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Could tapping into capital markets in the form of extreme-mortality bonds help to immunize the insurance industry against catastrophic risk?
[snips]
The risk of pandemic disease is so unmanageable that many insurance carriers don?t even bother to try. Hedging the risk through traditional treaty reinsurance (in which the reinsurer assumes a specific portion or category of risk) is so costly that it can put pressure on earnings. When forced to balance quarterly performance results against potential long-term risk, most insurance companies have concluded that the likelihood of an event simply doesn?t justify the expense.
But does it? Three pandemics (and a near miss) have all occurred in the past century. Fortunately, a new approach has surfaced in the area of insurance-linked securities (ILS).* By tapping into the depth and flexibility of capital markets through extreme-mortality bonds?a subset of catastrophe bonds?insurance and reinsurance companies may be able to remove pandemic risk from their portfolios and better manage the cost of coverage.
Management Solutions? (RMS) pandemic model puts an outbreak on the level of the 1957 influenza pandemic as a 1-in-40-years event. According to RMS, the chances of a 1918-caliber outbreak (which could result in at least 2 million fatalities in the United States alone) are even more remote: 1 in 475 years.
At the same time, markets around the world are interconnected, and insurance companies are globalizing their life portfolios. Even as pandemic risk becomes medically more remote, the costs of such an event grow higher.
Given the difficulties?and lack of perceived benefit?associated with transferring pandemic risk, insurers have traditionally downplayed its importance. Typically, they believe that having enough capital relative to peers provides ample protection, under the assumption that not being the first carrier drained of capital is sufficient. They argue that doomsday scenarios, in which the implications are world-changing, simply cannot be hedged.
2 page pdf: http://www.contingencies.org/janfeb09/pandemic.pdf
[snips]
The risk of pandemic disease is so unmanageable that many insurance carriers don?t even bother to try. Hedging the risk through traditional treaty reinsurance (in which the reinsurer assumes a specific portion or category of risk) is so costly that it can put pressure on earnings. When forced to balance quarterly performance results against potential long-term risk, most insurance companies have concluded that the likelihood of an event simply doesn?t justify the expense.
But does it? Three pandemics (and a near miss) have all occurred in the past century. Fortunately, a new approach has surfaced in the area of insurance-linked securities (ILS).* By tapping into the depth and flexibility of capital markets through extreme-mortality bonds?a subset of catastrophe bonds?insurance and reinsurance companies may be able to remove pandemic risk from their portfolios and better manage the cost of coverage.
Management Solutions? (RMS) pandemic model puts an outbreak on the level of the 1957 influenza pandemic as a 1-in-40-years event. According to RMS, the chances of a 1918-caliber outbreak (which could result in at least 2 million fatalities in the United States alone) are even more remote: 1 in 475 years.
At the same time, markets around the world are interconnected, and insurance companies are globalizing their life portfolios. Even as pandemic risk becomes medically more remote, the costs of such an event grow higher.
Given the difficulties?and lack of perceived benefit?associated with transferring pandemic risk, insurers have traditionally downplayed its importance. Typically, they believe that having enough capital relative to peers provides ample protection, under the assumption that not being the first carrier drained of capital is sufficient. They argue that doomsday scenarios, in which the implications are world-changing, simply cannot be hedged.
2 page pdf: http://www.contingencies.org/janfeb09/pandemic.pdf
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