Catastrophic business: Managing the risk of a country

The Japan earthquake has shown the world that even the biggest economic powers can be brought to their knees by natural catastrophes. Insurance complacency is no longer an option. Latin American governments are now seeking ways to spread the disaster cost from fiscal books into the reinsurance sector and capital markets.

BNamericas spoke to Swiss Re's public sector liaison, Nikhil Da Victoria Silva, about the evolution of so-called macro insurance in Latin America.

BNamericas: In 2009, Mexico blazed the trail in catastrophic insurance by covering itself against earthquakes and hurricanes through the World Bank's nascent MultiCat program. How has this type of work advanced since?

Da Victoria Lobo: I would say there have been three developments in this area. The first is that in January 2010, we actually had a payment to the government of Haiti following an earthquake in that country. That payment was a strong proof of the concept, but also it practically put money into the hands of the Haitian government when they needed it most.

The second critical development was the Alabama transaction last summer for the hurricane risk coverage. It demonstrated that these solutions aren't just for emerging markets but truly for all markets. What governments are realizing is that we live in an unpredictable world where even minor events can have huge material economic cost.

The third development, I think, was a broader approach to closing the gap between individual and macro insurance. Countries are not just adopting protection at the individual level, such as a microinsurance scheme, but also adopting protection at the government level, or vice versa.

BNamericas: Are we seeing these trends throughout Latin America and the Caribbean?

Da Victoria Lobo: Definitely. Haiti is one clear example of this dual approach. In Mexico, the government has now invested more resources in protecting its national assets as well as the uninsured population.

And I think several members of the Caribbean [Catastrophe Risk Insurance] Facility are also thinking about how they can protect their population. So the leaders in this field are Mexico and the Caribbean Basin.

BNamericas: Why are some of the bigger regional countries such as Brazil not taking advantage of these policies, given their catastrophe exposure and relative financial strength?

Da Victoria Lobo: It's a combination of things, I think. One is that the field is very new. Even the MultiCat [bond program] was only two years ago. Governments typically don't move that quickly; we just have to be realistic.

But I think governments have now realized that one day of earth shaking or wind blowing can set the country's economic development backward a generation. In that respect, the earthquake in Japan was a big wakeup call. I think you will now see even the wealthiest governments in the region putting much more resources into pre-financing these disasters.

BNamericas: What are the broad policy options available to the governments?

Da Victoria Lobo: The most common are catastrophic covers, i.e., the natural hazard side. Traditionally this includes earthquakes and hurricanes, but increasingly we're seeing both the appetite and ability to protect against flooding. Moreover, we're seeing growing interest in the broader range of catastrophes, such as volcano eruptions or issues related to health. So really the field is moving beyond catastrophes and into the bigger question of how we can manage the risk of the country.

Apart from the big natural disasters, there are two growing areas. First are the broader weather patterns and their risk for the agricultural sector. And the second, the economic costs and challenges that come with an aging population.

These are the three areas where governments recognize that they have systemic risk and that traditional financial options are inadequate, and that pre-financing helps to put a price tag on the risk.

BNamericas: So these policies in a sense quantify the risk?

Da Victoria Lobo: Yes, you quantify the risk. Equally as important, you open up the market for private companies. One of the most important trends we've seen in the last few years was private entities following government transactions to hedge their own risk using the same methodology.

BNamericas: Given that the number of catastrophic events is expected to rise in the future, is climate change something you incorporate into models?

Da Victoria Lobo: Our models not only consider some aspects of the climate change. More importantly, when we work on transactions such as MultiCat we try to look at a multi-year horizon. Not only is this more efficient but it also allows the government to see how the changes are evolving. I hope, as the field develops, that we'll see these policies get longer and longer, so that more aspects of the climatic shifts can be embedded in the coverage.

There are different science theories. But we definitely have a view on it: The climate is changing.

Now we need to work on both sides - the government and the industry - to move away from broad talks to implementing more concrete solutions, because mother nature won't wait for our talks to finish.