Adopting new technology may be challenging and even disruptive. But it has been proved that the future belongs to those who anticipated change and prepared themselves for challenges to stay ahead of the curve.
The world is moving from localised wealth or asset creation to more inclusive economy. As every location has high-value assets and human lives, the risk of natural catastrophe wiping them out are much higher. The frequency of natural disasters in the past four years has sent dangerous signals to scientists and insurers. As risk bearers of the society, the insurance industry cannot overlook the dimension of cover that may be required by the insured and the high probability of servicing potentially high claims that may exceed their risk-carrying capacity in spite of reinsurance arrangement.
Insurers have ensured that in case of any future shock, they will not only meet their liability but also continue to survive in the business. However, they are also realising that the premium or the cover secured through reinsurance may not be adequate to settle claims arising out of a major natural calamity like the one in Uttarakhand last summer.
Insurers have to find risk-bearing tools beyond the conventional methods. In the past, there have been instances when insurance companies in developed markets have paid out their entire premium and even their entire capital to honour claims arising out of a single widespread disaster.
So, to overcome such a burden, the American insurance market had come out with catastrophe bond, popularly known as cat bonds. Insurers floated these bonds with the help of investment bankers after taking approvals of the money market and the insurance regulator. These bonds, when subscribed, give decent return to investors. Most of the funds are invested in sovereign or, at least, fairly rated bonds. The uniqueness of these bonds is the risk that it carries for the investors. The return is, therefore, high.
The investment of the cat bonds is generally managed by a collateral fund or SPV and is not mixed with the insurer?s assets accumulated out of premium.
It guarantees decent rate through monthly or quarterly coupons. But if the event occurs as per the prospectus of the issue and if the insurance amount exceeds the premium collected and the reinsurance sum, the investment in the bonds is partially or fully utilised by the insurer to settle claims and, in that case, the bondholders forgo whole or part of their investment. In the US, this instrument is being gradually refined and made popular. Several sophisticated models for risk transfer are evolving so that the Cat Bonds grow popular and the insurers withstand the possible shock caused by catastrophe.
This risk-hedging instrument is not known in India so far. But I believe that the industry, regulator and the government must start thinking about cat bonds. India?s rapid economic growth and the emergence of mega towns and cities multiply risk of various kinds every year.
If all insurable assets are insured, as they ideally should be, the total sum at risk could be higher by several multiples than the claim paying capacity of the insurers and the reinsurers. As the need and awareness for insurance grows, the need for innovations in risk management will also grow. The concerned agencies must support any such initiative as the time for introducing the cat bond has arrived.
Kamalji Sahay
The writer is advisor (Life Re) GIC Re and former MD & CEO,
Star Union Dai-ichi