A European approach to natural catastrophe risk management

Europe is facing a rapidly intensifying natural catastrophe challenge. Climate change has increased both the frequency and severity of floods, storms, heatwaves, wildfires and earthquakes, generating significant economic losses and putting growing strain on households, businesses and public finances. Yet insurance coverage across Europe remains limited. The result is a substantial “protection gap” between total economic losses and insured losses, leaving much of the financial burden to be absorbed ex post by governments and affected communities.

A joint discussion paper by the European Stability Mechanism (ESM) and the European Insurance and Occupational Pensions Authority (EIOPA) (the “Paper”) explores how a European-level risk sharing mechanism could help close this gap. The Paper demonstrates that pooling natural catastrophe risks across countries and perils, combined with a loan based public backstop, could materially enhance insurance capacity, reduce volatility, and lower overall costs, while crowding in rather than crowding out the private sector.

The scale of the protection gap

The analysis shows that Europe’s insurance protection gap remains wide. Depending on methodology, between 50% (model-based estimates) and 75% (historical loss data) of economic losses from natural catastrophes are currently uninsured. The gap is pronounced for earthquakes and particularly in countries such as Italy, Greece, Portugal, Bulgaria, Romania and Slovenia. France, Spain and Belgium exhibit comparatively higher coverage due to established national schemes.

Historical data reveals more than €900 billion in direct economic losses in the EU since 1981, with a sharp increase in recent years. However, historical records alone underestimate future risks, as they do not fully capture climate trends, rising asset values, urbanisation or inflation. To address this, the Paper complements historical analysis with catastrophe modelling, offering a forward looking view of expected losses under current exposure and hazard conditions.

The case for European risk pooling

At the heart of the Paper is a proposal for a solution – a European natural catastrophe insurance pool. By pooling risks across countries and multiple perils, insurers can benefit from diversification effects that are not achievable at national level. Losses from catastrophes are rarely perfectly correlated across Europe: earthquakes dominate risk in Southern Europe, floods in Central and Eastern Europe, windstorms in Northern Europe and heat-related events in parts of Southern and Western Europe. Pooling these risks substantially reduces overall portfolio volatility.

Model simulations indicate that pooling risks and perils across EU Member States could reduce capital requirements by up to 67% compared with standalone national solutions, while maintaining the same level of protection. This capital relief would allow insurers to underwrite more business without increasing their capital base, strengthening insurance supply and improving affordability for policyholders.

The Paper illustrates how different pool designs, such as catastrophe excess of loss structures and hybrid combinations with quota share elements, could reduce the European property insurance protection gap to around 10%. Such a level is considered efficient for mature insurance markets, as it reflects risks that are economically insurable while recognising that some losses are better managed through alternative mechanisms.

The role of a loan-based backstop

To address extreme tail risks that exceed the pool’s capacity, the Paper proposes a complementary European loan based backstop. Acting as a reinsurer of last resort, the backstop would provide predictable and affordable funding during severe catastrophe scenarios. Importantly, loans would be repaid over time by pool members, ensuring fiscal neutrality in the medium term and avoiding permanent public subsidies.

Simulation results suggest that the required backstop capacity would range between €10 billion and €65 billion, depending on risk appetite and climate dynamics. As the pool accumulates reserves over time, the probability of drawing on the backstop declines, although it remains critical for extreme events. Compared to insurers raising capital in stressed market conditions, the backstop’s favourable funding terms significantly reduce financing costs.

Enhancing the structure via insurance-linked securities (ILS)

The Paper explains that the insurance structure could be enhanced by insurance-linked securities (ILS), such as the issuance of cat bonds, which could help reduce the required pool size. The pool could also act as a special purpose vehicle for the issuance of catastrophe bonds, which would allow the European insurance industry to enter a reinsurance contract with the pool. The pool would issue notes in the capital markets against regular coupon payments. This way, part of the expected losses can be transferred to the capital markets with corresponding impact on the losses to be distributed among pool members. The Paper notes that the insurance-linked securities market is still a niche market, and that the broader scale potential in Europe still needs further exploration.

Benefits and broader policy implications

For insurers, the combined pool and backstop structure reduces cash flow volatility, improves predictability, and lowers capital costs in scenarios where the backstop is triggered. For policyholders, these efficiency gains are expected to translate into more stable and affordable premiums over time. For governments, the mechanism reduces reliance on ad hoc post disaster support and enhances overall economic resilience.

The Paper emphasises that a European risk sharing mechanism is not a standalone solution. It must be embedded in a broader strategy that also addresses demand side barriers to insurance uptake and strengthens adaptation and risk reduction measures. While not a formal policy proposal, the analysis provides robust quantitative evidence to support informed debate on how Europe can better manage growing natural catastrophe risks through collective action.

Malta as a destination of choice for ILS

Malta is an emerging European jurisdiction for ILS, offering comprehensive legislation for the creation and authorization of Reinsurance Special Purpose Vehicles (RSPVs). It stands out as the only European country with laws enabling the formation of Securitisation Cell Companies (SCCs).

Malta is an ideal location for setting up RSPVs due to its:

• strong legal structure governing the establishment of RSPVs;
• access to local service providers, including international insurance managers, corporate services, audit firms, and legal professionals specializing in insurance securitisation;
• ability to set up a limited liability company within 2–5 business days;
• full compliance of company law and fiscal regulations with EU standards;
• rich pool of insurance talent, complemented by a well-educated, multi-lingual, and dynamic workforce;
• vibrant insurance community, offering close collaboration with leading insurers, captives, major reinsurance companies, as well as both international and local insurance managers.

Due to its robust legal framework for ILS, Malta provides a European-based solution that allows insurance or reinsurance entities to transfer risk by funding potential liabilities via capital markets.

In addition, Malta’s financial services regulator, the Malta Financial Services Authority (MFSA), has indicated that it is open to expediting applications for structures issuing ILS. This is possible as long as participants agree on timeframes beforehand and provide precise and thorough information throughout every phase of the structuring and documentation process.