Analysis by catastrophe risk modeller RMS undertaken for the UK’s Department for International Development (DFID), shows that the establishment of insurance schemes to protect against natural disasters in low and low-middle income countries can provide average annual recoveries equivalent to 11% of asset losses.
RMS has completed analysis to determine how feasible insurance schemes could lower the financial impact of disaster losses on low and low-middle income countries over the next decade.
The catastrophe risk modeller reports that the average annual asset loss from natural catastrophes in low to low-middle income countries is equal to $29.1 billion, of which 3%, or $900 million is covered by insurance. A further $2.2 billion, or roughly 8% of the total is currently covered by humanitarian aid expenditure.
RMS sought to evaluate pre-existing insurance schemes and determined feasible and realistic insurance mechanisms that could be implemented in the regions over the next ten years, and also incorporated plausible increases in insurance penetration, which is dangerously low in low to low-middle income countries.
The firm then applied three different hypothetical insurance structures to a set of simulated losses, which was done at current day exposure and population levels, and then performed sensitivity analysis around base assumptions for each structure.
The structures chosen were insurance for public assets, insurance for private assets, and emergency response and insurance or reinsurance backed social protection.
The analysis reveals that under the base assumption, the average annual recovery from all three structures is $3.1 billion, which is up from the $0.9 billion annual recovery reported today, and represents roughly 11% of total losses.
Furthermore, additional sensitivity analysis reveals that the annual average recovery could range from between $1.5 million (roughly 5% of total losses) to $5.1 billion (roughly 18% of losses).
For private assets, annual insurance recoveries vary between $1.2 billion and $2.2 billion, dependent on low or high sensitivity analysis. For public assets, annual insurance recoveries vary between $0.3 billion and $2.1 billion, and for the emergency response scheme the volume of recoveries varies between $0.1 billion and $0.9 billion, explained RMS.
Continuing to state that under the base assumption, the one-in-ten-year return period insurance recovery is $5.2 billion, which compares to a one-in-ten-year asset loss of some $48.3 billion.
RMS explains that owing to “inherent loss escalation after an event, the reduction in the financial consequences of natural disaster events achieved through insurance recoveries is greater than the monetary value of the insurance payout.”
The $48.3 billion one-in-ten-year asset loss reduces by 16%, or $7.6 billion to $40.7 billion under the base assumption, which RMS calculates as a 45% rise in the monetary value of the one-in-ten-year recovery, of $5.2 billion.
Importantly, the firm also incorporated the impacts of plausible increases in insurance penetration in low to low-middle income countries over the next decade, which lowered the average annual asset losses to between $21.9 billion and $26.4 billion, dependent on high or low sensitivity assumptions. This represents “an annual reduction in financial consequences of between 8% and 24%,” said RMS.
The report was commission by the DFID, and the analysis informed the policy debate in Whitehall, with the UK Prime Minister announcing a new London Centre for Global Disaster Protection.
RMS’ analysis clearly shows that insurance schemes can be used in low to low-middle income countries to mitigate the financial impact of natural disasters, and reduce the reliance of humanitarian aid and governmental support post-event.
Importantly, RMS also highlights the need for improved disaster resilience in these parts of the world, alongside increased awareness and utilization of insurance solutions, such as parametric structures that enable rapid payout post-event, alongside traditional structures. The capital markets and reinsurance solutions such as catastrophe bonds clearly also have an important role to play here.
“Overall, the quantitative analysis presented in this study suggests that plausible development of insurance schemes to cover losses from natural disasters in low and low-middle income countries over the next ten years has the potential to provide average annual insurance recoveries of $3.1 billion (approximately 11% of average annual asset losses).
“Taking into account the positive impact of ex-ante risk financing that acts to mitigate the longer-term development of disaster losses, these recoveries reduce the financial consequences of catastrophe risk by $4.4 billion per year (approximately 15% of average total asset losses),” concluded RMS.