Buffeted by a fault line, prone to major hurricane activity and with limited access to reinsurance, Latin American would appear to be an ideal market for alternative risk transfer.
However, the region’s multiple risks have resulted in only a single dedicated catastrophe bond so far, and local authorities remain hesitant to push the boundaries of traditional cover beyond a few experiments.
For ILS professionals, Latin America remains a region of unfulfilled potential.
“There has been a developing interest in catastrophe bonds as a way of spreading out risk in Latin America,” says Machua Millett, a partner with Edwards Angell Palmer & Dodge in Boston. “But anything that is outside the usual will be scrutinized closely by local industry leaders and governments. The industry needs to get over that hurdle.”
Latin America represents about 2 percent of the global insurance market, and is about one-fifth the size of the UK market, according to a report issued in 2007 by Benfield. Insurance penetration in the region is also low, running between 4 and 10 percent of the population in different countries. A majority of the penetration is dedicated to life insurance, the Benfield report added.
But limited cover does not translate into limited exposure.
The countries in Latin America are exposed to a multitude of natural perils, says Pascal Karsenti, senior risk consultant at AIR Worldwide.
A large area of seismicity runs the length of the Pacific from Alaska to Tierra del Fuego and threatens the entire Central America region and coastal cities throughout Colombia, Ecuador, Peru and Chile.
Large inland cities in the region are also not immune to coastal seismic events. “Mexico City is far away from the seismic area, but it’s built on a lake where the silt amplifies the wave until it becomes actually higher than the area around its Pacific epicenter,” says Karsenti. “The result is that the soil essentially liquifies and buildings fall as if they are in quicksand.”
Separately, Central America and the Mexican coasts are susceptible to hurricanes.
The mountainous terrain of Central and South America results in less wind damage from hurricanes but actually increases damage from flood and mudslide, Kasenti says. “Properly modeling rainfall and runoff are very important. How does rainfall pool into a valley and what damage [results] as it moves downhill? There are wide areas of deforestation and structurally unsound buildings placed on cliffs.”
The combination of natural perils threatening the region with the lack of private property/casualty insurance means losses will fall on the governments’ shoulders.
Several Latin American countries have attempted to entice private insurance through market deregulation, says Millett. “Most of the major markets have opened and reinsurance is still fairly open with minimum capital requirements and easy paper filing,” he explains. “Brazil and Costa Rica are just now liberalizing and they are very large markets.”
But take up remains scarce, forcing local governments to bear the brunt of major catastrophic losses.
In 2006 the Mexican government issued a $160 million catastrophe bond modeled by AIR dubbed CatMex. The bond provided catastrophe cover to the Mexican government for financing emergency costs if an earthquake of moment magnitude 7.5 or 8 hit regions near Mexico City or along the Pacific Coast.
Private insurers have also dabbled in Latin American cat bonds. Last year Swiss Re issued an $85 million bond under the GlobeCat program that included a $25 million tranche covering non-peak perils of Guatemala and El Salvador earthquakes that was modeled by Equecat.
While both issues were welcomed, they are a drop in the bucket when compared to possible losses. Additionally, no other insurance linked securities have been issued since these bonds have matured.
“Latin America is subject to the same conditions that have affected these bonds,” says Millett. “A softening reinsurance market and investors demanding a higher return.”
That is not to say that insurance linked securities could not become a vibrant alternative for the region. In some cases it could take a major event for local countries to realize the need for a capital markets solution, such as the large quake that took place in Costa Rica’s mountainous central region.
“If the Costa Rica earthquake was centered in San Jose, there is a real question whether the government monopoly insurer would be able to deal with that,” Millett argued.
International development agencies and modeling firms are trying to encourage local insurers to become aware of alternative risk transfer.
Karsenti explains that the World Bank has been a proponent of transferring regional catastrophe risks to the capital markets. Additionally, as global industrial companies expand their presence in the region, they will demand more insurance cover.
“Large mining, oil and gas and other industries are expanding in Latin American and we want these companies to know that we are there,” Karsenti says, adding that providing modeled losses is a significant first step to transferring risk.