Now, more than ever insurance is vital to the sustainability of the world's economies
What do a cattle farmer in Kenya and a homeowner in Florida have in common? They are both vulnerable to extreme weather, which can destroy their lives and livelihood. The Kenyan cattle farmer stands to lose his income when his herd perishes in a drought, and the Floridian could suffer flood damage to her home during a hurricane.
How quickly and thoroughly these people recover depends on their resilience. It’s a word that’s commonly used but it's also quite descriptive, because it reflects the individual’s ability – and society’s ability – to withstand political, economic and environmental shocks.
Insurance helps make the world more resilient. It compensates the Kenyan farmer for lost income and pays to help the Florida resident rebuild. While those examples are small on a global scale, they illustrate the significant and broad capability of risk transfer. Both demonstrate how insurance can and does mitigate the innumerable knock-on effects of climate change.
Now, more than ever, insurance is vital to the sustainability of the world’s economies, institutions and people, as resilience is being threatened. According to Swiss Re Institute-London School of Economics Macro Resilience Index, the global economy has less capacity to absorb the impact of a shock event than it did in 2007.
So, just what threatens a nation’s resilience? It can be ineffective monetary policy, suboptimal use of human capital, failure to comply with carbon regulation, political instability or labour market inefficiency, to name a few. Swiss Re’s sigma report examines the world’s economic and social vulnerabilities and outlines how insurance can reverse these negative trends and contribute to improved resilience.
To frame the issue, the report employs a number of key indices: the Swiss Re Institute-London School of Economics Macro Resilience Index (noted above) and the SRI Insurance Resilience Indices. The latter tracks the world’s insurance protection gap, which quantifies the lack of resilience in three core areas of risk: natural catastrophes, mortality and healthcare spending. That amount currently stands at approx. USD 1.2 trillion, the equivalent of a quarter of all insurance premiums written in a single year!
The news is not all bad, though. Insurance has kept pace with growing risks, helping individuals, households and organisations withstand shock scenarios like drought in Kenya or a hurricane in Florida. The strongest gains in the SR Insurance Resilience Indices have come in property catastrophe insurance in advanced economies and emerging market mortality protection in emerging markets.
Consider natural catastrophes, which make up 18% of the protection gap, or over USD 200bn of annual costs. We – and by “we” I mean all stakeholders – stand the best chance of closing the gap and making communities more resilient when the private and public sectors step up, together. For example:
- In the public sector, Swiss Re and other reinsurers support the US National Flood Insurance Program (NFIP) with claims-paying capacity, so more residents can access coverage in communities that enforce regulations to reduce flood losses.
- Also, in the public sector, earthquake cover is automatically provided in New Zealand when home and contents’ fire insurance is purchased from a private insurance company. This means that as much as 80% of the economic losses caused by an earthquake are insured, securing funding for reconstruction.
- In the private sector, Swiss Re is working with insurers in Florida to offer water damage, including flood coverage, as part of a standard homeowners policy. It’s a breakthrough in flood protection, as flooding is often more destructive than winds in a hurricane and coverage for this peril was previously difficult to obtain in the private market.
Technological advances provide us with some tools which support us addressing these challenges:
- A key enabler of progress here is parametric insurance, which pays out rapidly based on predetermined triggers. This can shorten the claims settlement process, which means that payouts have the biggest impact, and works in areas where its hard to quantify the economic cost that requires indemnification. Local governments can use the funds for things like emergency response and ensuring public safety, which helps communities get back on their feet faster. Individual consumers can fund high insurance policy deductibles or pay for costs that aren’t covered by their standard policies.
- Satellite imagery enables a quick and accurate estimation of the impact of flood damage to large areas, and even extends to the ability to estimate how droughts affect the root zone of crops.
- Smartphones now enable us to provide our customers with user-friendly policy purchase and administration, and can even support claim validation, dramatically increasing accessibility and the customer experience.
On a macro level, gains are being made in the quest for resilience when governments focus on improving environmental and social responsibility. This is particularly noteworthy in three areas: people, carbon and sustainable development.
People are a nation’s greatest resource, and their social mobility is an indicator of equal opportunities. In countries where efforts are made to close the gender gap, limitations on the talent pool are removed and the economy benefits because talent has been maximised and efficiently allocated.
One factor in the Resilience Index is carbon emission. Countries with a low carbon economy can set an example for others. In fact, five of the top eight countries in the Swiss Re Institute-London School of Economics Macro Resilience Index have a low carbon economy score of 70% or greater, with three scoring 100%.
By transferring risk to re/insurers, these enterprises can raise capital, secure loans, begin hiring and start innovating. If an event occurs that could potentially threaten or disrupt operations, the insured receives a payout so it can continue operating seamlessly. With the assurance of uninterrupted cash flows, investors and lenders have greater confidence.
The sigma report also finds that achieving the UN's Sustainable Development Goals and higher levels of resilience are mutually reinforcing. Insurance lies at the heart of virtually every one of the 17 goals, which include Health, Water & Sanitation, Energy, Economic Growth, Infrastructure, Cities and Climate Change.
Climate change warrants special attention because it is so pervasive and its impact widespread. By addressing the risks that climate change poses, Swiss Re is helping ensure sustainability on many, varied fronts. Our goal is to help mitigate the risk our clients face and facilitate the transition to a low carbon economy. Swiss Re has decarbonised its business model. We have committed to net-zero emissions by 2050 on the asset (investment) and liability (underwriting) side. We apply a sustainability test to our underwriting, adapting our risk appetite and focusing on five priorities: Health, Nat Cat Protection Gap (where we can make insurance more accessible), Food, Energy and Water/Infrastructure.
Swiss Re is active in all renewable energy re/insurance and is the lead market for offshore wind risks. We have also made a commitment to the United Nations to advise up to 50 sovereigns and sub-sovereigns on climate risk resilience and to offer them USD10 billion against this risk by 2020.
The aggregate impact of all of this is substantial. Swiss Re estimates that closing the protection gaps for the three risk areas – natural catastrophes, mortality and healthcare – would increase average expected claims payments to cover insured events by more than USD 1 trillion per year, thereby improving societal financial resilience, and representing a huge potential new business area for the industry.
And it starts with understanding the needs of people like the Kenyan farmer and Florida homeowner.