Parametric bonds the best option for the protection gap

Parametric cat bonds can help the countries of South Eastern Europe, Central Asia, the Caucasus, and the Commonwealth of Independent States as well as Turkey (ECIS) close the protection gap associated with natural catastrophe risk, Kirill Savrassov, chief executive officer of Phoenix CRetro, a niche Bermudian ILS specialist, told Baden-Baden Today.

“With low insurance penetration (less than 2 percent), reinsurance protectionism and growing climate change consequences, the countries of the ECIS region really need to address disaster risk transfer with the use of all available alternative instruments, and that is where the ILS market has something to offer,” said Savrassov.

He noted that the region is exposed to a number of risks, with earthquakes being the most devastating. Between 2005 to 2014, the region suffered 314 natural disasters events affecting over 11 million people and causing more than 60,000 deaths.

The economic impact of these events is estimated to have been around $25 billion—but little of that total was covered by insurance.

“The human cost of natural disasters is measured not just in the deaths and injuries they cause, but also in terms of their lasting economic impact on survivors and countries,” Savrassov added. “Natural disasters don’t just destroy homes and fields; they can altogether annihilate years of economic growth.”

The UN Office for Disaster Risk Reduction (UNISDR) commented on the impact of natural catastrophes on low and middle-income countries in its newly issued report, Economic Losses, Poverty and Disasters 1998–2017.

“We can see that climate change is playing an increasingly important role in driving up disaster losses around the world, and that probably will be the case in the future as well,” the report said.

Unbalanced impact

Although rich countries shoulder the highest absolute economic losses, the report noted the disproportionate impact of disasters on low and middle-income countries. In developing countries, economic losses are not analysed for many disasters, meaning the new data were just “the tip of the iceberg”.

Some of the significant events in the last century cited by Savrassov include the 1948 Ashgabat earthquake, killing almost 10 percent of the population of Turkmen SSR at that time; the 1966 Tashkent earthquake destroying most of the buildings in the city; and the 1988 Spitak earthquake, with nearly 50,000 deaths, another 130,000 people injured and 517,000 becoming homeless—it also halted about 40 percent of nation’s production capacity.

In addition, and due to climate change, Savrassov noted that the Balkans region is now having extreme weather events as the new ‘normal’, especially with regard to flood exposure.

The 2014 Balkan floods caused damage and losses equivalent to nearly 5 percent of Serbia’s GDP and nearly 15 percent of Bosnia and Herzegovina’s GDP, he added.

“When disaster strikes, immediate steps must be taken to protect survivors and provide temporary shelter and emergency food and clothes. Homes need to be rebuilt and infrastructure of the area re-established. All this costs money,” said Savrassov.

“If there is to be a solution that benefits everyone, it is likely that the solution will have to be organised by the government on a national level.”

In trying to increase insurance penetration, he suggested that sovereign disaster risk transfer solutions cannot always take the form of insurance, as this requires an insurable interest which states may not always have when it comes to critical infrastructure.

Another hurdle he sees is that insurance requires proof of loss and the resulting payments are made only on an indemnity basis—he suggested the adjustment process can be time-consuming and delay the payment of funds. Reinsurance protectionism in certain countries can also limit access to the market for local players and vice versa, which make the use of insurance for the government difficult in case of a large disaster.

Savrassov noted that there are viable ILS solutions and a choice of options for different regions and governments with regard to disaster risk transfer, thanks to the proactive position of international organisations (the UN, international financial institutions) along with a good track record of ILS so far.

“Any such solution needs to be tailor-made, but in our opinion and because of various local specifics, parametric cat bonds seems to be the best option for the ECIS region,” said Savrassov.

“With steady development over the last decade, assets over $100 billion, strong performance, growing appetite from institutional investors like pension funds and the ability to create and develop independent transparent parametric triggers there is no doubt that the ILS market can offer good, reliable risk transfer solutions for the region.

“This will be not only be a solution for governments but provide capital markets with needed intra-class diversification whereby new territorial exposures will fit perfectly into ILS fund management strategies.”

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