capital markets, comprising nearly 50 times the capital of the world insurance markets', are well suited to absorb some of the risks and financial payouts generated by catastrophic events.

Various financial market mechanisms have evolved for this purpose, of which 'catastrophe bonds' are a prime example of securitizing insurance risks. Such bonds, which are issued publicly to investors, generally pay interest much above the market rates in order to compensate for the risk of interest or principal defaults by the borrower, in the event of a major catastrophe. However, since the borrower's intermediary can invest the funds in risk free securities (to be used only on a 'catastrophe day'), the net cost to the borrower is reduced substantially and approaches that of traditional reinsurance.

In addition, recent innovations such as basing 'disaster payouts' on objective hazard intensity measurements (e.g.: wind speed, earthquake intensity) provide more confidence to investors that underlying damage assessments cannot be manipulated by the borrower/insured, and permit accessibility and transparency in the risk assessment process. Given that such bonds are linked to events unrelated to the traditional financial markets, they also serve as a portfolio diversification hedge for investors. The actuarial probability of default of such bonds is generally lower than similarly rated investment securities already actively traded in the capital markets.

Governments, particularly in the developed economies in Europe and the U.S., have already witnessed the 'exit' of insurers from private markets prone to natural catastrophes and have therefore established public/private collaborative schemes to insure catastrophic cover through risk pooling (and removal of catastrophe risks from company balance sheets), coupled with group reinsurance arrangements and last resort credit backup. Capital markets have been willing to provide credit support for insurance purposes since projections of future premiums and other charges can suffice to secure such debt and its repayment, if utilized. Thus, capital markets have been able to increase insurance capacity, particularly at the upper loss layers which could strain the balance sheets of insurers and reinsurers alike. For smaller vulnerable economies, such support might be catalyzed by multilateral institutions not only to assure coverage capacity, but also to help stabilize the premiums paid through long term funding arrangements.

To a large extent, however, developing countries facing high risks of natural catastrophe exposure have not had the market access or the industry collaboration required to tap into the latest financial structures and instruments which could optimize their risk coverage and premium terms, taking into account the priority to reduce insurance market volatility and permit sustainable and affordable financial protection. Multilateral institutions can help support the development of broader risk pooling schemes with supporting credit enhancements, to provide actuarially cost effective arrangements to manage catastrophic risks, while promoting efficient markets.

l Source: Goldman Sachs; U.S. Insurance Services Office, FIBV International Federation of Stock Exchanges, Guy Carpenter / Marsh McLennan.