View from the Top: The role of reinsurance in disaster risk management

Reinsurers are gaining recognition in the light of disasters for the role they are playing in helping insurers, governments and society as a whole to deal with today’s risk landscape.

This year alone we have witnessed major events - the floods in Australia, the earthquake in New Zealand, and very recently the devastating combination of earthquake and tsunami in Japan. All of these bring home the important function that reinsurance companies have in supporting the insurance industry in paying a significant portion of the claims to their policyholders.

Thanks to their globally diversified business, reinsurers can absorb local insurers' peak risks, stabilise their balance sheets and free up capital they would otherwise need to hold. Our ability to release funds rapidly helps ease post-catastrophe burdens on individuals, companies and governments, mitigating the cost of emergency relief efforts, reconstruction and stalled economic activity.

Uncertain estimates
Swiss Re estimates claims costs of $1.2bn, net of retrocession and before tax, from the earthquake and the tsunami in Japan. These estimates are subject to a high degree of uncertainty as the event continues to unfold, making loss assessment particularly challenging.

Using the Chile earthquake last year it is possible to illustrate how reinsurers can stabilise the economic system: insured losses in Chile, a country with deep-rooted insurance tradition, amounted to $8bn. Of this sum, around 80% will have to be paid by reinsurers, of which around $630mn by Swiss Re. Local insurers could not carry such a loss burden on a stand-alone basis.

Growing gap
The increasing severity and frequency of natural catastrophes are driving up the cost of disaster relief and reconstruction. The gap between the actual economic loss and the insured loss is large, especially in developing and emerging markets - which are those most hurt and the least prepared - just think of the devastating earthquake in Haiti, a country which has had to rely almost entirely on humanitarian aid for its reconstruction.

Thanks to innovative solutions, the reinsurance industry can help close the gap between economic and insured losses. For example, the Caribbean Catastrophe Risk Insurance Facility paid out $8m to the government of Haiti in the aftermath of the disaster. Measured against the loss of life and devastation on the island, the CCRIF's payout was not a major sum of money. But that's not the point, the point is that the Haitian catastrophe has highlighted the potential of parametric insurance as an innovative solution to help countries plan for and pre-finance natural disasters as part of a comprehensive disaster risk management strategy. The payout provided much needed liquidity to get the wheels of government turning again.

Available relief
Each year features new headlines about devastating natural catastrophes in different parts of the world. The resilience of a country not only depends on the severity of the catastrophic event but also on available funding for relief, recovery and reconstruction.

Currently, a large part of the economic costs are not insured. New approaches to financing disaster risks are, therefore, key to making societies more resilient, as no organisation or country can fully insulate itself against extreme events.

Governments too should play their part: by building up financial reserves or using insurance solutions, they can reduce their financial burden after a disaster occurs. These measures also lower the volatility on the government budget and help improve planning certainty for the public sector. But disaster financing instruments should never be seen in isolation. Rather, they must be viewed in a country's wider risk management context, as risk mitigation and risk transfer must go hand in hand.