Catastrophe Insurance Programs for Public Assets— Operational Framework ©2020 The World Bank International Bank for Reconstruction and Development The World Bank Group, 1818 H Street NW, Washington, DC 20433 USA October 2020 DISCLAIMERS This work is a product of the staff of the World Bank with external contributions. The findings, interpretations, and conclusions expressed in this work do not necessarily reflect the views of The World Bank, its Board of Executive Directors, or the governments they represent. The World Bank does not guarantee the accuracy of the data included in this work. The boundaries, colors, denominations, and other information shown on any map in this work do not imply any judgment on the part of The World Bank concerning the legal status of any territory or the endorsement or acceptance of such boundaries. RIGHTS AND PERMISSIONS The material in this work is subject to copyright. 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Table of Contents Acknowledgments ��������������������������������������������������������������������������������������������������������������������������������������������������������������������������������������������� 3 Abbreviations ������������������������������������������������������������������������������������������������������������������������������������������������������������������������������������������������������ 4 Executive Summary and Framework Overview���������������������������������������������������������������������������������������������������������������������������������� 5 Introduction ��������������������������������������������������������������������������������������������������������������������������������������������������������������������������������������������������������� 13 Scope and Methodology�������������������������������������������������������������������������������������������������������������������������������������������������������������������������������� 15 Preconditions and Limitations�������������������������������������������������������������������������������������������������������������������������������������������������������������������� 17 Operation 1. Assess the financial protection gap for natural disasters����������������������������������������������������������������������������������� 19 Operation 2. Create a legislative and policy framework to enable the use of insurance where effective�����������20 2-1. Internal stakeholder engagement �������������������������������������������������������������������������������������������������������������������������������������������� 21 2-2. Clarify and limit what central government will cover����������������������������������������������������������������������������������������������������� 21 2-3. Incentivize use of insurance ������������������������������������������������������������������������������������������������������������������������������������������������������� 21 2-3-1. Conditional access to other financing���������������������������������������������������������������������������������������������������������������������� 22 2-3-2. Compulsion by the Ministry of Finance or other entity with financial oversight of participating entities ���������������������������������������������������������������������������������������������������������� 22 2-3-3. Mechanisms that verify that purchase of insurance has taken place ����������������������������������������������������� 23 2-3-4. Mandate identification and quantification of disaster risk within long-term financial planning processes of public sector entities ������������������������������������������������������������������������������������ 23 2-4. Ensure ability to pay premiums����������������������������������������������������������������������������������������������������������������������������������������������� 24 Operation 3. Determine the extent of centralization for the insurance approach ���������������������������������������������������������� 25 3-1. Centralized approach; aggregation of risk into an insurance vehicle or program������������������������������������������ 27 3-2. Partially centralized approach: Framework agreement with the insurance market ������������������������������������� 29 3-3. Decentralized approach: Individual agency/entity approaches �����������������������������������������������������������������������������30 Operation 4. Determine the nature of the vehicle or program entity ������������������������������������������������������������������������������������ 31 4-1. Identify the type of program or vehicle most appropriate to the institutional, legal and regulatory context���������������������������������������������������������������������������������������������������������������������������� 31 4-2. Develop an effective, representative governance structure������������������������������������������������������������������������������������� 32 4-3. Determine the balance of retained internal expertise versus outsourcing�������������������������������������������������������� 32 Operation 5. Determine the role of the private (re)insurance sector ������������������������������������������������������������������������������������ 34 5-1. The transfer of risk to protect government budgets����������������������������������������������������������������������������������������������������� 34 5-2. Increasing transparency and data standards�������������������������������������������������������������������������������������������������������������������� 34 5-3. Developing the domestic insurance market���������������������������������������������������������������������������������������������������������������������� 35 5-4. Challenges in using commercial (re)insurance—volatility in the cost of cover������������������������������������������������ 35 Operation 6. Define the extent and nature of insurance coverage����������������������������������������������������������������������������������������� 36 6-1. Set priorities for asset and loss types to be covered ��������������������������������������������������������������������������������������������������� 36 6-2. Facilitate resilient reconstruction within post-event processes������������������������������������������������������������������������������ 37 6-3. Set coverage terms to minimize underinsurance������������������������������������������������������������������������������������������������������������ 37 6-4. Decide upon a risk-based versus solidarity model for pricing��������������������������������������������������������������������������������� 38 6-5. Ensure sustainable pricing���������������������������������������������������������������������������������������������������������������������������������������������������������� 39 Operation 7. Develop a post-disaster process������������������������������������������������������������������������������������������������������������������������������������ 41 7-1. Incorporate an established public sector loss assessment process������������������������������������������������������������������������ 41 7-2. Bring the claims management function in-house������������������������������������������������������������������������������������������������������������� 41 7-3. Share loss adjustment resources between public and private sector������������������������������������������������������������������� 41 7-4. Establish a long-term partnership with an external provider of loss adjustment services ����������������������� 42 7-5. Use technology to facilitate rapid settlement������������������������������������������������������������������������������������������������������������������� 42 2 Catastrophe Insurance Programs for Public Assets - Operational Framework Operation 8. Undertake Stakeholder and market engagement ����������������������������������������������������������������������������������������������� 43 8-1. Engaging with the domestic insurance market ��������������������������������������������������������������������������������������������������������������� 43 8-2. Commercial process—optimizing price and coverage outcomes���������������������������������������������������������������������������44 8-2-1. Structuring the risk to increase number of bidding insurers�������������������������������������������������������������������������44 8-2-2. Pre-engagement with the market������������������������������������������������������������������������������������������������������������������������������44 8-2-3. Designing a bidding process����������������������������������������������������������������������������������������������������������������������������������������44 8-2-4. Understanding the role of brokers���������������������������������������������������������������������������������������������������������������������������� 45 8-2-5. Taking selection criteria beyond price�������������������������������������������������������������������������������������������������������������������� 45 8-3. Stakeholder engagement �����������������������������������������������������������������������������������������������������������������������������������������������������������46 Moving forward�������������������������������������������������������������������������������������������������������������������������������������������������������������������������������������������������� 47 Annex 1. Case Study: The Queensland Government Insurance Fund (QGIF)��������������������������������������������������������������������� 48 Annex 2. Case Study: Japan Insurance Arrangements for the Shinkansen Rail Infrastructure���������������������������������� 49 Annex 3. Case Study: Mexico’s National Disaster Fund (FONDEN)����������������������������������������������������������������������������������������50  ase Study: The New Zealand Local Government Insurance Corporation Limited and the Local Annex 4. C Authority Protection Program������������������������������������������������������������������������������������������������������������������������������������������������� 51 Annex 5.  Case Study: Enforcement of Minimum Standards of Insurance Protection for Transport Infrastructure Managed as PPPs in Colombia����������������������������������������������������������������������������������������������������������������� 52 Annex 6. Case Study: The UK Department for Education’s Risk Protection Arrangement (RPA)�������������������������� 53 Annex 7. Case Study: UK’s Insurance Services II Framework (ISII)������������������������������������������������������������������������������������������ 54 References������������������������������������������������������������������������������������������������������������������������������������������������������������������������������������������������������������ 55 3 Catastrophe Insurance Programs for Public Assets - Operational Framework Acknowledgments This report was authored by Emily White under Partners, Australia); Masaaki Nagamura (Tokio Marine the guidance of Hideaki Hamada as part of the & Nichido Fire Insurance Co., Ltd., Japan); Agnieszka World Bank’s Disaster Risk Financing and Insurance Gajli (YPO, the United Kingdom (UK)); Matt Program (DRFIP) of the Finance, Competitiveness, Kirkpatrick (UK Government Actuaries’ Department), and Innovation Global Practice under the leadership Clive Sillince, Janet Fletcher, Tony Pickstock, Laura of Olivier Mahul. The team is grateful to World Bank Abbott, and Luke Adey-Rennard (all from the UK Risk colleagues Hang Thu Vu, Benedikt Signer, Shoko Protection Arrangement for Academies); Arie van Takemoto, Jose Angel Villalobos, John Plevin, Cynthia den Berg (Queensland Government, Australia); Paul Clarita Kusharto, Bianca Adam, Barry Maher, Mirtha Allison (Crown Commercial Service, UK),; Stephen Liliana Escobar, Greg Fowler, and Rui Xu for their Bull (Sheffield City Council, UK); and Salvador Pérez help, insights, and comments. Maldonado (Consultant, Mexico). The authors would also like to acknowledge valuable content made This report has been produced at the request of the publicly available from the New Zealand Auditor Working Group on Regional Disaster Risk Financing General’s Office. and Insurance (DRFI) Solutions for APEC (Asia-Pacific Economic Cooperation) Economies under the APEC The team gratefully acknowledges the support of Finance Ministers’ process. Its aim is to synthesize the APEC Secretariat and contributions provided peer-to-peer learning among APEC economies into by participants during the APEC Workshop on a format that provides useful, practical guidance Financial Management of Public Assets against to finance officials in APEC economies but that Disaster Risks held in Tokyo, Japan, June 21–22, 2018. can be applied to other economies on the design Those contributors included representatives from and implementation of catastrophe risk insurance Finance Ministries from Chile; China; Indonesia; Japan; programs for public assets. This report extends Malaysia; Mexico; New Zealand; Papua New Guinea; work presented in the APEC reports on “Financial the Philippines; Russia; Chinese Taipei; and Viet Risk Management of Public Assets against Natural Nam. Also in attendance were the representatives of Disasters in APEC Economies” and “Improving Public Queensland Government Insurance Fund (QGIF) and Assets and Insurance Data for Disaster Risk Financing Queensland Reconstruction Authority (QRA) from and Insurance Solutions,” which were prepared by the Australia; Asian Development Bank (ADB); Tokio World Bank for 2017 APEC Finance Ministers’ Meeting. Marine & Nichido Fire Insurance Co., Ltd. (a Sherpa of Asia Pacific Financing Forum); Fujitsu Limited The team is extremely grateful for the time and (on behalf of Japan Bosai Platform); and Japan contributions given by case study representatives International Cooperation Agency (JICA). across the globe, particularly for Bill Dwyer (Queensland Government Insurance Fund, Australia); This work is supported by the World Bank Disaster Risk Rodrigo Sanchez Mujica and Juan Miguel Adaya Valle Management (DRM) Hub, Tokyo, through the Global (Agroasemex, Mexico); Steve Cantwell (Treasury, Facility for Disaster Reduction and Recovery and Japan- New Zealand); Bryan Whitefield (Risk Management World Bank Program for Mainstreaming DRM. 4 Catastrophe Insurance Programs for Public Assets - Operational Framework Abbreviations ADB Asian Development Bank ANI National Infrastructure Agency APEC Asia-Pacific Economic Cooperation CCS Central Public Sector Procurement Agency DHBs District Health Boards DRFA Disaster Recovery Funding Arrangements DRFI (Regional) Disaster Risk Financing and Insurance DRM Disaster Risk Management DTMR Department of Transport and Main Roads FONDEN Mexican National Fund for Natural Disasters ISII Insurance Services II (United Kingdom) JICA Japan International Cooperation Agency JR Japan Railways JRTT Japan Railway Construction, Transport, and Technology Agency LAPP Local Authority Protection Program (New Zealand) MHCP Ministry of Finance and Public Credit MLIT Ministry of Land, Infrastructure, Transport, and Tourism MoF Ministry of Finance NHS National Health Service (United Kingdom) PFI Private Finance Initiative PPPs Public-Private Partnerships QGIF Queensland Government Insurance Fund (Australia) QRA Queensland Reconstruction Authority (Australia) RPA Risk Protection Arrangement (UK Department of Education) SHCP Ministry of Finance and Public Credit (Mexico) UK United Kingdom UNAM Universidad Nacional Autónoma de México 5 Catastrophe Insurance Programs for Public Assets - Operational Framework Executive Summary and Framework Overview Natural disasters in APEC (Asia-Pacific Economic The case studies identify seven key activities in the Cooperation) economies have significant impacts on the design and implementation of disaster insurance economy and daily lives of the population. To minimize schemes for public assets (see figure 1). Within each those impacts, a comprehensive policy package is of the activities, economies can learn valuable lessons required, which covers the key strands of “Prevention, from the success and failures of schemes globally. Preparedness and Response.” The establishment of an These elements are further outlined in the figure. insurance scheme to support the financial protection of The activities are numbered within this report, but it public assets against disasters can form an important should be noted that the activities are interconnected part of this package, alongside the use of complementary and are therefore not sequential. financial instruments within a broader disaster risk financing strategy, and investments in quality, resilient Before embarking on the process of design and infrastructure and buildings to prevent losses. implementation of any scheme, certain preconditions need to be in place. As discussed under Operation 1, This report has been produced at the request of the the appropriate data systems for public assets need Working Group on Regional Disaster Risk Financing to be in place. Additionally, the government entities and Insurance (DRFI) Solutions for APEC Economies that will lead the process need to have the technical to contribute to the APEC Finance Ministers’ Meetings. capacity required to undertake the exercise. Later on, It aims to synthesize peer-to-peer learning among this paper discusses options for retaining elements of APEC economies into a document that provides technical capacity versus outsourcing to partners, as useful, practical guidance to finance officials about observed in the case studies. the design and implementation of catastrophe risk insurance programs for public assets1 based on case studies of APEC economies and beyond. FIGURE 1. ACTIVITIES WITHIN AN OPERATIONAL FRAMEWORK FOR THE DESIGN AND IMPLEMENTATION OF DISASTER INSURANCE ARRANGEMENTS FOR PUBLIC ASSETS Create legislative and policy framework Assess the protection gap for natural disasters Determine the extent of centralization for insurance approach Determine the nature of the vehicle or program entity Execute Preconditions to begin design process: appropriate Determine the role of private (re)insurance sector data systems in place for public assets; technical capacity of government agencies Define the extent and nature of insurance coverage leading process. Develop a post-event process 1 This report extends work presented in the APEC reports on “Financial Risk Management of Public Assets against Natural Disasters in APEC Economies” and “Improving Public Assets and Insurance Data for Disaster Risk Financing and Insurance Solutions,” prepared by the World Bank for 2017 APEC Finance Ministers’ Meeting. 6 Catastrophe Insurance Programs for Public Assets - Operational Framework Operation 1. Assess the financial protection gap for natural disasters An understanding of the gaps in financial protection is needed in order to set policy priorities for a scheme for insurance of public assets. To assess this gap, an understanding of the possible losses arising from the catastrophe exposure of public assets is needed, along with detail of existing financial protection arrangements. The following are required: • Detailed data on the location, value and characteristics of assets (public assets database); • A quantitative (ideally probabilistic) view of the risk arising from the catastrophe exposure of these assets; and • A catalogue of existing arrangements for financial protection of public assets. The assessment of the financial protection gap based on these data is the starting point for all other activities described in this report. This report does not aim to cover best-practice in respect of the information listed above, as best-practice is covered extensively elsewhere.2 This activity lays the foundation for setting the scope of coverage for any scheme, as discussed under Operation 6. Operation 2. Create a legislative and policy framework to enable the use of insurance where effective A sound legislative basis for the financial management of public assets can support a long-term approach even through changing administrations. Accompanied by a sound policy framework, this approach can promote the effective use of insurance by managers of public assets. However, legislation needs to be carefully crafted and accompanied by additional actions to ensure the following: • Coverage is purchased where needed; • Coverage is appropriate; and that • Coverage is not being purchased in situations where it is not value for money. LESSONS LEARNED Explicitly clarifying and limiting the extent of financial assistance from the Ministry of Finance in legislative or guidance documents produces more effective outcomes. Mechanisms to incentivize the uptake of insurance are needed, such as: • Use of conditionality in access to other forms of financing; • Enforcement of compulsory insurance purchase by the Ministry of Finance, or other entity with financial oversight of participating entities within a scheme; • Mechanisms to verify that purchase of insurance has taken place; and • Mandating quantification of disaster risk within long-term financial planning processes of public sector entities. Ensuring that public sector entities have the funds and necessary authorizations to pay for insurance premiums. • It is not unusual—especially for economies with limited experience in the use of insurance— that insurance premiums are excluded from eligible expenditures for government entities, and revision of legislation and/or policy is needed. 2 Best practices in catastrophe risk assessment and in public asset databases are covered by the APEC reports on “Financial Risk Management of Public Assets against Natural Disasters in APEC Economies” and “Improving Public Assets and Insurance Data for Disaster Risk Financing and Insurance Solutions,” which were prepared by the World Bank for the 2017 APEC Finance Ministers’ Meeting. This document considers such areas out of its scope to avoid duplication. 7 Catastrophe Insurance Programs for Public Assets - Operational Framework Operation 3. Determine the extent of centralization for the insurance approach Some economies have opted to create centralized programs to insure public assets. This approach allows for oversight and consolidation of management of disaster risk for public assets. Other economies have opted for less intervention, with more flexibility in management given to individual entities. The advantages and disadvantages of the various approaches are laid out below in table 1. TABLE 1. CENTRALIZED, PARTIALLY CENTRALIZED, AND DECENTRALIZED INSURANCE APPROACHES APPROACH ADVANTAGES DISADVANTAGES PRECONDITIONS Centralized: • Consolidated purchasing • High administrative and • Strong alignment of centralized power and conduit to operational cost burden financial interest between insurance vehicle international market capacity participating and operating • Risk of disconnecting or program levels of government, to • Management of pricing insurance decision-making invest time/effort/resource Risk is aggregated volatility from experience of risk in scheme into a program or • Financial efficiencies from • Removal of choice in vehicle, such as • Appropriate data systems risk pooling/better managed financial decision-making the Queensland for public assets, with the risk retention from direct managers of Government potential for consistency assets Insurance Fund (the • Quality control for insurance across participating entities State Level) and coverage standards • Technical capacity within Mexico’s FONDEN • Visibility over multiple lead agency to undertake (Federal Level). classes of risk, allowing the process for comprehensive risk management Partially • Facilitates access to • Relatively high level of effort • Relatively developed Centralized: commercial insurance to implement domestic insurance market framework with required financial/ • Standardizes insurance • Reduction of choice of agreement with the technical capacity to purchase process, increasing suppliers insurance market underwrite property the chance of successful • Application of minimum catastrophe risk An insurance placement standards in insurance terms procurement • Robust and transparent • Promotes competition on and pricing that may not be framework of approach to procurement price possible in certain market contracts that within the public sector contexts facilitates and • Provides robustness in • Technical capacity within standardizes access overall terms of engagement • No additional financial government to manage the to the commercial between insurers and public efficiencies from risk procurement framework markets for public sector (but not necessarily in pooling/better managed risk once developed agencies. terms of coverage itself) retention • Appropriate data systems • Protects freedom of choice for public assets in financial management for managers of public assets Decentralized: • Protects freedom of choice • Variability in price and • Relatively developed individual agency in financial management coverage quality outcomes, domestic insurance market approaches for managers of public with particular risk for small with required financial/ assets—keeping experience scale public entities with technical capacity and of risk and financial decision- limited purchasing power appetite to underwrite making in the same place property catastrophe risk • Increased risk of • Has no administrative or unsuccessful placements • Strong technical capacity operational burden for at all levels of government • No additional financial government (central to local) for effective efficiencies from risk risk management and robust • Protects free market pooling/better managed risk procurement competition between retention suppliers • Appropriate data systems for public assets Source: Authors 8 Catastrophe Insurance Programs for Public Assets - Operational Framework Operation 4. Determine the nature of the vehicle or program entity Where a decision has been made to establish a vehicle or program for public asset insurance, the next step is to determine the nature of the vehicle or program; namely, the type of entity (e.g. a trust, foundation, company, or program within the budget) and how it will be governed and managed. The decision on the type of entity should be guided by: the level of operational and administrative burden that is acceptable to the government; the extent of financial segregation required from government accounts; the level of independence or integration of the vehicle with existing public agencies; the role of government agencies and other stakeholders in the governance and management of the vehicle. LESSONS LEARNED The decision to create a separate legal entity for the insurance vehicle depends on the importance of transparency and ring-fencing of funds, versus the appetite for operational and administrative burden in establishing a vehicle. An effective governance structure can substantially improve outcomes, particularly on sustainability and uptake of insurance, with actions such as; • Ensuring senior representation from the end-users on the governing Board; • Ensuring that governance processes actively and frequently engage the Board; • Ensuring that the secretariat function for governance forums is given appropriate priority; • Ensuring that the selection of Board appointees and the rotation of the Board Chair give a breadth of end-user representation; • Making strategic political appointments to the Board. While outsourcing of specialist functions may be most practical in the early days of operations for an insurance scheme, keeping certain areas of expertise in-house can add substantial value in the longer term. These included: • An internal challenge function for pricing; • Expertise to stress test of the prevalent view of risk; • Basic Geographic Information System (GIS) skills for catastrophe exposure management and event monitoring; • Data management and manipulation functions to exploit asset catalogues and claims data for broader risk management and response; • Expertise in valuation and vulnerability estimations for assets. 9 Catastrophe Insurance Programs for Public Assets - Operational Framework Operation 5. Determine the role of private (re) insurance sector Governments need to consider how private (re)insurance can be used effectively. The balance between risk retention (self-insurance) and risk transfer should be determined by the size of potential catastrophic shocks in the context of budget flexibility and borrowing capacity. For potential large losses beyond the capacity of contingency and flexibility within the budget, and where borrowing is not a practical or desired option for the government, then risk transfer to the commercial markets can be a highly useful option. Case studies reveal a wide variety of roles for the private (re)insurance sector within public asset insurance schemes, including; the use of international reinsurance capacity for self-insurance vehicles; framework agreements with domestic insurers to facilitate access to insurance for smaller-scale public entities; use of the domestic insurance market for large portfolios of exposure for specific central government departments. LESSONS LEARNED Risk transfer to the commercial markets is helping governments manage the volatility of the cost of disasters, and avoid budget disruption from large shocks Commercial insurance and reinsurance are valuable tools for large shocks beyond the financial response capacity of governments. However, governments should consider where self-insurance may be feasible— for example, for smaller shocks—alongside commercial risk transfer to ensure a cost-effective strategy. The use of commercial (re)insurance has increased transparency and data standards for public asset insurance schemes The minimum standards in data collection required by commercial (re)insurers can produce multiple indirect benefits in insurance vehicles for public assets, including for self-insurance vehicles. These benefits included: reduced uncertainty in pricing; improvements in insurance products; identification of additional risk reduction opportunities; improved catastrophe exposure management within vehicles; and increased trust from the end-users of the schemes. The use of commercial (re)insurance can help develop the domestic market Insurance schemes for public assets have demonstrated an ability to develop the domestic insurance market, both in terms of its capacity to absorb public asset risk, but also in its competitiveness with respect to covering such risk. Governments should be aware of, and prepared for, pricing volatility when using commercial (re) insurance, particularly after a large disaster The volatility of commercial premiums was a recurring issue across case studies, particularly after the occurrence of large catastrophe events where premiums often increased substantially. At the time of writing of this report, this issue was apparent through the hardening of reinsurance pricing as the international reinsurance markets responded to the impact of Coronavirus Disease 2019 (COVID-19). Lloyd’s of London has warned of potential US$200 billion in underwriting and investment losses that could negatively impact the global non-life markets in 2020, with a number of large international catastrophe risk carriers already reporting substantial COVID-19 losses through pandemic underwriting on business interruption, trade credit and event cancellation. 10 Catastrophe Insurance Programs for Public Assets - Operational Framework Operation 6. Define the extent and nature of insurance coverage Governments need to define the types of loss, and the types of asset that they want to bring within scope for coverage within an insurance scheme for public assets. Some schemes opt for a broad spectrum of asset inclusion, while others carve out very specific liability to keep premiums low. Building damage, contents damage, and service interruption, were typically all within the scope of cover. It was noted in multiple cases that the costs of service interruption, although harder to quantify, had the potential to dwarf the costs of restoring physical assets.3 In some cases, the scope of assets brought within a scheme was driven by disaster resilience objectives, with a broad inclusion covering even low-income housing. In others, governments prioritized specific assets for cover, to minimize costs. In one example, modelling was undertaken to identify those assets most critical to service continuity in the event of a disaster, and these were prioritized for insurance purchase. Another approach was to carve out those assets where pricing would be less favorable on the commercial markets (specialist infrastructure, and social housing as two examples), and then to exclude these from programs to improve overall cost outcomes. The case studies showed that schemes can also facilitate resilient reconstruction by using coverage terms to promote risk reduction investments. LESSONS LEARNED Governments need to set scope for cover within their public asset insurance schemes, balancing disaster resilience objectives and financial efficiency The scope of insurance schemes varies across case studies, from inclusive coverage of a broad range of public assets and even low-income households, to schemes that only cover a specific type of hard-to- insure asset such as underground water and flood control infrastructure. Post-event loss adjustment and claims settlement processes can be designed to enable the public sector to ‘build-back-better’ Although the cost of betterment in reconstruction was not covered by commercial (re)insurers, in multiple case studies, the post-event process of assessing and settling a (re)insurance claim allowed assets to be ‘built-back- better’ with the additional costs of betterment being funded from outside of the commercial contract. Coverage terms can be set to minimize underinsurance and promote risk reduction The strategies being used by schemes to set effective terms of cover include: the use of deductibles4 to promote risk averse behavior; ensuring that coverage limits for assets properly account for replacement costs and additional site management costs (e.g. demolition, securing of unstable sites); and the inclusion of multiple reinstatement provisions5 to ensure that cover is in place for sequences of events. Risk-based pricing model offers advantages Most schemes use risk-based pricing for participating entities. Risk-based pricing can incentivize risk reduction and reduce the risk of adverse selection.6 Other schemes link the cost of cover to the financial capacity of the insured entity, rather than its underlying risk, creating implicit premium subsidies. In these cases, alternative methods to encourage risk reduction can be applied in parallel, such as technical capacity building, and the use of program surpluses to undertake targeted investments to reduce risk. A range of methods can be used to ensure price adequacy for insurance schemes for public assets; Among the methodologies applied to set pricing in insurance schemes, probabilistic modelling provides the most sophisticated approach. However, these models are not available for all perils and territories, and in cases, the uncertainty in model results can be very high. Therefore, a complementary approach was almost always required. Public sector actuarial functions played an important role in a number of schemes, working with claims’ histories or other data to develop a view of risk. Pricing methods also included the use of industry benchmarking for likely claims experience; and the use of specialized engineering expertise. 3 For example, the Queensland government identified the cost of relocating hospital services to another building in the event of damage as their largest potential loss arising from a single physical asset. 4 The level of loss at which a contract begins to pay. 5 A reinstatement provision automatically reinstates cover after an event leads to a claim, typically with the payment of a pre-agreed reinstatement premium. 6 The risk of adverse selection is a risk that only the entities more likely to make a claim choose to participate in an insurance scheme, leading to sustainability issues 11 Catastrophe Insurance Programs for Public Assets - Operational Framework Operation 7. Develop a post-event process Claims management processes need to allow governments to rebuild their assets, and particularly, critical infrastructure, quickly after a disaster occurs. Standard practices for claims management in the commercial (re)insurance markets are not always suitable for public sector entities, given the specific procurement processes that may apply in the public sector, government policy on ‘building-back-better’, and the high importance of restoring critical infrastructure as soon as possible after the event. LESSONS LEARNED A variety of strategies can be considered to facilitate the post-event claims management process for public assets These include: • Incorporating pre-existing public sector loss assessment processes into insurance contracts; • Developing the claims management function within the government; • Sharing loss adjustment resources between the public and private sector; • Establishing long term partnerships with loss adjustment service providers; • Use of technology to facilitate rapid settlement. 12 Catastrophe Insurance Programs for Public Assets - Operational Framework Operation 8. Undertake stakeholder and market engagement Whatever the approach, stakeholder and market engagement will be a critical part of design and implementation of catastrophe insurance programs for public assets. Early and effective integration of the right stakeholders into the development process for an insurance scheme can substantially improve outcomes. The case studies also provided useful guidance on how governments can apply strategies in their interactions with the commercial markets to improve the price and coverage outcomes when placing risk. LESSONS LEARNED A variety of strategies were being used within the case studies, to improve the price and capacity outcomes of an approach to the commercial insurance and reinsurance markets These include: • Structuring the risk (i.e. separating into frequency layers, splitting capacity between competing brokers, separating certain types of asset) to increase the number of bidding (re)insurers; • Engaging early with the market before the competitive tender, to present the risk; • Crafting a bidding process for (re)insurers that promotes structured competition and transparency; • Properly leveraging and understanding the role of the broker, including financial relationships between brokers and (re)insurers; • Ensuring that selection criteria for (re)insurers take into account the quality of the cover (and thus the (re)insurer supplying cover) and not solely the price. Fully integrate end-user public agencies into the process of designing a scheme, and connect with the insurance regulator and domestic insurance market early in the design process—even where they will not have a formal role in the scheme • The common lessons learned raised from multiple case studies were to engage earlier with interested stakeholders, to properly bring end-users into the design process, and to present the concept for the scheme early on to stakeholders with an indirect interest. 13 Catastrophe Insurance Programs for Public Assets - Operational Framework Introduction APEC (Asia-Pacific Economic Cooperation) Effective financial protection strategies for public economies are situated along the Pacific Ring of Fire, assets can help reduce disaster-related contingent exposed to a wide range of natural disaster hazards liabilities linked to infrastructure and other assets. including earthquakes, tsunamis, tropical cyclones Well defined cost-sharing rules for rebuilding public and floods, wildfire, and volcanic eruptions. Risk is assets between the public and private sector help expected to rise with increasing disaster exposure to smooth volatility for the fiscal budget, freeing up and vulnerability linked to climate change. This limited fiscal resources for the most urgently needed will bring further widespread social and economic recovery activities. By clarifying the scope of costs costs in these economies, impacting the daily that will be covered at different levels of government, lives of the population, the health of the economy, it is possible to encourage the uptake of private and bringing disruption to the implementation insurance and promote risk reduction activities. of key development programs. Strengthening disaster resilience is critical for protecting exposed To realize disaster risk management objectives of populations and their livelihoods, protecting macro- minimizing such impacts, a comprehensive policy fiscal stability, and securing progress towards the package is required, which covers the key strands of Sustainable Development Goals. “Prevention, Preparedness and Response”. It is only through the application of a comprehensive approach Disasters create substantial fiscal risks when addressing all three actions that both physical resilience governments bear the burden of costs of emergency and financial resilience can be achieved. In the context relief, recovery and reconstruction efforts. Ministries of financial management of public assets, this means of Finance (MoF) have a leading role in coordinating development of quality, resilient infrastructure and post-disaster financing, where potential contingent buildings to prevent losses, as well as the development liabilities can occur outside the regular government of effective financial strategies including insurance, to budget, especially where insurance penetration is speed response and ensure preparedness. low, as is the case in many emerging economics. Disaster risk management of public assets also needs The cost of restoring damaged public assets owned to account for emerging risks such as the ongoing by government entities, and the associated cost coronavirus pandemic, which has the potential to arising from service interruption as a result of that create a significant compound risk event should a damage, is a significant source of contingent liability natural disaster occur during its ongoing impact. for governments. With increasing investment in Pandemic could be a prolonged, multi-faceted infrastructure in many economies, this contingent global shock, creating large fiscal, economic, and liability is growing. This is especially true for the social impacts in economies worldwide. It has put APEC region where infrastructure investments in increasing strains on governments’ fiscal capacity and member economies have been growing rapidly; as exacerbated debt distress in many middle- and low- highlighted by programs such as the “Build, Build, income economies. For those economies also exposed Build” campaign launched in 2016 by the Philippines, to natural disaster risks, this leaves them in a place of setting out US$158 billion of investments in airports, exceptional vulnerability, and efforts to strengthen rail and urban transport, and power plants. The financial resilience to disasters are more urgent than 2019 World Bank report on resilient infrastructure ever. Early financing for infrastructure resilience estimates direct disaster damages to power and is essential to ensure quick restoration of critical transport infrastructure at US$18 billion a year in services after disasters and climate shocks, allowing low- and middle-income economies. Enhancing the economies to financially prepare for compounding financial resilience of infrastructure is fundamental shocks when resources are more stretched, and to mitigating disaster impacts. Rapid reinstatement households and firms are more vulnerable. This is both of critical infrastructure can protect continuity of critical for protecting businesses and households in livelihoods, and provision of public services. the short term as they battle the immediate impacts 14 Catastrophe Insurance Programs for Public Assets - Operational Framework from the pandemic, and also important for long-term management system. Such programs require a high socioeconomic recovery. level of effort to design and implement, and must take into consideration the wider macroeconomic Many Ministries of Finance in APEC economies are framework, economy-specific legal and institutional using a range of instruments to boost their financial arrangements, and the capacity and appetite of the management of public assets in the face of disaster local insurance market, among many other factors. It risks. These include a range of ex-ante tools such is as a result of this, that the APEC Working Group on as reserves provisioned within the budget, disaster DRFI Solutions requested that the World Bank provide response funds, contingent loans, and risk transfer practical guidance on the design and implementation instruments such as insurance. While more frequent, of insurance schemes for public assets. less severe disasters can be addressed by retaining risk through reserve-type mechanisms, a number This report builds on previous work focused on of governments opt to transfer risks of large-scale, public asset financial protection in the APEC region. catastrophic events to the international markets It extends work presented in the APEC reports through pre-arranged insurance and reinsurance. The on “Financial Risk Management of Public Assets combination of these instruments, each applied to the against Natural Disasters in APEC Economies” and layers of risk at which they are most effective (World “Improving Public Assets and Insurance Data for Bank, 2014),7 can produce an optimized overall system Disaster Risk Financing and Insurance Solutions,” for managing the costs of disasters. prepared by the World Bank for 2017 APEC Finance Ministers’ Meeting. There has been great progress in the APEC community to develop disaster risk financing strategies and This report aims to synthesize peer-to-peer solutions that aim to manage governments’ financial learning among APEC economies into a format exposure to disasters through risk transfer and risk that provides useful, practical guidance to finance sharing mechanisms. Indonesia developed a national officials in APEC economies but can be a foundation disaster risk financing and insurance strategy in 2018 to be applied to other economies on undertaking and is currently in the process of developing an the design and implementation of catastrophe insurance scheme for public assets. The Philippines risk insurance programs for public assets. This became the first economy to transfer a portfolio report takes a broad definition of catastrophe risk of subnational risks onto the international financial insurance programs for public assets, considering markets by launching a parametric insurance any structure designed to transfer or pool the program in 2017 that provided coverage to national disaster risks arising from physical assets owned government assets and to 25 provinces against and managed by central or local governments or losses from major typhoons and earthquakes, with state-owned enterprises. This is done deliberately, the World Bank as intermediary. Four Pacific Alliance as we find that government arrangements that economies—Chile, Colombia, Mexico, and Peru— may appear very different in composition are often placed a joint catastrophe bond issued by the World fulfilling a common function. The report considers Bank for total earthquake coverage of US$1.36 billion all aspects of design and implementation, from legal in 2018. and institutional aspects, to instrument structuring, to scope of participation and covered risk, to Insurance for public assets is only one component stakeholder engagement. of a comprehensive and layered disaster risk 7 See the World Bank’s operational framework on disaster risk financing for further detail (World Bank, 2014). http://documents.worldbank.org/curated/ en/523011468129274796/Financial-protection-against-natural-disasters-from-products-to-comprehensive-strategies-an-operational-framework-for-disaster- risk-financing-and-insurance 15 Catastrophe Insurance Programs for Public Assets - Operational Framework Scope and Methodology The scope of this work is to provide an operational This report is aimed at finance officials in middle framework for the design and implementation of income economies responsible for fiscal policy and insurance schemes for public assets against disaster financial management of public assets. Given the risk, based on experience from APEC economies and audience and purpose of this report, the lessons beyond. learned are presented through a public sector lens in the spirit of a peer-to-peer learning exercise. This A selection of case studies forms the principal basis report does not review best practice in product of content, although lessons learned from other offerings from the commercial markets; such a contexts and best practice frameworks relevant review is outside our scope. In addition to the target to the field have also been drawn upon. Research audience, the proposed framework aims to provide a has relied upon interviews with stakeholders from foundation for knowledge products and guidelines for the principal case studies, supplemented with other economies, including low-income economies, publicly available information in reports. The authors through the lessons learned. For those uses—both in acknowledge that the selected case studies do not particular and in general—recommendations will need represent the complete range of approaches globally to be tailored to address specific economy context. to the insurance of public assets against disaster risks. However, the selected examples represent a diverse The case studies used as the principal source of range of approaches with applicable lessons learned. content are established schemes from among APEC The proceedings of the 2018 APEC Workshop on economies and beyond as shown in table 1 and further Financial Management of Public Assets against detailed in the annexes. As discussed above, a broad Disaster Risks (June 21–22, 2018, in Tokyo) have also definition of catastrophe risk insurance program for been used to develop the content presented herein. public assets is taken. The case studies cover a range As shown in the Acknowledgements section, the of types of coverage, although the focus is primarily authors are extremely grateful for the contributions costs arising from damage to physical assets, of the many participating contributors, but note again where useful lessons can be drawn, case studies are here that any errors or omissions in the text are the expanded beyond this. authors’ own, and this document does not represent the views of any institutions referenced herein. 16 Catastrophe Insurance Programs for Public Assets - Operational Framework TABLE 2. CASE STUDIES USED AS THE PRINCIPAL SOURCE OF CONTENT Australia The Queensland Government Insurance Fund A state-level insurance “captive” managed as an internal program, providing standardized insurance cover for public assets. (See Annex 1) The Disaster Recovery Funding National-level policy that formalizes terms of financial Arrangements, formerly the National Disaster assistance from the Commonwealth to sub-national entities Relief and Recovery Arrangements in the event of a disaster. Japan Insurance arrangements for the Shinkansen The use of commercial insurance for a specific layer of risk rail infrastructure for this extensive nationwide high-speed rail infrastructure. (See Annex 2) Mexico The Mexican national fund for natural A long-established national financial program, including disasters (FONDEN) a trust vehicle, that formalizes cost sharing arrangements for disasters, consolidates disaster-related liabilities, and through which reserves and risk transfer arrangements to cover such liabilities are arranged.8 (See Annex 3) Additional State and Federal Department Commercial insurance programs for public assets for arrangements for insurance of public assets federal departments and state governments. against disasters New The New Zealand Local Authority Protection A mutual insurance arrangement for specialist infrastructure Zealand Program (LAPP) of local authorities in New Zealand. (See Annex 4) The New Zealand Local Government A public insurer previously offering property catastrophe Insurance Corporation Limited (Civic risk coverage to local authorities, but which has ceased Assurance) to offer catastrophe-related cover due to circumstances arising from the Christchurch earthquakes. The New Zealand District Health Boards’ A collective insurance program established to improve insurance program efficiencies in procuring insurance for district health boards, which has been discontinued. Other approaches to insurance of public Lessons drawn from general practice on the insurance of assets in New Zealand public assets. Colombia The insurance of transport infrastructure A government initiative to improve standards of insurance managed as public-private partnerships for concessions. (See Annex 5) United The Insurance Services II Framework A nationwide procurement framework for public sector Kingdom entities in the UK that standardizes and facilitates access to (UK) commercial insurance. (See Annex 6) The National Health Service (NHS)-Resolution The self-insurance program of the national health service. insurance scheme The Risk Protection Arrangement (RPA) self- An internal program of the UK Department for Education to insurance scheme for Academy Trust schools9 self-insure schools. (See Annex 7) Other general arrangements for insurance Lessons drawn from general practice on the insurance of of public assets including the experience of public assets. individual Local Authorities 8 Disaster risk reduction investments are also within the remit of the overall program. 9 And extended in 2020 to Local Authority managed schools. 17 Catastrophe Insurance Programs for Public Assets - Operational Framework Preconditions and Limitations The establishment of catastrophe insurance programs for public assets is a highly complex process, and requires certain pre-conditions to be in place both in the public sector and the target insurance market (specifically where domestic risk carriers will be part of the scheme). The conditions revealed by the case studies include the following: • Clear ownership of public assets and the on where to access external expertise through disaster-related contingent liability arising outsourcing, and where to keep expertise in- from these public assets at the various levels house, will be highly context specific. Factors of government and by any related non- such as pre-existing public institutions carrying governmental stakeholders is the first step out relevant functions, the condition of the local towards understanding the potential scope of market to access specific expertise, and internal any insurance scheme and the types of assets decisions on headcount will determine what is to be covered. It is critical to clarify where appropriate in each case. accountability for disaster losses will sit through • Robust and transparent procurement formal, explicit, advance arrangements in order framework and practice in the public sector is to facilitate active financial management of key to most, although not all approaches. In all risk at all levels. For example, when central and cases where risk is shared between the public state governments clarify and limit their share of and private sector, the procurement of cover disaster risk, it encourages managers of public is a key step. For some of the case studies, assets to plan for the residual portion. the government’s approach to improving the • Appropriate data systems for public assets are insurance coverage of public assets is focused required, including details such as the location on standardization of procurement. These efforts and characteristics of assets (age, function, require the existence of effective procurement asset type, size, etc.). The data structure across standards and practice in the first place, to serve participating government entities needs some as a foundation for this further work. level of consistency, or a centralized database • A developed domestic insurance market is required, to facilitate data sharing and with the necessary financial and technical management. Historical data on damage from capacity to underwrite property catastrophe natural disasters is also valuable, where available, risk, is required, although not for all types of to support quantification of risk. scheme. Many of the case studies integrate • Funding is required, either for the payment of the domestic insurance market into schemes, insurance premiums, or for allocation into any although, as the LAPP and FONDEN case studies funds used for retaining or pooling risk. demonstrate, this may not be desirable or • Alignment of financial interest between the feasible at the outset of scheme development, participating agencies and the operating entity depending on the capacity of the market and was a pre-requisite for a number of the case pricing (see Section 5-3). Where this does studies. The development and subsequent uptake occur, the domestic insurance market needs to of schemes requires investment of time, effort demonstrate the appropriate level of insurance and resource. Without the correct alignment literacy, specifically for property catastrophe of financial interest between participating and underwriting, with an understanding of the operating entities, these investments may not be assets and risks to be covered. Domestic carriers prioritized, and schemes are likely to fail. need to have both the willingness, and financial • Technical capacity and coordination of capacity, to underwrite such risks. Where this responsible agencies, such as finance ministries, capacity is not in place at the outset, it may be is required for the design and implementation developed over the course of the scheme such of any scheme to be successful. The decision that domestic insurers can be later integrated. 18 Catastrophe Insurance Programs for Public Assets - Operational Framework Catastrophe insurance programs for public assets are not without limitations. It is important for governments to take into account limitations and challenges when planning for public asset insurance schemes, and to acknowledge that insurance is not a silver bullet and must be used in concert with other financial and non- financial arrangements to improve disaster outcomes. • Insurance schemes take time and effort to • Pricing volatility often occurs in the market, establish, requiring strong political support and particularly as (re)insurers respond to the aftermath consistent political will for both implementation of large events. At the time of writing of this report and ongoing uptake and maintenance; in 2020, this issue was apparent through the • As insurance requires up-front payment of hardening of reinsurance pricing as the international premiums, which can be significant for economies reinsurance markets responded to the impact of with limited fiscal space, there are implications for the pandemic. Lloyd’s of London has warned of the fiscal budget and allocation of funds to other potential $200bn underwriting and investment resilience and development activities; losses impacting the global non-life markets • It is not cost-effective, or feasible, to cover in 2020, with a number of large international all risks arising from the disaster exposure of catastrophe risk carriers already reporting public assets through insurance. The risk of substantial COVID-19 losses through pandemic underinsurance is exacerbated where asset underwriting on business interruption, trade credit information is limited and the understanding of and event cancellation. Significant changes in asset exposure to disaster hazards is incomplete; premium pricing or market retrenchment may occur • Insurers and reinsurers may be reluctant to after a catastrophic event impacts international or underwrite risks if historical data on disaster domestic (re)insurance capacity. events and asset damage is insufficient, or if the • A high level of coordination and clearly defined assets in question are highly specialized; governance structure is crucial, as the successful • For parametric insurance that replies on pre- development and implementation of public defined physical hazard parameters and asset insurance programs require a high level of thresholds, it is possible that insurance payouts are coordination between finance ministries, disaster not triggered where damage and loss is incurred. risk management agencies, regulators, private This is due to the imperfect capture of event sector participants, modeling agencies, among experience through the modeling (basis risk); other stakeholders. 19 Catastrophe Insurance Programs for Public Assets - Operational Framework Operation 1. Assess the financial protection gap for natural disasters A strategy for insurance of public assets against lays the foundation for setting the scope of coverage disaster risk needs to be developed within an overall for any scheme, as discussed under Operation 6. comprehensive national strategy for financial protection By quantifying potential contingent liabilities, both against disasters, and the government’s broader implicit and explicit,10 the government can make a framework for financial management of public assets. decision on what type, and magnitude, of contingent liability it wants to bring within any scheme. As the The first step is the decision to proceed and invest the following sections demonstrate, this is an iterative time and resources required to formalize any scheme process, combining an assessment of feasibility, an for the financial protection of public assets. Whether understanding of potential losses, and setting of the subsequent design decisions take the strategy priorities for coverage. in the direction of self-insurance or commercial insurance, the creation of a dedicated vehicle or no Next, a stock-taking of current insurance—or other program at all, the starting point is the same. Both financial protection—arrangements in place can an understanding of the risk, and building on this, an highlight the extent to which potential disaster costs understanding of the gaps in protection are required will not be covered by existing insurance or self- in order to set policy priorities in the development of insurance arrangements. a scheme for insurance of public assets. Best practices in catastrophe risk assessment, and To achieve an understanding of the risk, a quantitative public asset databases are covered by the APEC risk assessment will deliver an understanding of reports on “Financial Risk Management of Public the size of potential costs arising from disaster Assets against Natural Disasters in APEC Economies” damage to public assets, and thus the government’s and “Improving Public Assets and Insurance Data contingent liability in this area. Detail on the location for Disaster Risk Financing and Insurance Solutions,” and characteristics of assets is needed to produce prepared by the World Bank for 2017 APEC Finance this, as an input into the model of the catastrophe Ministers’ Meeting. This document considers such risk to which such assets are exposed. This activity areas out of scope to avoid duplication. 10 Governments are exposed to both explicit and implicit contingent liabilities in the aftermath of disasters. Explicit liabilities are those clearly laid out in advance, in policy commitments, laws, or contracts. Implicit liabilities are those arising from political or social pressure in the aftermath of a disaster event. 20 Catastrophe Insurance Programs for Public Assets - Operational Framework Operation 2. Create a legislative and policy framework to enable the use of insurance where effective Insurance is a long-term strategy for the financial method of financial management to the accountable protection of public assets, being most cost-effective managers, conferring only a statutory duty for when applied to events that occur infrequently but prudent financial management of public assets but no with high severity. A sound legislative basis for the requirement to use insurance to achieve this. Amongst insurance of public assets can support a long-term the case studies examined for this report, the approach approach even through changing administrations. of giving freedom in method of financial management However, legislation needs to be carefully crafted, was more prevalent in those economies with a stronger and accompanied by additional actions (see below), insurance culture, where insurance penetration was to ensure the following: relatively high across all sectors, public and private. It may be the case that insurance is less likely to be used • Coverage is purchased where needed; within this ‘freedom of financial management’ model in • Coverage is appropriate; and that economies where penetration is low and thus general • Coverage is not being purchased in situations familiarity with insurance is lower. where it is not adding value. International experience points to the following Some governments opt to mandate the purchase of five actions to create a favorable environment for insurance, while others elect to give freedom in the insurance of public assets; BOX 1. NEW ZEALAND, MEXICO AND THE UNITED KINGDOM—STIMULATING ACTIVE FINANCIAL MANAGEMENT OF RISK BY LIMITING SUPPORT The Government of New Zealand sets general principles regarding the limitations of its financial assistance to local authorities in the event of a disaster, in the National Civil Defense Emergency Management Plan, and then further defines these limitations with quantitative boundaries in accompanying guidance to local authorities. To encourage local governments to plan financially, central government reduced its post-disaster funding provision to cover 60 percent of damage but only for uninsurable assets. This led to the creation of the Local Authority Protection Program (LAPP), established to cover the share of liability that fell to Local Authorities for underground water and flood control infrastructure. Mexico uses a similar mechanism through its Natural Disaster Fund (FONDEN), which limits its financing to 50 percent of the recovery and reconstruction costs for the damaged infrastructure of states and municipalities. These local government entities are required to have insurance in place to manage the residual portion of costs, which has led to some states drawing from the best-practice applied at the federal level to place risk into the international markets using the tools and channels developed for FONDEN’s own catastrophe exposure management purposes. In the United Kingdom, funding through the Bellwin scheme administered at the central government level is made available for local authorities for response and recovery spending following emergencies such as extreme weather events. Support is limited to expenditures deemed “uninsurable” and a deductible is applied, such that emergency costs must exceed 0.2 percent of the relevant local authority annual budget before it qualifies for financial assistance. 21 Catastrophe Insurance Programs for Public Assets - Operational Framework 2-1. Internal stakeholder engagement 2-2. Clarify and limit what central government will cover To ensure the success and sustainability of a public asset insurance scheme, it is vital to integrate It is critical to clarify where accountability for disaster the target end-users (i.e. public sector entities losses will sit through formal, explicit, advance who will be policyholders or equivalent) into the arrangements in order to facilitate active financial design process from the outset. There needs to management of risk at all levels. When central and be agreement on the program objectives from state governments clarify and limit their share of the end-users, and the entity or entities leading disaster risk, it encourages managers of public assets the scheme development and providing oversight, to plan for the residual portion (see Box 1). Policies for before development work begins. Consistent financial assistance to departments, local government, feedback from across case studies, was that while it and other public sector entities are typically set was often difficult to secure time and commitment for certain types of asset (e.g. central government from the target end-users, where this process was will or will not cover road infrastructure under the not conducted properly, the end-users did not feel management of local authorities), and will constitute a sense of ownership of the resulting scheme and a percentage of costs above a certain threshold. this impacted participation rates. This explicit allocation of risk ownership is even more For some of the schemes reviewed, the lead agency important when responsibility for assets is shared developing the scheme undertook roadshows, between public and private actors. When private where they travelled to spend time with each of finance and/or private management of assets are the target public sector agencies for the scheme, an issue, the sharing of costs incurred by disasters as part of the consultation process. Strategies should be made explicit within the contract for the used to engage end-users included creation of infrastructure/concession in question. The allocation user working-groups, end-user engagement days of costs between public and private actors is a policy to present scheme design, customer insight days decision, and many different structures of ownership where brokers and insurers were invited to present and operational responsibilities mean that there to the end-users, and surveys. is no single right answer to setting this allocation. Some governments allocate 100 percent of the Other entities that need to be engaged in scheme responsibility for disaster costs to concessionaires or design, include the legal/compliance function within private construction firms for infrastructure, and then the relevant government entities, the audit function set contractual obligations for these private entities (internal, and potentially external, as relevant to to purchase insurance. Japan provides an example the economy-specific context), and the insurance of a sharing arrangement, where private finance regulator. Where the insurance regulator is at initiative (PFI) contracts for Sendai Airport mandate arms’ length from the scheme development, early insurance purchase from the private operator, but presentation of the scheme design is advisable the government assumes responsibility for any costs within the implementation timeline. The role of in excess of this cover (World Bank 2017). the regulator in the establishment of a scheme for public assets will vary significantly depending on Even where the cost of reconstruction is formally the specific institutional contexts in economies. assigned to the private sector party, the government There will be scenarios under which the insurance may still find itself ultimately responsible for costs in regulator is an integral part of the scheme design cases where assets have not been properly insured by and implementation. In cases where the insurance private operators, and there is a strong public interest regulator is not involved in implementation, and even to resume operations for certain infrastructure. where regulatory approvals are not needed, early engagement is prudent and often necessary when 2-3. Incentivize use of insurance establishing an insurance scheme. An opinion may be needed from the regulator that the establishment Even for those economies where the purchase of of a scheme does not adversely impact the fair insurance is explicitly mandated by law for public functioning of the domestic insurance market. assets, a strong legislative basis is not, on its own, 22 Catastrophe Insurance Programs for Public Assets - Operational Framework BOX 2. COLOMBIA—ENSURING MINIMUM STANDARDS FOR INSURANCE COVER OF INFRASTRUCTURE UNDER CONCESSION Colombia provides an example of how the government can act to ensure that liability for disaster losses falls properly to private sector partners. Following catastrophic flooding from the 2010-11 La Niña season, extensive damage to transport infrastructure resulted in a dispute between the Government of Colombia, and the concessionaires managing the infrastructure as to where the cost of restoring assets should be borne. Consequently, the Government has worked to avoid a repeat of this by using the concession contracts as a mechanism to enforce minimum standards of insurance protection for infrastructure managed by the private sector. The additions to the concession contract include: • Minimum requirements for insurers and reinsurers eligible to act as risk carriers for the infrastructure in question; • Minimum requirements for the terms and conditions for certain types of insurance; and • Minimum information requirements for the risks to be insured, which will also be provided to the reinsurance market. By stipulating a minimum standard for information required for underwriting, the Government of Colombia will ensure broad access to high quality risk carriers.for financial assistance. enough to ensure insurance uptake.11 Mechanisms to claim. If assets are uninsured following two claims incentivize insurance purchase can be effective in to FONDEN, they become ineligible for support.12 increasing insurance penetration and compliance with (World Bank 2012). mandatory purchase. Case studies show the following to be effective: 2-3-2. Compulsion by the Ministry of Finance or other entity with financial 2-3-1. Conditional access to other financing oversight of participating entities Conditional access to other financing such as disaster One way to ensure insurance uptake is to structure an relief funds and contingency budget can incentivize insurance scheme that is administered and overseen insurance purchase. In Australia, section 4.5 of the by the entity that has oversight of budgets and Natural Disaster Relief and Recovery Determination emergency funding in the event of a disaster. For required States to have "adequate capital or access example, the Queensland Government Insurance to capital to fund liabilities or infrastructure losses, Fund (QGIF) is situated within Queensland Treasury. and to proactively explore a range of insurance Agencies all have a specific line entry in their options in the market place and assess available budgets to pay for QGIF insurance premiums, and options on a cost-benefit basis" in order to access since participation is compulsory, the scheme has central funding from the Natural Disaster Relief and a 100 percent compliance rate for eligible assets. Recovery Arrangements (now the Disaster Recovery The UK Department for Education’s Risk Protection Funding Arrangements). Arrangement (RPA) scheme is a contrasting example, where the scheme is run by the Ministry financially In Mexico, FONDEN rules limit repeat eligibility for responsible for eligible Academy Trust schools, FONDEN resources, such that coverage drops from but is not compulsory. The voluntary nature of the 100 percent to 50 percent of the reconstruction cost scheme is consistent with the Departmental policy to for eligible federal assets where the asset remains empower financial decision by responsible entities. uninsured following a prior disaster claim, and from The participation rate is about 60 percent of the total 50 percent to 25 percent for eligible State assets academies in the United Kingdom (UK). that remain uninsured following a prior disaster 11 This is best demonstrated by the widespread flood damage to uninsured public assets during the 2010-2011 la Niña season in Colombia, despite the longstanding legal requirement for managers of public assets to purchase insurance, and the existence of penalties for non-compliance. 12 2012. FONDEN : Mexico's natural disaster fund—a review (English). Washington DC : World Bank. http://documents.worldbank.org/curated/ en/408711468286527149/FONDEN-Mexicos-natural-disaster-fund-a-review 23 Catastrophe Insurance Programs for Public Assets - Operational Framework The decision to take a voluntary or compulsory of land registration processes in Turkey, mortgage approach will be context-specific, depending to a large qualification in the UK), and there are limitations to all part on the objectives of the scheme. Compulsion these mechanisms, the principle of a regular verification can ensure the sustainability and effectiveness of of purchase is valid across contexts. the scheme, by keeping participation rates high, and giving end-users a strong incentive to engage actively 2-3-4. Mandate identification and in scheme design and implementation. Conversely, a quantification of disaster risk within long- voluntary approach to scheme use protects freedom of term financial planning processes of public choice in financial management for managers of public sector entities assets—keeping the experience of risk and financial decision-making in the same place. There may also not When public sector entities have to explicitly account be political appetite for a compulsory approach. for potential costs arising from disasters in their core financial planning, the incentive to actively manage 2-3-3. Mechanisms that verify that risk is increased. When the potential cost of disasters purchase of insurance has taken place is visible, the cost of insurance is easier to justify. Whilst catastrophe risk modelling does provide Development of mechanisms to verify insurance options for presenting the potential cost of disasters purchase can increase uptake of insurance cover. In the over a short timeframe,13 the fact that disasters are case of Australia, eligibility to Commonwealth funds by their nature infrequent and severe means that it is (Disaster Recovery Funding Arrangements, or DRFA, easier to articulate the potential cost of disasters in formerly the National Disaster Relief and Recovery financial planning over a longer time horizon. Space Arrangements, or NDRRA) is verified by a compulsory, needs to be created within core financial planning independent review of the details of insurance for processes to properly account for, and manage, essential public assets. Experience in the residential disaster risk to public assets. In complement to these insurance market for catastrophe risk has long shown processes, development of a long-term disaster risk that verification mechanisms influence purchasing financing strategy can encourage officials to make behavior. Although the mechanisms in the residential policy decisions that maximize benefit in the long market are not applicable in this context (e.g. use run. (See box 3.) BOX 3. NEW ZEALAND—THE IMPACT OF PLANNING TIME HORIZONS The introduction of 10-year Long Term Plans for Local Authorities in New Zealand has created a financial planning format that lends itself better to the evaluation of insurance as a tool for financial disaster risk management, with Local Authority infrastructure strategies uniformly taking account of the risks of natural disasters. Conversely, an Auditor General review of the collective insurance program established for District Health Boards (DHBs) in New Zealand cites a misalignment of planning horizons as a key factor in the failure of the scheme. The pressure to demonstrate financial results in the short term reduced the incentive for DHBs to engage in the insurance program, which offered longer term cost reductions but required upfront additional investment from the DHBs. 13 For example, an average annual loss can show the average annual expected cost of disasters when spread over the long term. Probabilistic metrics can also be presented, that show the probability of different levels of severe events. 24 Catastrophe Insurance Programs for Public Assets - Operational Framework 2-4. Ensure ability to pay premiums parametric catastrophe insurance program.15 (Philippine Department of Finance 2017). Giving public sector entities the funds and necessary authorizations to pay for insurance premiums can The issue of funding horizon for premiums is also improve uptake of insurance. It is not unusual— important. Whilst (re)insurance programs are especially for economies with limited experience in the typically annual in nature, increasing options for use of insurance—that insurance premiums are excluded multi-year cover are emerging. These include multi- from eligible expenditures for government entities.14 year reinsurance and insurance contracts, and In such a case, legislation and/or policy may need to capital markets instruments for risk transfer (such be revised. The importance of dedicating and funding as catastrophe bonds) where multi-year cover is a budget lines for insurance premiums for responsible longstanding and widespread feature. In the early agencies was a recurring theme across case studies. As stages of scheme design and implementation, the noted earlier, these lines are funded automatically for political visibility and momentum behind schemes agencies eligible for QGIF. In the case of Mexico, the can facilitate the sourcing of funds for premiums. requirement to make budget provision for insurance However, once the initial momentum and of assets, and the introduction of insurance premiums political visibility transition into business-as-usual as permissible expenditures, are conferred by Decree operations, the policyholders/end-users will still (Ley de Adquisiciones Arrendamientos y Servicios del require a sustainable, consistent source of premium Sector Público). In the Philippines, a special provision funding to maintain the scheme. It is therefore was introduced to the Act relevant to the National important to consider, at the outset, how funding Disaster Risk Reduction and Management Fund to will be maintained to support schemes beyond the allow its use for payment of insurance premiums for a first year. 14 For example, as a special vehicle, FONDEN was not able to access risk transfer instruments prior to a change to its operational manual in 2004. This issue has also appeared for core government agencies in less developed economies. 15 https://www.dbm.gov.ph/wp-content/uploads/Issuances/2017/Joint%20Memorandum%20Circular/JOINT%20MEMORANDUM%20CIRCULAR%20NO.%20 2017-1%20DATED%20JUNE%2030,%202017.pdf 25 Catastrophe Insurance Programs for Public Assets - Operational Framework Operation 3. Determine the extent of centralization for the insurance approach Many factors need to be considered to ensure that Some economies have opted to create comprehensive scale and extent of centralization of an insurance centralized programs with considerable structure, approach is appropriate for the risk-profile and public allowing for oversight and consolidation of management assets in question, and for the existing related systems of disaster risk for public assets. Other economies and institutions. Economies are applying diverse sets have opted for less intervention, with more freedom in of structures for the insurance of public assets (see financial management given to individual entities. The figure 2). broader policy environment will guide this decision. FIGURE 2. SIMPLIFIED DIAGRAMS OF STRATEGIES FOR INSURANCE OF PUBLIC ASSETS APPLIED BY GOVERNMENTS ACROSS SELECTED CASE STUDIES, TO ILLUSTRATE DIVERSITY Approach A. Use of a self-insurance strategy with a purchasing framework for smaller entities unable to self-insure effectively (e.g. UK) Increasing Framework agreement with Self-insurance program losses commercial market Central government departments Smaller scale public entitites Approach B. Use of a self-insurance program to access international reinsurance capacity (e.g. Queensland Government Insurance Fund) Conditional access to central government funds Increasing Commercial reinsurance losses Self-insurance program Approach C. Prevailing use of commercial insurance on individual entity basis, with a mutual public insurer for selected hard-to-insure assets (e.g. New Zealand) Commercial market approach by Commercial reinsurance individual agencies Increasing losses Mutual insurance pool Retention Selected hard-to-insure assets 26 Catastrophe Insurance Programs for Public Assets - Operational Framework Mexico provides an example of a highly centralized and provides a contrasting example of a decentralized structured approach, with the creation of a federal-level approach, where public sector agencies at both entity (FONDEN) through which exposure from both the central and local level tend to make individual federal and state level public sector entities is covered,16 approaches to the commercial markets.17 Options for and through which an approach to the international insurance structure with advantages and disadvantages capital and reinsurance markets is made. New Zealand of each approach are summarized in Table 3. TABLE 3. CENTRALIZED, PARTIALLY CENTRALIZED, AND DECENTRALIZED INSURANCE APPROACHES APPROACH ADVANTAGES DISADVANTAGES PRECONDITIONS Centralized: • Consolidated purchasing • High administrative and • Strong alignment of financial centralized power and conduit to operational cost burden interest between participating insurance international market capacity and operating levels of • Risk of disconnecting vehicle or government, to invest time/ • Management of pricing insurance decision-making program effort/resource in scheme volatility from experience of risk Risk is • Appropriate data systems for • Financial efficiencies from risk • Removal of choice in financial aggregated into public assets, with potential pooling/better managed risk decision-making from direct a program or for consistency across retention managers of assets vehicle, such as participating entities the Queensland • Quality control for insurance • Technical capacity within lead Government coverage standards agency to undertake process Insurance Fund • Visibility over multiple (the State Level) classes of risk allowing and Mexico’s comprehensive risk FONDEN (the management Federal Level) Partially • Facilitates access to • Relatively high level of effort • Relatively developed domestic Centralized: commercial insurance to implement insurance market with framework required financial/technical • Standardizes insurance • Reduction of choice of agreement with capacity to underwrite purchase process, increasing suppliers the insurance property catastrophe risk chance of successful market • Application of minimum placement • Robust and transparent standards in insurance terms An insurance approach to procurement • Promotes competition on price and pricing that may not be procurement within public sector possible in certain market framework of • Provides robustness in contexts • Technical capacity within contracts that overall terms of engagement government to manage the facilitates and between insurers and public • No additional financial procurement framework once standardizes sector (but not necessarily in efficiencies of risk pooling/ developed access to the terms of coverage itself) better managed risk retention commercial • Appropriate data systems for • Protects freedom of choice markets for public assets in financial management for public agencies. managers of public assets Decentralized: • Protects freedom of choice • Variability in price and • Relatively developed individual in financial management for coverage quality outcomes, domestic insurance market agency managers of public assets— with particular risk for small with required financial/ approaches keeping experience of risk scale public entities with technical capacity and and financial decision-making limited purchasing power appetite to underwrite in the same place property catastrophe risk • Increased risk of unsuccessful • Has no administrative or placements • Strong technical capacity operational burden for at all levels of government • No additional financial government (central to local) for effective efficiencies from risk pooling/ risk management and robust • Protects free market better managed risk retention procurement competition between suppliers • Appropriate data systems for public assets 16 FONDEN covers 100 percent of reconstruction of federal and 50 percent of reconstruction of state assets, with some exclusions. 17 The Local Authority Protection Program (LAPP) is one such exception, and a risk-pooling vehicle (Civic Assurance) for general local authority assets did exist at one point. There have also been additional limited attempts to pool risks for certain sectors (such as the District Health Boards). 27 Catastrophe Insurance Programs for Public Assets - Operational Framework 3-1. Centralized approach; risk into an insurance vehicle or program. Examples aggregation of risk into an include self-insurance captive programs (QGIF), national Natural Disaster Funds as public trusts insurance vehicle or program (FONDEN), mutual insurance funds (the LAPP trust) Some economies opt to create a program or vehicle and self-insurance pools for specific assets (the through which the liabilities arising from public UK RPA for schools) amongst many others. These asset exposure to disaster risk can be pooled and benefits should be weighed against the increased managed. For example, disaster funds or self- administrative and operational cost burden of taking insurance programs that underwrite losses. There such an approach (see Box 4 for the rationale for a are many benefits to a centralized aggregation of centralized aggregation of risk) BOX 4. BENEFITS OF A CENTRALIZED AGGREGATION OF RISK 1. Consolidated purchasing power Aggregating risk into a vehicle or program increases scale, and thus demand for the risk. This produces more favorable pricing, and broader risk carrier options. For example, in the last renewal season (as of June 2018), around 30 risk carriers participated in Mexico’s FONDEN reinsurance program, and in prior years, demand was so strong that FONDEN was able to further tighten its requirements on the financial strength ratings of reinsurers. Conversely, in other economies, some local government authorities have reported challenges in generating strong demand from insurers due to their smaller portfolios. In order to overcome this, some governments have created mutual vehicles such as Civic Assurance, the LAPP in New Zealand and a Local Government Mutual under development in the UK. 2. Reduce volatility in premiums for agencies A number of self-insurance schemes use their structure to protect entities from volatility in (re)insurance premiums. For example, the LAPP in New Zealand adds an additional component into its insurance pricing to allow for the accumulation of a fund. The fund aims to reduce reliance on reinsurance to mitigate the impact of volatility of reinsurance costs from market cycles. QGIF in Australia has protected its participating entities from excessive upwards or downwards pressure on pricing, by smoothing this volatility over time. The issue of significant changes in commercial pricing was frequently reported as a challenge in case studies, notably after significant catastrophes. The Auditor General’s Office in New Zealand reported significant insurance premium increases for the public sector in the aftermath of the Christchurch earthquakes in 2011. About 40 percent of surveyed insurance policies showed an increase of more than 20 percent in premium between 2011 and 2012, and about 14 percent of insurance policies had premiums that more than doubled during that period. 3. Conduit to international market capacity New Zealand’s LAPP, and Mexico’s FONDEN provide examples of how self-insurance vehicles can access the international reinsurance market. In 1993, commercial insurance cover for underground water infrastructure was not readily available in New Zealand for local authorities. Thus, the LAPP was developed to overcome this gap, as a mutual insurance fund that was able to connect hard-to-insure underground water and flood control infrastructure with international reinsurance capacity. 4. Comprehensive risk management across multiple agencies Aggregating risk into a single program can provide an opportunity for comprehensive management of risk across multiple agencies and types of asset. For example, QGIF in Australia oversees exposure and claims data pertaining to all its eligible agencies, and supports capacity building at the agency level by providing regular reports on claims and trends to QGIF participants. This high level of oversight of claims data allowed QGIF, working with the Department for Education, to identify that shade sails used on Queensland schools were highly vulnerable to storm damage. As both the ultimate owner of the assets, and the insurer, the Queensland government had the information, the means, and the incentive to then take action to replace the shade sails with less vulnerable options. 28 Catastrophe Insurance Programs for Public Assets - Operational Framework BOX 4. BENEFITS OF A CENTRALIZED AGGREGATION OF RISK continued 5. Opportunities to better manage retention Retention of risk can be the most cost-effective option where there is financial capacity to absorb the potential losses, and particularly for the lowest ‘frequency’ layers of risk which experience frequent smaller disaster losses (Box Note 1). Aggregating risk into a centralized structure allows more efficient determination of retention levels, and the benefit of risk pooling across entities—specifically, allowing more efficient use of budget capacity to cover individual large losses. As a mutual instrument, the fund component of New Zealand’s LAPP provides an opportunity to efficiently retain risk for local authorities. FONDEN provides perhaps the best example of informed and well-structured retention of risk. The FONDEN Trust aggregates risks from across departments and states, and then determines its retention capacity based on: its accrued funds and legislated annual contribution, individual property catastrophe insurance covers in place for specific departments, and using analysis from the R-FONDEN catastrophe risk model (see section Operation 5) to determine potential claims. BOX FIGURE 4-1. THE FEDERAL RISK FINANCING STRATEGY OF THE GOVERNMENT OF MEXICO Loss Levels Residual Risk (>US100 Mdd aprox) Cat Bonds (US 210 Mdd FONDEN 2017 + US 260 PAlliance) XL Reinsurance Program (US 225 Mdd) FONDEN US 700 Mdd Hydraulic Low income Roads and bridges Sectors underliying infrastructure houses (no insurance) Policies (if applied) Schools (no insurance) Hospitals US 100 Mdd US 120 Mdd US 30 Mdd US 10 Mdd Emergency and Reconstruction Source: Salvador Pérez Maldonado As another example, one Local Authority in the UK exposed to flood risk uses a mutual contingent credit pool to efficiently manage risk that cannot be transferred to the commercial markets. The responsible managers for the assets pay annual fees into a collective fund, which covers the residual higher frequency, low severity risk that commercial insurers in the UK will not cover (e.g. losses below the commercial deductible for the commercial policy covering the portfolio of exposures). When significant asset damage occurs, funds are available from the collective pool on a loan basis, to be later repaid by the borrowing entity over a two-year period (Box Note 2). 6. Quality control One rationale for the establishment of QGIF in Australia was the application of consistent insurance coverage terms across all eligible agency assets. Where exposed assets are brought within an insurance vehicle or program, it is easier to apply minimum policy standards, to ensure that: pricing is fair and signals risk (Box note 3); coverage limits and deductibles are appropriate; and that policy exclusions are consistent with the risk management objectives of the Government. Where there is no central oversight of insurance purchase, and where public agencies have limited experience of insurance, issues have been raised across case studies regarding poor quality of insurance cover. Notes: This is due to the way that technical premiums are calculated. For more information, see the Operational Framework for Disaster 1.  Risk Financing and Insurance, (World Bank, 2014). 2: The local authority in question is Sheffield City Council, a part of the United Kingdom that has high flood exposure. 3: That is, higher pricing indicates higher risk exposure. 29 Catastrophe Insurance Programs for Public Assets - Operational Framework One issue faced by centralized schemes for the • How do the lost benefits from low participation insurance of public assets, is how to maintain rates in a scheme weigh against the effects the connection between financial decisions, of empowering financial decision-making on accountability for outcomes and physical risk insurance purchase by managers of public assets? management. All of the structured, centralized • What mechanisms could be established to keep schemes examined for this report were managing the managers of public assets connected to data the challenge of having removed elements of on claims experiences, and able to feedback financial decision-making from the manager directly productively into the insurance product design, accountable for the asset. The importance of even where they are not themselves evaluating connection between the manager of the asset, and and selecting insurance? For example, QGIF the insurance decision-making process is twofold: provides regular claims experience reports to its participating agencies. 1. Where managers accountable for assets are integrated into the insurance process, it can help 3-2. Partially centralized approach: ensure that claims and exposure data produced Framework agreement with the as part of that process are being used to inform risk management; and insurance market 2. The consequences of outstanding, or poor, risk A framework agreement with the insurance market management practices appear in insurance can be used to facilitate purchase of insurance, pricing—thus a financial incentive for improving ensure competition on price, and to some extent, risk management practices is created when to introduce minimum contract standards that decision-making on insurance and risk reduction appropriately represent the interest of public sector activities is appropriately aligned. entities. Framework agreements do not offer the opportunities for comprehensive oversight and When determining how much autonomy to give to management, and financial efficiencies of risk public sector entities in respect of participating in pooling, which a centralized aggregation of risk an insurance scheme for public assets, governments offers. However, they give more responsibility and should ask the following: freedom in choice to the managers of assets, and can provide particular value to smaller scale public BOX 5. A FRAMEWORK AGREEMENT APPROACH IN THE UK The UK’s Insurance Services II (ISII) Framework provides value to smaller public sector entities that don’t have the capacity to self-insure, the scale to individually create strong market demand, or the appetite to develop collective insurance vehicles—for example, universities, fire services and certain local authorities. As its use is optional, and as it provides a range of options on insurance cover, it protects the freedom of public sector entities to choose how they manage risk. The ISII framework provides some level of guidance of public sector entities throughout the process of insurance purchase. Although the terms and conditions and pricing of the insurance contracts vary by supplier, there is protection to public sector agency framework users in the quality of suppliers. The framework includes 12 brokers, and 27 insurers which have been pre-qualified for ISII based on a series of criteria including past performance and financial strength. An overarching contract defines the relationship between the authorized brokers and insurers, and the central public sector procurement agency (CCS), and individual insurance contracts are developed underneath this overarching umbrella agreement. This overarching agreement provides some assurance of quality and robustness in the terms under which business is conducted between the market and framework users. Framework users also benefit from capacity building and templates on: how to engage the market prior to placement; data collection; portfolio presentation; and how to remain compliant within legislative boundaries. 30 Catastrophe Insurance Programs for Public Assets - Operational Framework entities that don’t have the capacity to self-insure As well as consolidated purchasing power, central effectively, or the scale to create strong market government entities can make use of the geographic demand for their risk. diversification across their portfolios to keep insurance costs low. The Ministry of Education in New Zealand 3-3. Decentralized approach: is one such case, where the department insures for Individual agency/entity approaches less than the total replacement value of its assets as the geographic spread of buildings means a probable In economies with ready access to commercial maximum loss will not impact 100 percent of the insurance and reinsurance, and a policy for portfolio19 (New Zealand Auditor General 2013). The empowering financial decision-making by individual Government of Mexico complements cover through managers of public assets, there may be less impetus its central fund for natural disasters (FONDEN) with to create vehicles or frameworks for the insurance individual commercial property insurance programs of public assets. Central government departments for education assets, hydraulic infrastructure are themselves natural aggregators of risk, with and hospitals. The federal departments—such consolidated purchasing power. For example, in New as the Ministry of Education—are the individual Zealand, the majority of central government risk from counterparties for these insurance placements. It the disaster exposure of public assets is spread across should be noted, however, that the data, processes a small number of departments,18 and these have and channels to market developed for FONDEN are portfolios of sufficient size to attract the services of utilized to make these placements, so it is not a wholly brokers that have considerable weight in the market. independent departmental approach. 18 Insuring Public Assets, Auditor General, New Zealand, 2013 19 Insuring Public Assets, Auditor General, New Zealand, 2013 31 Catastrophe Insurance Programs for Public Assets - Operational Framework Operation 4. Determine the nature of the vehicle or program entity Where a decision has been made to adopt a capacity to easily absorb the total liability caused by centralized approach and to establish a vehicle for the insurance scheme. insurance of public assets, a decision as to the nature of that entity needs to be made. There are a variety A separate legal entity of options, which will depend on conditions specific to the economy in question, and particularly the legal An insurance program can be given a distinct legal and regulatory environment. It is recommended that character through its establishment as a trust, the government develop a set of principles for the foundation, or type of company. The Government nature of the entity, based on the key decisions that of Mexico, and the New Zealand Local Government have to be made. Detailed legal and technical work Association have established trusts—the FONDEN on the most appropriate vehicle within the relevant Trust and the LAPP Fund Trust respectively—for their jurisdiction can then be commissioned on the basis of self-insurance vehicles. These dedicated entities allow those principles. Those key decisions are: for further separation of the finances of the insurance scheme, which offers additional transparency and • The level of operational and administrative burden; ring-fencing of funds. Although these trusts are • The extent of financial separation from public funded very differently (the FONDEN Trust through accounts; an annual federal budgetary provision, the LAPP • The level of independence or integration of the fund through annual member contributions), they vehicle with respect to existing, relevant public take a broadly similar approach to managing their agencies; and contingent liabilities with reserves accumulated over • The role of government agencies and other time to retain risk, and the purchase of reinsurance. stakeholders in vehicle governance and One key advantage of an entity entirely separated management. from the budget (such as a trust, or an insurance company) is the possibility of accumulating reserves 4-1. Identify the type of program over time, and thereby retaining risk and reducing the or vehicle most appropriate to the cost of reinsurance. institutional, legal and regulatory Use of pre-existing public insurers is an option for context the structure of an insurance scheme for public assets. Both the Mexico and New Zealand case study A fund integrated into government finances schemes used pre-existing public insurers such as Agroasemex in Mexico (as a conduit for FONDEN to One option for a self-insurance scheme is to manage international capacity) and Civic Financial Services it as an integrated part of government finances, rather (formerly Civic Assurance) in New Zealand (as the than to have a separate entity. For example, claims administration manager for the LAPP Fund). under the QGIF scheme come out of Queensland Treasury’s administered accounts, and provisions for In the case of FONDEN, Agroasemex has played future claims are managed within the Queensland a fundamental role in accessing international risk- government’s long-term investment portfolio. QGIF bearing capacity, and the Government has also made is essentially an agreement between the Queensland use of the state-owned development bank, Banobras, Treasury and the covered entities, and it sits on the as fiduciary agent and trustee for the resources balance sheet of the Queensland government. This transferred to the FONDEN Trust. type of approach offers lower cost and administrative burden compared to the full financial isolation of the The LAPP Fund is a distinct legal entity, but Civic scheme into a separate entity, but is only suitable in Financial Services (formerly Civic Assurance) provides cases where the government has adequate financial administration management. Civic is financial services 32 Catastrophe Insurance Programs for Public Assets - Operational Framework provider, and the local authorities using its services • Ensure that the selection of Board appointees are its shareholders. It was established by the 1960 and the rotation of the Board Chair selection Municipal Insurance Act20 as a cooperative insurer give a breadth of end-user representation in for local authorities, and prior to the Christchurch the governance structure, so that there is no earthquakes, was underwriting general property risks perception of imbalance towards a particular for local authorities. The company ceased underwriting group of end-users; property catastrophe risk after its financial strength • Consider strategic political appointments to the rating was substantially downgraded following Board, to give vehicles a strong base for their the impact of the Christchurch earthquakes on its interactions with end-user public agencies, and financial position. However, its successor entity (Civic broader market participants.22 Financial Services Limited) acts as the administration manager for the LAPP Fund. 4-3. Determine the balance of retained internal expertise versus 4-2. Develop an effective, outsourcing representative governance structure For the operations of insurance programs and vehicles, The governance structure of an insurance entity has the decision on where to access external expertise multiple functions. In addition to their governance through outsourcing, and where to keep expertise in- function, governance structures can be used to: house, will be highly context specific. Factors such as pre-existing public institutions carrying out relevant • Confer a strong sense of ownership of the functions, the condition of the local market to access initiative to participating entities; specific expertise, and internal decisions on headcount • Develop the trust of participating entities through will determine what is appropriate in each case. their integration into decision-making processes; • Provide political leverage to vehicles. However, a general theme across case studies was the importance of keeping certain types of expertise A well-crafted governance structure is needed to in-house in order to ensure effective operations. And bring a sense of shared interest in the success of where it is not possible to retain this critical expertise a scheme. Global experience demonstrates that within the entity itself, the importance of having creating active roles within the governance structure independent technical advice from an agency that: for the public agencies that will be insured, builds trust does not have a financial interest in any placement in the undertaking. This in turn promotes sustained of risk itself; or has an alignment of interest with the participation21 and also can help schemes successfully public-sector entity seeking cover. In the case of QGIF navigate particular challenges; for example, disputes in Australia and the UK RPA, government actuarial over large claims payments or loss of participation. functions play an advisory role. In the case of FONDEN in Mexico, the Insurance, Pensions and Social Security A number of lessons learned were taken from the Unit of the Ministry of Finance and Public Credit has successes and failures of insurance schemes, on what played a significant technical advisory role, as has public good governance looks like in practice. Key lessons insurer Agroasemex. Many governments have brought learned from these examples are summarized below: expertise in-house by hiring from the private sector, in cases moving from an outsourcing model to an in-house • Ensure senior representation from the end-users/ function by building up technical capacity over time. clients of any vehicle on the governing Board; • Ensure that the forums for governance actively The following examples demonstrate where retained and frequently engage the Board, and that the expertise has added particular value: secretariat function for running these forums is given appropriate priority; 20 The act was fully repealed last year. See http://www.legislation.govt.nz/act/public/1960/0029/latest/DLM324688.html#DLM324687. 21 One reason cited by the Auditor General review for the failure of the New Zealand District Health Board collective insurance scheme, was that the governance processes and forums did not appropriately engage the Board of the scheme. As this was where the senior representation from the end-users (District Health Boards) was, this failure to engage had significant impacts on the success of the scheme. See ‘Insuring public assets’, New Zealand Auditor General, 2013 22 For example, the presence of the Ministry of Finance on the Board of Agroasemex has contributed to the sustainability and effectiveness of the public insurer. 33 Catastrophe Insurance Programs for Public Assets - Operational Framework 1. Pricing of risk and publicly available information on flood zones and storm tracks was a common theme. It is important that Governments have access to an additional view of the pricing for their risk, beyond 4. Exploiting public asset and claims the view provided from those entities within the risk datasets for broader risk management and transfer chain. In the context of FONDEN in Mexico, response the Government has access to its own view through R-FONDEN, which it complements with loss results Having data management functions within public from vendor models provided by the firms bidding agencies can ensure that a close connection to the on the risk for FONDEN’s reinsurance placement. data is maintained, and that opportunities to use data QGIF in Australia provides a very specific example, for risk management are properly exploited. This is where the close connection of the QGIF team to covered further above under Box 4, however an the exposure data, and understanding of their risk additional example comes from Japan. The Ministry of allowed them to challenge over-pricing relating to a Finance of Japan has a comprehensive database for specific high-rise asset. The QGIF team was able to public assets managed by multiple ministries, and used use its understanding of the data to demonstrate that for multiple public asset management purposes. The the covered assets were all on the higher floors of database enables the Ministry of Finance to provide the building in question, and there was therefore no information to local government authorities on which flood risk to the contents or service provision covered state assets have vacant rooms in their locality in under the policy. the event of a catastrophe. These vacant rooms can then be used to respond to urgent needs including 2. Stress testing of the prevalent view of risk evacuation sites. This process provided substantial value to the disaster response especially following Governments’ insurance schemes should have access the earthquakes in 2016. Although the database in to the expertise needed to understand the major this case is not part of an insurance scheme, its use assumptions within catastrophe risk models. Otherwise, is shared here due to its equivalence with insurance the exposure management and pricing strategy for a exposure datasets. scheme could be overly reliant on a single view of risk.23 In both Mexico and New Zealand, public technical agencies 5. Valuations and vulnerability estimations add substantial value in this process. In New Zealand, for specific assets unfamiliar to the the GNS Science Institute has been commissioned by commercial market the LAPP fund to produce models. GNS played a vital role in the early days of development of the LAPP Fund, A number of types of public asset included within when data, and the understanding of risk, was limited. In insurance programs and vehicles from the case Mexico, the Institute of Engineering of the Universidad studies, are highly atypical compared to assets Nacional Autónoma de México has played a core role underwritten within the commercial market. In such in the development of the Government’s R-FONDEN cases, the public entity may have a comparative risk platform, which provides an internal view of risk advantage in commissioning and leading work to to complement market provision of vendor modelled estimate the value of the assets and their vulnerability results. to disasters. In the case of the underground water and flood control infrastructure covered by the 3. Basic GIS functions for catastrophe LAPP in New Zealand, the expertise on the value and exposure management and event vulnerability of these assets sits with the public sector monitoring rather than in the insurance market. These views are then incorporated into the underwriting process from A number of schemes that do not retain extensive the commercial market. catastrophe risk modelling expertise, still retain basic GIS expertise in order to map risk zones and the onset of events over their portfolio of assets. The use of publicly available tools such as google maps, 23 One strong lesson learned from all the case studies, was that views of catastrophe risk change dramatically after a large event. The Christchurch earthquakes are one such example, where a new understanding of the presence of highly liquefiable soils after the events led to a dramatic increase in the modelled risk. 34 Catastrophe Insurance Programs for Public Assets - Operational Framework Operation 5. Determine the role of the private (re)insurance sector The most fundamental question to ask in the design 5-1. The transfer of risk to protect of a scheme for insurance of public assets, is what risk government budgets to retain, versus what risk to transfer to domestic or international (re)insurers. Policy on whether or not The use of commercial (re)insurance can be a prudent to transfer risk to the commercial markets should be way to avoid budget disruption post-disaster, by driven by the size of potential catastrophic shocks in the transferring the volatile contingent liabilities that arise context of budget flexibility and borrowing capacity. from catastrophe events. Risk transfer can add value even in cases where governments are not budget It can be more cost-effective to self-insure in cases where constrained; the Government of Japan provides an governments have ready access to alternative financing example of a targeted use of risk transfer to the private options for post-disaster losses, and particularly for sector to reduce the contingent liabilities arising the ‘lower layers’ of risk—the type of loss events that from disaster damage to rail infrastructure. Note that occur more frequently and are less severe. For example, public assets in Japan are in most cases self-insured, guidance to public entities from Treasury in the United with a restoration budget being made available Kingdom stipulates that self-insurance is better value by the responsible line ministry (e.g the Ministry of for money than commercial insurance,24 where feasible Land, Infrastructure, Transport and Tourism (MLIT)), in the UK context. The substantial financial response even in some cases where the asset is privately capacity of the UK Government to meet disaster needs operated. In the case of new Seibi Shinkansen rail in the absence of insurance25 makes a self-insurance infrastructure, Japan Railway Construction, Transport approach viable. However, where disasters overwhelm and Technology Agency has arranged disaster risk the financial response capacity of government budgets, insurance to reduce the frequency of access to the the costs of delayed response and of diverting funds contingency budget. from priority investment areas are ultimately more expensive than insurance (Clarke et al. 2017).26 5-2. Increasing transparency and data standards Governments need to determine how private (re) insurance can be used effectively. Case studies reveal Within the case studies examined, the interaction a wide variety of potential arrangements with the with the commercial markets was instrumental in private (re)insurance sector, including; increasing transparency and data standards within insurance schemes for public assets. In cases, the • Use of international markets to reinsure self- minimum standards on exposure (asset) and claims insurance vehicles; information required by commercial reinsurers • Framework agreements with domestic insurers transformed the quality of exposure management, and to facilitate access to insurance for smaller-scale the insurance offering itself, in self-insurance vehicles. public entities under an umbrella agreement with These transformations, driven by the involvement the public sector; of the private sector, have not just served to reduce • Use of the domestic insurance market for uncertainty in pricing of commercial contracts, but large portfolios of exposure for specific central have also facilitated risk management by the public government departments. agencies using these schemes. As one example bringing assets within scope for schemes served to When determining how to bring the commercial highlight their condition, bringing issues such as the market into a scheme for insurance of public assets, need for increased investment in ongoing maintenance governments should consider the following: into focus. Some case studies also reported increases 24 Managing Public Money, HM Treasury UK, 2013 25 Ibid 26 Clarke et al.,“Evaluating sovereign disaster risk-financing strategies: a framework”, 2017. 35 Catastrophe Insurance Programs for Public Assets - Operational Framework in trust from the public agencies participating in UK, the establishment of a self-insurance vehicle for public asset insurance schemes, arising from the schools—the Department for Education’s RPA—has inclusion of an external commercial provider. As well put considerable downwards pressure on pricing, as bringing about these positive changes within the such that insurers are now competing effectively with schemes that they serve, (re)insurers and brokers the self-insurance scheme for the Academy Trusts. are also providing valuable technical inputs—such as alternative probabilistic views of risk—that are being 5-4. Challenges in using commercial used to improve catastrophe exposure management, (re)insurance—volatility in the cost targeting of cover, and pricing within schemes. of cover 5-3. Developing the domestic The volatility of commercial premiums is one reason insurance market why governments have adopted self-insurance approaches in cases, and why they have also sought Insurance schemes for public assets can be an to minimize the use of commercial reinsurance to opportunity to develop the domestic insurance support self-insurance schemes. This volatility, which market. However, a domestic market route for public is inherent in the (re)insurance industry, has posed a asset risks may not always be feasible or desirable, challenge to the sustainable management of insurance depending on the capacity of the market and on schemes for public assets. pricing. The LAPP in New Zealand and FONDEN in Mexico are examples of self-insurance vehicles Volatility of pricing after large disasters is an issue created in response to the infeasibility of placing that governments must plan for when relying on risk risk in the domestic insurance market. For example, transfer to the private sector. For example, many early consultation with the local insurance market public entities throughout New Zealand reported to association in Mexico on FONDEN revealed that the the Auditor General that one of their most significant domestic market did not have capacity to support cost pressures after the Canterbury earthquakes has the program. Consequently, the FONDEN vehicle been insurance. Nearly 40 percent of the insurance accessed reinsurance through the public insurer policies of public entities participating in the Auditor Agroasemex, which transfers the risk onto the General’s review of insurance of public assets included international reinsurance markets. In the case of the an increase in premiums of more than 20 percent LAPP, a self-insurance vehicle was necessary, as the in the year following the Canterbury quakes. Some domestic insurance market did not have appetite or survey respondents reported premium increases technical capacity to underwrite underground water of 200 percent or more. Insurers and reinsurers and flood control infrastructure of local authorities in also increased the deductibles/excesses on their 1993. The LAPP fund retains some risk, but also passes policy offerings, requiring public agencies to retain risk on through reinsurance. more risk. These changes in the terms under which cover can be accessed arise from multiple reasons. Domestic insurance markets have in cases, responded Insurers and reinsurers may be dealing with changes in positive ways to the establishment of self-insurance to their capital position, following large claims vehicles for public assets. The LAPP played a facilitating payouts. Catastrophe events also inevitably provide role in the opening of the domestic insurance new information on the risk exposure of assets, market to the highly specialized underground water and the nature of perils, necessitating a review of infrastructure that previously had been considered pricing adequacy. In the case of New Zealand, new commercially uninsurable. The domestic insurance information around the presence of, and vulnerability market in New Zealand has now evolved to the from, highly liquefiable soils substantially changed point that it is able to compete with the LAPP on the understanding of seismic risk to structures in underwriting these risks. The Government of Mexico the economy after the Christchurch events. As is now also passing risk into the domestic market noted earlier in this report, a self-insurance vehicle through property catastrophe indemnity insurance can elect to smooth volatility in pricing, as QGIF in policies under its overall risk financing strategy. In the Australia does. 36 Catastrophe Insurance Programs for Public Assets - Operational Framework Operation 6. Define the extent and nature of insurance coverage 6-1. Set priorities for asset and loss commercial insurance program. Getting certain assets back online in a short time period can have types to be covered a huge impact on the overall cost of a disaster. When establishing a scheme for insurance of public Identifying these assets through modelling can assets, governments need to determine the types help in prioritizing insurance cover.29 of loss, and the types of asset, that they want to bring within scope for coverage. This will be partly There are also examples of schemes choosing a policy decision, partly a question of feasibility. to separate certain types of asset/operation out Some schemes opt for a broad spectrum of asset of the portfolio they present to the commercial inclusion, while others carve out very specific liability market, due to low demand from insurers for these to manage costs of premiums. Building damage, particular risks. Where the commercial market is contents damage, and service interruption, were less willing to underwrite risk from certain types typically all within the scope of cover. It was noted in of asset/operation, it can result in low demand, multiple cases that the costs of service interruption, reduced choice in insurer, and less favorable although harder to quantify, had the potential to be pricing. In these cases, it may be advisable to larger than the costs of restoring physical assets.27 separate coverage of these less desirable risks Some contrasting approaches to setting scope for out of the portfolio, to protect competition on coverage are shared below: other classes of business. This is the case for social housing under the Insurance Services II framework • Scope defined by disaster resilience objectives: in the UK, where a decision was made to separate Mexico’s FONDEN provides broad coverage these exposures from the rest of the framework of assets,28 including even low-income housing and take them to market separately. to offer protection to affected vulnerable communities. It also includes very few exclusions in • Scope defined by a market failure: the cover offered for assets. This comprehensive, The LAPP in New Zealand was established to cover inclusive approach to cover arises from the a very specific exposure; underground water and disaster resilience objectives of the overall flood control infrastructure. This carving out of program. FONDEN has been successful in passing such a specific liability arises from the purpose of this broad spectrum of risks into the reinsurance the vehicle—to fill a market gap that was present market. Exclusions from FONDEN’s commercial at the time of the vehicle’s creation. reinsurance policy are relocation expenses arising from damage, and costs for ‘building-back- • Scope defined by benchmarking against the better’, which are covered by FONDEN but not best available commercial coverage: passed onto the commercial markets. Australia’s QGIF and other schemes reviewed available commercial cover in their developed • Scope defined by financial efficiency: domestic insurance markets when considering To most effectively manage the cost of premiums, the best available terms to meet the needs of some schemes prioritize assets for cover. For their end users. example, some public agencies focused on maintaining service continuity in the event of How to include transport infrastructure posed a disaster, with those assets most critical to a specific challenge across all the schemes that this continuity prioritized for inclusion in the considered its inclusion. For QGIF in Australia, while 27 For example, the Queensland government identified the cost of relocating hospital services to another building in the event of damage as their largest potential loss arising from a single physical asset. 28 Roads and bridges, water infrastructure, schools, hospitals and low-income housing make up 90 percent of the historical support requirements through FONDEN. 29 The impact of downtime for service infrastructure on overall disaster costs is modelled and elaborated here: http://pubdocs.worldbank.org/ en/959121528158915945/IPF-Resilience-drmhubtokyo.pdf https://www.tandfonline.com/doi/abs/10.1080/09535314.2013.872081?journalCode=cesr20& 37 Catastrophe Insurance Programs for Public Assets - Operational Framework certain infrastructure such as bridges and tunnels are approve post-disaster reconstruction funding not only included,30 roads were not deemed cost-effective to for the replacement, but also for the improvement, of cover. This was due to the extensive size of the road damaged assets to increase resilience against future network (many tens of thousands of kilometers), the disasters. However, it is not viable to include these poor quality of parts of the network, and the fact that additional costs in FONDEN’s commercial reinsurance the State of Queensland has to budget for resurfacing policy, so the indemnity reinsurance program of roads on a frequent basis, even without the covered by the reinsurance market only covers occurrence of a disaster. Where discrete elements of replacement costs.31 As the claims settlement process the transport network are selected for cover, issues of has been developed to accommodate FONDEN’s defining the covered element can cause challenges in processes, and as the oversight and responsibility for the post-event loss assessment process. One example reconstruction sits with FONDEN, the government has shared by QGIF, was the challenge of agreeing the the mandate and agency to undertake reconstruction exact start and end point of a bridge; the bridge had in the way it deems most effective. Similarly, QGIF been damaged by a severe weather event, and QGIF in Australia has developed its own claims settlement and its commercial reinsurers had some difficulty in processes that allow its participants to build back agreeing the extent of damage that fell within the better, despite the cost of improvements not being commercial policy. covered under the insurance contract. Experience from the devastating Christchurch earthquakes in New Similar considerations were raised by local authorities Zealand (2010-2011) was that standard commercial in the UK, where, while disasters can increase the loss adjustment processes can pose a challenge to extent of resurfacing needed, there is a need to betterment in reconstruction. There were difficulties resurface roads on a regular basis anyway. Thus, in separating the costs of betterment from the costs many public sector entities opt to retain the cost of reconstruction covered by commercial contracts, of disaster damage to roads, through their roads’ which led to long delays of loss adjustment. Developing maintenance funds where possible. Conversely, a claims settlement process that allows betterment to the Government of Mexico has elected to transfer occur, without the cost of it being paid for through a the cost of damage to roads through FONDEN, to commercial (re)insurance contract, was a key lesson the commercial reinsurance markets. The different learned across multiple of the case studies. A further types of damage caused to transport infrastructure identified challenge to inclusion of betterment within in economies exposed to seismic hazards versus insurance contracts, is the treatment of public assets those only exposed to hydro-meteorological perils is with heritage value. In these cases, standardized also significant when considering the feasibility and coverage may not be suitable anyway, due to desirability of retaining losses that arise. preservation requirements that need to be applied within any reconstruction approach. 6-2. Facilitate resilient reconstruction within post-event 6-3. Set coverage terms to processes minimize underinsurance Some schemes facilitate a ‘build back better’ approach Deductibles: In some commercial markets, standard through their claims processes, although this is not deductibles for natural perils can be high. For example, funded by the commercial insurance policy. In these insurers in Japan did not consider it feasible to cases, it is agreed that the commercial payout will underwrite losses below the 1 billion yen (around US$10 cover a portion of the cost of rebuilding the asset, with million) mark for the Shinkansen rail infrastructure the cost of betterment being funded from elsewhere. insurance program, and in the UK, one local authority The key design feature is that the procurement of placing risk in the domestic market reported that services and materials for reconstruction of assets can deductibles imposed by the market for natural perils be excess of the figure agreed with the risk carrier as were four times higher than for other risks. Self- part of the loss adjustment process. For example, in insurance schemes offer ways around this issue. QGIF in Mexico, the FONDEN Technical Committee is able to Australia, for example, covers 100 percent of the cost of 30 Bridges and tunnels are included in the commercial contract, but QGIF does not cover losses below the commercial deductible for the state agency responsible for transport infrastructure (DTMR). 31 Those costs are estimated to represent, on average, around 75 percent of total reconstruction costs for the scheme. 38 Catastrophe Insurance Programs for Public Assets - Operational Framework rebuilding assets—with no deductible for participating new understanding of the risk from highly liquefiable agencies. Sheffield City Council in the UK has created soils; demand exceeding capacity for construction a mutual contingent credit pool for its sub-agencies, services and materials; substantial claims reducing to manage the retained risk below the deductible on the capacity of insurers to take on risk; and the their commercial policy. However, deductibles have an international reinsurance market reviewing its high important function in aligning the interest of the insured levels of aggregate exposure to earthquake in and insurer, and mitigating the risk and administrative the New Zealand market. Reinstatement clauses burden of unnecessary small claims. In recognition of are a prudent inclusion, to ensure that cover is this, some schemes opt to use commercial benchmarks automatically reinstated following a catastrophe or for deductibles for participating agencies when setting series of shocks, given the difficulties in approaching their insurance coverage terms. Where participation the market for cover after a large disaster. For rate is an issue, some schemes have opted to lower example, the LAPP had one automatic reinstatement deductibles to increase the frequency of payouts and of cover in its reinsurance policy, which meant that thereby demonstrate how the scheme adds value to cover was reinstated after the first earthquake event, its members. and was therefore in place for the second event, but that the third earthquake in the Christchurch Coverage limits: As regards coverage limits for sequence was not covered. For economies exposed individual assets, underinsurance was a frequently to seismic perils, it is also important to review the reported issue in global experience, with insurance definition of an earthquake event within policies for policies covering a current carrying value of an coverage, to determine whether multiple shocks in asset rather than the replacement cost. Ensuring a sequence would be treated as a single event or that exposure data includes up-to-date valuations multiple, and to consider how the financial terms of that account for replacement costs, and demolition the policy (deductibles, reinstatements, limits) will costs where possible, is recommended. The apply in each case. Christchurch earthquakes in New Zealand revealed a substantial undervaluation issue for the LAPP It is also worth noting here that some public sector coverage of underground and flood control assets. entities purchase multi-year covers to fix in costs and There were significant, unforeseen, additional costs reduce the burden of tendering on an annual basis. in reconstruction that arose from expensive actions For example, a five-year cover with the option to required to make the sites safe to survey and build on. break on an annual basis. When considering how to set coverage limits for a 6-4. Decide upon a risk-based portfolio being placed in the commercial market, versus solidarity model for pricing the New Zealand Ministry of Education provides an interesting example of how to save costs. The Ministry Most schemes use a risk-based approach to setting elects to insure its portfolio of assets for less than 100 pricing for participating agencies, in which the cost percent of the total replacement value to save costs, of premiums reflects the level of risk in respect of and benefit from the geographic diversification of a participating agency. The UK RPA for schools is losses that is inherent in its nationwide portfolio (New an exception, where schools pay a fixed per-pupil Zealand 2013).32 amount that is reviewed annually by the Government Actuary’s Department to ensure that the overall Reinstatement of cover: Reinstatement clauses are income for the scheme is adequate given its contingent of particular significance. As noted above, it is not liabilities. The riskier schools are therefore having unusual for the cost of insurance and reinsurance their cover subsidized by those with better claims to increase dramatically following a catastrophe experience (i.e. solidarity model). The advantage of occurrence (see Box 4: Manage volatility of pricing). this approach is that it links the cost of cover to the Cover may also no longer be offered by the market. capacity of institutions to pay; schools in the UK are After the Christchurch earthquakes in New Zealand, funded (largely) on a per-pupil basis. it was difficult to access insurance or reinsurance in the impacted area. This was due to factors such as: a 32 Insuring Public Assets, Auditor General, New Zealand, 2013 39 Catastrophe Insurance Programs for Public Assets - Operational Framework The disadvantage of the solidarity model is that it premiums across the agencies. Although this example does not use price to incentivize risk reduction. Other does not come from property catastrophe insurance, schemes actively seek to achieve this outcome, with the idea of a partially risk-based, but simple, approach risk-based premiums, and in the case of the LAPP, to pricing could add value in the context of physical the offer of premium discounts to local authorities damage to public assets. that display strong risk management practices. This missing feature of the pricing model is acknowledged 6-5. Ensure sustainable pricing by the RPA management team, who use alternative strategies to promote risk reduction. This includes While differing policies for pricing within schemes using the surplus from the scheme to invest in the are perfectly valid, price adequacy for schemes as resilience of schools that the RPA data identifies a whole must be maintained. Schemes have choice as being particularly exposed, the application of in how they allocate the cost of cover to individual deductibles on the contracts so that risk experience participating agencies, and even in how the cost of is partially shared across the insured and insurer, and cover is distributed year-on-year (i.e. schemes may the delivery of risk management workshops and risk elect to smooth large cost rises or reductions over audits,33 in which the risk management practices of time). However, ensuring that pricing is adequate to Academy Trusts are reviewed. support the long-term sustainability of the scheme must be the basis of any model. Another disadvantage of the solidarity model is that it can lead to adverse selection issues, whereby Among the methodologies applied to set pricing schools with lower levels of risk will opt to buy cover in self-insurance schemes, probabilistic modelling in the commercial market where their premiums are results provide the most sophisticated approach. lower, and the scheme would then attract only the However, these models are not available for all riskier exposures. This could lead to issues with price perils and territories, and in cases, (particularly flood adequacy, if it is assumed in setting pricing that the modelling) the uncertainty in model results can be participating schools will represent a full cross-section very high. Therefore, a complementary approach is of risk-exposed Academies. almost always required. Where the participating agencies in an insurance Methods being used to determine pricing include: scheme are independent of each other, the desire for cross-subsidization tends to be lower. One of • Outputs of probabilistic catastrophe risk the greatest challenges reported by the LAPP was models (either delivered by broker, (re)insurer, managing the perceptions of members as to their or developed internally): subsidizing other member’s coverage, despite the Probabilistic catastrophe risk models provide a risk-based allocation of member contributions sophisticated view of risk, but are not available to the fund (their premium equivalent). Working for all perils and territories, and development of with members to understand their differing risk new models requires a large investment. Both profiles for flood, earthquake, volcanic and tsunami Australia’s QGIF and Mexico’s FONDEN use when compared to other members was critical to probabilistic modelling results provided by the maintaining participation in the scheme, by clarifying commercial market to supplement their own with members that pricing was fair, and no cross- methods for risk assessment. FONDEN also has subsidization was occurring. its own in-house model, R-FONDEN; The UK National Health Service operates a self- • Pricing developed by the government actuarial insurance scheme (NHS-Resolution) for claims arising function based on claims history (with scenario from injury or negligence. The scheme uses a three- modelling of possible large losses): tiered approach to charging, in which the insured Government actuarial functions play a core role agencies are assigned to one of the pricing tiers based in pricing for multiple schemes. Best practice on their claims history. This provides some signaling methodologies for calculating premiums using of risk in the cost of cover, but there is subsidization of such data are well-established in developed 33 To ensure learning, risk management audits occur for new joiners to the scheme, but also for Trusts with high or low claims experience compared to the average claims made by Trusts using the scheme 40 Catastrophe Insurance Programs for Public Assets - Operational Framework insurance markets, and working with actuarial the quality of information from the surveys varied resources affiliated with a globally recognized from school to school, and that the performance actuarial body will ensure that these are applied. of the industry benchmarks in capturing actual Both the UK RPA and QGIF in Australia rely on claims experiences has not been strong. However, internal actuarial expertise to maintain price this approach offered a starting point to an entity adequacy in their schemes; operating in a data poor environment, and as the scheme develops its own claims experience over • The use of industry benchmarks alongside the years, this is being blended with the industry survey methods on past damage: benchmarks to improve pricing. In the case of the UK RPA, pricing for the early years was established using survey results from schools • Engineer assessment for hard-to-insure assets: on their past damage and claims experiences, In the case of the LAPP, the challenge of modelling alongside the provision of industry benchmarks flood damage to hard-to-insure underground for claims from similar risks being underwritten water and flood control infrastructure was elsewhere in the market. The RPA team worked approached using engineer assessment, and self- with a broker who provided these industry assessment from local authorities on the portion benchmarks, and also with a claims service provider of their infrastructure located in different flood to further understand likely claims patterns. There zones. The availability of detailed flood zoning in were challenges with this approach; namely that New Zealand contributed to this approach. BOX 6. CHALLENGES COMPARING SELF-INSURANCE TO COMMERCIAL INSURANCE PRICING Issues with high commercial pricing, or high volatility in pricing can be the stimulus for the creation of a self-insurance scheme. The pricing for what appears to be equivalent cover can be significantly lower for self-insurance schemes. This can be due to inefficiencies in the market, or how risk pooling in a scheme can bring diversification benefits into premiums compared to individual policies for covered agencies. However, it is important to note that self-insurance schemes are often not fully isolating their assets and contingent liabilities from the budget of the relevant government agency. They may therefore be implicitly relying on flexibility in the government budget to cover large losses, which does not appear in premiums in the same way that an insurer or reinsurer will account for the cost of capital to back large losses into their calculations of price. Therefore, a direct comparison of the cost of commercial insurance versus pricing for a self-insurance scheme relying on central government budget capacity is not really valid. However, relying on budget flexibility for self-insurance schemes, where possible maximum losses have been quantified and can be absorbed by flexible budget capacity, is one option for a strategy in seeking to achieve value for money. Especially since those liabilities are usually held on the balance sheet of the government anyway, even in the absence of an insurance scheme. For example, the UK RPA was established following an assessment that a self-insurance approach could save the Department for Education about £100 million per year in costs (Department of Education, 2014). 41 Catastrophe Insurance Programs for Public Assets - Operational Framework Operation 7. Develop a post-disaster process Standard practices for claims management in the FONDEN reinsurance program in Mexico, placed commercial markets are not always suitable for public through public-insurer Agroasemex, makes use of the sector entities. Commercial practices may need to protocols developed for FONDEN’s determination be adjusted to allow governments to efficiently, of its own payouts to federal and state entities. A and quickly, reconstruct assets, and to get critical collaborative approach is taken, whereby engineers infrastructure back online as soon as possible. In from local and federal government go into the field the event of a severe catastrophe, insurance of alongside the reinsurance loss-adjustors, to estimate public assets serves not just the government but damage. Multiple loss estimates are produced, and the population as well. Hospitals, utilities, schools, a process of reconciling these figures then follows. transport infrastructure, and government services Because the government has designed the post- need to be restored as soon as possible after a event loss assessment process, it is consistent with disaster, and where insurance funds are a planned FONDEN timeframes. part of that recovery, they need to be executed quickly and efficiently. 7-2. Bring the claims management function in-house Challenges in loss adjustment after disasters can add years onto the timeframe for settlement of QGIF in Australia works with external loss adjustors, claims, as demonstrated by the experience of the but keeps the overall claims management function in- 2010-11 Queensland floods in Australia and the 2010- house. Due to the nature of the scheme, they are able 11 Christchurch earthquakes in New Zealand. Even to set post-event processes that accommodate the where the claims settlement process is efficient, and existing procurement processes of their participating funds can be released in a matter of a few months agencies. For example, public sector agencies (large settlements have been achieved in three may have emergency procurement arrangements months for indemnity cover used in Mexico’s FONDEN with service providers to make procurement for context), governments will need access to more reconstruction faster. Conversely, commercial immediate financing options to get reconstruction insurance claims processes may require that work of critical infrastructure underway immediately to be procured in a certain way, and may involve minimize service interruption. In the FONDEN case, putting out a tender for quotes after the damage has an Immediate Partial Response Mechanism fills this occurred. QGIF allows agencies to work through their gap. After a disaster occurs, resources are authorized emergency procurement arrangements. by the Ministry of Finance and Public Credit within 24 hours of the receipt of a request from a federal or state 7-3. Share loss adjustment resources entity, and are then released through the FONDEN between public and private sector Trust. These early payments are later deducted from the total approved FONDEN allocation through the One challenge across multiple case studies, was of the full loss assessment process. disagreements that arose from having multiple loss adjustors on-site post-disaster, representing different The following strategies may be applied to facilitate the parties, and arriving at different figures. FONDEN post-event claims settlement process for public assets: manages this issue through the joint loss assessment activity between the public and private sector as 7-1. Incorporate an established public described above. One local authority in the UK, with sector loss assessment process a self-insurance structure sitting below a commercial placement, opted to share the procurement of loss Where processes exist already for the assessment of adjustors with their commercial insurance provider. damage by public sector agencies, the incorporation A framework agreement is put in place with a panel of these processes into commercial insurance of individual loss adjustors on an annual basis, with processes can facilitate rapid settlement. The the insurer’s approval of the selected panel. When an 42 Catastrophe Insurance Programs for Public Assets - Operational Framework event occurs the loss adjustors can be on the ground 7-5. Use technology to facilitate in 24 hours. rapid settlement 7-4. Establish a long-term FONDEN uses a web-system for rapid sharing of partnership with an external post-event damage information, to facilitate quick agreement on a loss figure by the responsible provider of loss adjustment services committees within FONDEN and the commercial The hard-to-insure nature of certain types of parties involved. Geo-referenced damage assessment infrastructure can make loss assessment challenging. evidence—namely photographs –are uploaded onto This was the case for the underground water and the system for sharing with the FONDEN damage flood control infrastructure in New Zealand covered assessment committee. Federal and State entities by the LAPP, which was impacted by the 2010-11 are required to give precise detail on losses before Christchurch earthquakes. Loss adjustors struggled requesting assistance from FONDEN (geolocation with the damage assessment for these underground data, photographic evidence and a full description). assets, with issues such as differentiation between betterment and reconstruction causing long delays. Subsequently, LAPP has worked in partnership with a loss adjustment firm over an extended period, to build expertise in-house regarding the underground assets. 43 Catastrophe Insurance Programs for Public Assets - Operational Framework Operation 8. Undertake Stakeholder and market engagement Whatever the approach, stakeholder engagement a valuable activity in developing financial resilience will be a critical part of design and implementation within an economy—for both public and private of catastrophe insurance programs for public assets. sector exposures. Therefore, engaging the domestic Early and effective integration of the right stakeholders insurance market within the development of any into the development process for an insurance scheme, even where it is not feasible to pass risk scheme can substantially improve outcomes. The through it at the outset, can serve a longer-term case studies also provided useful guidance on how resilience strategy. For economies with relatively governments can apply strategies in their interactions under-developed insurance markets, governments with the commercial markets to improve the price will need to balance the feasibility and sustainability and coverage outcomes when placing risk of any insurance program for its assets against the longer-term objective of developing the domestic 8-1. Engaging with the domestic market, when it sets the level of involvement of insurance market domestic insurers. For almost all of the case studies, the market For certain types of program that rely on domestic engagement was with either the international insurance market capacity—for example, the reinsurance market, or a domestic insurance market procurement framework approach with the domestic that was already relatively developed. In these market—a relatively developed, competitive local cases, governments were dealing with experienced market is a pre-requisite for scheme success. For the counterparties with strong technical capacity, able more centralized approaches that aggregate risk into to understand the risk and price for it appropriately. a program or vehicle, domestic carriers do not need The case studies therefore provide examples of the to be an integral part of the risk transfer chain. In fact, different strategies applied to get the best out of as noted earlier, both the FONDEN and the LAPP case a competitive, developed market for catastrophe studies demonstrate where the infeasibility of passing risk. For many developing economies, the domestic risk through the domestic market in a cost-effective insurance market cannot be approached in this way, way pushed governments to take a more structured, as domestic carriers lack the technical and financial centralized approach to insuring assets. capacity to underwrite catastrophe risks as effectively, and as competitively. An assessment of the capacity of the domestic insurance market to form part of the risk transfer Catastrophe insurance schemes for public assets chain is a starting point for any scheme. Governments present an opportunity to develop domestic insurance need to keep in mind the following factors: one, that market capacity—both technical and financial. The the more involved the domestic market is, the better section on “the Role of the Private (Re)insurance the development outcome for these carriers; and two, Sector” discusses this opportunity in more detail that in the event of a significant catastrophe impacting Mexico is an example where the domestic insurance an economy, having risk concentrated within the market did not have capacity to support the FONDEN domestic market could lead to poor outcomes for all program in its early years, but where both the stakeholders. Mitigating options for this are the use Government of Mexico’s strategy for insurance of of reinsurance, and a robust post-event process that public assets, and the domestic market, developed allows the scheme to fulfill its obligations to its public to the point that some public sector risk is currently sector policyholders, even where domestic carriers being absorbed through domestic carriers. may be operationally overwhelmed by responding to insured losses incurred across all sectors of the The development of the domestic insurance market economy. These factors are discussed in more detail to underwrite catastrophe risks effectively is itself earlier in the note. 44 Catastrophe Insurance Programs for Public Assets - Operational Framework 8-2. Commercial process— present their risk management strategies and the optimizing price and coverage portfolio claims experience in person to the market, during organized insurance days where the market is outcomes invited to a series of presentations. A common strategy to keep the cost of premiums low, but also to manage the risk of counterparty 8-2-3. Designing a bidding process default, is to increase the number of participating (re)insurers. Global experience shows that disputes The process for competitive tender of risk varies over payments of large claims after catastrophes are substantially between case studies. In the case of the not uncommon.34 Having multiple high-quality (re) UK ISII framework, a direct award option is also made insurers reduces the impact should a dispute arise available to users alongside the option to invite bids with any individual participant. Many of the case on the risk. study schemes use a panel of (re)insurers, although for entities with smaller portfolios this may not be an For FONDEN, a multi-broker approach is taken to option due to low demand from the market. Placing maintain competition and downwards pressure on risk with multiple insurers or reinsurers adds some pricing. A number of brokers are invited to compete complexity to the process of settling claims, but the on the program, and written guidance is provided to role of the broker and/or the lead (re)insurer can reinsurers and brokers on the rules that will be used to mitigate this. allocate capacity for each renewal of the program. The brokers return with offers on price and capacity, and 8-2-1. Structuring the risk to increase the risk is allocated under these set rules, including: number of bidding insurers • One offer at 40 percent or more of capacity To improve the price and coverage outcomes of an (the total amount of cover sought) is required to approach to the market, the risk can be structured assign a program lead to coordinate across all the in a way that allows the maximum number of (re) participants at the point of claim; insurers to bid. Strategies being used by public sector • 50 percent of the risk is allocated to reinsurers entities to improve outcomes include; risk layering to that quote below the average premium rate (the appeal to a broad range of risk appetites (i.e. splitting average across the full set of quotes received risk into higher and lower frequency event layers); during the tender). dividing capacity between multiple brokers who • To allow a range of brokers to participate, the each approach the market to compete on price and minimum capacity requirement threshold (i.e. the capacity (FONDEN in Mexico); splitting risk by class minimum amount of risk that a broker must place of business (type of asset/operation) within insurance in order to participate) is set low, at 5 percent of procurement frameworks such that insurers can bid the total program. There is no minimum capacity on specific types of public asset (this facilitates the requirement for reinsurers. participation of specialist and smaller insurers on the UK ISII Framework that cannot offer cover for all This approach, plus the strong demand for the types of asset that the public sector requires). program, attracted around 30 reinsurers, and six brokers for the last renewal.35 8-2-2. Pre-engagement with the market The bidding process for the UK ISII framework approach The interactions with the commercial market before provides another approach, with the same objective of the competitive tender can play an important role maintaining effective competition to drive down price, in price and capacity outcomes. Submitting high but with the added complexity of needing to work for quality information on the exposures in the portfolio a broad range of public sector entities and classes of is critical. Some public sector entities go further, to business (i.e. types of asset/operation). There are two 34 For example, not all of Civic Assurance and the LAPP's reinsurers agreed to meet in full the claims made in respect of the Christchurch earthquakes. Arbitration, and ultimately legal action was taken. See New Zealand Dispute Resolution Centre, https://www.nzdrc.co.nz/site/commercialdisputes1/files/Court%20 Decisions/NEW%20ZEALAND%20LOCAL%20AUTHORITY%20PROTECTION%20PROGRAMME%20DISASTER%20FUND%20v%20THE%20NEW%20INDIA%20 ASSURANCE%20COMPANY%20LTD%20CIV-2012-404-7453%20[2013]%20NZHC%201327%206%20June%202013.PDF 35 Numbers were provided by Agroasemex at the time this report was being written. 45 Catastrophe Insurance Programs for Public Assets - Operational Framework points of competition; one at the point of framework Within the case studies reviewed here, brokers are establishment to determine the participating brokers providing catastrophe risk modelling results for the and insurers for the four-year duration of the framework; public sector agency portfolios of exposure, giving and one at the point of access to the framework by an additional view of risk that has utility beyond just public sector agencies looking for cover, where the insurance-decision making. They are also providing framework brokers compete for the specific business. guidance and modelling for how to best structure There are 12 brokers participating in the framework, and programs and present portfolios to improve 27 insurers,36 of which the vast majority (24) will only competition on risk. One key area of value is in the offer coverage through a broker. claims process, where brokers play a coordinating role, and for those that carry considerable weight This structured approach to negotiating has both within the market, they can help facilitate disputes. positives and negatives: As noted earlier, disputes over large claims payments after catastrophes are not uncommon, so having • The framework must appeal to both the service the intermediation of a respected broker through providers as well as the public sector users this process can be invaluable. Under the UK ISII to work. Therefore, it is necessary to limit the framework, brokers offer a broad range of fee-based number of prequalified service providers in the technical services to clients. A number of the schemes first layer of competition to make participation reviewed opt to contract with a broker for a multi- in the framework an attractive proposition to year period, with annual break options, to take best brokers and insurers. Conversely, the panel of advantage of the partnership. providers must be broad enough to protect choice for public sector agencies, and to allow It is important for public sector agencies contracting effective competition on risk that is presented the services of brokers to understand their structure through the framework.37 of remuneration, and how this may impact whether • By its very nature, and the nature of insurance and how (re)insurers will bid on risk. Public sector pricing, the framework necessarily limits agencies looking to place risk may pay an insurance competition without information on how insurers brokerage services fee upfront, to engage a broker. will price risk. The framework offers other This cost is usually transparent, and will be linked to advantages, such as a minimum level of quality of the size of the risk placement. Additionally, brokers participating service providers, and a facilitated will often receive commission from the insurers that purchasing process for its users—reducing the risk they invite to bid on the risk, and this amount may of failure of tenders. However, the principal area be larger than the insurance brokerage service fee. of price competition is on insurance brokerage One issue raised by stakeholders from multiple case services, and not on the price of the risk which is studies was of not having visibility of this amount considerably larger. within the quoted overall price for the risk. It is also important to understand that many brokers have pre- 8-2-4. Understanding the role of brokers existing tied relationships with certain (re)insurers; these relationships are a reality of certain insurance A good broker can offer far more than just the and reinsurance markets. Therefore, when working placement of risk to public sector entities. They can with a broker, public sector agencies should be aware bring technical assistance and increased negotiating of how these relationships, and how commission from power on both premiums and claims. While they (re)insurers, will impact how a broker will place risk add additional cost into the process, they have the potential to positively influence outcomes and deliver 8-2-5. Taking selection criteria beyond price significant value for money. However, it is important for public sector entities to understand how brokers Price is an important factor in achieving a successful are remunerated, and how this may influence their placement, but it should not take precedence over interactions with (re)insurers. the quality of cover. As the experience of the 2010- 2011 Christchurch earthquakes in New Zealand shows, 36 At time this report was being written. 37 When this report was being written, the UK was considering whether a dynamic purchasing agreement that allows suppliers to enter during the framework period should be considered for the next iteration of the Insurance Services initiative 46 Catastrophe Insurance Programs for Public Assets - Operational Framework non-payment and disputes over claims, can and do not an active player in a scheme, can ensure that occur. Eligibility criteria for insurers and brokers to where future cost-effective opportunities to pass enter the tender process are being used to mitigate risk through the domestic market exist, they are not this issue, including factors such as; overlooked. For example, although the domestic market in Mexico did not have capacity to support the • Financial strength/credit quality; FONDEN program in its early years, the Ministry of • Regulatory authorizations; Finance consulted from the outset of FONDEN with • Prior performance in claims payment. the local insurance market association. Currently, both the Government of Mexico’s strategy for insurance of The terms and conditions of the insurance contract public assets, and the domestic market, have evolved should also be a key factor in selection, as these to the point that some public sector risk is being can vary substantially from (re)insurer to (re)insurer absorbed through the domestic insurance market. in areas such as coverage exclusions. It is vital that the terms of cover be reviewed by a party with the Where the insurance regulator is at arms’ length from necessary technical capacity, whether this be an the scheme development, early presentation of the internal or external function to the public sector agency scheme design is advisable within the implementation being covered. For most of the case study schemes timeline. The role of the regulator in the establishment reviewed, individuals with insurance expertise had of a scheme for public assets will vary significantly been hired out of the market and into the relevant depending on the specific institutional contexts in public sector entity to perform this function. Brokers economies. There will be scenarios under which the can also play a role in this process. insurance regulator is an integral part of the scheme design and implementation. In cases where the 8-3. Stakeholder engagement insurance regulator is not involved in implementation, and even where regulatory approvals are not To ensure the success and sustainability of a public needed, early engagement is prudent and often asset insurance scheme, it is vital to integrate the necessary when establishing an insurance scheme. An target end-users (i.e. public sector agencies) into opinion may be needed from the regulator that the the design process from the outset. For some of establishment of a scheme does not adversely impact the schemes reviewed, the scheme development the fair functioning of the domestic insurance market. teams undertook roadshows, where they travelled to spend time sitting with the target public sector Other entities that need to be engaged in scheme agencies for the scheme, as part of the consultation design, include the legal/compliance function within process. Consistent feedback from across case the relevant government entities, the audit function studies, was that while it was often difficult to secure (internal, and potentially external as relevant to time and commitment from the target end-users, the economy-specific context), and the insurance where this process was not conducted properly, regulator. Where the insurance regulator is at the public sector agencies did not feel a sense of arms’ length from the scheme development, early ownership of the resulting scheme and this impacted presentation of the scheme design is advisable participation rates. Strategies used to engage end- within the implementation timeline. The role of users included creation of user working-groups, end- the regulator in the establishment of a scheme for user engagement days to present scheme design, public assets will vary significantly depending on customer insight days where brokers and insurers the specific institutional contexts in economies. were invited to present to the end-users, and surveys. There will be scenarios under which the insurance regulator is an integral part of the scheme design Engaging with the domestic insurance market can be and implementation. In cases where the insurance beneficial, even where their role is not integral to the regulator is not involved in implementation, and even operation of the scheme. The role of the domestic where regulatory approvals are not needed, early market varies substantially across schemes, from engagement is prudent and often necessary when being an integral player in a framework agreement, establishing an insurance scheme. An opinion may to cases where a self-insurance strategy is taken and be needed from the regulator that the establishment there is no role for the private sector. Engaging with of a scheme does not adversely impact the fair the domestic insurance market, even when they are functioning of the domestic insurance market. 47 Catastrophe Insurance Programs for Public Assets - Operational Framework Moving forward This technical note highlights eight key operations for economy settings, it is important to recognize that the design and implementation of catastrophe risk these pre-conditions will not exist in many target insurance programs for public assets economies. In a low capacity environment where the government has limited fiscal capacity, the • Assess the financial protection gap for natural domestic insurance market is underdeveloped, and disasters. data is sparse, priority must be given to develop • Create a legislative and policy framework to these foundational elements, alongside any design enable the use of insurance where effective. endeavors for an insurance scheme. Policy-makers are • Determine the extent of centralization for the reminded that the process of setting up public asset insurance approach. insurance programs is time and resource-consuming, • Determine the nature of the vehicle or program and it is advisable to create an enabling environment • Determine the role of the private (re)insurance first and put in place the fundamental building sector. blocks through capacity building and domestic • Define the extent and nature of insurance market development. coverage. • Develop a postevent process. As demonstrated by the case studies, catastrophe • Undertake stakeholder and market engagement. insurance programs for public assets can bring a variety of benefits: taking pressure off of the fiscal It is important to note that this list is not exhaustive budget to free up resources for the most urgent and that the application of the proposed framework recovery activities post-disaster; enhancing risk should be tailored to an economy's specific context, management in the public sector; and developing demands, and objectives. the domestic insurance market, to name a few. However, catastrophe risk insurance is not a silver In the current circumstances in 2020, the risk of bullet and works best in combination with other natural disaster shocks is compounded by the ongoing disaster risk financing instruments. To realize climate COVID-19 pandemic, which further underlines the role risk management objectives and minimize disaster of resilient public infrastructure to maintain delivery of impacts on businesses and vulnerable households, critical services and protect livelihoods. The process a comprehensive policy package is required using a of establishing a catastrophe insurance program for range of tools to address risks of various frequency public assets will assist economies in their response and severity. Many economies adopt a variety of ex- and recovery endeavors in the long-term. Activities ante risk financing tools such as disaster reserves, such as the identification and valuation of key public contingent credit, and risk transfer instruments, assets, the establishment of data systems for public each applied to the layers of risk at which they are assets, and the clarification of ownership of the most effective, to produce the optimal financial contingent liability associated with asset damage, will protection against disaster shocks. In the context of help strengthen fiscal discipline and improve financial financial management of public assets, this means risk management of public assets in many economies, activities to strengthen both physical resilience thus speeding socioeconomic recovery as economies (e.g. resilient infrastructure, disaster risk reduction emerge from the pandemic. incentives) and financial resilience (e.g. insurance) to speed up response and recovery. Decision makers A number of pre-conditions for the feasibility of the should approach public asset catastrophe insurance different types of insurance schemes are highlighted programs as a component of comprehensive DRFI throughout this note. In the effort to adapt the strategies, not a standalone program. proposed operational framework to low-income 48 Catastrophe Insurance Programs for Public Assets - Operational Framework Annex 1. Case Study: The Queensland Government Insurance Fund (QGIF) A centralized state-level insurance “captive” In-house expertise is kept to ensure effective is managed as an internal program, provides operations and sustainable pricing. QGIF retains standardized insurance coverage for eligible state- actuarial and claims management expertise that has owned public assets, and uses a self-insurance contributed to the efficiency and cost-effectiveness scheme to access international reinsurance capacity. of the program. Pricing developed by the government actuarial function is based on claims histories and is Compulsory public asset insurance that has a supplemented by probabilistic modeling provided by dedicated budget line. The Queensland Government the commercial market. Because QGIF has oversight Insurance Fund (QGIF) is operated by the Queensland of the exposure data and risk profile, the team has been Treasury, and all state agencies have a specific budget able to challenge pricing from the commercial market line automatically funded to pay for QGIF insurance on its reinsurance contract; smooth the volatility of premiums, with a 100 percent compliance rate for the cost of the scheme for participating entities, and eligible assets. Essentially an agreement between the set effective terms for the insurance agreements with Queensland Treasury and the covered entities, QGIF participating agencies. QGIF also keeps the claims is fully integrated into government finances as the management function in-house and hires expertise government has adequate financial capacity to absorb from the private sector; the majority of staff members the contingent liabilities. Claims under the scheme have prior experience as claims administrators. come out of Queensland Treasury’s administered Bringing claims management in-house has allowed accounts, and provisions for future claims are the scheme to accommodate the existing emergency managed within the Queensland government’s long- procurement processes of the participating agencies, term investment portfolio. which facilitates the rapid recovery of assets. Benefits come from centralized risk aggregation. Scope of coverage is defined based on cost-benefit By aggregating risks into a single program, QGIF analysis and commercial benchmarking. QGIF applies consistent insurance terms and quality reviewed available commercial cover in the domestic control across all eligible agency assets and provides insurance market when considering the best comprehensive risk management across multiple available terms to meet the needs of the end users. agencies. QGIF has oversight of exposure and claims Although the scheme generally takes an inclusive data and provides regular claims experience reports approach to coverage, roads are not deemed cost- to participating agencies in order to keep the asset effective to cover because of the extensive size of managers connected to the data and to enable the road network, the poor quality of certain parts, feedback into insurance product design. QGIF covers the low appetite from the commercial market to 100 percent of the cost of rebuilding assets with no reinsure this risk, and the ongoing expenditure on deductible for participating agencies, thus minimizing restoration activities even without a disaster. The the risk of underinsurance. QGIF has also protected state agency responsible for transport infrastructure its participating entities from excessive upward or (the Department of Transport and Main Roads, downward pressure on pricing by smoothing the or DTMR) retains the cost of damage to the road volatility of premiums over time. network, although it has potential support from the Commonwealth Disaster Recovery Arrangements (DRFA) whereby the Commonwealth reimburses 75 percent of state losses for restoration of certain public assets when a minimum damage threshold is reached for the state overall. 49 Catastrophe Insurance Programs for Public Assets - Operational Framework Annex 2. Case Study: Japan Insurance Arrangements for the Shinkansen Rail Infrastructure A targeted use of commercial insurance for a specific Role of insurance in managing risks of infrastructure. layer of risk exists for the extensive nationwide high- Commercial insurance companies have the technical speed rail infrastructure. expertise and capacity to assess risks of disaster perils on the rail infrastructure and to quantify such risks with Explicit allocation of risk ownership. The allocation statistical modeling and analysis. The companies are of costs between public and private sectors is an able to design policies that use technology (artificial important policy decision for large public infrastructure intelligence [AI], satellite imagery, drones, etc.) and projects. Public assets in Japan are in most cases expert claims handling to enable swift payment after self-insured, with a restoration budget being made a disaster occurs. Insurance as a de-risking pool also available by the responsible line ministry—even in helps to attract quality finance and investment from some cases where the asset is privately operated. the private sector. For certain assets, the government provides a cost- sharing arrangement between public and private Targeted use of risk transfer to protect government sectors. As an example, the private financing budget. JRTT introduced an indemnity insurance initiative (PFI) contracts for Sendai Airport mandate policy for the Shinkansen rail infrastructure to reduce insurance purchase from the private operator, but the the contingent liabilities for the government and government assumes responsibility for any costs in to minimize budget disruption caused by natural excess of this coverage. disasters. The program insures assets including viaducts, bridges, tunnels, embankments, railroad Cost-sharing framework between public and private tracks, crossties, overhead wires, utility poles, and sectors. The Shinkansen bullet train network is other relevant facilities and equipment, but it excludes owned by the Japan Railway Construction, Transport, mechanical and electrical breakdown. Among the and Technology Agency (JRTT), which is the state- covered perils are fire, lightning, flood, landslide, backed corporation that builds and owns the network earthquake, and tsunami; damage from volcanic and receives its budget allocation from the Ministry of eruption is not covered. Land, Infrastructure, Transport ,and Tourism (MLIT). The Shinkansen trains are operated by Japan Railways Arrangement of a layered insurance framework. For (JR) Group companies. Under the current cost- the Shinkansen rail infrastructure insurance program, sharing framework, members of the formerly state- the bottom layer of risk up to 1 billion yen (US$10 owned JR Group lease the bullet train’s infrastructure million) is retained by the JRTT, because insurers in from the JRTT using fixed price, 30-year leases that Japan did not consider it feasible to underwrite losses have been based on estimated earnings from rail below this amount. A panel of insurers underwrite operations over 30 years. an indemnity policy for losses up to approximate US$100 million and coordinate access to reinsurance capacity.38 The targeted use of commercial insurance for the middle layer of risk helps reduce disaster related contingent liabilities for the government, protects the budget, and enhances fiscal stability. 38 Tokio Marine Holdings, Inc. 2019. “The Role of Insurance Industry to Strengthen Resilience of Infrastructure—Experience in Japan.” APEC seminar on Disaster Risk Finance. 50 Catastrophe Insurance Programs for Public Assets - Operational Framework Annex 3. Case Study: Mexico’s National Disaster Fund (FONDEN) Mexico provides an example of a highly centralized Multiple views of risk for pricing. FONDEN use and structured approach with the creation of the modelling offered by the commercial market for Natural Disaster Fund (FONDEN) in 1996 to support risk pricing, based on catastrophe risk models from disaster relief for the affected population and fund global third party vendors. This is supplemented reconstruction of damaged public infrastructure at by its own in-house model R-FONDEN jointly the federal and state level. developed by the Ministry of Finance and Public Credit (SHCP) and Universidad Nacional Autónoma Comprehensive and layered approach to disaster de México (UNAM) to provide an internal view of risk financing. By aggregating risk into a centralized risk. Both R-FONDEN and the third party vendor vehicle, FONDEN increases the market demand for views of risk are probabilistic in nature, providing risk and produces favorable pricing. FONDEN was a sophisticated approach to pricing that extends established as a trust in BANOBRAS, the state-owned beyond the historical record of damage and loss. development bank, allowing it to aggregate risks from across departments and states. FONDEN determines Integration of technology and established processes its retention capacity based on its accrued funds, its to facilitate rapid settlement and recovery. FONDEN legislated annual contribution from the fiscal budget, uses a web system for rapid sharing of post event and individual property catastrophe insurance covers damage information—including geo-referenced in place for specific departments (that reduce liability evidence of damage—to facilitate quick agreement through the vehicle). The program then uses risk on a loss figure by the responsible FONDEN transfer to manage its contingent liability, including committees and the commercial parties involved. the issuance of Catastrophe Bonds with parametric The FONDEN commercial reinsurance program uses triggers, and a substantial reinsurance program with protocols developed for FONDEN’s determination the international markets. of its own payouts to federal and state entities: engineers from local and federal governments go Ways to incentivize insurance uptake with into the field alongside the reinsurance loss adjustors. conditional access to financing. FONDEN covers 100 percent and 50 percent of the reconstruction of Early stakeholder engagement and domestic federal and state assets, respectively. To incentivize market development. The Government of Mexico active financial management, FONDEN coverage consulted from the outset of FONDEN with the drops from 100 percent to 50 percent for eligible local insurance market and determined that it did federal assets and from 50 percent to 25 percent not have the capacity to support the program. for state assets, where the asset remains uninsured Currently, both the government’s strategy for following a prior disaster claim. If assets are uninsured insurance and the domestic market have evolved after two claims to FONDEN, they become ineligible sufficiently, such that domestic carriers absorb for support. This has encouraged local government some public sector risk. entities to draw from the best-practice applied at the federal level to seek commercial insurance coverage. 51 Catastrophe Insurance Programs for Public Assets - Operational Framework Annex 4. Case Study: The New Zealand Local Government Insurance Corporation Limited and the Local Authority Protection Program Civic Assurance (now Civic Financial Services) was approach to pricing is applied for the LAPP through a mutual insurer that was owned by local authorities risk-based allocation of member contributions to the in New Zealand. It was established by the 1960 fund with premium discounts for those members Municipal Insurance Act as a cooperative for local who display strong risk management practices. The authorities, and prior to the Christchurch earthquakes, LAPP fund retains some risk, but it also passes risk on it was underwriting general property risks for local through reinsurance. One fund objective is to reduce authorities. The Local Authority Protection Program reliance on reinsurance to manage the volatility of (LAPP) is a separate mutual insurance arrangement reinsurance costs from market cycles. An additional for specialist infrastructure of local authorities in component is added into its insurance pricing to allow New Zealand. LAPP was set up in 1993 by Local for the accumulation of a fund to achieve this goal. Government New Zealand and Civic Assurance. The experience of Civic Assurance has provided A mutual insurance arrangement to overcome a a cautionary lesson. When Civic Assurance ceased market gap. The LAPP was established to cover underwriting property catastrophe risk after its specific exposure: underground water infrastructure. financial strength rating was downgraded following The vehicle was created in response to the following: the Christchurch earthquakes, it was unable to renew or secure new reinsurance capacity. Before the • Under the Civil Defence Emergency earthquakes, it had built a sizeable insurance portfolio Management Plan, the central government and reinsurance program. However, it suffered sought to encourage local governments to plan substantial underwriting losses from the quakes; the financially for disasters. To achieve this goal, outstanding claims liability in December 2012 was the government reduced post-disaster funding estimated to be in excess of $800 million (Auditor provision to cover 60% of damage for local General 2012).39 Reinsurance bore a substantial part governments, but only for uninsurable assets; of these costs, although not all members of Civic’s • The domestic insurance market did not have reinsurance panel honored their obligations, which appetite or technical capacity to underwrite meant the insurer was forced to enter disputes over underground water infrastructure of local nonpayment (New Zealand 2020).40 Civic Assurance authorities in 1993. was not able to secure reinsurance after the Christchurch events; consequently, it ceased offering These two factors led to creation of the LAPP to property catastrophe coverage. cover the share of “uninsurable asset” liability that fell to Local Authorities for underground water Development of the domestic insurance market. infrastructure. The LAPP Fund is a distinct legal entity The LAPP played a facilitating role in opening the (a trust fund). Civic Financial Services (formerly Civic domestic insurance market to the highly specialized Assurance) provides administration management. underground water infrastructure that previously had been considered commercially uninsurable. The Pricing to avoid cross-subsidization, to incentivize domestic insurance market in New Zealand has now risk management, and to manage reliance on the evolved to the point that it is able to compete with the international reinsurance market. A risk-based LAPP on underwriting those risks. 39 Controller and Auditor General of New Zealand, Insuring Public Assets, 2012. 40 New Zealand Dispute Resolution Centre, 2020, https://www.nzdrc.co.nz/site/commercialdisputes1/files/Court%20Decisions/NEW%20ZEALAND%20 LOCAL%20AUTHORITY%20PROTECTION%20PROGRAMME%20DISASTER%20FUND%20v%20THE%20NEW%20INDIA%20ASSURANCE%20COMPANY%20 LTD%20CIV-2012-404-7453%20[2013]%20NZHC%201327%206%20June%202013.PDF. 52 Catastrophe Insurance Programs for Public Assets - Operational Framework Annex 5. Case Study: Enforcement of Minimum Standards of Insurance Protection for Transport Infrastructure Managed as PPPs in Colombia Following the widespread flood damage to uninsured Ministry of Finance and Public Credit (MHCP) is public assets during the 2010–11 La Niña season, responsible for reviewing new concession contracts the Government of Colombia set out to improve between the National Infrastructure Agency (ANI) standards of insurance for transport infrastructure and potential concessionaires. The MHCP requested managed as Public-Private Partnerships (PPPs). technical assistance from the World Bank in 2012 to introduce targeted, technical guidelines Low compliance for insurance adoption. In on insurance requirements for PPPs based on Colombia, each public entity at both the national and international best practice as well as local context. subnational levels is responsible for insuring its public These recommendations have been integrated into assets with its own budgetary resource as mandated the Master Insurance Contract, with which PPPs by law. Public asset insurance is required by Article must comply. 107 of Act 42 of 1993, which makes it compulsory for all entities and individuals managing public assets Enhanced minimum standards of insurance to purchase insurance policies or special funds. The arrangements for transport infrastructure under failure to do so could lead to disciplinary action as PPPs. The additions to the Master Insurance stipulated in Article 48 Act 734 of 2002 (Disciplinary Contract include: Code) (World Bank 2017).41 Despite this longstanding legal requirement, the severe La Niña season in 2010- • Minimum requirements for insurance contract 11 revealed that public assets—and particularly PPP participants such as insurers, reinsurers, local infrastructure—had not been properly insured. While intermediaries, reinsurance brokers, and loss the total replacement costs for public buildings were adjustors. estimated at US$89 billion, only US$400 million was • Minimum requirements for the terms and collected from private insurance policies (World conditions for certain types of insurance; and Bank 2013a).42 The public transport sector suffered • Minimum information requirements for the greatly, with damage to primary and secondary roads risks to be insured, which will also be provided approximated at US$1.7 billion (World Bank 2013b).43 to the reinsurance market. By stipulating a minimum standard for information required for Insurance requirements for transport infrastructure underwriting, the Government of Colombia will PPPs as government priority. The Government of ensure broad access to high quality risk carriers. Colombia has been developing and implementing a Disaster Risk Financing and Insurance (DRFI) strategy Subsequently, the first contracts of the fourth since 2012. One priority area of the DRFI strategy generation of concessions under PPPs between ANI is to improve insurance protection in concession and the concessionaires were approved in compliance contracts for transportation infrastructure. The with the new technical guidelines in July 2013. 41 World Bank 2017. “Financial Risk Management of Public Assets against Natural Disasters in APEC Economies -World Bank Technical Contribution to the APEC Finance Ministers’ Process”. 42 World Bank 2013a. “Insurance of Public Buildings”. 43 World Bank 2013b. “Insurance of Public Infrastructure Under Concessions—Colombia”. 53 Catastrophe Insurance Programs for Public Assets - Operational Framework Annex 6. Case Study: The UK Department for Education’s Risk Protection Arrangement (RPA) An internal program of the UK Department for risk reduction. This is acknowledged by the RPA Education to self-insure schools, the Risk Protection management team, who use alternative strategies Arrangement (RPA) was established in 2014 as an to promote risk reduction. This includes using the optional alternative to commercial insurance and surplus from the scheme to invest in resilience, the with the aim of reducing insurance costs. application of deductibles so that risk experience is partially shared across the insured and insurer, and Risk retention versus private sector insurance. the delivery of risk management workshops and risk Self-insurance is widely used in the UK, where the audits for school trusts. substantial fiscal space of the government to meet post-disaster financial needs in the absence of A voluntary approach to empower asset managers. insurance makes the approach viable. The UK RPA The participation rate was about 60 percent of the was established following an analysis that a self- total academies in the UK in 2018.45 The rationale for a insurance approach could save the Department for voluntary approach was to protect freedom of choice Education about £100 million per year in costs (UK in financial management for managers of public Department of Education 2014).44 Self-insurance assets—keeping the experience of risk and financial by pooling risks across schools was a viable option, decision-making in the same place. because the Government was able to assess the liability from the scheme, and found that this could Managing data gaps in scheme design and pricing. be absorbed by budget capacity. The existence A comprehensive claims history for participating of a strong actuarial function facilitated this—the schools was not available to support scheme design. UK Government Actuary’s Department. Since the The RPA team had to collate this data as part of scheme launch, downwards pressure on commercial the exercise. Initial pricing was established using pricing for school trusts has been observed, such that survey results from schools on their past damage insurers are now competing effectively with the self- and claims experiences, alongside the provision of insurance scheme. industry benchmarks for claims from similar risks being underwritten elsewhere in the market. The Linking cost of cover to capacity to pay. Many RPA team worked with a broker who provided these schemes use a risk-based approach to set pricing. The industry benchmarks, and also with a claims service UK RPA is an exception, where schools pay a fixed provider to understand likely claims patterns. There per-pupil amount that is reviewed annually by the were challenges with this approach; namely that Government Actuary’s Department to ensure that the the quality of information from the surveys varied overall income for the scheme is adequate given its from school to school, and that the performance contingent liabilities. The riskier schools are therefore of the industry benchmarks in capturing actual having their cover subsidized by those with better claims experiences has not been strong. However, claims experience. The advantage of this approach this approach offered a starting point to an entity is that it links the cost of cover to the capacity of operating in a data poor environment, and as the institutions to pay; schools in the UK are funded scheme develops its own claims experience over (largely) on a per-pupil basis. The disadvantage of the years, this is being blended with the industry this model is that it does not use price to incentivize benchmarks to improve pricing. 44 The Department for Education, Risk Protection Arrangement for Academies, Willis Towers Watson, 2014, https://assets.publishing.service.gov.uk/government/ uploads/system/uploads/attachment_data/file/391343/RPA_actuarial_analysis.pdf. 45 Although the scheme has been expanded to cover other types of state-funded school as of 2020 54 Catastrophe Insurance Programs for Public Assets - Operational Framework Annex 7. Case Study: UK’s Insurance Services II Framework (ISII) The Insurance Services II Framework (ISII) is a Capacity building for participating entities. The ISII nationwide procurement framework for public sector framework facilitates and provides some level of entities in the United Kingdom (UK). It standardizes guidance for public sector entities throughout the and facilitates access to commercial insurance. process of insurance purchase. Framework users also benefit from capacity building and templates Filling a market gap for insurance of small public on how to engage the market prior to placement; sector entities. Public assets are generally self- data collection; portfolio presentation; and legal insured in the UK as the government agencies have compliance requirements. Brokers in the framework sufficient fiscal capacity to meet the expenditure offer a variety of fee-based technical services to requirement arising from contingencies including clients, which can be purchased if needed. natural disasters. However, smaller public sector entities, e.g. universities, fire services and certain Strategic risk structuring to increase bidders. The local authorities, may not have the capacity to self- framework splits risk by class of business (type of insure, and cannot access the insurance market on asset/operation) so that insurers can bid on specific favorable terms due to their small size and lack of types of public assets rather than an entity’s entire bargaining power. Through a collective insurance asset portfolio. This allows the participation of framework, the ISII is able to create the economies specialist and smaller insurers, which increases the of scale and offer value for these entities. diversity within the framework and fosters domestic insurance market development. Partially centralized insurance system with some degree of freedom. The framework includes 12 Limited competition. Although the ISII framework brokers, and 27 insurers (as of August 2018) which promotes competition between service providers have been pre-qualified for ISII based on a series to drive down insurance pricing, it is challenging to of criteria including past performance and financial create the right amount of competition to appeal strength. An overarching contract defines the to both the supply and demand side. The number relationship between the authorized brokers and of prequalified providers (insurers/brokers) must insurers, and the central public sector procurement be somewhat limited to make participation an agency (CCS). Individual insurance contracts are attractive option to them (otherwise the competition then developed upon request under this umbrella on risk will be too high to warrant the process for agreement. This overarching agreement connects participating). On the other hand, the participating the market and the framework users (public entities) providers must also be broad enough to protect and provides quality assurance and protection to diversity of choice for the end users (public sector both sides, creating efficiency in the market which entities). The bidding process for the ISII framework would not have existed otherwise. The system has two points of competition: 1) at framework provides a large range of options on insurance cover, establishment to determine the pre-qualified service allowing some extent of freedom for public sector providers; 2) at the point of access to the framework entities to choose the level of coverage best suited by public sector agencies looking for cover, where to their needs. the brokers can compete for specific business. 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