Disaster Risk Insurance: Five Insights From the Philippines
With disasters a growing threat, insurance for countries trying to manage climate and disaster risk is becoming increasingly critical. While insight on what works – and what doesn’t – to build resilience is still limited, the experience of the Philippines shows how countries can improve their protection to disasters by working with international insurance markets.
The Philippines is expected to incur, on average, $3.5 billion in asset losses each year from typhoons and earthquakes alone, and 74% of the population is exposed to multiple natural hazards. Building on a decade-long partnership with the Philippines to reduce the economic impact of disasters, in 2017 the Bank helped the country transfer $200 million of typhoon and earthquake risk to a panel of international reinsurers. In 2018, the government renewed this insurance program and doubled the amount of coverage. As a ‘parametric insurance’ program, payouts were triggered when an earthquake or tropical cyclone strength exceeded a predefined threshold. These transactions marked the first time the World Bank entered into a reinsurance agreement with a governmental agency, and the first time it executed a catastrophe risk transaction in a local currency.
Building on a decade-long partnership with the Philippines to reduce the economic impact of disasters, in 2017 the Bank helped the country transfer $200 million of typhoon and earthquake risk to a panel of international reinsurers.
How did these efforts make a difference? An evaluation of the Philippines’ pathbreaking parametric catastrophe risk insurance program lends insight. We are sharing our top 5 takeaways in hope they may contribute to similar programs being explored or implemented across the world:
- Parametric insurance can provide governments with rapid liquidity following disasters. Over two years, the program made three payouts for a total of approximately $28 million, triggered by typhoon and earthquake events. All payouts were made within the contractually agreed timelines from international markets to the World Bank, through the government-owned insurance company GSIS, and finally to the Bureau of Treasury.
- The private sector will support well-designed parametric insurance programs, resulting in pricing comparable to other parametric programs placed in the international market. In the case of the Philippines, reinsurers expressed very strong interest in participating, likely as they saw the program as a way to diversify their own risk portfolios, and the number of counterparties to the policy doubled in its second year.
- A market transaction must be paired with strong preparedness planning. Public financial management rules need to ensure funds rapidly reach the intended beneficiaries after a shock. A focus on insurance alone misses the bulk of the work to build the institutions and budget rules that enable faster disaster response. This is also one of our core principles of disaster risk finance: Clear processes and rules for how payouts will be used is just as important as the source of post-disaster financing. One way to support the effective flow of payouts from parametric programs when the policy is held or paid for by a national government agency could be to name the intended beneficiaries of any payouts directly within the insurance policy.
- Plan for atypical outcomes. The experience of the Philippines highlights a relatively uncommon scenario where a payout following a typhoon event proved to be larger than the actual damages sustained by the province that triggered the payout. Basis risk (the risk that the payout from the policy does not match the actual losses sustained) is a well-known challenge of parametric risk transfer. The focus is usually on ‘negative basis risk’ (where the payout is less than the actual losses sustained). In this case, positive basis risk also caused delays as the government (understandably) preferred to allocate resources to provinces that sustained more severe damages. This resulted in revisions between the first and second policies to the rules that set out how payouts are allocated, further highlighting the need for clear rules and decision processes.
- Strong political and technical buy-in is instrumental to success. It is a slow process to build both market appetite and the understanding, institutions, regulations, and policies needed to successfully implement risk finance and insurance mechanisms. What seem like small success stories matter within the bigger picture. Examples of challenges faced in the preparation of this program include how to navigate strict procurement laws that are not well suited for parametric insurance and how to secure new guidance by the Commission of Audit to give local governments comfort to engage on insurance protection.
The preparation and execution of innovative market-based catastrophe risk programs take time and effort. In the Philippines, the program was the result of six years of both technical collaboration and World Bank lending. This significant technical assistance and advisory support over an extended period is often enabled through donor funds.
The good news is that these investments can contribute to a larger shift in government planning, and it is possible to develop procedures that are replicable and scalable. Many of the steps undertaken in the development of this program helped enable the placement of the Philippines Catastrophe bond in December 2019, the first sovereign CAT bond placed in Asia, under the World Bank’s “capital at risk” notes program. In addition, the government is now in the final stages of preparing the National Indemnity Insurance Program to transfer risk of critical public assets to international insurance markets.
This pilot program not only provided protection for the two years it was in place but contributed to a larger shift in the government’s approach to financial protection as well as efforts to reduce disaster risk.
Photo credit: Richard Whitcombe/Shutterstock
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