begin to flow in very soon after the event. This helps to reduce the short-term strain on government and consumer budgets. Reinsurers’ success in developing the market for this type of product line could reinforce the industry’s relevance in many catastrophe-exposed high-growth markets, as it has in Turkey, and open up new insurance markets as these economies mature.
Changing The Mindset
In many developing economies, insurance is viewed as a tax, rather than a valuable protection, particularly if no major loss events have occurred recently in the region. As a result, authorities are likely to underestimate or de-emphasize their catastrophe exposure. Even if they recognize the scale of their exposure to catastrophe risk, elected politicians must consider how the public assesses the value of any insurance-backed transaction, especially in times of austerity. Because the protection may only provide benefit if an infrequent and severe event occurs, over the short term, the benefit may be significantly less than the premiums paid. Indeed, if reinsurers are to make any money in these transactions, it is likely that over the long term, premiums paid would likely exceed the value of the indemnification received, as any premiums paid would include the reinsurers’ profit and cost of capital margins. Reinsurers will have to invest time and effort to change how politicians and the electorate consider the value of insurance.
Authorities that take a longer-term view may be tempted to choose to self- insure, rather than purchase explicit, insurance-based protection. However, this choice would deprive them of the benefit of protection against very extreme events. Instead, they could choose a product that will pay out after a more-frequent event; in other words, the protection kicks in for smaller catastrophes. If insured states receive benefits more regularly, it will be easier for voters and governments to recognize the value of such protection.
Making The Economics Work
Reinsurers are not charities, and at the end of the day the economics of these deals must make sense for them too. In our view, some aspects of these structures could keep the arranging costs high for reinsurers. Once a government has shown interest, the firm it works with will have to develop a product that takes that country’s regulatory
Global Reinsurance Highlights 2014
“In many emerging markets, the attitude toward insurance and risk awareness is changing.”
framework and decision-making process into account. This is likely to increase the time and cost that reinsurers need to develop and execute the protection plan. These costs may reduce the value of the structures for both reinsurers and states.
In addition, reinsurers may face reputational damage if a major event occurs and the structures do not perform as promised, in the eyes of authorities and the public. For example, some structures may pay claims based on simple parameters such as wind speed or earthquake magnitude. In some scenarios, an event may occur that does not meet these parameters and the protection won’t be triggered. Payouts will then differ from the actual losses; this is known as basis risk. Any material differences may undermine the transaction’s value and damage a reinsurer’s reputation—voters may consider that the reinsurer is avoiding paying the true cost. Although reinsurers may aim to minimize their basis risk, having parameter triggers is an important structural feature that enables reinsurers to pay claims quickly. Reinsurers may find it difficult to build a robust risk view because the modeling of some of the perils in developing markets is not as developed as for other key industry perils, such as a U.S. hurricane or Japanese earthquake. Insufficient data on loss history or exposures is one of the primary challenges reinsurers face when building robust models for these new regions and perils. In our view, it will be important for reinsurers to demonstrate to buyers and investors that the models they use are
sufficiently robust. This is because the models are likely to be reinsurers’ main tool for demonstrating the benefits of their insurance structures to their clients. Modeling uncertainty presents reinsurers with a difficult balancing act: if their pricing includes margins built in to reflect the modeling uncertainty, it may reduce the value for their customers; but if it doesn’t, they risk accepting underpriced risks.
Building Disaster Resilience Could Help Open High-Growth Markets To Reinsurers In our opinion, there is a strong case to be made for the benefits of government-backed risk protection solutions. The successful development of this market could be key to entrenching the relevance of insurance in high-growth markets. Various market trends—regulatory changes, insurance growth in emerging markets, and insurance- linked securitization—could also help to increase the profile and attractiveness of these insurance-backed solutions. We have also observed that in many emerging markets, the attitude toward insurance and risk awareness is changing and regulators are increasing capital requirements and mandating the purchase of insurance in some lines of business. At the same time, insurers and reinsurers are increasingly looking for ways to expand their presence in emerging markets. They are therefore expending more effort on working with stakeholders to find solutions that help to develop these insurance markets. We also consider that the recent influx of capital markets capacity and the resultant demand to diversify risks by region and peril could make it easier to find capital to back these solutions.
We consider that the reinsurance industry has a long-term and important role to play in developing awareness and acceptance of insurance-backed solutions for states’ catastrophe exposure. In our view, taking on this role will provide diversification of risk exposure, help to educate and develop new insurance markets that can provide growth potential for years to come, and ultimately reinforce reinsurers’ relevance to a new set of potential clients.
Dennis P Sugrue
London, (44) 20-7176-7056
dennis.sugrue@
standardandpoors.com
Miroslav Petkov London, (44) 20-7176-7043
miroslav.petkov@
standardandpoors.com 27
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