ECB, EIOPA propose EU nat cat reinsurance solution, with catastrophe bond support

A proposal published by the European Central Bank (ECB) and the European Insurance and Occupational Pensions Authority (EIOPA) calls for a natural catastrophe insurance system that includes pooling private risks, strengthening disaster risk management, and the use of catastrophe bonds to support catastrophe reinsurance availability for Europe.

It follows a discussion paper from 2023 that called for increased use of catastrophe bonds to support the overall supply of catastrophe insurance across the European Union (EU), as climate change threatened to widen the protection gap.

An ECB executive had also highlighted that deeper catastrophe bond markets could help in tackling the climate insurance protection gap in Europe.

While research reports from the World Bank Group and European Commission called on governments across Europe to utilise more in the way of disaster risk transfer and insurance to reduce the pressure from weather and natural perils on budgets, including the use of catastrophe bonds.

Plus, the European Central Bank (ECB) alongside a macro-prudential oversight body it operates, the European Systemic Risk Board (ESRB), has called for greater use of catastrophe bonds to address the insurance protection gap and mitigate catastrophe risks from climate change in the European Union.

All of which has led us to this new proposal for a two-pillar solution designed to provide an EU-level approach to reduce insurance protection gap for natural catastrophes, building on existing national and EU structures.

“This proposal is a response to the growing frequency and severity of natural catastrophes linked to climate change and the rising economic losses they entail. The proposal seeks to protect people, businesses and governments from these losses, thereby also mitigating the associated macroeconomic and financial stability risks in the EU. It does so by incentivising risk mitigation and adaptation and clarifying the division of responsibilities between the private and public sectors,” the ECB explained today.

The first pillar in the proposal is an EU public-private reinsurance scheme, which the ECB and EIOPA says can “increase the insurance coverage for natural catastrophe risk.”

This would be achieved by pooling private risks and perils across the EU, exploiting “economies of scale and diversify the coverage of high risks at the European level.”

This EU reinsurance scheme would be funded by risk-based premiums from re/insurers or national insurance schemes.

But, importantly, the proposal published today calls for the capital markets to be called on in support, with catastrophe bonds a tool that can be used to crowd in efficient institutional capital to support this reinsurance pool approach.

The proposal explains, “The EU reinsurance scheme could seek to transfer part of the risks to capital markets via instruments such as catastrophe bonds. The market for these products is less developed in the EU than in North America. Part of the reason is the smaller scale of the issuances.

“The EU scheme could explore the feasibility of a pan-European catastrophe bond covering more perils than the bonds currently issued. This would serve the dual purpose of expanding the catastrophe bond market and bringing more niche risks directly to capital markets investors. The investors, in return, could benefit from the additional diversification offered by exposure to these risks relative to the risks currently covered.”

The scheme itself could act as a platform for issuing catastrophe bonds, the proposal suggests, to provide an additional layer of loss-absorption protection.

The second pillar is a call for an EU fund for public disaster financing, to reinforce public disaster risk management in Member States and help rebuild public infrastructure following natural disasters.

“Recent events in Europe have shown the challenges the EU and its Member States are facing in dealing with natural catastrophes,” explained EIOPA Chairperson Petra Hielkema. “This calls for coordinated action. The proposals presented are meant to spark a discussion on possible ways to reduce the insurance protection gap through an EU-level solution, while preserving the integrity of national insurance schemes,” she added.

ECB Vice-President Luis de Guindos added, “We need to get prepared for the rising climate risks. The proposed solution is one possible way to mitigate the macroeconomic and financial stability risks from natural catastrophes, while also reducing moral hazard.”