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Home > Insurance Markets Viewpoints > The Role of Insurance in Bringing Resilience to Societies Challenged by Global Warming

Insurance Markets Viewpoints

The Role of Insurance in Bringing Resilience to Societies Challenged by Global Warming

by David Bresch

How does Swiss Re approach sustainability? Is it very different as a concept for a reinsurer, given that by definition what you manufacture is a technical insurance solution, not a tangible widget that takes a set number of carbon units to produce?

The key point to grasp is that for every reinsurer, the nature of the game has to be long-term. You have to take a long-term view of risk, since this is fundamental to the idea of insuring insurers and large corporates against specific risks for moderately long periods. Much of what stood against sustainability—and which the whole sustainability effort was partly aimed at redressing—was the myopic dash after short-term profits regardless, for example, of long-term environmental damage caused in the pursuit of those profits. Since Swiss Re was founded 150 years ago, we’ve worked together to find smarter ways to manage risk sustainably, so that people all over the world can turn pioneering ideas into reality or get back on track when things go wrong.

Risk for us comes in two flavors, both of which have to do with “sustainability” in that they are about sustainable growth over time. First, there is the emergence of new technologies and the risks associated with managing new technologies, which for us means assessing how to provide cover for these new technologies and their inherent risks. The second is more directly associated with climate change and has to do with development in hazard-prone areas, such as coastal plains. This is where a lot of our focus is and our aim here is to make societies and communities more resilient by providing them with natural-catastrophe cover.

“Resilience” differs from “sustainability,” but they imply each other. A “fragile” society will not be very sustainable. However, in helping societies to be more resilient you must look closely at their exposure to environmental risk. I imagine this also means looking at what they must do to mitigate risk?

Absolutely. We must have a sustainable business, since we are engaged and committed for the long term. So we have to make sure that we do not engage in transactions that we would later regret. We use our in-depth knowledge of risk and our capacity to model a wide range of environmental risks to evaluate specific opportunities to see if they fit within acceptable parameters, or, if they don’t, what would be needed to bring the risk within acceptable parameters. It is often not helpful simply to refuse a proposal. The better approach is to engage in a conversation with the client to see what we would require to be changed for the risk to be insurable. Take a house that is on the edge of a crumbling cliff, for example. That is not an insurable proposition as it stands, but a serious consideration would want to look at whether the cliff top could be stabilized, or the cliff supported, perhaps for other reasons such as coastal defense that would justify the cost. To explore these kinds of issues we formed the Economics of Climate Adaptation working group in 2008 with a view to forming partnering relationships with communities, cities, and regions There are large numbers of cities or regions that would be in a better position if they could get some of the risk volatility out of their balance sheets, with much of that volatility coming from the stresses that follow “acts of God.”

The best example of this is the Caribbean Catastrophe Risk Insurance Facility (CCRIF). The CCRIF is a risk-pooling facility owned, operated, and registered in the Caribbean for Caribbean governments. It is designed to limit the financial impact of catastrophic hurricanes and earthquakes to Caribbean governments by quickly providing short-term liquidity when a policy is triggered. It is the world’s first and, to date, only regional fund utilizing parametric insurance, thus giving Caribbean governments the unique opportunity to purchase earthquake and hurricane catastrophe coverage with lowest-possible pricing. The CCRIF represents a paradigm shift in the way governments treat risk. The facility was developed through funding from the Japanese Government, and was capitalized through contributions to a multi-donor Trust Fund by the Canadian Government, the European Union, the World Bank, the governments of the United Kingdom and France, the Caribbean Development Bank, and the governments of Ireland and Bermuda, as well as through membership fees paid by participating governments.

Sixteen governments are currently members of the CCRIF, namely: Anguilla, Antigua and Barbuda, Bahamas, Barbados, Belize, Bermuda, Cayman Islands, Dominica, Grenada, Haiti, Jamaica, St Kitts and Nevis, St Lucia, St Vincent and the Grenadines, Trinidad and Tobago, and the Turks and Caicos Islands. In 2007, the CCRIF paid out almost US$1 million to the Dominican and St Lucian governments after the November 29 earthquake in the eastern Caribbean; in 2008, the CCRIF paid out US$6.3 million to the Turks and Caicos Islands after Hurricane Ike made a direct hit on Grand Turk; and in 2010, the CCRIF made a payment of US$7.75 million to the government of Haiti after the January 12 earthquake. Swiss Re provides the reinsurance for the fund and was instrumental in its establishment.

We got together with the World Bank and others to look at how we could combine to help Caribbean communities deal in a better way with hurricanes and earthquakes in a forward-looking manner, instead of having the world community provide aid after the event. The key here was to find ways of structuring the finances of these countries so that they would be able to get fast access to relief money and to provide an insurance mechanism that would make funds available to all the affected governments rapidly. The mechanism we came up with means that the scale of the payout is precisely calibrated to the intensity of the disaster.

What this shows is that even if the world does move into a more unstable, more volatile phase, if global warming takes hold it will still be possible to model potential events and to plan for them in a coherent fashion. However, we have to engage and develop the dialogue with various regions, cities, and communities because if matters are left to local insurers, they very often simply do not have the capacity to deal with the scale of what is being envisaged. We also find that there are a great many public infrastructure exposures that are not being insured, and these too represent opportunities.

We have a similar example to the Caribbean fund that we can point to, namely the Mexico catastrophe bond. This has a similar logic behind it, in that if there is a large earthquake or hurricane, then the bond pays out. This is not reinsured by us, but it was brought to the capital markets and was very well received by investors. It might seem odd that investors would want to take on the risk of insuring against catastrophes, but you have to remember that the risk is well-rewarded and that it is not correlated with any other risk in the investor’s portfolio, so it adds considerably to their diversification.

Another strong argument in favor of investing in catastrophe bonds for many investors is that this is an investment that is a good thing in and of itself. It does good in the world by helping to make a particular area or region more resilient and better able to recover should disaster strike. Many investors want to secure some ethical dimension for at least a portion of their investment and they can therefore justify the investment on two grounds: on the probable returns, and on the fact that this is an investment that does good. This is well beyond aid, in that investors are not just giving away money. They are entitled to a share of the profits if things go well and they have the satisfaction of knowing that the fund they are creating will do good if things go badly.

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