ECB & EIOPA call for EU cat bond issuance platform

A new paper from the European Central Bank (ECB) and the European Insurance and Occupational Pensions Authority (EIOPA) highlights the potential for increased use of catastrophe bonds to support the overall supply of catastrophe insurance across the European Union (EU), as climate change threatens to widen the protection gap.

According to the joint discussion paper, currently, just 25% of EU climate-related catastrophe losses are insured, meaning that when disaster strikes, 75% of the financial impact is not covered by re/insurers. In fact, the report finds that in some countries within the EU, the insured figure is below 5%, which is dangerously low and poses risks to economy and financial stability.

“We need to increase the uptake of climate catastrophe insurance to limit the growing impact of natural disasters on the economy and the financial system,” said ECB Vice-President, Luis de Guindos. “However, to reduce losses in the first place, we must ensure that a smooth and speedy green transition is complemented by effective measures to adapt to climate change.”

As the report highlights, low climate catastrophe insurance penetration can adversely impact economic recovery post event, and with climate change driving more frequent and severe natural disasters, insurance costs are forecast to rise. The impacts of this are already visible, with some carriers reducing coverage while others have stopped providing certain types of catastrophe insurance all together, which threatens to widen the protection gap.

In order to foster insurance coverage, the ECB and EIOPA have made a number of suggestions, including greater use of catastrophe bonds to transfer some of the risk to the capital markets.

“Policy measures could be undertaken at both national and EU level to foster greater and more effective use of cat bond markets in both the private and public sector, thereby helping to reduce the climate insurance protection gap,” reads the paper.

The paper notes that currently, issuing a cat bond in Europe is not cheap and the process for establishing an insurance-linked securities (ILS) vehicle is more cumbersome than in other, non-European jurisdictions. Despite this, and as shown by the Artemis Deal Directory, a number of large re/insurers have issued cat bonds via ILS vehicles based in Ireland, which the report notes is a benefit from a Solvency II perspective as it simplifies the calculation and reporting of capital requirements.

“Public authorities in the EU could consider measures that help to foster a more vibrant cat bond market for the private sector,” continues the paper.

Using the Bermuda Monetary Authority, the Insurance Authority of Hong Kong and the Monetary Authority of Singapore as examples, the ECB and EIOPA note that some governments outside of the EU have taken steps to attract issuers of cat bonds to their shores. This includes a more efficient and quicker issuance process in Bermuda introduced in 2021, while in Hong Kong and Singapore issuers can take advantage of a grant scheme that covers some of the costs.

The paper also discusses increasing cat bond issuance by the public sector, and highlights how public-private partnerships (PPPs) could enable the pooling of residual risks at higher loss layers more efficiently than the private sector, with part of the pool then being securitised in the form of cat bonds.

“While a cat bond issued by a national PPP would typically cover risks that are limited geographically to the Member State concerned, a platform at the EU level could be used to identify securitisation opportunities to pool residual risks from multiple national PPPs,” reads the paper. “This could be made possible by improving the exchange of information on catastrophe risks and combining expertise on underwriting and placement of securities at the EU level.”

Alongside the potential for greater cat bond issuance in the EU, the paper suggests that insurers should design their policies to encourage the reduction of risk, while governments should also do their bit and provide strong incentives to reduce risks. Additionally, the report calls for national-level insurance schemes which could be complemented by an EU-wide public scheme, designed to ensure sufficient funds are made available to European countries for reconstruction following rare, large-scale climate-related catastrophes.

“Insurance plays a major role in protecting businesses and people against climate-related catastrophe losses by swiftly providing the necessary funds for reconstruction. In order to efficiently protect our society, we need to address the concern of the increasing insurance protection gap by proposing and finding appropriate solutions,” said EIOPA Chairperson, Petra Hielkema.