Securitize EU health risks to limit national fiscal deficits

Systemic crises often have significant political consequences. In Europe, however, these consequences have often been resolved through a strengthening of the European Union. Take the 2008-2011 financial and economic crisis for example, this led to new regulatory and supervisory arrangements for financial institutions, as well as the implementation of EU-wide contingency funds, writes Professor David Veredas, Vlerick Business School.

The Great Lockdown Crisis of 2020, and the public health and economic consequences of this, must be learned from. A key lesson is the need for deeper union across the European health care sector. Though we do not know when the next health crisis will strike, COVID-19 is unlikely to be the last. The changing climate, the emergence of new pathogens, and the re-emergence of others poses significant risks to the health security of the EU. Plus, there are chemical, radiological, and nuclear risks to be considered. Risks that demand a similar response.

The current and unprecedented COVID-19 public health crisis has completely overstretched the structures and mechanisms of the European Union, in particular those that deal with emergencies. In order to be ready for the next health emergency, the EU needs effective and unified response arrangements, and collaboration between member States, instead of the country-specific approaches we have seen across all 27 member States. It also needs a significant financial cushion for rapid and predictably increasing funding.

So how could we ensure that a collaborative response is not only possible, but also affordable and realistic for EU member states? The key to this relies on financial innovation. I, alongside other Vlerick Business School academics, propose the creation of the Emergency Health Financing Facility (EHFF in short).

In its broader version, this facility integrates some of the existing EU emergencies structures, namely the Emergency Support Instrument, and adds a new layer for the most extreme emergencies that does not increase the burden on public finances. This new layer essentially consists of securitizing health emergency risks in the form of fixed income securities that are sold to institutional investors. The Facility follows the growth of market-based risk financing facilities across global and regional initiatives, led by the World Bank.

The EHFF finances can be used for ramping up medical supplies, testing kits, building infrastructures, and sudden increases of personnel, amongst others, in line with rescEU and the Emergency Support Instrument. This is a vital necessity for future crises, after seeing the difficulties at the beginning of Lockdown’s for EU healthcare systems to obtain medical supplies such as PPE, and enough testing kits to have a desired impact on controlling the spread of the virus.

Specifically, the EHFF is a health risk management tool that provides liquidity when it is most needed, and without allocating large amounts of cash in advance. It will have positive spill overs on the public finances of EU countries, in the sense that member states will be better off, as part of the EHFF, than managing the risk of a health emergency individually.

The EHFF is therefore a cost-effective solution that protects national budgets, which are going to be under serious strain for the years to come, from the impacts of health emergencies, and allows all Member States to have the funding to tackle these future crises.

Similar facilities exist or are being considered in other parts of the world. The most prominent cases are the Pandemic Emergency Facility of the World Bank, the ASEAN+3 Disaster Risk Insurance Facility, and the Pacific Alliance Catastrophe Bonds that offers earthquake coverage to four South American countries. These have been deemed successful in a cross-country wide approach to tackling large crises, and the EU must follow suit with its own to protect Member States efficiently and fairly.

The securitization of risk goes back to the early 1990s. The insurance industry (reinsurers in particular) were pioneers due to the hurricanes in the Caribbean. Securities that result from risk securitization are known as Insurance Linked Securities, or ILS in short. Catastrophe bonds are the predominant form of ILS. The market of ILS has increased steadily since the mid-90s: from $785.5m in 1997 to $41.8bn in 2020. The predominant risks covered are natural catastrophes, like named storms and earthquakes, though they also cover mortgage, operational, and mortality risks, among others.

It’s safe to say that securitizing the potential risks of another public health crises, or even chemical, radiological, and nuclear risks, is certainly not unheard of. The EU prides itself on collaboration, fairness, and partnership – we must reflect this in our future crises responses, and a joint EHFF is the way to do so. Not only does it strengthen the European Union further, therefore improving the response, but due to its financial innovation, it comes at no financial burden to any EU member States fiscal budgets.

David Veredas (pictured) is a professor of Financial Markets at Vlerick Business School. He is an elected member of the European Shadow Financial Regulatory Committee, and a founding member of the Society for Financial Econometrics.

Reference: Ashby, S., Kolokas, D., and Veredas, D. (2020) An Emergency Health Financing Facility for the European Union. A proposal. Vlerick Business School policy paper #10.


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