Indonesia: Liquidity Relief in the Aftermath of an Earthquake

Located on the Pacific Ring of Fire, Indonesia is one of the most seismically active regions globally. According to International Financial Corporation (IFC), some 12 million individuals in the country are currently exposed to seismic hazards, representing a total economic exposure of USD 79 billion in the country.

 

Financial Institutions in Indonesia

 

The financial landscape in Indonesia is dominated by rural banks and microfinance institutions that have extensive outreach to households and Small and Medium-sized Enterprises (SMEs) across the nation. As the backbone of Indonesia’s growing economy, these financial institutions provide microloans to SMEs and help stimulate local economic development. However, as individual policies are small in size and geographically concentrated, these financial institutions have limited opportunities to diversify their portfolio. As a result, rural banks and microfinance institutions in Indonesia are highly exposed to natural catastrophes risk.

On top of physical loss of assets, natural catastrophes can create liquidity shocks for financial institutions. In the event of a catastrophe, households and SMEs may suffer huge losses and be unable to service their debts. In such cases, financial institutions are forced to restructure their loans and suffer great losses in the process. According to the World Bank, major financial institutions in Yogyakarta (Java) or Padang (West Sumatra) could lose up to 35% of their annual income following a natural catastrophe.

Huge catastrophes also erode financial institutions’ capital reserves and cripple their ability to lend to other household and SMEs. Without significant recapitalization, they are forced to stop lending activities at a time when the community is in greatest need of resources for recovery and rebuilding, further impeding the economic recovery process. As such, the Government of Indonesia recognizes the importance of supporting rural banks and microfinance institutions in managing catastrophic risk.

 

Earthquake Index Insurance (EQII)

 

 

Figure 1 Zonal Map for EQII (Maipark, 2016)

 

In 2013, the Indonesia Ministry of Finance drafted a decree to develop earthquake insurance products targeted at financial institutions. With support from International Finance Corporation (IFC) 1 , PT. Asuransi MAIPARK (Maipark) 2 launched an index insurance product that aims at providing rural banks and microfinance institutions with liquidity in the aftermath of an earthquake.

Unlike traditional earthquake insurance which indemnifies actual losses, EQII disburses payouts based on a pre-defined index (Modified Mercalli Intensity, MMI). This approach negates the need for lengthy and laborious loss assessment and allows financial institutions to continue to lending operations to the community in the aftermath of an earthquake. The following section outlines the premium rates and payout structure of the programme.

 

A. Premium Rates

 

In the EQII programme, Indonesia is categorized into three distinct zones, each representing a different level of seismic risk (Figure 1). The premium rates for each zone are correlated to the underlying seismic risk. Financial institutions interested in buying this new insurance product will need to provide their aggregate loan portfolio data per district to the insurer. In practice, a bank who operates in Zone 3 (High risk), would be charged a higher premium as compared to another bank who operates in Zone 1 (Low risk).

In order to cater to the wider market, EQII has also outlined two pricing plans for the programme (Table 1). The premium rates across all three zones in Pricing Plan A is significantly higher than those in Pricing Plan B. For example, if a bank who operates in Zone 1 is interested in obtaining a coverage of $100,000, it has the option of going for Pricing Plan A (premium rate of $480) or Pricing Plan B (premium rate of $90). By opting for the more expensive pricing plan, the bank will receive a higher payout amount in the event of a catastrophe (see Table 2).

 

Table 1 : Premium Rates for EQII (Maipark, 2016)

Location

Premium (as % of coverage)

Pricing Plan A

Pricing Plan B

Zone 1

0.48 0.09
Zone 2 3.48

0.56

Zone 3 8.11

1.88

 

B. Payout Structure

 

Payouts for EQII are triggered by earthquake intensity, as indicated by the Modified Mercalli Intensity (MMI) scale. MMI data in the Indonesia are reported by entities such as the Indonesia’s Meteorological, Climatological, and Geophysical Agency (BMKG) and the United States Geological Survey (USGS). Payout is dependent on the pricing plans that the insured has purchased, and it generally increases with the event intensity.

 

Table 2 : Payouts as % coverage for EQII (Maipark, 2016)

Intensity

Payouts (as % of coverage)

Pricing Plan A

Pricing Plan B

VI

5%

0%

VII 10%

5%

VIII

25% 15%

IX

45% 30%
X 75%

50%

XI 85%

75%

XII 100%

100%

 

According to Maipark, the MMI data can be verified and released as early as 24 hours after the event, which allows insurers to start processing payouts to affected financial institutions in a timely manner. This is important in providing liquidity and supporting the communities to rebuild and recover at the soonest possible time.

 

Moving Forward

 

Presently, EQII has met with limited success during the initial stages of implementation. This is mostly attributed to the lack of demand from the financial institutions for the product. Hence, it is crucial for insurers to develop extensive marketing and education materials to reach out to financial institutions across the nation.  Publicity campaigns, educational workshops and ease of enrolment will gradually lead to an increase in the uptake of insurance in the long run.

Furthermore, it is important for insurance companies to continuously improve EQII’s product design to increase its relevance in the market. Here are some suggested areas of work that could further improve EQII’s scalability and sustainability.

 

  • Provision of subsidies to stimulate demand in the early stages of implementation.

 

  • Enforcement of compulsory participation for insurers operating in both high and low-risk areas to reduce adverse selection and moral hazards.

 

  • Improvement on the product design (such as refining the seismic zone map) to keep basis risk at admissible levels.

 

  • Integration of EQII with other financial instruments to achieve greater market scale.

 

While the programme is still in its infancy stage with many hurdles to overcome, we believe that EQII has tremendous potential in helping financial institutions in Indonesia to build resilience against natural disaster. We hope that the eventual success of EQII would inspire and catalyze a wave of insurance innovation across South East Asia, helping to insure millions of livelihoods against catastrophes.

 


Footnote
1.      Headquartered in Washington, D.C., the International Finance Corporation (IFC) is an international financial institution that offers investment, advisory, and asset-management services to encourage private-sector development in developing countries. The IFC is a member of the World Bank Group.
2.      Founded and headquartered in Jakarta, PT Asuransi Maipark functions as a specialized agency to assist the insurance industry better manage all special risks (including terrorism and catastrophic risks) in Indonesia. It is owned by the private sector, and all licensed general insurance companies (80+ companies) are the shareholders of MAIPARK.

 

Published in Asia Natural Catastrophe Insurance Technology

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