days of an ‘event’ occurring
§ Simplified policy terms can speed up indemnity payments but the chance of delay and dispute
remains
If avoiding basis risk is important, indemnity or near indemnity is required
§ Individuals cannot be exposed to basis risk; at micro level risk is too high and tolerance low
§ But a fund may consider accepting some low level basis risk as a trade against speed of settlement
It is possible to migrate
§ CCRIF started with a parametric index, allowing the scheme to be up and be in place quickly
§ After 3 years, and after more research/model building, they switched to a Modelled Loss basis
It is also possible to have both
§ Fonden scheme had a parametric catastrophe bond element to provide immediate post-disaster
funding
§ Also has an indemnity based insurance to cover local governmental assets
§ “Hybrid” schemes are very possible and readily placeable
9. Structure and Design
a hybrid scheme
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Example of a hybrid scheme: Fonden
Schools
Water
infrastructure
Hospitals
DeductibleDeductible Deductible
Roadand
Bridges
Deductible
Trigger product
Fast Payout
Indemnification
insurance
Cost of reconstruction and repair
Special Vehicle (Fonden)
Capable of near immediate implementation Mid-/long-term development perspective
10. Data and Modelling Requirement
Is Good Data a Pre-Requisite?
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Data Requirement
The better the data, the better the product
§ Good data also makes the product more attractive to reinsurers
But data is never perfect, and to wait for perfection implies a very long wait
§ It is possible to put a scheme in place quickly with imperfect data, refining it as data (and models
reflecting and using that data) become available
Parametric products can provide real, immediate value without heavy data requirements
§ Data for wind and rainfall, both live and historical, are usually available from reputable sources
§ A Parametric Index product based upon these data could be put in place immediately
§ Attractive to reinsurers as transparent and based upon excellent, homogenous hazard data
The product can be refined as data becomes available
§ CCRIF has not moved from Parametric Index to a full indemnity basis as it wants the fast payment
that a Modelled Loss basis brings
§ Similarly, ARC continues to use a Parametric Index basis as fast payment is fundamental to its value
11. Data and Modelling Requirement
Example: PRISM
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Proposed Philippines municipality scheme example (PRISM)
The exceedance of a defined rainfall amount or wind speed triggers a payment
The payment is based on a calculated return period
*PRISM concept suggests payout as percentage of LGU (= local government unit) tax income class and based on state of calamity declaration
3. Trigger payment
per LGU*
1. Return period
calculation
per LGU*
2. Actual event
monitoring
Real time monitoring (meteorology)
§ 3 hourly rainfall (daily
aggregation)
§ 6 hourly wind speed (daily max)
Categorization
of intensity
13. Why these schemes work for re/insurers
General Principles
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Reinsurance/Risk Mitigation
Reinsurers (and capital markets) like
§ Transparency
§ Verifiable modelling
§ Consistency of relationship/trust
Reinsurers do not like
§ Political risk
§ Poor, incomplete or misleading modelling
§ Uncertainty (around what they are covering)
Different reinsurers have different appetites
§ Some like writing risks with a lot of premium but relatively high risk
§ Others like writing risks with less risk but commensurately less premium
§ It is important to know the market and split up the reinsurance placement to appeal to all appetites
But all have appetite for non-correlating exposure
§ $1 of exposure in Florida may require 80¢ of capital to write as their capital is driven by hurricane risk
§ $1 of exposure in the Pacific may require 1¢ of capital as reinsurers have relatively little existing
exposure
§ This should result in low technical pricing for Pacific catastrophe business assuming risk assessment
is trusted
14. CCRIF: Caribbean Catastrophe Risk Insurance Facility
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The global template scheme
A mutual insurer owned by member governments issues policies to members
§ Established in 2007
§ Initially English Speaking Caribbean (CARICOM) plus Haiti; 16 countries
§ Recently extended to include Central America
Allow Caribbean governments to receive immediate post-catastrophe funding
§ Aid money post-disaster arrives too slowly by traditional channels
§ CCRIF delivers funds within two weeks of a triggering event
§ A parametric insurance
Sponsored by the World Bank
§ Initial funding (>$60m) from WB, EU, UK, Canada, France
§ Held in multi-lateral trust fund
Coverage intended to cover:
§ Loss to government buildings/infrastructure
§ Emergency Costs
§ Loss of tax/tourist income
§ Against perils of tropical cyclone (wind) and earthquake: later adding excess rainfall
16. Africa Risk Capacity
Introduction to African Risk Capacity (ARC) and ARC Ltd
n Inspired by CCRIF but adding more explicit risk
management / contingency planning
n A sovereign risk pool designed to provide
immediate financial response if there is a
drought
n Coverage:
§ 2014/15 4 countries covered
§ 2017/18 8 countries covered
§ Within 4 years 20+ countries covered
n Cover is triggered by a parametric index developed with the
World Food Programme, based on staple crop rainfall
requirements
n Rainfall is measured by a network of satellites at a 10km x
10km square resolution, proofed by ground observation
ARC Members as at March
2015 (Mali joined in April)
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17. African Risk Capacity
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Risk Management Benefits
§ Countries spend up to a year working with ARC experts to understand the drought risk in
their countries
§ Countries are also required to draft a Disaster Response Plan, outlining how insurance
recovery will be spent to maximise impact
.
§ They must also obtain a Certificated of Good Standing to demonstrate good financial
management so money’s received will be put to appropriate use
§ Post loss they must further provide a Final Implementation Plan, refining the draft
Disaster Response Plan to determine a precise plan of action to maximise the societal
benefit of the cash received
The process of buying cover is arguably as important as the cover itself
18. Reinsurance Risk Appetite
Example: African Risk Capacity
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How has reinsurance appetite changed over the last 8 years?
It is interesting to compare to the experience of trying to place the African Risk Capacity for
the first time in 2014 compared to the experience of CCRIF when it launched 7 years
earlier
ARC “flew off the shelves” despite a contract structure that was tough to
understand, unknown modelling and very competitive pricing
African Risk Capacity in 2014 CCRIF in 2007
Interest from 25+ reinsurers and
funds-backed markets
Interest from circa 8 reinsurers
15 quotations received 5 quotations received
12 reinsurers on contract 3 reinsurers on the contract
Very keen price Very keen price
22. Conclusion
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Re/insurance provides real benefits to developing countries
Global re/insurance markets actively support developing country catastrophe schemes
§ We have not just financial capacity, but modelling and structuring expertise to share
There are a variety of existing templates to consider
§ But the scheme for each national/regional must be designed to suit their specific needs
Certain features attract both reinsurance markets and donor capital
§ Transparency is the key
Data and modelling are important but there is no need to wait for perfection
§ The scheme can grow and develop over time
§ Move to a more technical trigger as enhanced data and modelling become available (CCRIF)
§ Or like Fonden, a hybrid with both parametric and indemnity elements
Schemes can be constructed to encourage transfer or risk management expertise
§ CCRIF, ARC and COAST are great examples of the possible
Reinsurers have a big appetite for developing market catastrophe risk
§ The price must be technically credible: the higher the uncertainty, the higher the price
§ But Pacific risk is diversifying, capital charges loads should be low making cover affordable
23. The Role of Insurance and
Reinsurance in Disaster Risk
Management
David Simmons
Managing Director: Capital, Science and Policy Practice
Email: david.c.simmons@willistowerswatson.com
Phone: +44 20 3124 8917
Mobile: +44 7947 383777
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