With more and more people living in catastrophe prone regions, the potential for enormous losses is growing. Cat bonds can help mitigate some of the damages caused by floods, hurricanes, and other natural disasters.
 | Floods in the United KingdomThe Allianz catastrophe bond ("cat bond") can transfer the risk of severe river floods (Photo: Reuters) |
Each time the UN Intergovernmental Panel on Climate Change (IPCC) comes out with a scientific assessment of climate change, its findings are more certain and alarming. In November, the IPCC published the final version of its Fourth Assessment Report, which said that warming global temperatures will cause more frequent heat waves, longer droughts, and more intense storms.
While certainly troubling, these trends may come as no surprise to insurance and reinsurance companies that have been tracking the rising costs of natural disasters for decades. According to "Hedging Climate Change," a report recently published by Allianz SE, the number of natural catastrophes has been on the rise since the 1970s. The vast majority of these have been weather-related, suggesting a connection with climate change.
"Allianz has analyzed the trends in the number of natural catastrophes and the resulting insured losses,” says Allianz SE board member Clement B. Booth. After other trends, such as urbanization and coastal and floodplain development, were also considered, annual insured damages are projected to rise by 41 billion US dollars per annum during 2010 to 2019.
Ensuring insurability
One of the report’s central questions is how and under which conditions the rising number of climate change-related catastrophes will be insurable. According to the report, one way to improve the insurability of catastrophes is to develop risk partnerships between private insurers and governments. A few examples of insurer-government risk partnerships already exist, such as flood coverage in the UK or government reinsurance schemes in Australia.
According to the report, another way to sustain insurability is to diversify risk in the capital markets. So far, Allianz has launched two catastrophe bond (cat bond) programs, one to transfer the risks of severe floods in Britain and earthquakes in most parts of North America, and the other to transfer risks of windstorms in seven European countries.
“Cat bonds have been around for awhile, and there's been a slow uptake, but they've become more popular over the last couple of years,” says Nick Silver, a UK-based actuary and advisor to the Carbon Disclosure Project. “They have increased capacity, market efficiency, and targeted at certain areas affected by climate change.”
 | Picture Gallery (click on the image to start)Find out more about the causes of floods, their impacts, and how to limit their damage (Photo: Reuters) |
But Silver says that cat bonds are only a localized solution, focused mainly on small areas of large risk. While they may help insurability in some areas, he says cat bonds alone cannot compensate for the growing and largely unknown underlying risks of global warming.
“The thing about climate change is that is changing the risk profile: the underlying risk has changed and things are happen in areas where they weren't happening before,” says Silver. “Cat bonds won't cover that bit – at least not at the moment. It requires the next generation of cat bonds to be able to deal with the changing scale of risk and change of areas of risk.”
Rift between total and insured losses
Still, cat bonds have proven popular among investors. The number of bond issuances in 2007 has about tripled compared to 2005. By the end of November 2007, Allianz’s two cat bond programs had raised around 300 million euros.
Despite the uptake of cat bonds and other innovative insurance and re-insurance tools, a large proportion of catastrophe risks remain uninsured. In the biggest individual case of financial loss to date, Hurricane Katrina caused 144 billion dollars in total losses in the southern United States, only 49 billion of which were insured.
The rift between total losses and insured losses, however, is greatest in developing countries, where insurance markets are still rudimentary. The floods that struck China in 1996, for example, caused around 24 billion dollars in damages, of which less than 500 million dollars were covered by insurance.
The developing world is also where the impacts of climate change – floods, droughts, and massive storms – are felt the most. According to Munich Re statistics, Asia was hit by the most natural disasters (4,500) during 1980 to 2005, which together killed over 800,000 people. Although these disasters also included non-weather catastrophes like earthquakes, most damages and fatalities were caused by storms and flooding.
editor: Valdis Wish
publishing date: March 18, 2008
Do you have something interesting to add? Write a comment and discuss this topic with other readers. Comments should be on-topic, non-commercial, and not contain abuse of any kind.
Comment Policy
