Governments are looking for new ways to meet the spiralling costs of disaster relief and the private sector is willing to get involved because of the new investment opportunities such schemes offer.

Swiss Re said it has seen an increase in governments looking to transfer the risk of costly natural catastrophes to the private market via insurance-linked solutions and derivative instruments, rather than relying on one-off disaster levies for after the event.

The world’s second-biggest reinsurer said that in the 1980s, the economic cost of global natural disasters totalled about $25 billion, in the 1990s costs rose to $95 billion a year, and in the last decade economic damage has reached an annual average of $130 billion.

Since Jan.1, the insurance industry has suffered $10 billion in losses from the quake in New Zealand, still untold losses from floods in Australia and most recently, an estimated bill of up to $34 billion from Japan’s massive earthquake on March 11.

In the past, governments with no reinsurance programmes have had to dip into their own coffers to pay for the cost of regeneration after a natural disaster.

“Fiscally, it is not sustainable to ignore the cost of natural disasters,” said Guillermo Collich, senior financial sector specialist at the Inter-American Development Bank.

Data from the IBD said losses associated with earthquakes, hurricanes, droughts and flooding are growing at four times the rate of GDP growth.

Collich said it, together with Swiss Re, is creating a natural disaster refinance facility to help its catastrophe-vulnerable countries deal with natural disasters.

“This was previously totally unfunded,” he said.

The IDB plans to issue a $100 million insurance facility in the Dominican Republic to protect the country against hurricanes and earthquakes under a five year policy.

GLOBAL GOVERNMENTS LOOK TO PRIVATE SECTOR

Governments in both emerging markets and richer countries are looking to securitise catastrophe risks through Public Private Partnerships, which provide governments with immediate disaster relief and insurance protection against human health, crop yields, as well as rebuilding and rehabilitation costs from weather-related risks.

Australia’s government expressed the need for a national disaster fund after recent cyclones and floods in Queensland state left the country with a clean-up bill of around A$10 billion.

“Major disasters can have negative impact on the long term development agenda of the developing countries,” Olivier Mahul, co-ordinator of the disaster risk financing and insurance program at the World Bank told Reuters.

“We have seen a major increase over the last five-six years from developing countries looking for disaster risk management and risk financing,” he said.

The World Bank entered the disaster insurance arena ten years ago after launching a catastrophe reinsurance pool in Turkey.

Since then, economic development, population growth and a higher concentration of assets in exposed areas, as well as climate change, has led to an ever increasing gap between the impact of catastrophes and the financial losses covered by insurance.

Insurance schemes and reinsurance pooling facilities have been tested all over the world, which has attracted the attentions of top reinsurers such as Swiss Re and Munich Re and insurance leaders, like the Lloyd’s of London, says David Simmons, MD of Analytics at WRN, part of reinsurance broker Willis Re.

There is a growing appetite from the private sector – looking for non-correlating risk to financial markets on their existing insurance books, he says.

A successful example is the Caribbean Catastrophe Risk Insurance Facility (CCRIF) – a reinsurance pool set up by the Caribbean government and the World Bank in 2007 to cover 13 Caribbean nations against hurricanes and earthquakes.

Last year, the CCRIF paid over $25 million to Barbados, Saint Lucia, St Vincent and the Grenadines following Hurricane Tomas, while in the previous January, CCRIF paid $8 million to Haiti after the devastating earthquake triggered the country’s earthquake coverage.

“The traditional response model of aid isn’t working – disaster risk reduction models are more sustainable development models. Governments are re-analysing their positions as aid is not going as far as they need it to go,” Simmons adds.

In October 2009, the World Bank launched a $290 million catastrophe bond with Mexico’s government and Swiss Re to cover the country against hurricane and earthquake events.

Catastrophe bonds transfer the risk of natural disasters to investors, who receive a yield in return for agreeing to cover damages they consider unlikely, and lock in funds for disaster relief before storms strike.

“As a government we have a responsibility to provide better protection and financial security for the Mexican people,” said Manuel Lobato-Osorio, head of insurance and pensions at the Mexican finance ministry. “We can develop a financial instrument or risk transfer mechanism for the sake of it – but that’s not the point.”

PRIVATE SECTOR WILLING TO MEET GOVERNMENTS’ NEEDS

Support from the private sector has been improving, having previously shied away from investing in high frequency risks, which tended to generate low returns, says the World Bank.

“The private sector now see developing countries as a new business opportunity – they see the value of diversifying their portfolio and adding – say tropical cyclone risk in Asia – to its high paying risks such as Florida and California hurricane and earthquake,” says Mahul.

Cat bonds, reinsurance pools or index based insurance policies all receive credit ratings – allowing industrialised countries to pick tradable instruments with capital market benchmarking and triggers.

“It’s an easy comparison for finance ministers to make to other market based instruments such as sovereign debt,” Nikhil da Victoria Lobo, client manager, public sector at Swiss Re said.

These insurance linked products can give governments access to large amounts of cash at short notice, compared to issuing debt to fund recovering efforts, he said.

The IDB’s Dominican insurance policy will be issued by a captive insurer, which will give the IDB’s institutional platform an investment grade rating.

“We are so happy,” says Collich. “We are going through the international reinsurance market – which means we are not entering through the main gate and not by the service door.”

Source : Reuters