World Bank & EC call for scaled up European disaster risk transfer & cat bonds

In a string of research reports, the World Bank Group and European Commission call 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 to access capital market investors for reinsurance risk capital.

The conclusion of the research is that European countries are retaining far too much of their natural catastrophe risk exposure, with the lions share of the costs continuing to be dealt with by government and European budgets, while too little is transferred to insurance, reinsurance and institutional investor markets.

The World Bank and EC reports state that the continent “needs smart investments to strengthen disaster resilience, adaptation and finance response to disaster and climate risks.”

With Europe seen as warming faster than any other continent, the pair say it is “highly vulnerable to the increasing risks associated with climate change.”

“2023 was the hottest year on record with disasters across Europe costing more than €77 billion. Projected costs of inaction in a high warming scenario could reach 7 percent of EU GDP,” they explain.

“Disasters are devasting for everyone, but can disproportionately impact Europe’s most vulnerable communities, increasing poverty and inequality,” Sameh Wahba, a Director at the World Bank said. “Without adequate systems, these events can erode development gains. There is still time for European countries to take actions that will protect people’s lives, infrastructure, and public finances from disaster and climate change impacts, though there is a narrowing window of opportunity to take action.”

Investment in resilience is a significant focus of the work, with many critical sectors of the European economy seen as exposed to multiple natural hazards.

“Investments in prevention and preparedness are urgently needed at all levels, starting with critical sectors that provide emergency response services,” Hanna Jahns, Director of the European Commission Humanitarian Aid & Civil Protection unit said. “The needs are significant and the pressure on the EU and government budgets is high. Going forward we need to invest in a smart way, prioritizing the investments with the highest resilience “dividends.””

They urge the use of risk and climate change data and analytics, to help in prioritising actions and to select the most impactful prevention, preparedness, and adaptation investments.

In Europe, climate change adaptation costs up to the 2030s are thought likely to be in the range of €15 billion to €64 billion annually, underscoring the significant investment required.

“There is a significant gap in adaptation financing in Europe,” explained Elina Bardram, Director, Directorate-General for Climate Action. “Closing it requires a major scale-up of public, private, and blended finance. Investment planning and financial strategies are not yet adequately informed by an understanding of the costs of climate change adaptation at national and EU levels. This needs to change.”

Where the reports become most relevant for our readers is around financial resilience.

The World Bank and European Commission reports state that, “too much of the disaster and climate risk is managed through budgetary instruments at the EU level and by EU Member States, with gaps concerning pre-arranged funds and the use of risk transfer mechanisms, such as risk insurance. ”

In seeking to maximise societal benefits from investments made, the use of risk transfer alongside this to cushion the costs of climate and natural disasters are seen as key.

Public finances are in some cases being stretched by multiple natural disasters each year, so upfront risk financing and transfer can help to lessen the burden on the budgets of European countries and their populations.

The reports identify funding gaps for major disasters and note that should countries face multiple major events in a year, the impact could drain funding at the EU level (as well as countries specifically).

As a result, the reports state that, “Countries in Europe need to enhance their financial resilience through better data utilization and innovative financial instruments, including risk transfer to the private sector.”

Here, catastrophe bonds are highlighted throughout the reports, as tools that can aid in preparing for financial impacts and enhancing the ability for Europe to fund the response to disasters.

The capital market is seen as one source of risk transfer that Europe should consider.

“At present there are no risk transfer products at the EU level or in the case study countries, and consideration should be given to their incorporation in future DRF strategies,” the report explains.

Citing the use of catastrophe bonds by US utilities for wildfire risk, the reports suggest a potential role in Europe.

“CAT bonds as a risk transfer mechanism are less common in the EU and should be further explored once risk models are available to see if this could provide a cost-effective option to manage the risk of wildfires,” one of the reports says.

Both index and parametric insurance techniques are also suggested as applicable to the disaster funding gaps faced in Europe, as these can help to make for responsive risk transfer tools, that can help in financing recovery quickly after disasters occur.

The European Union Solidarity Fund (EUSF) is seen as a financial structure already in existence that could be supported better by risk transfer.

One of the reports states, “The existing EU level instruments take time to disburse, which may delay emergency response. Due consideration should be given to the introduction of a EU level instrument to provide a top-up to national governments to help them finance emergency response. Such an instrument could be embedded within the European Union Solidarity Fund (EUSF).”

Disaster risk financing and transfer tools and techniques can help European countries and budgets reduce their liabilities after disaster strikes, including through responsive techniques and by tapping the capital markets.

The report continues, “A parametric risk transfer instrument — e.g., a catastrophe bond — could be introduced to secure private capital when needed. This approach would recognize the significant opportunity cost of holding reserves at the EU level and instead structure an additional instrument to release finance into the EUSF when severe events occur.”

The report uses the example set by Mexico, in its use of private insurance, reinsurance and capital markets through its catastrophe bonds, as setting an example that Europe can draw from.

The World Bank sees Mexico as “setting the standard” for disaster risk management through its use of financial instruments such as cat bonds.

The reports go into much more detail around how Europe can put in place safety nets, both for its budgets and for its populations, while making the best use of modern financing techniques, risk transfer tools and the appetites of private and capital markets.

It’s encouraging to see the discussion on Europe continuing, as in the last year we’ve also seen the European Central Bank (ECB) alongside a macro-prudential oversight body it operates, the European Systemic Risk Board (ESRB), calling for greater use of catastrophe bonds to address the insurance protection gap and mitigate catastrophe risks from climate change in the European Union.