Sovereign risk transfer solutions
Learn more about managing natural catastrophe risk at a national or regional level
Cope with avoidable and unavoidable risks
Managing natural catastrophe risk on a sovereign level requires a comprehensive approach. First, it should help both national and regional governments avoid disasters as far as possible and, second, it should put contingencies in place for any risks that might be unavoidable. With this in mind, we partner international development banks, donor governments, the Insurance Development Forum and other stakeholders involved in the development of sovereign risk transfer solutions.
Typically, these include the provision of reinsurance to private or state-owned local insurers, as well as consultancy services that support governments in assessing risks. Effective consulting provides the basis for the development of effective action plans and ensures the necessary insurance is in place to cover any unavoidable losses you might face.
Access broad global expertise for focused local solutions
A broad approach to catastrophe risk management is recommended
AVOIDING DISASTERS
Reduce risk and prevent disaster through mitigation and adaption
- Understand Risk
(Re)insurance helps understand hazards to build a comprehensive exposure database as well as to understand vulnerability: how hazards turn exposure into loss for the gov. As a result, a price tag can be put on the risk. - Risk prevention/ Mitigation
Understanding risk informs prevention and risk reduction measures (e.g. reinforcement of public-school buildings, flood protection). The (re)insurance sector could be an investor in risk preventing and reducing infrastructure.
MANAGING THE UNAVOIDABLE
Improve preparedness and response capacity
- Action plans
(Re)insurance payouts can be bound to pre-agreed plans for post-disaster action. The involvement of the private insurance sector can enhance discipline, transparency and predictability in post-disaster spending. - Risk financing
(Re)insurance has the ability to provide significant risk transfer. The most efficient and effective mix of ex-ante and ex-post risk financing and risk transfer will vary from case to case and needs a thorough assessment of the different options. - Loss adjustment
(Re)insurance can be very supportive in developing and implementing a rule-based, transparent and robust approach for loss adjustment (“loss protocol”). Loss adjustment as joint effort with aligned interest to achieve fair results while controlling loss.
Best practice approaches to managing catastrophe risk
Governments can effectively manage catastrophe risk by focusing on avoiding disasters through mitigation and adaptation and, as importantly, through improving preparedness, response and reconstruction capacity to cope with unavoidable risks.
- Avoiding disaster requires a thorough understanding of the risks. The insurance sector has developed probabilistic risk models for exactly this purpose. These models make informed decisions possible as to where risk reduction and prevention is possible and to what level it should be prioritized.
- Managing unavoidable risks requires tightly defined action plans and the financial capacity to implement them. The plans should also allow for the cover of any tax loss a government might suffer as a result of a catastrophic event as well as for the reconstruction of damaged assets.
Ultimately, the value of insurance goes far beyond the risk financing. It helps governments better understand risks, motivates prevention and reduction of risk, and makes response to emergency more efficient by calculating the financing of implementation. This supports governments in the efficient assessment of any loss as well as in bearing the costs associated with reconstruction. It also puts governments in a position ensure the rapid reconstruction of any assets destroyed by a catastrophe.
Particular challenges governments face
Loss of tax income
Uninsured public assets
Liabilities arising from private assets
Additional losses
A reduction in revenue
The choices available to governments
Risk Transfer within the Sovereign Risk Management Framework
Different possibilities
| Sovereign risk protection | Protection for households | Social protection | |
|---|---|---|---|
| Policyholder | Governments (often Ministry of Finance) | Private households or companies | Government with low-income households as beneficiaries |
| Funding / Government role | Part of the federal budget: Government manages allocation of resources in case of natural disasters | Government creates legal and regulatory framework for high insurance penetration | Government pays the premium while low-income households are the beneficiaries |
| Insured interest | Public assets and/or ex-ante financing of emergency response | Private property | Contingent public liability for low income households |
| Examples | – FONDEN (Mexico, public assets) – CCRIF (Carribean, emergency response) – PSPI (Philippines) | – TCIP (Turkey) – NFIP (United States) – Flood Re (UK) | – ARC (Africa) – NNDIS (Sri Lanka) |
Perhaps the best way to illustrate how the above can be applied is by way of three specific examples
Example 1: Mexico – FONDEN
The Mexican government focuses on protecting its public assets stock by reducing the adverse fiscal impact of natural disasters. Different asset classes amounting to almost 250 billion USD are insured through FONDEN (Fondo Nacional de Desastres Naturales), which is effectively a state-owned catastrophic risk fund that makes use of international reinsurance. Mexico implemented FONDEN for the specific purposes of risk financing, risk transfer, and enhancing governance of loss adjustment. Good governance significantly reduces costs of reconstruction as it avoids having to compensate for pre-existing damages and reduces the risk of willful destruction, cost inflation, and fraud.
In addition to FONDEN, which is an indemnity-based insurance program, Mexico mandated the World Bank to issue a catastrophe bond on its behalf. Usefully, the cat bond finances emergency response and relief in advance of a catastrophic event taking place. Payment is automatic and immediate on activation of pre-determined triggers, such as the intensity of a hurricane making landfall or the strength of earthquakes in predefined geographical areas. This means the government can respond to natural disasters in good time.
Example 2: UK – Flood Re
In the UK, penetration of flood insurance among residential property owners is historically very high. Some years ago, the insurance sector became more cautious when insuring flood risks in highly exposed geographies.
Flood Re, a UK insurance industry-owned and government supported insurance scheme, was set up as a solution. Financed by a levy on premiums from property insurance policies throughout the country, this public private partnership cross-subsidizes premiums in highly exposed areas to keep insurance affordable. A similar approach could easily be taken to insure property against losses stemming from earthquakes or hurricanes in other parts of the world.
Example 3: The Bahamas — CCRIF
The Bahamas has 3 tropical cyclone policies with the Caribbean Catastrophe Risk Insurance Facility (CCRIF). Each policy covers a defined section or zone of the archipelago – North West, South East, and Central. It is the tropical cyclone policy for the North West Zone – which includes the Abaco Islands and Grand Bahama – that was triggered by Hurricane Dorian in September 2019. CCRIF’s payouts are normally made within 14 days of an event, but in the case of Dorian, it paid 50 per cent in advance to allow the Government to begin addressing its most pressing needs – with the remaining 50 per cent paid within the normal 14-day window.
CCRIF encourages member countries to use its parametric insurance policies in conjunction with other disaster risk financing instruments. This enables them to build a financial protection strategy that combines a number of instruments that address different layers or types of risk, as well as balance budgetary conditions with the need to manage the ongoing economic liability that natural disasters present, especially in the face of a changing climate.
- erauch@munichre.com
