4

Adapting Insurance Products
for Pandemic Risk

Panos Varangis of the World Bank moderated the next panel on adapting insurance products for pandemic risk. He opened by thanking the previous panelists for introducing the topic and commenting on the use of insurance to finance natural disasters and pandemics. A key difference between the two kinds of risk is the externalities associated with epidemics. A disease outbreak poses a risk to countries other than those most obviously affected because of the contagion. Given this significant externality, Varangis questioned how to calculate the true insurance premium and who to hold accountable for payment. Even with insurance for hurricanes, which hit Caribbean countries on a fairly predictable basis, enthusiasm for paying the premium tends to ebb a few years after a serious storm.

Olivier Mahul of the World Bank built on this point. When asked to discuss his experience in setting up financial plans for disasters with governments, he emphasized the importance of involving the minister of finance from the start. Finance ministers tend to respond to data on the economic impact of the disaster, both direct and indirect. Therefore, the ability to

quantify the effects of an outbreak on the national budget, the economy, and fiscal growth will help the finance minister make informed decisions about how to manage the outbreak risk. Furthermore, the emergency funding presented in the previous sessions was mostly short-term aid. Finance ministers, Mahul advised, will be more comfortable with a secure, long-term funding source that can be accessed at the cheapest possible rate and in the most efficient amount, neither too little nor too much. Finally, the ministers need a plan for budget execution (the protocol for monitoring, adjusting, and reporting on a current year’s budget). Too often, he observed, disaster appropriations are available to the ministry of finance but cannot be disbursed. A proper budget execution plan, with a protocol for procurement, might help avoid that problem.

Disaster financing mechanisms can be used to engage ministers of finance in planning with health ministers. Mahul gave an example of a recent operation where the government of Sri Lanka took a line of credit from the World Bank for disasters. The credit ensures that, when a disaster strikes, the government will have money available. As part of the process to establish the credit, the World Bank worked with the Sri Lankan finance ministry to invest in disaster mitigation measures. The bank can guarantee that funds be made available after a disaster, but the strategy behind that funding is important. The product used to fund the response—be it insurance, bonds, promissory notes, or more often, a combination of all three—is less important than the process to introduce it. In general, he saw insurance as working best for extreme or rare events and internal reserves as a more suitable funding source for recurrent problems.

Mahul mentioned that one lesson learned over his years in disaster finance was the value of a bottom-up strategy, one where there is money set aside to respond to the country’s immediate needs before the extraordinary ones. Ministers of finance are concerned with extreme events, but usually much more bothered by recurrent ones. The parallels with pandemics, he concluded, are meaningful, with finance ministers more likely to be compelled by financing routine health system advances than pandemic surveillance.

The cost-to-benefit analysis for paying disaster insurance premiums is therefore complicated. Mahul described two main costs that enter into the calculation: the financial cost of the premium and the political cost of explaining to a parliament why they have to make appropriations for a premium when there will be many years of nothing in return. Furthermore, insurance payouts will never cover all the losses a country incurs in a crisis; the payout is invariably smaller than what the politicians expect, and that discrepancy also incurs political cost. He observed that the hesitation of many countries to buy the insurance product has less to do with the price of the premium and more with the political liability.

The liability can be overcome, he acknowledged, especially in middle-income countries. In Mexico, for example, the government uses insurance products in balance with other sophisticated reserve financing during crisis periods. Underlying the government’s mixing of financial tools is a calculus through which the direct and indirect costs of the crisis are quantified. In outbreaks, the analysis is further complicated by the question of monetizing the cost of human lives. A proper cost-benefit analysis needs to confront these questions, Mahul continued, and generally favors a risk-layering approach, wherein the budget, banks, and insurers finance different risks depending on their size and frequency.

Simon Young of the African Risk Capacity (ARC) built on these points in discussing the value of insurance products to governments. He cautioned the audience to see insurance not as a single product, but as a discipline of risk analytics, the ability to quantify a risk. Even in the example of hurricane risk, he found Caribbean finance ministers were not able to estimate either the probability or the costs of a Category 4 storm hitting their country. Insurance, he found, brought with it a discipline of quantifying risk and making an abstract problem more concrete and solvable. Quantifying pandemic risk requires data that might not be available, and he suggested that an independent source of infection and death rates for known pathogens would be needed for the risk analysis.

For the nine current member countries Young works with in ARC, the process of quantifying risk starts with a 12- to 18-month contingency planning and risk analysis process, where they work with ARC staff and other experts, including the World Bank, on understanding the benefits of insurance. In this stage, countries design their drought response plan and clarify how they will spend the payout. He estimated the value of insurance payouts in time of drought to a country like Niger at five to one, meaning that it would take $5 in traditional humanitarian response funding to cover $1 of insurance payout, mostly because the ARC drought insurance pays on an early signal and in a prenegotiated deployment plan. Traditional or ex post fundraising, he cautioned, cannot meet a country’s true needs during a disaster.

The ARC insurance program requires countries to take significant responsibility for disaster mitigation, and Young speculated that something similar could be possible in health. Parametric insurance pays out on the hazard of the disaster, and the terms of the trigger are written in the contract. This helps avoid any gray areas or complicated claims management. Insurers and reinsurers, he said, make their money in the gray area of assessing and reimbursing damages. The assessment slows payment and increases labor costs. The parametric product is more simply underwritten, thereby reducing the price of the risk on international markets.

Nikhil da Victoria Lobo of Swiss Re expanded on Young’s point about

the claims adjustment process, describing it as an administratively complex and expensive process, which can hurt the financial performance of insurance companies if not managed well. For this reason, he described the parametric insurance product as the future, especially for pandemics and natural disasters, as it removes much of the administrative burden and keeps costs down. He felt that the industry was at the point now where parametric products could be adapted to pandemic risks; though he was not free to share all the information backing his position, he emphasized the feasibility of the tool.

Aside from the ease of the claims process, da Victoria Lobo saw value in the incentives inherent in insurance. In a parametric insurance risk analysis, countries could be told precisely what actions they could take to lower their premiums. Even the poorest countries could reduce their premiums by putting preventative measures in place. The source of pandemic risk is mostly in the countries that can least afford it, and in such places insurance can be a way to reduce that exposure. He maintained that these countries should have insurance regardless of the quality of their prevention plans, but that they should be given a timeline to put preventative measures in place and reduce their premiums.

Gunther Kraut of Munich Re continued on this point, saying that epidemic risk was something all insurers are exposed to, but diversification of risk is important. A catastrophe happening in one country is not usually a risk in another country, but pandemics defy diversification. He described the insurer’s motivation to cover pandemic and epidemic risk as “a double bottom-line approach”: the insurer has a desire to develop a profitable product for the company and, in the case of outbreaks, this profit motive aligns with the good of society. The world is already exposed to pandemic risk, he continued, but it is not insured.

Kraut echoed the earlier sentiment that risk modeling is a very important instrument through which insurance benefits society. The modeling process draws attention to the full-blown pandemic situation and also to the more likely outbreak scenario, and encourages the development of a containment strategy for this event. The better quantified risk may push businesses to buy, for example, nonphysical business interruption coverage because, if all the workers take ill during an outbreak, that is not a risk any company wants exposed. In this way, he continued, the World Bank’s Pandemic Emergency Finance Facility can spur the development of other insurance products over time. Time also gives a better understanding of the risk being insured. New and innovative products will be expensive, but as time passes and the product becomes more established, the market will bring the price down.

Historical examples help insurance companies to price risk, but there are only three or four full-blown pandemic examples in the past century to

inform these models. Stochastic scenario modeling can help build additional information into the risk analysis, or modelers can focus on the early outbreak scenario for which there is more information available. Kraut cautioned against basing the insurance trigger only on the number of fatalities. Parametric products provide a simple way around the uncertainty inherent in pandemic risk, he concluded, but the better defined the risk is, the more clarity that will bring to identifying the trigger.

José Ángel Villalobos of the World Bank continued the discussion of insurance, describing it as one of the final parts of the risk management process. He encouraged the use of historical data in pricing pandemic insurance, going back to the Middle Ages if need be. He also stressed that, without appropriate measures to reduce or transfer risk, the losses can only increase, and no company would be willing to insure it. For example, during the Ebola outbreak, pharmaceutical companies were called on to produce vaccines, but the companies feared possible lawsuits at national and international levels. Villalobos encouraged managing this risk in advance of the epidemic and working out liability insurance for pharmaceutical companies.

In the subsequent discussion, the panelists were asked about the suitability of banking and insurance tools for different kinds of risk. Mahul acknowledged that the line is not always clear. Insurance may be better suited to catastrophic risks, raising the question of what is meant by a catastrophe. He pointed to ARC’s emerging position of a disaster as something likely once in 5 or 10 years. In such a case, a cost-to-benefit analysis is still necessary to determine if the insurance solution is the best option. He saw the World Bank’s role as helping governments make this calculation, to enable them to stand in their parliaments and guarantee that they will have the necessary money in the event of a disaster. Da Victoria Lobo agreed, discussing the distinction between insurance and banking products. Banking and credit products, he explained, look at the creditworthiness of the recipient; insurance products look at the risk. Private banks might not be willing to lend to the government of Liberia to fund its Ebola response. Securitizing the loan would be complicated, but insuring it much less so because insurance is based on the cost of the underlying risk; the discussion is more about risk reduction than creditworthiness.

Young expanded on this point, explaining that, unlike indemnity insurance which covers actual losses, parametric insurance might be thought of as the derivative of a triggering event. The derivative is available for indirect costs and does not require a full understanding of all the possible outcomes of the trigger event. ARC, he continued, is a capitalized insurance company bolstered on the insurance market that offers its client countries the best possible price for different types of parametric insurance with an eye to risk diversification across Africa. Jeanette Vega of the Chilean National

Health Fund suggested that this diversification could be seen as going against the principle of solidarity, which is important in public health. Da Victoria Lobo responded that pandemic risk is global and shared, much like group risk in a health or life insurance pool. Nevertheless, there is value in understanding how one’s individual risk factors affect the pool because that empowers people to reduce their risks.

Martin Meltzer of the U.S. Centers for Disease Control and Prevention questioned the use of insurance products for pandemics because the probability of an outbreak is more difficult to model than the probability of an earthquake or storm. Da Victoria Lobo responded that the people who work on those risks would argue that quantifying them is equally challenging. Especially with climate change, it is hard to say how weather patterns will emerge, and the uncertainty has to be built into all varieties of insurance products. Kraut clarified that giving the probability of occurrence is not the same as predicting the next outbreak. At the same time, Adam Bornstein of the Global Fund cautioned against overselling the value of pandemic insurance as a hedge for risk in the life insurance market, as people in poor countries do not generally have life insurance. He and Staci Warden of the Milken Institute agreed that it is very difficult to get governments to pay premiums to hedge risks against shocks. Jennifer Adams of the U.S. Agency for International Development pointed out that asking donors to pay premiums for the poorest countries might obscure the useful link between premium price and the strength of the preparedness system. She described rapid access to cash as very much a limiting factor in Ebola response, but logistics and management were also serious problems not related to money. Mahul responded that a long-term interest in fiscal discipline could assuage the problem; setting aside an outbreak contingency fund is probably not an option in much of the world, but having the fiscal space to absorb the first weeks of a crisis could be.

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