Category Archive : Protection gap

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In a string of research reports, the World Bank Group and European Commission call on governments across Europe to utilise more in the way of disaster risk transfer and insurance to reduce the pressure from weather and natural perils on budgets, including the use of catastrophe bonds to access capital market investors for reinsurance risk capital.

european-commissionThe conclusion of the research is that European countries are retaining far too much of their natural catastrophe risk exposure, with the lions share of the costs continuing to be dealt with by government and European budgets, while too little is transferred to insurance, reinsurance and institutional investor markets.

The World Bank and EC reports state that the continent “needs smart investments to strengthen disaster resilience, adaptation and finance response to disaster and climate risks.”

With Europe seen as warming faster than any other continent, the pair say it is “highly vulnerable to the increasing risks associated with climate change.”

“2023 was the hottest year on record with disasters across Europe costing more than €77 billion. Projected costs of inaction in a high warming scenario could reach 7 percent of EU GDP,” they explain.

“Disasters are devasting for everyone, but can disproportionately impact Europe’s most vulnerable communities, increasing poverty and inequality,” Sameh Wahba, a Director at the World Bank said. “Without adequate systems, these events can erode development gains. There is still time for European countries to take actions that will protect people’s lives, infrastructure, and public finances from disaster and climate change impacts, though there is a narrowing window of opportunity to take action.”

Investment in resilience is a significant focus of the work, with many critical sectors of the European economy seen as exposed to multiple natural hazards.

“Investments in prevention and preparedness are urgently needed at all levels, starting with critical sectors that provide emergency response services,” Hanna Jahns, Director of the European Commission Humanitarian Aid & Civil Protection unit said. “The needs are significant and the pressure on the EU and government budgets is high. Going forward we need to invest in a smart way, prioritizing the investments with the highest resilience “dividends.””

They urge the use of risk and climate change data and analytics, to help in prioritising actions and to select the most impactful prevention, preparedness, and adaptation investments.

In Europe, climate change adaptation costs up to the 2030s are thought likely to be in the range of €15 billion to €64 billion annually, underscoring the significant investment required.

“There is a significant gap in adaptation financing in Europe,” explained Elina Bardram, Director, Directorate-General for Climate Action. “Closing it requires a major scale-up of public, private, and blended finance. Investment planning and financial strategies are not yet adequately informed by an understanding of the costs of climate change adaptation at national and EU levels. This needs to change.”

Where the reports become most relevant for our readers is around financial resilience.

The World Bank and European Commission reports state that, “too much of the disaster and climate risk is managed through budgetary instruments at the EU level and by EU Member States, with gaps concerning pre-arranged funds and the use of risk transfer mechanisms, such as risk insurance. ”

In seeking to maximise societal benefits from investments made, the use of risk transfer alongside this to cushion the costs of climate and natural disasters are seen as key.

Public finances are in some cases being stretched by multiple natural disasters each year, so upfront risk financing and transfer can help to lessen the burden on the budgets of European countries and their populations.

The reports identify funding gaps for major disasters and note that should countries face multiple major events in a year, the impact could drain funding at the EU level (as well as countries specifically).

As a result, the reports state that, “Countries in Europe need to enhance their financial resilience through better data utilization and innovative financial instruments, including risk transfer to the private sector.”

Here, catastrophe bonds are highlighted throughout the reports, as tools that can aid in preparing for financial impacts and enhancing the ability for Europe to fund the response to disasters.

The capital market is seen as one source of risk transfer that Europe should consider.

“At present there are no risk transfer products at the EU level or in the case study countries, and consideration should be given to their incorporation in future DRF strategies,” the report explains.

Citing the use of catastrophe bonds by US utilities for wildfire risk, the reports suggest a potential role in Europe.

“CAT bonds as a risk transfer mechanism are less common in the EU and should be further explored once risk models are available to see if this could provide a cost-effective option to manage the risk of wildfires,” one of the reports says.

Both index and parametric insurance techniques are also suggested as applicable to the disaster funding gaps faced in Europe, as these can help to make for responsive risk transfer tools, that can help in financing recovery quickly after disasters occur.

The European Union Solidarity Fund (EUSF) is seen as a financial structure already in existence that could be supported better by risk transfer.

One of the reports states, “The existing EU level instruments take time to disburse, which may delay emergency response. Due consideration should be given to the introduction of a EU level instrument to provide a top-up to national governments to help them finance emergency response. Such an instrument could be embedded within the European Union Solidarity Fund (EUSF).”

Disaster risk financing and transfer tools and techniques can help European countries and budgets reduce their liabilities after disaster strikes, including through responsive techniques and by tapping the capital markets.

The report continues, “A parametric risk transfer instrument — e.g., a catastrophe bond — could be introduced to secure private capital when needed. This approach would recognize the significant opportunity cost of holding reserves at the EU level and instead structure an additional instrument to release finance into the EUSF when severe events occur.”

The report uses the example set by Mexico, in its use of private insurance, reinsurance and capital markets through its catastrophe bonds, as setting an example that Europe can draw from.

The World Bank sees Mexico as “setting the standard” for disaster risk management through its use of financial instruments such as cat bonds.

The reports go into much more detail around how Europe can put in place safety nets, both for its budgets and for its populations, while making the best use of modern financing techniques, risk transfer tools and the appetites of private and capital markets.

It’s encouraging to see the discussion on Europe continuing, as in the last year we’ve also seen the European Central Bank (ECB) alongside a macro-prudential oversight body it operates, the European Systemic Risk Board (ESRB), calling for greater use of catastrophe bonds to address the insurance protection gap and mitigate catastrophe risks from climate change in the European Union.

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An innovative parametric insurance product that provides protection to fund repairs following storm damage to coral reefs in Hawaii has been renewed and its coverage expanded, while global reinsurance firm Munich Re is again backing the cover, which is arranged by WTW.

coral-reef-imageBack in November 2022, WTW alongside The Nature Conservancy launched the parametric coral reef insurance concept in the United States for the first time with a policy focused on Hawaii. Munich Re underwrote the risk for that first Hawaiian coral reef parametric insurance arrangement.

The same parametric risk transfer product concept had already been utilised in Mexico and was then expanded to also cover the Mesoamerican Reef system.

As we reported earlier this month, broker WTW has now taken the coral reef insurance concept across the globe to cover a South pacific coral reef in the Fiji archipelago as well.

Now, the Hawaii instance of the product has been renewed, with expanded coverage and higher payouts available, so that it can make more impact on the reef and the communities that rely on it.

The new parametric coral reef insurance policy expands coverage around the main Hawaiian islands and increases payouts after qualifying storms, WTW explained.

The new Hawaiian policy adds 314,976 square miles to the coverage area so that it can capture more storm events, with a maximum payout of $2 million total over the year-long policy period and $1 million possible per storm.

At the same time, the minimum payout after the parametric trigger is activated has doubled to $200,000, enabling a more meaningful post-storm response.

Payouts can be triggered when tropical storm winds of 50 knots or greater occur in the core of the coverage area.

Once again, a Munich Re insurance entity was selected as the coverage provider from seven competitive bids.

WTW said that more companies bid on this year’s policy, which it noted shows “increasing interest among insurers in nature-based solutions to protect against climate impacts.”

“Parametric insurance is increasingly demonstrating value in addressing disaster risk for natural assets, in this case providing Hawai’i with a tangible solution to quickly finance post- storm restoration activities that help reefs better recover and maintain resilience in the face of increasing climate impacts,” explained Simon Young, Senior Director in WTW’s Disaster Risk Finance and Parametrics team. “Increasing recognition of this value by conservation organisations, government bodies and other stakeholders on the demand side and by insurers on the supply side is mainstreaming parametric protections, driving accessibility and sustainability.”

“We are building something really transformative for communities and ecosystems as we respond to increasing storm activity associated with the climate crisis,” added Ulalia Woodside Lee, Executive Director, The Nature Conservancy, Hawai‘i and Palmyra. “The first policy provided momentum to develop response plans and partnerships. With these now in place and an increased minimum payout, we will be able to start damage assessments and reef repairs after a storm as soon as it’s safe to get in the water. This is important because corals must be reattached within several weeks after breaking or they will likely die.”

René Mück, Munich Re’s Global Head of Natural Catastrophe Parametrics, also said ”Using parametric risk transfer as a means to contribute to TNC’s conservation objectives in Hawaii aligns exactly with the objectives of Munich Re’s parametric business unit. We are proud to support TNC in Hawaii and appreciate the work with WTW on such initiatives.”

The parametric coral reef insurance product has already demonstrated its utility, when Hurricane Lisa’s landfall in Belize on November 2nd 2022 triggered the Mesoamerican Reef system parametric insurance product.

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An innovative parametric insurance program has been taken across the globe to cover a South pacific coral reef in the Fiji archipelago, with broker WTW saying it will provide up to US $450,000 of cover for reef restoration and community assistance if cyclones hit.

coral-reef-parametric-insuranceThe payout would go to Fiji’s island communities, if a cyclone hits the coral reef system of the South Pacific Ocean’s volcano-formed Lau Group of islands.

The Indigenous people of Lau depend on the reef ecosystem as a source of food and income, so protecting it using a parametric risk transfer insurance product that will pay out after a cyclone strikes which could damage the reef, can enable the community to recover faster and put funds into reef conservation, restoration and resilience.

Development insurer and risk pool the Pacific Catastrophe Risk Insurance Company (PCRIC) is the insurer for this South Pacific parametric reef insurance, winning the bid after what WTW called “a competitive placement process.”

WTW worked with local correspondent broker Insurance Holdings (Pacific) Pte Ltd. and Fiji’s Vatuvara Foundation (VVF), which is the policyholder of the parametric insurance programme.

As well as helping to protect and repair the reef in the event of a cyclone, the parametric insurance payouts can be used to support the community with assistance activities to help address food and water security concerns caused by storm damage.

The initial coverage is for Vatuvara Island, a protected natural reserve; Yacata, where the local community resides; and Kaibu, the Vatuvara Private Islands Resort, while further sites in the Lau Seascape may be covered in future years.

Broker WTW has successfully renewed a similar parametric coral reef insurance product for the Mesoamerican coral reef a number of times now, expanding it with each renewal.

Sarah Conway, Director and Ecosystem Resilience Lead, WTW, commented “We are grateful to BHP for supporting the design and implementation of the first coral reef insurance programme in Fiji. Building on lessons learned from our involvement with similar initiatives in other countries, this programme provides an exciting opportunity to innovate beyond rapid reef response to also include community assistance, enhancing the resilience of the ecosystem and those who depend on it.”

PCRIC CEO, Aholotu Palu, stated, “PCRIC is very pleased to demonstrate its commitment to serve non-sovereign entities with innovative parametric insurance products, in line with PCRIC’s mission to help the island communities of the Pacific to better prepare, structure and manage finances to foster disaster resilience and ensure rapid access to funds; the work of the Vatuvara Foundation, both in reef conservation and in local community empowerment, is recognised by the Government of Fiji as being in the national interest and consistent with development priorities, particularly the Blue Pacific Strategy, as well as commitments to climate change adaptation and disaster risk management.”

Katy Miller, Director, Vatuvara Foundation, added, “We are thankful that the innovative parametric policy will allow for the prompt access to funds following a destructive cyclone event to identify reef damage and assist reef recovery with a community-led team in Northern Lau. Increased frequency and severity of extreme weather events is expected in the area, and protecting natural ecosystems in the Lau Group is crucial to build long-term community resilience to anthropogenic threats including climate change.”

Ashley Preston, Head of Climate Resilience, BHP, also said, “BHP is funding an innovative parametric insurance product, which aims to support the conservation of coral reefs and surrounding local communities in Fiji’s northern Lau Group, and build the knowledge base for how similar financial products could be used to improve climate resilience. We are pleased to work with WTW and Vatuvara Foundation on this project, which supports BHP’s commitments to action on climate, conservation and empowering communities.”

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A few signs emerged at the recent January 1st 2024 reinsurance renewals that bode well for protection buyers as we move through this year and into the next, as broker Aon highlighted that appetite is returning for some of the more challenged products and areas of the tower.

reinsurance-program-designOver the last couple of years appetite to underwrite aggregate reinsurance or retrocession and lower layers of towers, had dried up in many cases, as reinsurers shied away from the business that had driven so many losses to them in the years prior.

But certain factors are beginning to drive more appetite to support insurer and protection buyer demand for cover, in aggregate form or lower down.

Aon’s Reinsurance Solutions team recently highlighted that one of the factors driving more appetite for these risks is the fact many reinsurers remain keen to grow, but the growth opportunity higher-up may now be less available, or facing more competition and a slight softening of prices.

Joe Monaghan, Global Growth Leader at Aon’s Reinsurance Solutions said that, at the January renewals, “Some reinsurers were also more flexible in more challenging areas, such as peril-specific lower layers and aggregate covers, particularly where insurers were able to offer potentially profitable participations elsewhere.”

By supporting cedents needs, reinsurers are able to secure better shares higher-up, is a common feature of a reinsurance market that is now stabilising and where capital has been less of a challenge to secure.

As well as leverage, using the aggregate and lower layers as a way to elicit more share of the most attractive layers, there are also reinsurers that believe the market has reset considerably, with much higher pricing and updated terms making some of these previously more challenges areas of the catastrophe reinsurance tower appealing again.

“Following the resetting of the property market and much improved results in 2023, many reinsurers are now keen to grow. As a result, some reinsurers were more accommodating at the renewal when it came to meeting the needs of individual insurers in more challenging areas, such peril specific lower layers and aggregate covers, as well as reinstating certain terms and conditions,” Aon’s Reinsurance Solutions team explained in more detail.

They added, “The increases in deductible levels a year ago have helped mitigate reinsurer losses, and reinforced necessary changes in the insurance value chain that should ultimately result in a much healthier and more sustainable market.

“In the meantime, reinsurers that want to grow in the segment should look to support insurers with flexibility in lower layers, aggregate covers and structured solutions.”

At the 1/1 2024 renewals most reinsurers went into negotiations with a desire to grow in property catastrophe reinsurance, Aon explained.

This gave insurers the ability to use their upper-layers and specialty portfolios as ways to attract reinsurer support for lower catastrophe layers and frequency coverage.

Aon said that the reinsurers that were most supportive at renewals in 2023, have benefited most from these market dynamics in 2024.

Aggregate covers are now “back on the table” Aon believes, with the reinsurance broker saying that more reinsurers are willing to consider them, at the right price and terms, in 2024.

Aon has called before for the market to innovate to narrow the reinsurance protection gaps that had emerged, when it comes to secondary perils and frequency exposures.

As we also reported, model confidence had been a driver of lower certainty in the ability to predict secondary perils and we asked whether the pendulum may have swung too far on catastrophe risk retention as well.

Aon’s Joe Monaghan again highlighted the broker’s concerns over whether the reinsurance market has retrenched too far, away from frequency and secondary perils.

He said, “As capacity continues to build, there will be opportunities for insurers to buy additional limit at the top of programs, and for reinsurers to work with brokers and clients to share the burden of secondary perils more equitably.”

Monaghan believes the industry must work to restore more of a risk-sharing balance, “The increases in retentions a year ago have mitigated reinsurer losses and contributed to their positive returns in 2023. But this has come at the expense of increased retained losses for insurers many of whom are struggling to achieve the improvements in primary pricing and underwriting which are often slowed by regulatory approval process quickly enough given their limited sources of capital to sustain increased catastrophes.

“We must work collectively to create the solutions necessary to sustain re/insurance symbiosis.”

Through greater participation in appropriately structured and designed aggregate covers, as well as lower-layers and finding ways to support secondary peril coverage, while also working to enhance risk models for these exposures, the reinsurance market can rebuild a way back into the critical areas of towers.

But, it does need to happen in an equitable way, where the rates paid by cedents are risk commensurate and the proportion of risk retained to ceded does not shift dramatically back to how it was around five to ten years ago, at the height (low) of the last soft market.

Read all of our reinsurance renewal news coverage.

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A new reinsurance fund has been launched to support delivery of innovative insurance products to protect smallholder farmers in Africa, with One Acre Fund Re expected to become a source of capacity to back what will likely be largely parametric risk transfer instruments.

africa-mapThe initiative has been launched by One Acre Fund, a social enterprise supporting smallholder farmers across Sub-Saharan Africa, with a focus on enhancing food security and resilience to climate risks, with a goal of supporting the development of prosperous communities.

The reinsurance fund, named One Acre Fund Re, has been designed with the support and partnership of the International Finance Corporation (IFC), U.S. International Development Finance Corporation (DFC) and parametric risk transfer specialist and risk pooling entity the African Risk Capacity (ARC).

One Acre Fund Re will provide a critical financial safety net for 1 million smallholder farmers in 2024 and that figure is expected to scale steadily in future years.

The idea is to improve the insurance offering for farmers in the face of devastating impacts on crop yields.

The goal is to cover at least 4 million farmers by 2030, with a range of insurance products, backed by reinsurance from One Acre Fund Re.

One Acre Fund Re will use One Acre Fund’s on the ground presence and rigorous data gathering, to allow for the design and implementation of new insurance products with direct payouts, in a way that more effectively responds to farmer experiences.

Right now, agricultural insurance is only available in 4 out of 54 countries across Africa, and currently, only 3% of farmers have insurance coverage for their farms.

So there is an enormous opportunity to bring together capital sources and create a new risk pool specifically focused on delivering smallholder farmer specific parametric insurance and crop covers.

It’s not immediately clear how this will be structured. But we assume that African Risk Capacity (ARC) will lend its expertise in risk pooling and the design of parametric insurance, to assist in the creation and roll-out of One Acre Fund Re.

On the reinsurance capital side, it could be interesting to see if One Acre Fund might find the new reinsurance fund a way it could crowd in private capital to support the rolling out of more insurance product in years to come.

There is a significant opportunity to leverage risk pooling and risk diversification techniques, alongside the learnings of the ILS market in utilising the appetite for insurance-linked returns, to generate efficiencies in the delivery of smallholder insurance products.

Even if the reinsurance fund is donor supported, there are still significant efficiencies to be had by better structuring a system for delivery of micro-insurance in both indemnity and parametric forms.

Annie Wakanyi, Director of Global Government Partnerships, at One Acre Fund, commented, “Smallholder farmers make up one of the most climate-vulnerable populations on the planet, facing increased frequency of climate events with devastating consequences on yields and household stability. This insurance offer has the potential to provide smallholder families with a strong safety net when these events occur; yet current market failures mean that most insurance products are too expensive or too limited in coverage to support meaningful resilience. But it doesn’t have to be this way.

“Agricultural insurance can support lasting impact and resilience for small-scale farmers. With economic growth from agriculture 11 times more effective at reducing extreme poverty than any other sector in sub-Saharan Africa, One Acre Fund Re aims to support smallholder families to achieve long-term poverty reduction and resilience.”

The Netherlands Ministry of Foreign Affairs is a long-term strategic partner of One Acre Fund, working together since 2016 and it recently extended its support up till 2027.

Marchel Gerrmann, Ambassador for Business and Development Cooperation of the Netherlands, also said, “When climate shocks hit, like the devastating cyclone we saw earlier this year in Malawi, farmers have no safety nets to fall back on. They are forced to pull children from schools they can no longer pay for, take out high-interest loans, sell assets, and endure protracted hunger.

“One Acre Fund Re aims to transform the way financial entities support smallholders and all profits will be used to increase impact and decrease climate risk.”

Johannes Borchert, Global Head of Risk & Resilience at One Acre Fund, added, “We are planning to roll out One Acre Fund Re in 2024 to five out of nine country programs. From year one, it will benefit over 1m farmers across Africa. As this facility grows, we will extend our services to farmers in all our areas of operation and beyond. We believe the data, experience and underwriting capacity we bring should be extended to offer climate safety nets to as many smallholder farmers as possible.”

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New technologies can serve as a bridge between the re/insurance industry and the world’s most vulnerable, and alongside the use of insurance-linked securities (ILS) and innovative solutions such as parametrics, can help to close the global protection gap, according to the Insurance Development Forum (IDF).

lies-Iyahen-IDFArtemis spoke with Michel Liès, Chair of the IDF Steering Committee and Ekhosuehi Iyahen, IDF Secretary General, around the COP28 conference in the UAE this week, about increasing insurance penetration and building resilience against natural disasters.

“I firmly believe that new technologies have the potential to connect us with the people who are completely unaware of what insurance can bring them,” said Liès.

Expanding on this, Liès noted that in most developing countries many people have access to a phone, but few have an insurance policy, while many vulnerable to the impacts of natural disasters aren’t even aware of the benefits of securing protection.

“I understand that there are certain priorities in life. But if somebody has a phone it becomes connectable. This connectivity, in turn, means that we can share critical messages regarding prevention and preparedness measures to mitigate the impact of disruptive events that have the potential to destroy an individual’s life,” said Liès.

“So, I believe that there is, thanks to advancement of technology, a lot of potential to accelerate progress in addressing and solving these protection gaps. This entails not only using technology to improve productivity in the mature markets, but also leveraging it to enhance insurance penetration in the emerging markets,” he added.

As part of that, added Iyahen, the IDF is exploring parametric insurance solutions.

“Obviously, the importance is the speed in terms of availability of resources. We saw it most recently in Morocco with the earthquake, even though that was not a weather or climate driven event. The value was also in the independence/transparency in terms of the triggering of resources. And I think that this is the governance component that perhaps we could pay a little bit more attention to, in terms of how you objectively release resources in very difficult, sometimes politically fraught contexts,” said Iyahen.

“Taking it back to the climate space and the discussions that are happening around loss and damage etc., it’s important we have conversations around how you actually trigger resources to communities who are affected. I do think that that opens up an opportunity that could be quite interesting for the industry,” she added.

As well as innovative solutions such as parametrics, to close the world’s expanding protection gaps it will take more than the capital of the traditional insurance and reinsurance industry.

“Definitely, ILS is an opportunity for countries where individuals or large communities do not have access to classical insurance and in which you can make efforts made by government to address the protection gap more visible. That’s definitely possible,” said Liès.

Catastrophe bonds, a sub-sector of the ILS space, have been issued by the World Bank’s International Bank for Reconstruction and Development (IBRD) for multiple countries, providing them with protection against natural disasters.

The parametric insurance coverage provided by these transactions shows that ILS can play an important role in building resilience, notably for some of the world’s poorest and most vulnerable to impacts of natural disasters and climate events.

Read all of our interviews with ILS market and reinsurance sector professionals here.

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In a perhaps surprising turn of events, the opening hours of the COP28 climate talks today have seen a landmark agreement to operationalise and provide initial funding for the much-discussed loss and damage fund, that is designed to help the countries that are most vulnerable to the adverse effects of climate change.

cop28-logoThe fund had been agreed on back at COP27 and much-discussed ever since, with agreements as to who should fund it, how that funding should be used, what kind of financing products should disburse funding and how should funding be triggered, all still seeming to be up in the air, to a degree at least as COP28 began.

Which is why we say ‘perhaps surprising’, as most had expected discussion and negotiation over the loss and damage fund to run on for at least a few days, if not the majority of the COP28 event.

There have always been discussions about whether some of the funding could be used to pay risk transfer premiums, to help the countries most vulnerable to the effects of climate change lock-in long-term insurance-like risk financing.

Agreements as to how the loss and damage fund will be put to work remain missing or unclear so far, but the agreement to operationalise it today and the initial funding announced is a good step towards this actually becoming reality, despite all the disagreement that has gone before.

The UAE, the host of this years COP28 climate talks, said today that it will commit $100 million to the loss and damage Fund, a move it hops will pave the way for other nations to make pledges.

COP28 President Dr. Sultan Al Jaber said, “What was promised in Sharm El Sheikh, has already be delivered in Dubai. The speed at which the world came together, to get this Fund operationalized within one year since Parties agreed to it in Sharm El Sheikh is unprecedented.”

“This Fund will support billions of people, lives and livelihoods that are particularly vulnerable to the effects of climate change,” added Dr Sultan, “I want to thank my team for all their hard work to make this possible on day one of COP28. It proves, the world can unite, can act, and can deliver.”

Other significant commitments to the loss and damage fund included Germany, which committed $100 million, the UK, which committed £40 million for the Fund and £20 million for other arrangements, Japan, which contributed $10 million and the U.S., which committed $17.5 million.

The agreement and initial funding for the loss and damage fund was welcomed by the most vulnerable nations, but there is a clear recognition that the details will matter, as well as the follow-on funding, with over $400 billion a year estimated by some studies to be the cost of loss and damage each year.

Other countries are going to be expected to commit, while there will also be efforts to see how private capital can be crowded in to support the loss and damage financing needs of the world’s climate vulnerable nations.

The insurance, reinsurance and insurance-linked securities (ILS) industry do have a role here, albeit likely further down the line, once agreement has been reached on financing tools, structures and how to disburse capital, are made.

Risk transfer and insurance products remain at the heart of discussions and it’s clear that, as private capital gets considered as an elastic source of funding, the catastrophe bond and insurance-linked securities (ILS) could be up for discussion as potential options.

So too should responsive risk transfer options, using parametric and index triggers that could provide rapid payouts for use in disaster relief after climate-related events.

It’s a positive start to COP28, with agreement on an issue that has been discussed now for years.

Although, in reality, the perhaps lengthy discussions can now begin on the details that really matter.

Including, implementation, how funding will be gathered, used, and disbursed, as well as whether any of it can fund premiums to pay for upfront, longer-term risk transfer instruments, to support the most climate-vulnerable nations and their populations.

Also read: Risk-sharing systems must be a pillar of Loss and Damage architecture: Report.

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Having spent time in Bermuda and attended the recent PwC Insurance Summit on the island, the equity analyst team at BMO Capital Markets has concluded that the insurance and reinsurance industry is suffering a lack of confidence in its risk models, which they say has been a key driver in capital flight and retrenching higher.

light-question-ideaSpecifically on natural catastrophe risks, the BMO analysts team say that, “The industry is suffering from a lack of confidence in its models.”

Continuing to explain that, “Even if its models are more correct going forward, that mental dynamic will simply take time to fix.”

Weather is changing faster that what the climate models had suggested, the analysts state, which has been a driver of capital becoming “skittish” in reinsurance.

Capital becoming “skittish” means some has exited, but the analysts note that it has also led to capital asking for “more price and less risk”.

Capital will recover though, particularly, “If reinsurance returns are excellent this year and into the future, more capital should inevitably flow back into the marketplace.”

While demand is rising for capital to help out on bringing volatility back under control for corporates, insurers and others in the risk transfer chain.

Brokers are beginning to voice concerns and the BMO Capital Markets analysts said that, “Aon believes the pendulum has swung too far in terms of corporates being forced to take on higher deductibles, and it believes the market’s insurance policy terms & conditions will eventually ease.”

There is evidence that the utility of risk capital has reduced somewhat, for certain buyers of risk transfer protection, as they retain more of the ground-up losses themselves and find capital buffering from insurance or reinsurance has been reduced by the higher attachments and more restrictive terms.

Of course, capital has naturally retrenched higher and away from frequency risk, in response to the losses suffered and the fact models were seen to have been less effective on that specific period of catastrophe and weather loss activity.

The question then is whether climate is seen as a driver and how that evolves over time as well, as another factor impacting confidence to deploy capital to layers where loss activity can be more volatile.

To know all the answers needed, we really need to see a next phase of evolution in the models that are available, to deliver the confidence that might now be required in this volatile risk landscape.

Has the pendulum swung too far on catastrophe risk retention?

As we’ve explained recently, the increasing retention of catastrophe losses is becoming more of a challenge, as evidenced by some major insurance groups.

Aon had previously highlighted this issue as a critical area for market focus, where innovative efforts could help to fill some of the reinsurance protection gaps that have appeared.

While, a recent survey from reinsurance broker Gallagher Re showed that reinsurer appetite for writing aggregate coverage and lower-layers remains limited and is likely to remain so at the key January 2024 renewal season.

Plus rating agency Moody’s highlighted that the lack of aggregate reinsurance cover is now considered a business risk to the UK P&C insurance sector.

All of which has led to some, like US insurer Allstate, to enter the reinsurance market looking at aggregate stop-loss solutions that could help it cap the growing volatility in its results.

As well as an expectation that traditional reinsurance terms loosen somewhat, the BMO Capital Markets analysts believe we will see “creative alternative capital solutions” to this issue of greater catastrophe risk retention and weather volatility.

But the two issues, of confidence in models and resuming the underwriting of lower-layers and aggregate covers, are connected to a degree, as the confidence in the models is an element that gives capital more confidence to expose itself to greater potential volatility.

While structuring and capital markets innovation can certainly help here, without clearer visibility of the risks and a greater appreciation of the accuracy of models that help in understanding them, capital could remain cautious it seems.

At the same time, the inflationary effects on losses will continue, as values-at-risk in catastrophe exposed regions continue to rise.

Which means the number of large loss events that impact insurance and reinsurance capital can be expected to rise, meaning greater retention of volatility for as long as risk transfer solutions to lower-layers and aggregates remain less available.

Some in the industry are determined to remain at the higher-layers only and to avoid aggregate covers in the majority of cases.

The quota share is gaining favour as a solution to help in risk sharing of some lower-layer volatility, with sidecar activity elevated this year as a result.

But true solutions to the kind of frequency and volatility that delivers the most pain, both on the reinsurance and retrocession side, remain much less available at this time, despite a number of markets staying committed to provision of products that offer some support here.

On the risk model side, evolution continues apace and the advent of newer models, such as those utilising artificial intelligence, could help to restore more confidence in them.

But, models are only ever as good as their interpretation and the portfolio management and hedging decisions taken by their users, which of course is one area where the alpha in the industry is generated.

With model outputs directional, informing the choices that need to be made over how to construct portfolios, including what risks, regions, counterparties, and layers to underwrite or invest in, the models can feed into industry confidence which should in time help capital to become more willing to absorb frequency risks and lower-layer volatility.

But, whether we’ll ever see the kind of soft market products that have emerged in the past, remains to be seen.

Hopefully, we’ll see the market develop solutions that have an inherent alignment to them, that can help cedents with more of their volatility and frequency problems, while delivering risk commensurate returns to those providing the capital.

On model confidence, volatility, frequency and emergent reinsurance protection gaps was published by:
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Delivering a speech in Canberra today, Andrew Hall, the Executive Director and CEO of the Insurance Council of Australia (ICA) explained that insurance and reinsurance markets are repricing risk globally and for reinsurers, writing risk in Australia is no longer seen as the diversifying hedge it used to be.

australia-flooded-map-flagWhich is contributing to the development of insurance protection gaps, Hall said, driving a need for a partnership approach to reduce the pressure on premiums for consumers and ensure coverage is sustainable.

Australia has been beset by natural catastrophe and severe weather events in recent years, with the losses falling to the insurance and reinsurance market rising fast.

Hall explained the role of inflationary costs in driving claims quantum higher, highlighting that a repeat of the $3.3 billion 1999 Sydney hail storm could drive an insurance market loss of almost $9 billion today.

With the number and value of buildings increasing all the time in severe weather and catastrophe exposed regions, insurance is even more critical today.

Urbanisation, geopolitical strife, growing weather volatility, increasing cyber threats, rising exposure values, all mean “We are living in a time now though when risk is being reassessed,” Hall explained.

“The certainties about how we see the world are changing,” Hall said, “Risk isn’t receding, it’s accelerating.”

Hall stated, “All of these pressures have come together to create a perfect storm in insurance markets.

“Risk is being repriced.

“The pressures and costs are increasing. The trend lines are all going one way. Because of these pressures, insurers’ input costs are going up and up. One of those costs is capital.”

He went on to explain how the global capital markets have supported Australia’s insurance industry, in particular through the global reinsurance markets.

Saying that, “Reinsurance is our way of accessing a wider pool of protection when disasters strike. Year to year the financial performance of the insurance sector can be volatile, as we’ve seen in the years since the 2019 Black Summer fires. Reinsurance allows insurers to smooth their losses, protecting themselves and the Australian financial system from the impact of significant loss – usually as the result of a large event. And reinsurance is how global capital helps underwrite Australian risk.”

He continued to say, “Australia used to be seen by reinsurers as a good hedge against events in the northern hemisphere such as Japanese earthquakes, or Florida hurricanes.”

But, “Not anymore.”

Hall said that, due to the trends towards volatility in a world of rising values, “Australia is being re-assessed by reinsurers.”

“After wearing losses over several years in the Australian market they are having to put through significant increases in the cost of their cover,” Hall explained.

Which is being reflected in the price of premiums and has led to, “Some of the biggest price adjustments in nearly two decades have gone through the insurance system.”

With these price hikes in insurance hitting consumers at a time of high inflation, energy costs and a cost-of-living crisis, Hall said that this is driving a widening of the insurance protection gap.

Which means pressure on people, the economy, as well as banks and the financial system.

Hall said, “Extreme weather events in areas of growing population mean banks are increasingly exposed to the protection gap risks. It will also place greater pressure on governments to bear recovery costs.”

Posing the question, “What can we do in partnership with all levels of government, other stakeholders like banks, and customers, to alleviate the pressure on premiums, and not let the gap turn into a chasm?”

Then stating that, “For the industry this is the key problem to solve in this time of dramatic change.”

Hall has laid down the key challenge facing global insurance and reinsurance markets, maintaining adequate coverage at affordable prices, in a time of rising risks, exploding values, increasing volatility, climate change and currently a trend towards a retrenching of capital away from those factors, not towards them.

Hall, in his speech today, provided insights into what he and the ICA see as potential answers and the progress being made by the Australian insurance industry.

But, critical to the industry there, is going to be the cost of reinsurance over the longer-term, as this can act as a brake on insurers own capital deployment and ability to assume risk.

Australia faces the same issues as the rest of the world, which have become especially evident in insurance markets in California, Florida and elsewhere.

With consumer insurance premiums likely to keep rising, while reinsurance costs look set to remain higher than experienced over the last two decades, the industry must start to look for where efficiency gains can be made.

To lower the cost of risk capital, for its users. While maintaining adequate returns for the global capital providers, to ensure more capacity becomes available to help the world absorb volatility, rather than less.

Risk repriced. Australia no longer a “good hedge” for reinsurers: ICA CEO was published by:
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A new report calls on the world to implement risk sharing systems, such as parametric triggers in insurance, reinsurance and insurance-linked securities (ILS) such as catastrophe bonds, as a central pillar of the Loss and Damage architecture required to protect the most vulnerable nations against climate, weather and natural disasters.

cop27-loss-damageThe report published by lead author Dr Ana Gonzalez Pelaez, Fellow at the University of Cambridge Institute for Sustainability Leadership and prepared with the support of insurance and reinsurance broking group Howden, looks at how risk transfer can be a key component of global loss and damage mechanism design.

Specifically, the report provides a risk-sharing action plan to scale up the much discussed Loss & Damage (L&D) funding needed for Global South countries, some of the most vulnerable to climate change and disasters.

It found that the smallest and most vulnerable countries are at-risk of losing more than 100% of their GDP from extreme climate shocks next year.

But noted that these are insurable risks and research undertaken claims they will remain insurable, using insurance industry techniques, right up to 2050 at least.

“A solution using the power of insurance and capital markets could dramatically scale up the impact of Loss & Damage funding,” the report suggests.

It suggests utilising donor funding to pay premiums for risk transfer, using whatever instruments are most appropriate across insurance, reinsurance and the capital markets, including catastrophe bonds, and leveraging structuring techniques such as parametric triggers in order to deliver the financing just-in-time.

The aim would be to provide “guaranteed financial protection to exposed communities now, and through to at least 2050” the report explains.

The report estimates that $1 billion of donor-supported annual pure premium could be utilised to protect all 30 of the world’s smallest and most climate vulnerable countries with a population of less than one million from losing more than 10% of their GDP from climate shocks, through an umbrella stop-loss mechanism design.

By making risk sharing, insurance, reinsurance and instruments such as catastrophe bonds, a central pillar of the Loss & Damage initiative, the reports authors say the economies of the most vulnerable countries can be protected.

The report shows that risk sharing systems, such as insurance and capital market risk transfer, can be an efficient way to leverage the depth of expertise and financing available in private markets.

By putting some of the donor funding that could be put towards Loss & Damage to pay premiums, long-term risk transfer can be locked in to protect economies of those regions most vulnerable or climate, weather and natural disasters.

The research found that donor-supported annual pure premium of $10 million per country could equal roughly $25 billion of financial protection, contractually guaranteed, across 100 countries.

This is important work, as it takes a quantitative approach to demonstrating how funding can be made to go further, while risks shared, by utilising concepts from insurance and insurance-linked securities (ILS) markets, to mobilise significant private capital to support the most vulnerable countries in the world.

As we’ve stated before, responsive risk transfer and efficient capital markets can come together to provide the kind of protection vulnerable nations need, while also ensuring that donor funding is put to work in a manner that can offer real liquidity just when it is needed most.

As we have been saying for more than a decade, insurance-like structures should be dovetailed into these efforts to finance climate and disaster risks, such as the loss and damage initiative, to ensure there is access to capital for climate change disaster response, recovery and rebuilding.”

Finally there is a piece of work that can help to demonstrate the utility of this approach, which should help in gaining more traction for this idea in development circles as COP28 fast approaches.

The briefing paper on this important study can be accessed here.

Dr Ana Gonzalez Pelaez, Fellow, University of Cambridge Institute for Sustainability Leadership and lead author, explained, “We have demonstrated how public-private finance can be combined to protect billions of people, now and in the decades ahead. We are calling on the international community to make risk-sharing systems a pillar of the Loss and Damage architecture for all countries and introduce umbrella stop-loss mechanisms to protect the economies of the world’s smallest and most climate-vulnerable countries.

“The Action Plan presented in this study is ready and can be implemented using existing institutions to provide vulnerable countries with guaranteed payouts from the risk capital markets after a disaster. These funds could be used for critical priorities such as humanitarian assistance; rebuilding schools, hospitals and vital infrastructure; sovereign debt repayments; restoration of agriculture and ecosystems.”

Howden undertook actuarial and financial modelling analysis to establish the technical cost of reducing financial risks through the use of parametric solutions to implement the so-called umbrella stop loss concept and the $10 million standard pure premium allowance.

Umbrella Stop-Loss Protection is already a well-established concept in the global insurance and reinsurance industry.

It means that all defined losses above a given threshold are protected against, providing an overarching and strategic protection beyond lower-level losses.

This study saw the umbrella stop-loss structure applied for the first time to protect national economies at scale, using GDP as a reference and across six climate hazards.

The research notes that thresholds for attachment can be set at any chosen level, but in their analysis the authors opted for 10% because it can provide significant protection to small, vulnerable countries at risk of losing over 100% of GDP while still remaining affordable to donors.

Rowan Douglas CBE, CEO Climate Risk and Resilience, Howden, and Chair, Operating Committee, Insurance Development Forum, added, “The pure maths and dispassionate economics in this analysis are clear. Risk sharing systems empower hard won Loss and Damage funds to provide structural financial security to the widest range of vulnerable countries. We can mobilise existing expertise, institutions and partnerships to put this essential protection in place quickly. With this groundbreaking research by CISL, world leaders are guided by an Action Plan based on a bedrock of open science, rigorous analysis, shared alignment and collective purpose.”

Dr Mahmoud Mohieldin, UN Climate Change High-Level Champion, also said, “This innovative initiative has the potential to protect vulnerable countries from climate- related losses with pre-arranged financing at a large scale, unlocking the risk capital markets to multiply the impact of donor funds. Mobilising private finance alongside the new loss and damage fund is crucial in addressing these impacts, and more such initiatives are needed.”

Dr Youssef Nassef, Head of Adaptation, United Nations Framework Convention on Climate Change also commented, “Umbrella Stop-Loss provides a practical concept to the L&D common stance that it is an international responsibility that countries and individuals should not suffer, due to climate change, above a certain limit.”

Co-author Dr James Daniell, Natural Hazards Engineer, Risklayer GmbH; Centre for Disaster Management and Risk Reduction Technology (CEDIM) at Karlsruhe Institute of Technology and the University of Adelaide, further explained, “We have produced plausible, mid-range, estimates of climate risk for these countries using leading data sources and robust methodologies. This analysis frames Loss and Damage implementation within objective physical and economic realities, essential for effective outcomes. This pioneering research also opens up a vast global community of academic and professional expertise that stands ready to build on this work and support the urgent mission of bringing Loss & Damage protection to vulnerable countries worldwide.”

Risk-sharing systems must be a pillar of Loss and Damage architecture: Report was published by:
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