Friday, March 23, 2018

Solving the pandemic problem

The size of the reinsurance pie has not grown significantly during the past few years despite an abundance of capital. But as the market slowly begins to accept the permanence of this capacity, players are starting to look for new opportunities in earnest — and one risk that has consistently been overlooked is pandemics.

This is partly because pandemics have typically been viewed as a mortality risk affecting the life market, which has seen much less pressure from alternative capital due to the long-term nature of such risks. While it is understandable to see the risk in this way, the reality is that a severe pandemic is not only a problem for life portfolios. It is a huge potential issue in the non-life sector too.

But it is not clear that reinsurance is an obvious solution. Reinsurers that take a broad view of what happens during a pandemic get a rude awakening, because when they look beyond the insurance risk and consider how their overall position is affected, it becomes clear that the biggest problem is likely to be a collapse in asset values — and this is a much more challenging, systemic risk for the reinsurance industry to cope with compared to a natural catastrophe that has a limited geographic scope.

The worst-case benchmark that everyone in the industry uses is the Spanish flu of 1918-1920, which killed at least 40 million people, many of them young and otherwise healthy. A recent World Bank analysis reckons that a similar outbreak today could cost as much as 5% of global GDP, or nearly US$4 trillion.

At the same time, the capital position of every financial institution on the planet will be severely eroded as fear grips the market and forces a flight to quality that will see share prices and interest rates fall as everyone seeks out the safety of US dollars and treasuries.

Another assumption that is common to risk modellers who look at pandemics is that a major event is inevitable. It is not a question of if, but when. And Asia is likely to be at the heart of such an outbreak as millions more people are packed into increasingly crowded cities that are increasingly well connected to the rest of the world.

It is also likely that the Spanish flu is not, in fact, the worst-case outcome — and therefore there is an added risk that models may be overly optimised around an event that happened in a very different world to the one we currently inhabit. If a similarly deadly strain of influenza were to strike a major Chinese city today, the outcome could be even worse.

Given the systemic nature of pandemic risk, much like climate risk, the best solution might be to focus on building resilience at the source rather than transferring insoluble risks from insurers to reinsurers.

For example, that might mean ensuring that governments around the world are adequately prepared to respond to a major pandemic on the ground. The recent Ebola crisis clearly demonstrated that we are not yet there — and this realisation prompted the World Bank to launch its Pandemic Emergency Financing Facility (PEF) at the G7 Ministers of Finance Meeting in Japan last year.

PEF is an insurance plan for nation states that provides protection against certain types of viruses that lead to severe outbreaks. If an outbreak meets predetermined measures based on severity, speed and size, funding will be disbursed to lessen the effects of the outbreak. The scheme was initiated in collaboration with AIR Worldwide, Swiss Re and Munich Re.

This type of approach is a particularly attractive way for the industry to grow the pie — instead of simply trying to sell more insurance policies to individuals and corporations. By taking a more macro view, reinsurers can identify where the risks in the world are and propose solutions to them at the governmental level.

With the abundance of capital increasingly recognised as the new normal, expect more reinsurers to strike out in innovative ways to build new sources of income. Instead of competing with each other over a dwindling pie, such an approach may take greater collaboration within the industry.


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