Disaster risk financing

Catastrophe bonds represent a risk transfer mechanism in which an underlying sponsor (e.g., a government) – with the help of capital market and insurance experts – securitises and sells off specific risks related to natural catastrophe events to the capital market. Functioning like regular fixed income instruments, catastrophe bonds – in comparison to typical government or corporate bonds – offer investors higher interest payments to compensate for the risk of forfeiting some, or all, of the principal in the event of a disaster. Catastrophe bonds may use elements of indemnity-based insurance or parametric insurance to determine and process payouts to the sponsor should a natural catastrophe event occur.

Public Sector Solutions and our in-house experts at Swiss Re Capital Markets can provide our public sector partners with expertise in both the Property & Casualty (P&C) and Life & Health (L&H) risk markets and guidance on configuring an ideal disaster risk financing strategy using catastrophe bonds.​

The frequency and severity of natural disasters has increased significantly over the past decades – a trend that is forecast to continue in the face of the Earth's changing climate. As a result, the most exposed parts of society are faced with significantly higher insurance premiums, which widens the protection gap as households and businesses are increasingly unable to afford or access insurance.

Pooling allows risk to be covered at an affordable price, by allowing diversification and spreading out administration costs. Risk pools provide an increased level of financial preparedness for natural catastrophes, protect government budgets from unexpected shocks and strengthen the resilience of the households and businesses covered by the risk pool.

Whilst the objectives may be consistent, the design of a risk pool for a given country or region depends on the peril(s) covered, the maturity of the local insurance market, and the political objectives / appetite for such an intervention. At Public Sector Solutions, we work closely with existing pools such as Flood Re, the Turkish Catastrophe Insurance Pool (TCIP) or the National Flood Insurance Program (NFIP) and use our extensive knowledge to help other government organisations as they explore how risk pools could help them.​

Natural catastrophes, human-made disasters and other crises can lead to significant economic contraction that can limit a government's capacity to support a nation's recovery. By embedding risk transfer mechanisms in public borrowing programs, governments can be provided with the necessary financial room to manoeuvre in times of crisis and allows them to enhance the resilience of their borrowing to shocks and the sustainability of public debt. At Public Sector Solutions, we work closely with various public sector partners to raise awareness for the potential of this innovative approach and contribute to the strengthening of governmental resilience strategies.​

The International Bank for Reconstruction and Development (IBRD) has priced a joint catastrophe bond and swap transaction providing a total of $630 million of earthquake insurance coverage to the Government of Chile, which consists of $350 million of catastrophe bonds and $280 million of catastrophe swaps. By simultaneously offering the risk to both bond investors and to insurance and reinsurance companies in swap form, the World Bank and Chile were able to access a larger amount of risk bearing capacity than either market could offer on its own. It makes funds readily available in the case of disaster, protects Chile’s fiscal budget, and reduces the potential need to mobilize debt in an event’s aftermath. Payouts are triggered if an earthquake meets the pre-defined parametric criteria for location and severity. Swiss Re Public Sector Solutions managed this transaction with the client and Swiss Re Capital Markets supported this important transaction as a joint structuring agent, joint manager and joint bookrunner.

People living in flood-prone areas of the United Kingdom increasingly struggled to afford an insurance cover. In order to address this flood protection gap at a national level, the UK government and the insurance industry created Flood Re, a public-private partnership with the aim of providing affordable insurance to homeowners living in areas with higher flood risk. Flood Re transfers part of its risk to Swiss Re, which enables the flood insurance to remain affordable for the population living in areas at risk of flooding and sets the conditions for the creation of a free market.