Lloyd’s warns of $168 billion catastrophe insurance deficit in high growth countries

We’ve said for a number of years that one area where the reinsurance convergence markets, where insurance, reinsurance and capital markets come together, can find growth is in the underinsured and rapidly expanding developing economies of the world. A report published today by Lloyd’s of London highlights this opportunity by warning of an annualised $168 billion insurance deficit that they say leaves 17 high growth countries severely exposed to the long-term costs of catastrophic events.

The report is the outcome of a study commissioned by Lloyd’s and undertaken by the Centre for Economics & Business Research (CEBR). It reinforces all the problems we have discussed before on Artemis; rapidly growing exposures as economies expand and modernise, lack of insurance penetration, lack of robust risk modelling in some countries and the burden placed on the State after a catastrophe from disaster recovery etc.

Some examples from the report include:

• The State bears an excessive proportion of the cost of natural catastrophes in countries with a low level of insurance. A 1% increase in a country’s insurance penetration can reduce State liability by as much as 22% . For example, China’s Sichuan Earthquake in 2008 resulted in estimated damages of $125bn and yet just 0.3% was covered by insurance. This left the Chinese State paying for almost all the cost.
• Post-catastrophe recovery costs are lower in countries that have higher levels of insurance. A 1% increase in insurance penetration delivers a 13% reduction in uninsured losses.
• The pace and extent of global economic development has seen the cost of catastrophes grow by $870bn in real terms since 1980. The level of natural catastrophes in 2011 saw $107bn of insurance claims – the second costliest year overall for the insurance industry and its costliest for natural catastrophe claims on record.

Richard Ward, Chief Executive of Lloyd’s, commented; “With Superstorm Sandy still fresh in all our minds, I hope that this research will stimulate a debate on how governments – and businesses – manage the risk of natural catastrophes. It also raises an important question of the merits of risk transfer versus the use of public funds to cover the cost. Insurance exists for two simple reasons – to help prevent losses from happening in the first place, but to alleviate the financial consequences if disaster does strike.”

Ward continued; “As this research underlines, too many high-growth countries are failing to take the steps required to prepare properly for these sorts of events, leaving people and businesses exposed. As high-growth economies continue to develop and supply chains become increasingly interconnected, now is the time to ask ourselves: can the world afford to keep taking such a big risk?”

One of the outputs of the interesting report is the creation of a benchmark in ‘underinsurance’. The benchmark shows the 17 countries, which are all high-growth and in many cases still developing, face an annual insurance deficit of $168 billion with some of the most underinsured among the highest-growth. The graphic below shows the underinsured countries in red.

The 17 underinsured high-growth countries

Other key findings from the report include:

• An analysis of five major global disasters showed that only 21% ($115bn) of a total economic loss of $538bn was covered by insurance across the world.
• China insured just 1.4% of losses arising from natural catastrophes between 2004 and 2011, with $208bn in uninsured losses.
• In five of the 17 countries identified as severely underinsured, the average uninsured loss for major catastrophes is at least 80%. The average uninsured cost of catastrophe in China is $18.91bn; in India $1.96bn and in Indonesia $1.45bn.
• Higher levels of insurance correlate positively to economic growth. A 1% increase in insurance penetration is associated with increased investment of 2% of national GDP.

Lloyd’s calls for action from businesses, governments and the insurance sector to address what is a growing problem, adding that insurers need to take steps to better understand risk in growth economies which would enable them to research and price new risks. Lloyd’s adds that this could involve investing in local insurance companies in the exposed regions which would help them to develop products suitable to the growth economies.

One of the key points to consider is the availability of reinsurance in these regions of the world. Many reinsurers are reluctant to deploy capacity into some of these countries due to the peak-risks that are faced and the lack of robust models to help them really understand those risks.

Lloyd’s says that “A 1% increase in insurance penetration– a significant investment –  leads to a 13% reduction in uninsured losses and a 22% reduction in taxpayer contributions to recovery following a natural catastrophe.” So it is key to increase insurance penetration but to do that reinsurance needs to be available, both at the peak and lower levels of the required cover. There is also a question whether the global traditional reinsurers have the capacity necessary to really support an increase in insurance penetration across these developing regions peak-risk zones and this is where the convergence sector and capital markets could step in.

The peak-risks in these countries  will need to be insured and reinsured if a flourishing insurance sector with high penetration is to develop and achieving that aim will require capital, innovation and advances in risk models and re/insurance instruments. Tools such as index-insurance, parametric triggers and catastrophe bonds may be appropriate to help build a layer of peak-risk cover across underinsured regions but the capital source to back that would need support from the capital markets, as the reinsurance sector is too small alone.

There is a good chance that this is where we will see the convergence markets really come into their own as a supporting source of risk transfer for the world’s traditional reinsurers. Rather than being thought of as competition, capital market backed reinsurance capacity needs to be seen as a complement which is perhaps more suited to taking on these peak, less well understood risks, leaving traditional reinsurers to do what they do best as well.

However these growing, emerging economy catastrophe risks get dealt with it is going to require change in the insurance and reinsurance sectors, as well as a realisation that innovation and adaptation are going to become key as the world demands these underinsured catastrophe risks get covered.

Douglas McWilliams, founder and Chief Executive of CEBR, said; “This insurance gap has a huge and lasting impact on the ability of businesses, governments and people to recover from the earthquakes, hurricanes, flooding and forest fires that affect us all every year. This means lost orders, lost jobs and wasted taxpayer money as a failure to prepare ahead of such events creates costs that are more severe and unmanageable.”

This infographic from the report really drives home the size of the underinsurance gap for some countries:

Bridging the underinsurance gap - The costs

You can access the full report, its findings and supporting information here.