Fund aims to make the market for climate insurance

After drought and flooding damaged the maize crop in the Mposa area of Machinga, Malawi, Alice (pictured) was one of those to successfully apply for a loan from VisionFund, a network of microfinance institutions based around the developing world.

She invested it in growing vegetables and used a further loan to buy fertiliser and fuel for a communal pump, which irrigates her vegetable garden. She could then sell the vegetables at the local market. This prevented her family from having to take measures like splitting up to find employment elsewhere.

These types of loans allow families and businesses with little access to traditional insurance coverage to keep the show on the road after extreme weather events. But the microfinance firms themselves can lack the liquidity and capital needed when climate-related disasters strike.

A new fund run by Global Parametrics is aiming to change that, by offering these companies the protection needed for resilience, as part of the world’s largest non-government climate insurance scheme.

The programme provides pay-outs to VisionFund’s microfinance institutions in Malawi and five other developing countries after disasters.

But the organisation has a far grander goal beyond these pay-outs. It wants to create a market that will flourish without state support — it is backed by both the UK’s Department for International Development (DFID) and Germany’s government-owned KfW.

Unlike most financial institutions, it actually aims to make itself more irrelevant over time, by handing over the reins to the private sector after forging a path.

The organisation developed from a motivation to allow institutions to hedge their exposure to natural disasters in developing countries through innovate financial products, according to Hector Ibarra, chief executive officer at Global Parametrics. 

Ibarra previously worked at the World Bank, where he designed and placed more than $1bn of weather risk transfers in low and middle income countries. 

In discussions on the topic, three market gaps were identified, and the structure of the resulting company is aligned to those gaps.

The first was data and modelling capabilities for developing countries. One subsidiary of Global Parametrics now performs modelling. The second related to structuring the financial products; Global Parametrics Ltd. structures the contracts and is regulated by the Financial Conduct Authority.

The third was to create a fund as a testing ground to encourage private sector involvement. This experimentation was deemed necessary because of the difficulty in getting private money to venture into areas with no track record and limited models. Global Parametric’s Natural Disaster Fund will perform this task.

Global Parametrics sees itself as protecting the solvency of the institutions it works with and aims to influence how they allocate capital.

Reflecting its holistic approach, its key performance indicators relate to helping firms expand and invest more in priority areas of development. It looks at the balance sheet and the footprint of organisations and how they can improve.

“I usually explain to clients that we become like an outsourced CFO,” said Ibarra.

It provides data and coverage for VisionFund’s partners in Kenya, Malawi, Mali, Zambia, Cambodia and Myanmar, reaching up to four million people and more than 690,000 families. The agreement between the firm and VisionFund for a data services contract and a risk transfer contract started on April 9.

It will meet 1% of the G7 goal to increase access to insurance products that protect against climate risk for up to 400 million people in developing countries, the firm says.

The coverage comes in two parts: contingent liquidity and risk capital.

Contingent liquidity, in the form of a loan, is needed so that organisations can provide emergency recovery loans. It covers weather events with a return period of one in five years.

This is not in fact provided by the Natural Disaster Fund, but by the InsuResilience Investment Fund, managed by BlueOrchard Finance and backed by KfW. But it is Global Parametric’s model that is used to provide the triggers for the loan to be paid out.

Risk capital is paid out by the Natural Disaster Fund for events with a return period of between 10 and 15 years. This is to protect the balance sheets of the microfinance vehicles.

As Global Parametrics grows, it is looking to work with more partners and clients as well as VisionFund.

Ibarra believes investors are keen to allocate capital to this area, but up until now have not been able to find a way to do so.

The fund is preparing to take on an advisor for a roadshow, although it says it is unlikely to do any active fundraising until the end of the year. But it has already been having discussions with investors, and has seen interest in its modelling and origination capabilities. Reinsurers and the insurance-linked securities (ILS) sector are said to be attracted to the scheme.

It is targeting $200m in the first three years.

The fund is pitched particularly at impact investors: Ibarra suggests the return will be somewhere between a pure market return and a blended finance return.

Ibarra believes its government-backed status gives it a particular USP: “It’s a fully private entity, but the government has an oversight with regards to the developmental objectives.”

“Investors have one of the most experienced governments in the world monitoring the developmental impact of the entity,” he added.

The firm’s ambitions extend to modelling, where it sees its technique as cutting edge.

The most basic form of measuring climate risk involves looking at empirical data and taking a view based solely on that. Then you can use statistical methods on that data to create a simulation. “This is where most of the industry is,” said Ibarra.

But Global Parametrics has a third way, from using what it calls physical models as well. It looks globally at a full spectrum of weather related events, and combines different weather data to create a “three dimensional view of the world”, Ibarra said.

“We create this approach which is a hybrid where you have the empirical world, you have the statistical world and you have the physical world all in one system, and that’s the way we can extrapolate to areas of the world that do not have data,” he said.

Its IT platform can work at various resolutions, but for insurance applications the firm believes results are more reliable at one of about 25km by 25km.

And in keeping with its plan to develop the whole sector, the firm aims to foster an open-source community to improve the models, particularly involving research institutions.

“We are not a modelling agency,” Ibarra noted. “We just developed this first technology because we wanted to jumpstart the conversation about being able to do solutions in developing countries.”

But building such an open-source platform “is not trivial”, he said. In particular, the computing power needed is immense; Ibarra is looking to the wider IT community to lend a hand.

Traditional derivatives experts also have a role to play in the scheme.

Working on a pro-bono basis, law firm Mayer Brown helped draft and structure Global Parametrics’ derivative contracts using a tropical cyclone index and a soil moisture index. The way the contract works avoids the need to wait for cash for a long time after a disaster and has a certain simplicity.

“You’ve got the capital, you’ve got the liquidity behind it, you’ve got an objective method of determining the parametric trigger for the payment,” said Ed Parker, global head of the derivatives and structured products practice at Mayer Brown.

They used an ISDA Master Agreement, but with the ability for each separate arrangement to use a master confirmation with a transaction supplement, where for example the geographic location can be specified. “You’ve basically got a lot of flexibility there,” said Parker.

When a variable exceeds a certain level, there is a strike breach and the payment can be made.

DFID and KfW together own around two thirds of Global Parametrics. DFID has also put £25m into the Natural Disaster Fund in order to collateralise the derivatives offered to clients fully. But it sees this £25m as an investment, returnable after 20 years.

DFID told GlobalCapital it put money into fund “to increase access to financial protection against natural disasters in developing countries by supporting innovative transactions that will catalyse private sector provision of this kind of protection using either insurance or insurance-linked securities”.

The programme is part of wider work at DFID aiming to boost resilience in developing countries through disaster risk finance: both through increasing understanding of it and spreading access to it.

The government has made its move: now it is waiting for private investors.