The rise in global urbanisation to hazard prone areas, climate change and increased values at risk have sparked a new “era of catastrophes,” signalling an opportunity for the insurance and reinsurance sector to improve the management of extreme risks, according to Professor Howard Kunreuther.
Speaking at the Global Insurance Forum in mid June, Professor of Decision Sciences and Business Economics and Public Policy, Wharton School, University of Pennsylvania, Howard Kunreuther discussed changes and developments the insurance and reinsurance industry could adopt, to better mitigate the impact of extreme catastrophes.
Kunreuther explained that the “insurance industry today is not effectively meeting two of its most important objectives,” providing comprehensive information to residents in hazard prone areas and failing to provide good incentives to those at risk to invest in and reduce loss prevention measures.
One of the challenges explains Kunreuther is “how do you tell an individual that the best return on an insurance policy is no return at all. That you should say look at how happy you should be but continue to have your policy in case you do have a loss.”
It’s a good point, and one that has been at the forefront of insurers’ discussions and strategies for a very long time. Typically, following a hurricane, earthquake or flood event individuals will seek protection for their property, belongings and so on, but the problem arises when there isn’t a loss for a few years and the consumer begins to question why they are still paying for insurance.
One answer to this according to Kunreuther is to increase the use of multi-year deals, which can provide premium stability to the policy holder, reduced marketing costs to the insurer, reducing the cancellation of coverage absent losses and stops pricing fluctuating regardless of losses.
Another way the insurance and reinsurance industry can help mitigate losses of future extreme events is to improve the detail and availability of information to people living in hazard prone regions.
“Consumers have little experience with large extreme events and make imperfect decisions,” explains Kunreuther, stressing the importance of providing residents with comprehensive financial scenarios following the impact of a major event, with or without insurance protection so they can see the benefits.
Next, notes Kunreuther is that the role insurance and reinsurance can play in managing extreme risks would be greatly improved if the premium reflected the risk, mentioning a desire to return to the 19th Century model, where factories that undertook loss prevention measures received a reduced premium and the premium reflected the risk.
This, argues Kunreuther, ensures the delivery of “transparent information to people on how risky one is and secondly it encourages premium reduction if you are willing to invest in loss prevention measures.”
While providing residents with improved, relative and effective mitigation and loss prevention measures, incentives via food stamps, discounted premiums, public/private sector loans and so on for those doing their part to reduce future losses, can also lead to an uptake in insurance protection at times of benign losses.
But for this to happen there’s a need for solid and constructive public-private sector partnerships, explains Kunreuther, to develop affordable incentives to insurers, reinsurers and the consumer. This also includes the establishment of global, improved building codes and regulation.
As Kunreuther states, Florida now has the best building codes in the US for loss prevention, but that it took the devastating hurricane Andrew to happen before this was the case.
The expertise, knowledge, analytical capacity and capital base of the global re/insurance sector, as well of course as the capital markets which now augments global reinsurance capacity, signals an opportunity to innovate and develop improved measures for building resilience to extreme catastrophe events.
“Insurance markets can help spread the risk of unavoidable disasters and offer incentives to mitigate risk, but they cannot work miracles, especially in low-probability, high consequence settings,” said Kunreuther.
Concluding that; “insurers can encourage mitigation by being allowed by regulators to set premiums that reflect risks and partner with banks and financial institutions to provide long-term solutions. The premium reduction will by definition be greater than the annual cost of the loan for cost-effective measures.”
As insurers and reinsurers fight to remain relevant in a world where consumers perhaps increasingly see them as less so, Kunreuther’s words should provide a useful reminder that customer focus, design thinking and putting the user first is key.
This applies to the capital markets as well, especially insurance-linked securities (ILS) managers who seek to disintermediate the market and gain closer access to the risk. As this happens, and becomes an increasing trend, the need to understand the end-user or customer will increase as well.