Closing the natural catastrophe protection gap

This research paper defines and measures the protection gap, explores what we know about the reasons for the gap and lays out some measures how to close it.

Closing the natural catastrophe protection gap

Thomas Holzheu and Ginger Turner just published an article in the Geneva Papers for Risk and Insurance: "The Natural Catastrophe Protection Gap: Measurement, Root Causes and Ways of addressing Underinsurance for Extreme Events". The research paper defines and measures the protection gap, explores what we know about the reasons for the gap and lays out some measures how to close it.

In 2016, the protection gap for natural catastrophe risks amounted to around 180 billion US dollars globally for natural catastrophe and weather risk – some 80 billion dollars in Asia alone. Globally, an estimated USD 4 trillion has been lost over the past 40 years to extreme natural disaster events, of which USD 2.9 trillion were caused by climate-related events, such as windstorm, flood, drought, hail, and brushfire, and USD 1.1 trillion by other natural catastrophes such as earthquake and tsunami. Some USD 1.1 trillion were recovered through insurance and about 2.9 trillion remained uninsured. On average only some 30% of economic disaster losses are insured.

In fact, the protection gap is widening. Risk exposures, driven by economic and societal development, urbanization, value accumulation and concentration, as well as climate change tend to outgrow insurance premiums, leaving individuals, households, firms and the public sector alike underinsured. Underinsurance of property risks is a global challenge. In addition to the costs for people and businesses, this can create a significant and long-term financial burden for governments. Typically, the protection gap is smaller in relation to GDP in the mature (59%) than in emerging markets, where an average 94% of past economic losses were uninsured. Emerging economies are more vulnerable to suffer from the disruptions caused by uninsured catastrophes. The root causes and prevalence of insurance protection gaps vary widely across the globe, reflecting different stages of economic development as well as social, institutional and cultural characteristics.

Uninsured natural catastrophe risk has steadily risen over recent decades - about 9% average growth in nominal US dollars from 1990 to 2015. Weather-related uninsured losses grew one to two percentage points faster that GDP. We conclude that most of the historic growth of weather-related economic and insured losses can be attributed to economic development and the shift of growth to less-insured lower-income economies. Beyond economic development, insurance penetration is driven by financial sector development, access to the formal financial sector, specifically mortgage penetration, openness to foreign competition and low market concentration.

Economic reasons for not fully insuring

The paper anayzes a range of economic, financial, geographic, and social variables to identify significant determinants of property insurance penetration. First, increased economic development drives insurance penetration, both by increasing income, which allows for greater spending on insurance, and by increasing the stock of assets at risk. The speed of development matters. Countries that went through rapid growth during the prior decade lag behind in protection compared to countries that reached comparable levels of income and consumption at a slower pace.

Affordability is perhaps one of the biggest reasons for underinsurance, particularly for lower-income households and small and medium-sized enterprises. On the supply side, insurance contracts cannot be scaled down efficiently for lower-income customers due to transaction costs. This is where different products are necessary to open up risk transfer for these markets. Microinsurance, indexed-based insurance and the use of leapfrog technologies such as mobile distribution and mobile payment systems can bypass the lack of an established insurance industry.

For example, Swiss Re supported the launch of the first ever government-backed livestock insurance scheme in Kenya in 2016, protecting 14,000 farmers. The program uses satellite imagery to assess the state of grazing conditions by measuring deviation in the color of ground vegetation. When a certain threshold is reached, the insured farmers receive a lump sum payment – the majority via their mobile phones – which makes the value chain cost effective.

Governments can help further expand the availability of risk transfer solutions to individuals and corporations by introducing compulsory insurance schemes to create a sufficiently large risk community. Compulsory insurance is used in virtually all countries, albeit mostly as part of social security schemes related to health, old age and unemployment, or as compulsory motor liability insurance. The main advantage of mandatory schemes is that they form the widest possible risk community and eliminate adverse selection. Premiums are often made affordable by standardizing premiums rates across risk types.

Financial and institutional development

The degree of development of the financial sector strongly affects non-life insurance penetration. The insurance industry highly interdependent with financial markets and a well-functioning banking system also increases consumer confidence in financial transactions. We find that access to the formal financial sector is correlated with insurance penetration. Credit drives the financing of insurable assets and may require insurance to protect collateral, such as when property insurance is required for mortgages. Policies that promote financial inclusion therefore also may benefit insurance penetration.

Weak property rights, often prevalent in emerging economies, may limit insurance demand. Homes may be uninsurable without legal title or official recognition. Corruption and political risk may reduce insurance demand since they are detrimental to the enforcement of insurance contracts.

The competitiveness of insurance markets can further affect product attractiveness. Open markets and the presence of foreign competitors often increases competition and product variety which is beneficial to increase insurance penetration. A supportive regulatory environment supports the development of the industry while protecting customers and promoting trust in insurance products.

Risk perceptions

Behavioral research indicates that people under-estimate the risk of low-probability events such as natural catastrophes. People often fail to purchase insurance against low-probability high-loss events, even when it is offered at favorable premiums. One reason for low awareness about low-probability risks is the lack of experience with rare events.

Government can play an important role in providing risk information, for example by providing detailed and unbiased flood risk or earthquake risk maps. Also, the expectation of government post-disaster assistance may reduce the demand for private insurance, in both developed and emerging markets.

Insurance perceptions

Financial literacy and consumer education about insurance are critical for supporting take-up. Insurance is an abstract product that relies heavily on trust in the insurance company to pay potential claims. Catastrophe insurance adds an additional layer of comprehension and trust.

Many homeowners actually misperceive the coverage provided by their insurance policies. There is also misperception about the availability of government post-disaster assistance. While the majority of individuals expect some form of government post-disaster funding, the majority of federal post-disaster assistance goes to emergency relief services and to rebuilding public infrastructure.

In emerging economies, many potential customers have no experience with insurance.  For example, surveys by a major microinsurance intermediary, which operates in Africa, Asia, and Latin America, show that more than three quarters (77%) of customers never had insurance before. Especially in markets where there is little previous knowledge of insurance products, personal experience can be critical in making a "first impression" in the market.

Ease of purchase may also impact insurance buying behavior. While 50% of consumers reported buying insurance policies based on cost in a global insurance consumer survey (Ernst & Young, 2014), nearly 30% reported that frequency of communication with their insurer was an important factor, while 30% cited the quality of service.  Insurance is an abstract concept that often requires customized explanation.

A concept that is relevant in this context is product bundling, which can reduce distribution and underwriting costs and also reduce the decision making efforts for the household if the catastrophe insurance cover is added to a larger purchase. To reach farmers in rural or remote regions in the emerging markets, insurers are exploring bundling agricultural insurance products, either as an add-on to existing products and services or through already-existing distribution networks. Agricultural insurance can be bundled with, for example, credit products (through banks or microfinance institutions) or supplies (via fertilizer stores or seed distributors).

Governments can actively promote to recognition of insurance as a risk transfer mechanism. The Chinese government proactively encourages provinces to use part of their budget to buy insurance. In program launched in 2016, Swiss Re supports a natural disaster insurance scheme in Heilongjiang province which covers 28 counties against flood, excessive rain, drought and low temperatures. It's the first of its kind in China and uses satellite and weather data to allow for quick payouts. The scheme is a good example of how a public-private partnership can address government-assisted poverty alleviation.


There are numerous ways to deal with underinsurance and close the protection gap for property risks. Any comprehensive and promising approach requires a multi-stakeholder effort. The collaboration of private-sector insurers and local governments is of particular importance. These measures involve insurers and governments enhancing the awareness, attractiveness, access and affordability of insurance. All areas from risk perception and assessment, to risk reduction and mitigation, to finally risk transfer are part of a broad solution mix.

Access the full paper.