sigma 05/2015: Underinsurance of property risks: closing the gap
Underinsurance of property risks is a global challenge, says Swiss Re's latest sigma study Underinsurance of property risks: closing the gap. Much of the underinsurance is due to global natural catastrophe risk, which has risen steadily over the past 40 years. In the last 10 years, cumulative total damage to global property as a result of natural disaster events was USD 1.8 trillion, and about 30% of those losses were insured. In other words, the total shortfall in insurance cover – the protection gap – was USD 1.3 trillion.
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This sigma estimates a property protection gap of some USD 221 billion annually. The bulk (USD 153 billion) derives from underinsurance for natural catastrophe risks, mainly earthquake, flood and windstorm exposures. Out of these, the largest uninsured natural catastrophe exposures are in the US, Japan and China. In the emerging markets, insurance penetration is lower and a greater share of catastrophe losses are uninsured there. The remainder of underinsurance relates to general property risks, including fire, business interruption, and non-flood water damage.
The global property protection gap in natural catastrophe risk has widened steadily over the past 40 years, even though claims payments have increased significantly during that time. With economic development and ongoing urbanisation, particularly in emerging economies, the increase in the value of global property at risk has outpaced the purchase of insurance. There are different reasons for underinsurance, including perceptions of risk, insurance knowledge, affordability, reliance on government post-disaster relief, lack of trust in insurers, and limited access and ease of doing business. Undervaluation of assets due to lack of information and awareness is another contributing factor. Further, certain risks – such as some peak natural catastrophe, terrorism, cyber or contingent business interruption risk – can challenge the bounds of insurability.
Innovating to reduce underinsurance
Drawing on their expertise, insurers can play a key role in strengthening the resilience of households and companies against property risk. Innovation carves out new areas of insurability. One example is the Flood Re programme in the UK, designed to provide affordable flood cover for properties at highest risk of flooding. Flood Re is a not-for-profit flood reinsurance fund, owned and managed by the insurance industry. It accepts the transfer of insurance companies’ risk above a specified flood-related risk. In the case of a flood event, insurers are reimbursed from Flood Re for the claims of the insured homeowners.
Most homes around the world are uninsured against earthquake risk. In case of a large-loss event, many homeowners would not be able to bear the loss and would be more likely to default on their mortgages. Consequently, much of the world’s residential earthquake risk exposure is effectively borne by mortgage providers, who are usually uninsured. Working together with mortgage lenders, who have an interest in protecting their collateral, could be another way through which insurers can help narrow the protection gap.
Microinsurance is another important area for innovation, especially for low-income populations. By providing small amounts of coverage and premiums per person, and using innovative product designs, microinsurance can make cover both affordable for consumers and financially sustainable for providers. For instance, many microinsurance programs use weather index-based products to cover crop damage. By paying claims according to local weather parameters rather than individual damages, index-based products reduce the cost of underwriting and claims processing.
A private- and public-sector responsibility
The challenge for the insurance industry is to focus on the needs of those who are totally uninsured or insufficiently insured. Reducing underinsurance will require the industry to continue to develop data and analytical tools to track the evolving landscape of new risks and exposures, not only of natural catastrophes, but also of perils that are difficult to quantify such as terrorism, cyber, and supply chain risks. Further innovation in products, processes, and distribution are needed to reach previously uninsured consumers and risks. Simple language, while maintaining product integrity, is another important way for insurers to reach more customers. The insurance industry can help build awareness by making the concept of insurance more understandable, which is in itself an important step to building the trust of the general public in the insurance industry.
All told, insurers cannot act alone. They require supportive regulatory environments, risk information and, in specific cases such as terrorism or high-risk flood zones, government involvement to extend coverage capacity. Governments also have an important role in risk mitigation by setting and enforcing standards such as disaster-resistant building codes, overseeing flood control, providing risk data such as flood mapping, and promoting insurance. Successfully addressing property underinsurance requires a coordinated effort and innovative thinking by both the public and private sectors.