Natural disasters & uninsured economic losses

Natural disasters & uninsured economic losses

With a series of hurricanes, floods and earthquakes, the economic losses from natural disasters in 2017 rose to $353 billion –– a number that makes last year the second-costliest on record, according to Aon Benfield’s Weather, Climate & Catastrophe Insight Annual Report (2017). Interestingly enough, the vast majority of these losses were uninsured, with a mere $134 billion corresponding to insured costs.

At the moment, a large portion of the insured post-disaster recovery costs is retained by government assistance or international donors. For example, the US government provides the National Flood Insurance Program (NFIP) that covers residential and small business flood losses for around 5 million properties. However, such financial instruments become questionable as the frequency of large-scale disasters increases. Taking the example of NFIP, only those within the 100-year flood zone map proposed by FEMA (Federal Emergency Management Agency) are protected by the program. However, much of the damage from Hurricane Harvey last year occurred outside this zone, and most of those affected will not be compensated (Time, 2017). What is more, the program is already in depth to the US Treasury, for borrowing money to relieve recent years post-disaster losses. According to McKinsey (2017), a point will come when governmental financial assistance will no longer be sustainable.

As the world races towards more resilient communities, the role of the private insurance industry in the aftermath of a disaster becomes more and more pronounced. Determining who will pay for the post-event recovery as well as organizing payouts in the optimum way, is critical for successful resilience strategies and insurance forms a key component in managing the ex-post disaster consequences.

By providing timely post-disaster liquidity, insurance reduces downtime and long-term indirect losses, while it also provides economic security. For businesses, insurance creates a space of certainty and stability, meaning that higher-profit and higher-risk activities can be pursued. For governments, timely bounce-back equals economic competitiveness for the country and increased investor confidence. This leads to sustainable growth, in turn creating a plethora of new opportunities for countries and the insurance sector. Moreover, well-structured contracts can provide incentives for loss reduction. Insurers allocate a price to the risk to be insured, thereby increasing the incentive to lower that price through implementing measures to minimize the risk (Munich Re, 2017). For example, in Istanbul apartment owners pay less for their insurance if they retrofit their buildings (Bayer and Mechler, 2009).

With the frequency of natural disasters increasing and the gap between insured and overall economic losses growing, the insurance industry finds itself in front of a challenge: if it keeps repricing risk in a world where exposure to risk is growing exponentially, it will end up making insurance premiums unaffordable to a large percentage of the population, thus losing its share on the market. Opting out in providing cover for high risk areas does not seem like a solution either, as the global interest is now turned decisively – and will be for the years to come – on the effective management of natural perils in both developed and developing countries. One could say that the industry has an inherent interest in reducing societal risk exposure, in order to remain in the global market game.

The opportunity is out there, for insurers and reinsurers to take the strategic turn and increase their role in post-disaster financial protection, while having the opportunity to protect earnings and capital in the face of augmented exposure to natural hazards, with the aid of technological progress.

By partnering with public entities, insurance companies can reach out to more people and businesses, as well as to state and local governments and help in strengthening the resilience of communities and businesses that operate in regions vulnerable to natural hazards. Recent pilot insurance programs formed through partnerships between governments, international organizations and the insurance industry are already demonstrating their potential to pool economic losses and spread risk to the global financial markets. Such financial instruments are currently focused in developing countries, with examples in the Caribbean (Caribbean Catastrophe Risk Insurance Facility, CCRIF), the Pacific island states (Pacific Catastrophe Risk Assessment & Finance Initiative, PCRAFI), and Africa (African Risk Capacity, ARC) [Murich Re, 2017].

By establishing common ground with the scientific community, insurers can enter a fruitful give-and-take of information and expertise: the private insurance sector can provide its know-how in calculating risk to help towards accurate risk assessments and rapid payouts, in exchange with finding itself at the leading edge of scientific developments. Such multi-disciplinary partnerships always help in developing innovative solutions, hence, working beneficially both ways.

For the insurance companies, staying up-to-date with the latest technological achievements (satellite imagery, artificial intelligence systems etc.), can open a whole new perspective when allocating risk prices and deciding on deductibles for disaster risk contracts. Such innovations in technology increase the number of options available to determine the trigger for insurance payment. For instance, parametric insurance schemes are defined on the basis of a pre-determined amount and a specific parameter, e.g. wind speed, strength of a hurricane, rainfall amounts, and the magnitude of an earthquake. The payout from the Caribbean Catastrophe Risk Insurance Facility to the government of Haiti after the 2010 earthquake is an example of the use of a parametric insurance scheme.

Involvement in the current dynamics of the natural hazards risk mitigation and management could help the insurance industry in one more vital thing: to act as a partner to their clients throughout a disaster event, rather than simply being the payer of claims. Such an approach has been proven to lower losses, by more systematically rewarding mitigation efforts, but also to significantly improve a company’s reputation and trust, reducing complaints and increasing customer retention (McKinsey, 2017).

 

Sources:

[1] Aon Benfield (2017). Weather, Climate & Catastrophe Insight. Annual Report. Aon Plc.

[2] Linnerooth-Bayer J. and Mechler R. (2009). Insurance against Losses from Natural Disasters in Developing Countries. Background paper for United Nations World Economic and Social Survey.

[3] McKinsey and Company (2017). Insuring hurricanes: Perspectives, gaps, and opportunities after 2017. Article. https://www.mckinsey.com/industries/financial-services/our-insights/insuring-hurricanes-perspectives-gaps-and-opportunities-after-2017

[4] Munich Re (2017). Resilience – Overcoming natural disasters. Article.

https://www.munichre.com/topics-online/en/2017/topics-geo/resilience-overcoming-natural-disasters

[5] Time (2017). Hurricane Harvey Proved We Need More Flood Insurance Competition. Article. http://time.com/4927852/hurricane-harvey-flood-insurance/