The ins and outs of pools and parametrics

Pools

Particularly important in the context of a pool solution is the role of the government. The government sets up the necessary legal framework, i.e. introduces compulsory insurance and guarantees its enforcement in order to ensure an effective and efficient pooling of risks.

That said, we do not propose that  governments become risk takers themselves. They have enough other obligations to meet on the risk prevention, emergency response and regulatory side. State and Federal government’s role should not be as a private reinsurer.

• The creation of Nat Cat pools is usually most meaningful in (emerging) markets where no comprehensive solution is in place, for example in China, or where a new coverage can be introduced, say for Flood.
• Pools are less useful in markets where an adequate solution is already in operation, where inadequate premiums might be dictated by the government, or where a desirable risk has been taken out of the private insurance market.
• There is no standard pool solution: poper account also has to be taken of social, political and economic peculiarities, as well of market preferences.

In pool solutions, the natural catastrophe risk is pooled on a domestic basis. The main characteristics are:

• Pools achieve maximum insurance density (if compulsory);  this will lead to a significant increase in insurance coverage and penetration and thus dramatically reduce a government’s commitment to disaster relief and its burden as insurer of last resort.
• A mandatory scheme ensures avoidance of adverse selection and thus guarantees the building of a real risk sharing community.
• A pool can either be organised as (1) a separate company with pool participants (domestic insurance companies) as share holders or (2) as an association of participating pool members

Parametrics

Using the example of an earthquake risk, the government could purchase parametric cover from the insurance and capital markets:

• This protection would pay out a pre-determined amount in case of an earthquake exceeding certain physical and measurable parameters
• Trigger mechanism defined as a function of earthquake magnitude, location and distance to populated areas
• Claims are paid shortly after the event, once official data on the earthquake are available
• Unlike insurance/reinsurance, there is no need to evidence all claims or prove losses (subject to local regulation)
• The received funds can be used by the government to provide relief to the affected population and/or to rebuild infrastructure and to protect its revenue gap and thus ensures budget certainty

Benefits of pool solutions and parametric covers

Ex-ante risk transfer instruments increase the resilience to disasters and create fiscal room for action. A pre-event financing approach has the following advantages:

• Guaranteed right for compensation
• Rapid pay-out and recovery, especially with innovative instruments such as parametric solutions
• No payback obligation (in contrast to loans)
• Less pressure to divert government funds from other projects to affected areas
• Clear definition of scope of cover
• Professional loss settlement
• Every one‘s contribution can be based on their actual exposure
• Institutionalised framework to manage losses through an international network of risk carriers
• Prevention and  loss mitigation can be supported by risk adequate premiums, deductibles and discounts