Thomas Mutsvene, Heinz Eckart Klingelhoefer
Abstract
The insurance sector has been failing to provide cover for some risks of low frequency but high severity which could threaten their underwriting capacity. Such risks come in the form of natural disasters, often driven by climate change. With insurance sector regulators specifying maximum threshold values for each insurer, most insurers are left shunning these risks. These risks require insurers to consider alternative risk transfer (ART) mechanisms to increase their underwriting capacities. This paper looked at the possibility of using catastrophe bonds as an alternative risk transfer method to increase the underwriting capacity of South Africa’s insurance sector and provides insight to regulatory authorities regarding the implementation of CAT Bonds in South Africa (SA). Using a mixed study, we built a regression model for analysing the predictive content of CAT Bond impact on high-severity losses using terms and conditions of CAT Bonds as variables. Insurers’ and reinsurers’ reports, regulatory bodies’ reports, and the legal framework in South Africa were reviewed to assess how the use of alternative risk transfer mechanisms like catastrophe bonds may change the financial cover landscape. Through literature review, an operation model of CAT Bonds as an ART mechanism for South Africa was designed. Findings showed that combined catastrophe losses are driven by variables such as size and frequency of catastrophe losses as well as fluctuations of reinsurance prices and rate-on-line movements. As more losses come with more events, the regression that CAT loss directly drives overall combined losses while use of catastrophe bonds increase the insurers’ and reinsurers’ underwriting capacity was confirmed. Adopting CAT Bonds include improving the state of preparedness of an economy towards natural disasters and offering an alternative to reinsurance. Reinsurance regulators are recommended to develop policies that make it easier to transact with these bonds and to push for legislative provisions allowing (re)insurers and government departments to use them.