Public sector disaster risk financing & re/insurance is vital: Swiss Re

The commitment and capabilities of public and private sector entities is essential to closing the world’s ballooning protection gap, underlining the necessity of adequate insurance, reinsurance and alternative catastrophe risk financing, says Swiss Re.

During the last 10 years, according to global reinsurance firm Swiss Re, insurance has only covered around 30% of global catastrophe losses, meaning that 70%, which equals approximately $1.3 trillion of losses have been borne by governments, companies and individuals.

Natural catastrophe losses: Insured vs uninsured losses, 1975–2014 - Source: Swiss Re

With pressures in the international insurance and reinsurance landscape persisting and expected to continue into 2016, firms are increasingly looking for growth and diversification opportunities within developed and emerging markets.

And, as the frequency and severity of natural disaster events spiked, along with rapidly expanding populations, higher concentrations of assets in hazard prone areas, and global economic development, among other factors, the economic cost of a catastrophic event has risen markedly.

“Disaster risks are increasing but insurance hasn’t kept pace: the estimated $1.3 trillion gap between insured and total losses remains stubbornly large, hampering a country’s ability to recover,” says Swiss Re.

Many risk transfer discussions in recent times have focused on the broadening protection gap and a need to build disaster response and resilience efforts across the globe, particularly in developing, underserved regions where insurance and reinsurance penetration levels are often dangerously low.

In developing economies a rising middle class, increased concentration of assets in built up, vulnerable areas, and migration to coastal regions susceptible to flooding, tsunami events and storm surge, has seen the potential economic losses from a catastrophe event rise over the years.

In fact, Swiss Re claims that for the first time in human history, “more people live in urban centres than in rural areas,” highlighting the growing concentration of exposures in developing and developed regions of the planet.

What’s more, many of these underdeveloped and uninsured regions rely heavily on agriculture to earn a living, sometimes entire communities’ lives are dependent on their ability to harvest crop during a season, something that rainfall and drought can seriously hinder.

But it certainly isn’t just emerging markets and corners of the globe where underinsurance and disaster resilience and relief efforts are an issue, take hurricane Sandy for example.

According to reports hurricane Sandy impacted the most insured square mile on the planet when it struck the U.S., but only 50% of the overall losses were actually insured, again signalling that insurance and reinsurance take-up rates have not kept pace with the growth of exposures.

Some industry analysts and experts have described the protection gap as a sign that the re/insurance sector is failing to do its job properly, with Willis Re recently noting that a growing protection gap at a time of excess capacity in the space is a “market failure.”

But, as highlighted by Swiss Re in its comprehensive report on bridging the protection gap ‘Disaster risk financing: Smart solutions for the public sector,’ innovative insurance solutions through insurance, reinsurance and insurance-linked securities (ILS) participation can, and should be utilised to build the financial stability and sustainability of countries in the face of adverse weather and catastrophe events, ultimately serving to lower the gap between insured and economic losses.

Chairman of Swiss Re’s Global Partnerships, Martyn Parker said; “For risk protection to be effective, funds need to be quickly available in the wake of a natural catastrophe, meaning that financing arrangements must be in place already beforehand.”

“Financial preparedness lowers the volatility of the state budget and improves planning certainty for the public sector, besides making a country more attractive to investors.”

Being financially prepared prior to a catastrophe event can greatly take some of the burden away from governments, notes Swiss Re, limiting the amount the public sector must pay in order to begin rebuilding and substantially reduce the time recovery takes.

Certain pre-event measures including indemnity insurance, parametric cover, reserve funds, and we would add catastrophe risk financing pools like the TCIP and ARC, can and should be adopted to mitigate the impact of natural disasters and build social and economic awareness and preparedness to such events.

Notable here is the design and structure of a parametric insurance product or pool, as seen in ARC and other weather-related catastrophe risk financing funds around the world. Catastrophe bonds using parametric triggers can also provide a highly responsive source of disaster risk transfer and financing.

Parametric triggers out based on physical parameters such as wind speed or rainfall, eliminating the need for loss adjustments and therefore ensuring a rapid payout response, something of great importance to emerging economies post-event.

With the protection gap so large and showing no signs of shrinking, at least without the intervention and an increased effort from public and private sector entities, the skillset, capacity, willingness and ability of the insurance, reinsurance, ILS, catastrophe bond, ILW and other alternative risk transfer mechanisms’ will be needed to really make a difference.

Swiss Re’s Group Chief Executive Officer (CEO) Michel M. Liès, said; “The risk landscape is becoming more and more complex as the world becomes more interdependent. No country can afford to be left unprotected. The insurance industry is already rising to the challenge of underinsurance in both developed and developing countries through innovative risk management measures.”

While Swiss Re notes that efforts are underway and in some regions advanced, successful catastrophe risk pools and mechanisms already exist and serve their purpose well, there is an opportunity and need for greater involvement and innovation from the entire risk transfer landscape, public and private sector included.

Swiss Re stresses that “insurance coverage for catastrophe risk should be a central plank of the
financial strategies of all countries exposed to such events.” However, the reinsurer also notes that a functioning insurance market should be established before sovereign level catastrophe risk financing should be put in place.

This is a bit of a ‘chicken & egg’ issue right now, with some believing that without the sovereign level risk transfer and pre-event financing in place, such as parametric cat bonds or insurance, it is difficult for local insurance markets to flourish.

Hence, developing a tiered or multi-layered approach is vital, we believe, protecting the capital in an exposed country, the government finances, the people and also providing a buffer to protect the local and emerging insurance market as well.

This complex issue, which also provides the largest opportunity to insurance, reinsurance and ILS market participants, is not going to be solved quickly and requires a holistic approach involving traditional and alternative, macro and micro solutions. It is encouraging to see it getting increasing focus.

Read our series of articles focused on the insurance protection gap – underinsurance in emerging and developing economies and the gap between economic and insurance losses – an opportunity that is on every reinsurance CEO’s lips and which presents the largest opportunity to put excess risk transfer capital to use, requiring both traditional and capital markets support.