Resilience may replace catastrophe
Research into the catastrophe bond market, and ongoing infrastructure funding requirements at the local and central government level, has found that the two could be married in order to provide a new investment opportunity.
This is the gist of a new report “Leveraging catastrophe bonds as a mechanism for resilient infrastructure project finance” published by the RE.bound Programme, supported by the Rockerfeller Foundation, and featuring contributions from re:focus partners – a design firm dedicated to developing integrated resilience solutions – RMS – which provides models and software for insurers, financial markets, and public agencies – and Swiss Re.
The idea overall is that catastrophe bonds and conventional project finance can be systematically linked to build infrastructure resilience and mitigate disaster risk.
This would entail advances in use of catastrophe modelling, bond structuring and bond sponsorship, the report suggests. The interest in this for investors in catastrophe bonds is that where risks decrease, the value of such bonds increases, because there is less chance of a payout against previously determined payout triggers.
Taking a different appraoch to the nature of disasters means that the model proposed refers to resilience bonds rather than catastrophe bonds. However, on the basis of existing projects conducted by a number of US cities, intended to mitigate catastrophe risk, it may offer another way to access returns that are not correlated to traditional asset classes.
It would also provide an answer to the problem of public budgets increasingly not stretching to the sorts of infrastructure spending that will be required in the face of risks sparked by factors such as climate change, the report notes.
“Public sector authorities have historically funded and maintained public transportation, water, energy, and telecommunications networks. Public expectation has also long driven governments at all levels to step forward in the aftermath of catastrophes to support devastated communities and absorb the costs of recovery and rebuilding.
“In the face of growing long-term risks like climate change, these expectations are poorly matched with declining public budgets. The myriad urgent budget demands placed on public officials mean that investment in long-term priorities, including both infrastructure investment and insurance, are more often than not deferred.”
According to the report’s authors, there are also advantages in using ‘resilience bonds’ from an insurance market perspective: “Local governments and public authorities should get credit for protecting themselves.”
“Currently, many risk designations—such as flood hazard maps for programs like the US National Flood Insurance Program (NFIP)—are highly political and not updated with sufficient frequency to motivate proactive or urgent action to reduce risk. As a result, these programs impose high burdens on low-income policyholders and communities, who are locked into indefinite insurance obligations.”
“Conversely, meaningful options for reducing overall risk and exposure are often costly regional solutions, like large-scale flood defense systems, not protections that are available to individual property owners. As the cost of disasters continues to increase, public insurance programs themselves
present massive government liabilities.”
“Currently, program administrators are limited in their risk management options, and many programs facing insolvency have only one option: to raise the cost of premiums. Pricing at-risk asset holders out of insurance markets simply shifts the responsibility for catastrophic losses onto other public sector resources. One potential pathway to both improve the solvency of subsidized insurance programs and encourage proactive investments in local risk reduction is for relevant [US] federal authorities to create a pilot program in collaboration with select communities already pursuing large scale risk reduction projects to establish a replicable pathway to enable other participants to measurably reduce risk, validate the risk reductions, and eventually “graduate” to lower risk tiers or designations within mandated insurance purchase programs, such as the NFIP.”
The full report can be accessed here.