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Insurers must take the lead on disaster resilience coverage

Insurers must take the lead on disaster resilience coverage

Wildfires in California and Alberta, floods in Louisiana, drought and Ebola in Africa and Zika in the Americas and Asia: all reminders of how unprepared we are for the natural catastrophes that accompany climate change and globalization. They are reminders, too, that public and charitable funding for disaster recovery is often inconsistent, inefficient, and insufficient.

But a new group of public-private partnerships has pioneered a different approach to recovery funding — using insurance mechanisms to shift risk from public agencies to international financial markets, and leveraging philanthropic and public-sector funds to develop new innovative risk-sharing programs.

By creating ways to cover occurrences once considered uninsurable, these publicprivate partnerships have turned disaster recovery into a robust business and investment opportunity — for example, catastrophe bond purchases have grown 10% annually since 2009, with $26 billion currently in the market. And they have given public agencies a very cost-effective financing tool: Lloyd’s Global Underinsurance Report published in October 2012 indicated that a 1% increase in insurance penetration can reduce the cost of disasters to taxpayers by up to 22%. A recent example of making insurance markets work for a greater public good is the $29 million insurance payout from the Caribbean Catastrophe Risk Insurance Facility to Haiti, St. Lucia, St. Vincent, the Grenadines and Barbados, in the immediate aftermath of Hurricane Matthew. Though modest, the money has been used to help at least 1.4 million affected people to date.

The insurance industry has been a “slow follower” in this important new market, initially questioning whether events such as climate change and disease epidemics were insurable propositions, and whether such products could drive revenues. Yet disaster resilience insurance is indeed proving to be viable, providing an attractive opportunity for the insurance industry — a virtually untapped global market, where big-data and remote sensing technologies ease risk analysis and pricing, and funding from philanthropies and governments reduces initial product research and development costs.

Given the size of this new market — research from Swiss Re Ltd. in 2015 notes that 70% of global economic losses from natural disasters are uninsured, as are 80% to 100% of all economic losses in emerging markets — the disaster insurance business could help relieve the industry’s current problems with weak economic forecasts, underutilized capital and mounting competition in their traditional markets.

One of the market’s pioneering efforts is the Extreme Climate Facility, or XCF, being created by African Risk Capacity, a Johannesburg-based agency of the African Union. Designed to help African governments address climate change-driven weather shocks such as extreme heat and droughts, XCF will issue up to a billion dollars’ worth of catastrophe bonds in the next three decades — with coupon payments or premiums to global investors, funded in this case by international development organizations and foundations.

Another innovative program in the works is the Pandemic Emergency Financing facility, an insurance solution for curbing pandemic risk launched by the Washingtonbased World Bank Group. Funded by investor-purchased “pandemic catastrophe bonds” and by insurance and reinsurance contracts with coupon payments funded by development organizations, the PEF seeks to enable fast response to pandemics in low-income countries.

Building on cornerstones such as CCRIF, ARC and the PEF, the disaster resilience insurance market is poised to grow for decades. And insurers should be entering the market — working closely with governments, development organizations and philanthropies to create customertailored products. As they do, they should be mindful of the lessons learned by the market’s pioneers and note three imperatives:

Imperative One: Align expectations about what insurance can do.

Too often, public and development-sector organizations, including nongovernmental and intergovernmental organizations and foundations, view insurance as a panacea for disaster response. In reality, it works only for carefully defined, nonfrequent events. It cannot underwrite broad disaster recovery capacities, nor eliminate the need for preparedness funding from public coffers, development loans, and international aid.

Insurers must help development-sector organizations understand what these products are meant to accomplish, generally and specifically. They need to ensure that payers and policyholders know exactly what their policies will and won’t pay for and prompt them to develop a funding plan for essential services or commodities uncovered by insurance.

If companies fail in this “education” imperative, they risk having disappointed public- and development-sector leaders question the effectiveness and value of these products as public finance tools.

Imperative Two: Reduce any complexity and uncertainty that slows down payouts.

A core benefit of disaster resilience insurance is quick access to funds, circumventing delays by bureaucratic, process-heavy public systems and international development agencies. Anything that slows down payouts diminishes their value at the front end of crises. This happened in Mexico last year after Hurricane Patricia. The government had previously issued a $315 million catastrophe bond, which seemingly transferred the risk of hurricane losses to global capital markets and locked in disaster-relief funding. Unfortunately, the payout was delayed three months by disagreement on whether the event warranted a 100% payout or merely 50%.

To avoid these situations, companies must identify and where necessary develop mechanisms and triggers that leave no room for dispute between themselves, payers, regulators and policyholders.

Imperative Three: Create a safety net to mitigate innovation risk.

The disaster resilience insurance market is still nascent and there will be growing pains. Risk is unavoidable when innovation is so central to the market’s development and when the market’s context — a world undergoing climate change and issues increasingly crossing national boundaries — is uniquely unsettled. The private sector understands these challenges. It accepts that not all disaster resilience insurance solutions will work as intended right out of the box. It knows that complex products often need recalibration and refinement.

But public- and development-sector leaders do not have the same tolerance for risk or patience for the process, especially when it means that the poor and vulnerable populations affected by catastrophes are left even more exposed to suffering.

African Risk Capacity confronted this risk-tolerance problem when a drought insurance product purchased by the Government of Malawi initially underestimated the number of people affected by drought during the 2015-2016 season. As a result, despite widespread shortage of rain and food on the ground, a payout was not triggered.

The problem was one of data used, not intent or technology; and the situation was ultimately resolved when it was determined through field surveys that the governmentprovided technical data underpinning the insurance contract, including the variety of maize used for farming, was not in line with the actual farmer practices.

Insurers should anticipate the differential in risk tolerance and address it head-on with their public-, development- and philanthropicsector partners. Their mutual goal should be creating a “safety net” that permits product innovation and refinement while protecting affected populations. One option is a contingency fund to help communities when an insurance product needs technical recalibration. This kind of joint investment will afford insurers space and time to reinforce the quality and credibility of the disaster resilience insurance model.

Toward both profit and resilience

Disaster resilience insurance can become an indispensable product — a major contributor to public-sector recovery funding and a robust new market for insurers whose traditional business lines are constricting. But for disaster resilience insurance to succeed, insurers must take the lead. They must guide their new collaborators through the complex process of creating and refining products. They must foster the market’s growth by promoting wide adoption of their products. They must build confidence that their products will consistently help to protect vulnerable communities around the globe.

Saadia Madsbjerg is a managing director with The Rockefeller Foundation. She can be reached at 212-869-8500 and

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