Pandemic Risk

Financing Pandemic Risk

The World Bank's pandemic initiative may provide a roadmap to transfer the risk of Zika to capital markets.
By: | July 25, 2016 • 5 min read

Could capital markets offer an alternative to transfer the risk of financial losses caused by pandemics? The fast spread of the Zika virus in the past few months has made this question a valuable one for companies around the world.

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The answer might well be yes. There are already instances of insurance and reinsurance firms selling pandemic risks to capital markets. And investors appear to be keen on buying them.

“We like to buy this kind of risk. It can be a good diversifier to a global portfolio,” said Christophe Fritsch, co-head, securitized and structured assets, at AXA Investment Managers.

The challenge of a pandemic risk bond is to define triggers and conditions for the coverage.

Past market transactions involve insurance-linked securities that transfer pandemic risks, often along with other excess mortality events such as terrorism. They are used by insurers and reinsurers as an extra tool to manage their regulatory capital reserves.

But an initiative by the World Bank to issue pandemic bonds could lead the way for other kinds of issuers to employ similar capital markets instruments. The World Bank’s bond employs a parametric trigger that helps speed up payments when companies may need some urgent cash flow.

Bill Dubinsky, a managing director at Willis Capital Markets & Advisory, said a likely candidate could be an airport that sees dramatically reduced traffic if there is a pandemic in the country.

If the risk had been transferred to the capital markets, he said, the airport could have a considerable degree of cash flow through the duration of the outbreak.

Triggering Coverage

The challenge is to define triggers and conditions for the coverage.

The trigger of the World Bank’s bond, which should be placed with investors in the Fall, is linked to the level of confirmed deaths caused during a pandemic event. It might not be the best option in the case of pandemics such as Zika, where the number of deaths is fairly low, and companies face other effects such as the interruption of business or loss of revenues indirectly associated to the disease.

But other indicators, such as number of people infected in a limited period of time, could be employed, as is already the case with some parametric insurance coverage purchased by the tourism and airline industry.

Priya Basu, manager, development finance department, World Bank

Priya Basu, manager, development finance department, World Bank

The World Bank bond will test the market to assess whether there is appetite from investors for pandemic risks issued by players outside the insurance and reinsurance industries.

Priya Basu, a manager at the development finance department at the World Bank, said she expects the bond will pay a coupon of about 8.5 percent a year, which would be lower than the opening price for other CAT bond initiatives previously launched by the organization, such as the Caribbean Catastrophe Risk Insurance Facility.

The World Bank’s pandemic bond is part of a broader project called Pandemic Emergency Financing Facility, or PEF, which includes both a bond and insurance element, and aims to make $500 million available for pandemic emergencies at 77 poor countries.

The bond is expected to raise $300 million, while $200 million will be placed in the reinsurance market. Munich Re and Swiss Re are the insurance partners of the project.

The costs related to the bonds and insurance premiums are subsidized by donor countries, but the idea is that the facility will become a purely market-based one in the future.

“We are working both on a bond issuance and with the reinsurance market because we want to target a range of different investors with different risk appetites,” Basu said. “We expect that, over time, countries will be able to pay their own premiums and coupons.”

“One of the goals of the World Bank is to promote the utilization of market-based catastrophe schemes by governments that would otherwise struggle to provide urgent assistance to its citizens.” — Priya Basu, manager, development finance department, World Bank

The coverage would be activated when the aggregate number of deaths caused by a pandemic, as confirmed by the World Health Organization, reaches a certain limit. The formula also includes data about the rate of growth of the disease and the acceleration in the number of fatal cases. The index is calculated globally, but the payout is only released to the 77 countries covered by the program.

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The facility is complemented by a cash component, worth between $60 million to $100 million, which can be employed in case of a severe pandemic that does not cause enough deaths to trigger either the bond or the insurance coverage.

According to Basu, that is the money that could be used for Zika outbreaks, where the number of expected deaths is relatively low.

“There is a financing gap from the moment it is clear that there is an outbreak with pandemic potential, but it has not become pandemic yet. That is when the PEF comes in,” she said. “The parametric trigger enables us to respond in a much quicker and more timely manner.”

One of the goals of the World Bank is to promote the utilization of market-based catastrophe schemes by governments that would otherwise struggle to provide urgent assistance to its citizens, Busa said.

In her view, the use of facilities such as the PEF could result in significant savings of public resources and, especially, in reducing losses of life. If PEF was up and running back in 2014, she said, international money to fight off the the Ebola pandemic could have started to flow to the affected countries more quickly.

Instead, it took extra months to gain any steam, resulting in the cost of billions of dollars and thousands of lives.

The disease covered by the $500 million bond and insurance facility includes some kinds of influenza, SARS, MERS, Ebola, Marburg and other zoonotic diseases like the Lassa Fever.

Rodrigo Amaral is a freelance writer specializing in Latin American and European risk management and insurance markets. He can be reached at [email protected]

More from Risk & Insurance

More from Risk & Insurance

2017 RIMS

RIMS Conference Opens in Birthplace of Insurance in US

Carriers continue their vital role of helping insureds mitigate risks and promote safety.
By: | April 21, 2017 • 4 min read

As RIMS begins its annual conference in Philadelphia, it’s worth remembering that the City of Brotherly Love is not just the birthplace of liberty, but it is the birthplace of insurance in the United States as well.

In 1751, Benjamin Franklin and members of Philadelphia’s first volunteer fire brigade conceived of an insurance company, eventually named The Philadelphia Contributionship for the Insurance of Houses from Loss by Fire.

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For the first time in America — but certainly not for the last time – insurers became instrumental in protecting businesses by requiring safety inspections before agreeing to issue policies.

“That included fire brigades and the knowledge that a brick house was less susceptible to fire than a wood house,” said Martin Frappolli, director of knowledge resources at The Institutes.

It also included good hygiene habits, such as not placing oily rags next to a furnace and having a trap door to the roof to help the fire brigade fight roof and chimney blazes.

Businesses with high risk of fire, such as apothecary shops and brewers, were either denied policies or insured at significantly higher rates, according to the Independence Hall Association.

Robert Hartwig, co-director, Center of Risk and Uncertainty Management at the Darla Moore School of Business, University of South Carolina

Before that, fire was generally “not considered an insurable risk because it was so common and so destructive,” Frappolli said.

“Over the years, we have developed a lot of really good hygiene habits regarding the risk of fire and a lot of those were prompted by the insurance considerations,” he said. “There are parallels in a lot of other areas.”

Insurance companies were instrumental in the creation of Underwriters Laboratories (UL), which helps create standards for electrical devices, and the Insurance Institute for Highway Safety, which works to improve the safety of vehicles and highways, said Robert Hartwig, co-director, Center of Risk and Uncertainty Management at the Darla Moore School of Business at the University of South Carolina and former president of the Insurance Information Institute.

Insurers have also been active through the years in strengthening building codes and promoting wiser land use and zoning rules, he said.

When shipping was the predominant mode of commercial transport, insurers were active in ports, making sure vessels were seaworthy, captains were experienced and cargoes were stored safety, particularly since it was the common, but hazardous, practice to transport oil in barrels, Hartwig said.

Some underwriters refused to insure ships that carried oil, he said.

When commercial enterprises engaged in hazardous activities and were charged more for insurance, “insurers were sending a message about risk,” he said.

In the industrial area, the common risk of boiler and machinery explosions led insurers to insist on inspections. “The idea was to prevent an accident from occurring,” Hartwig said. Insurers of the day – and some like FM Global and Hartford Steam Boiler continue to exist today — “took a very active and early role in prevention and risk management.”

Whenever insurance gets involved in business, the emphasis on safety, loss control and risk mitigation takes on a higher priority, Frappolli said.

“It’s a really good example of how consideration for insurance has driven the nature of what needs to be insured and leads to better and safer habits,” he said.

Workers’ compensation insurance prompted the same response, he said. When workers’ compensation laws were passed in the early 1900s, employee injuries were frequent and costly, especially in factories and for other physical types of work.

Because insurers wanted to reduce losses and employers wanted reduced insurance premiums, safety procedures were introduced.

“Employers knew insurance would cost a lot more if they didn’t do the things necessary to reduce employee injury,” Frappolli said.

Martin J. Frappolli, senior director of knowledge resources, The Institutes

Cyber risk, he said, is another example where insurance companies are helping employers reduce their risk of loss by increasing cyber hygiene.

Cyber risk is immature now, Frappolli said, but it’s similar in some ways to boiler and machinery explosions. “That was once horribly damaging, unpredictable and expensive,” he said. “With prompting from risk management and insurance, people were educated about it and learned how to mitigate that risk.

“Insurance is just one tool in the toolbox. A true risk manager appreciates and cares about mitigating the risk and not just securing a lower insurance rate.

“Someone looking at managing risk for the long term will take a longer view, and as a byproduct, that will lead to lower insurance rates.”

Whenever technology has evolved, Hartwig said, insurance has been instrumental in increasing safety, whether it was when railroads eclipsed sailing ships for commerce, or when trucking and aviation took precedence.

The risks of terrorism and cyber attacks have led insurance companies and brokers to partner with outside companies with expertise in prevention and reduction of potential losses, he said. That knowledge is transmitted to insureds, who are provided insurance coverage that results in financial resources even when the risk management methods fail to prevent a cyber attack.

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This year’s RIMS Conference in Philadelphia shares with risk managers much of the knowledge that has been developed on so many critical exposures. Interestingly enough, the opening reception is at The Franklin Institute, which celebrates some of Ben Franklin’s innovations.

But in-depth sessions on a variety of industry sectors as well as presentations on emerging risks, cyber risk management, risk finance, technology and claims management, as well as other issues of concern help risk managers prepare their organizations to face continuing disruption, and take advantage of successful mitigation techniques.

“This is just the next iteration of the insurance world,” Hartwig said. “The insurance industry constantly reinvents itself. It is always on the cutting edge of insuring new and different risks and that will never change.” &

Anne Freedman is managing editor of Risk & Insurance. She can be reached at [email protected]