Cat bonds: Why is the Italian horse not drinking?

Despite the relatively high exposure of Italian businesses to natural catastrophe risks, they remain underinsured and underprepared for events such as earthquakes, with the main barriers being both cost and a lack of awareness of the potential benefits offered by traditional insurance and catastrophe bonds. For Italian companies to take this very real risk more seriously and invest in the protection offered by the insurance and capital markets, education and awareness of the risks and the potential solutions is needed. A focus on business continuity benefits, government incentives for risk management and transfer measures, and possibly regulatory pressure, are also needed. These are some of the key findings of research carried out by Italian risk management association Anra, along with the University of Milan, the University of Parma and the University of Florence, which was recently presented by the association. The research was based on a survey conducted among 647 Italian companies and provides analysis both from a legal and economic perspective. The main conclusion from the survey is that catastrophe bonds can play a significant role in responding to the need for cover against catastrophe risks. But this will not happen automatically and there is a need for greater knowledge about the benefits offered by these instruments. The first phase of the project was an investigation among Italian companies to understand their views on the subject. The majority (61.4%) reported a concrete exposure to possible catastrophic risks. Four out of ten companies that took part think they are vulnerable on several fronts, in particular those with operations in a hydro-geologically complex area that entails a higher exposure to earthquakes and floods. Some 15.6% of those who took part in the survey were unable to name a specific vulnerability, but did express concern about the consequences that catastrophic events can have in terms of business interruption, particularly from damage to infrastructure and transport. Some 78% of Italian companies declared that they had never experienced catastrophic damages. But those that have been victims of such events suffered very serious consequences. One third suffered losses of between €1m and €2m, while one in five incurred losses of between €5m and €10m. For 10.4% of the companies surveyed, the direct economic loss was greater than €50m. The proportion of companies that have purchased instruments for hedging catastrophe risks was 60%. The majority (96%) rely on an insurance policy – usually an all-risk or multi-risk policy – and sometimes cover that carries specific natural catastrophe coverage. Only 13.27% of the companies surveyed use financial instruments, mainly derivatives or BTPs (interest rate futures on long-term government bonds). Some 17.35% have implemented other types of measures, such as risk analysis and loss prevention activities with residual risk retention, or have equipped themselves with disaster recovery sites and/or business continuity plans. The risks covered are mainly property (78.57%), followed by business interruption (51.79%) and casualty (33.93%), while 13% also insured against cyber-related risks, pollution and professional liability. For those Italian companies that have never purchased coverage for catastrophic risks, the main reason given was that the consequences and possible damages are perceived as not relevant. The other main reason was excessive cost. Other reasons given were perceived lack of exposure or ignorance of hedging instruments. When asked what could encourage or push the use of insurance products for natural catastrophes, the main answers were an increase in natural disasters caused by climate change, the possibility to guarantee business continuity, the allocation of government incentives and/or new regulatory obligations. The survey also looked at what is actually offered by the insurance market currently to help cover these risks. The study found that 90% of insurers offer solutions for catastrophe risks, mainly within all-risk or multi-risk policies (34%). These are standalone coverage in 31% of cases and as an extension of another policy (mainly property) in 27% of cases. Most of the solutions (77%) cover all catastrophe risks, but only 10% include indirect damage from business interruption. The survey therefore asked whether the company issues, or has ever issued, catastrophe bonds or similar products. The respondents were asked to specify the characteristics of bonds issued and give reasons deemed to be an obstacle. The vast majority (82%) of insurers were not aware of the characteristics of the catastrophe bonds issued or declared that they cannot disclose them. The remaining 18% gave various responses, including three-year products to cover earthquakes, floods and storms, hybrid investment products, first-risk or absolute full-value contracts, and catastrophe bonds to cover the accumulated risk. Almost half of the insurers that took part in the survey were not familiar with catastrophe bonds or consider them a complicated tool to understand and therefore to offer to customers. Some 13% said catastrophe bonds were excluded for strategic business decisions, while 10% said that because they have a small to medium-sized customer base, their needs are sufficiently covered by traditional insurance products. The key conclusions of the survey were: From a financial point of view, catastrophe bonds provide important economic benefits compared to standard insurance coverage, but there is work to be done on the pricing methodology and its transparency for customers. The relative lack of use of catastrophe bonds – as evidenced by the survey – is also linked to the lack of knowledge of these tools and widespread confusion about how they differ from traditional insurance coverage, among companies and especially among operators in the insurance sector. There are legal constraints in Italy that can limit both the demand for and supply of catastrophe bonds as a possible alternative to insurance coverage. Specifically, there is a lack of standard contractual forms and guidelines that could facilitate their dissemination.

Cat bonds: Why is the Italian horse not drinking?

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