Secondary perils – a misnomer for mounting risks

Swiss Re Institute’s recent sigma research says insured losses from natural catastrophes and man-made disasters in 2018 amounted to USD85 billion, the fourth highest single year total on record. While there were no mega disasters like 2017 Hurricanes Harvey. Irma and Maria, secondary perils wreaked a lot of havoc and raised the 2018 significantly.

Short of a formal definition, the industry considers secondary perils as high-frequency, low-to-medium severity loss events such as hailstorms, flash floods, tornadoes, landslides, drought and wildfires. Many times, these events appear as secondary effects of primary natural perils such as tropical cyclone-induced flooding, liquefaction and landslides from earthquake shaking.   

Secondary perils are increasingly becoming primary drivers of losses. In 2018, close to 62% of all natural catastrophe-related insurance claims were caused by secondary perils and secondary effects of primary perils. In the last two years, these perils contributed to more than 50% of insured losses as well responsible for some severe nat cat losses (e.g. Hurricane Harvey (2017) induced flooding in Houston and record Camp Wildfire losses (2018) in California, severe flood resulting from Cyclone Debbie (2017) in Australia and record severe flood losses in Western Japan (2018) amplified by Typhoon Prapiroon). In some countries like Australia, secondary perils have historically been the main driver of natural catastrophe losses.

Unlike primary perils, secondary perils can largely occur anywhere, for example, torrential rainfall and resulting flooding can happen far away from flood plains or coastal regions. This makes the secondary perils even more vulnerable to rapid urbanization. The expanding areas of paved surfaces results in rainwater running and rising along these hard surfaces instead of being absorbed into the ground.

Further, the world is getting warmer, creating drier surface conditions and increasing the risks of wildfire outbreaks and droughts. Precipitation patterns are also changing, contributing to increased tropical cyclones-induced precipitation and severe storm surges due to rising sea level.

Extreme weather events only become catastrophes when they hit densely populated areas.  With Asia's rapid urbanization and population growth, the probability of heavy losses has multiplied. New hot spots will emerge and they will be likely remain unknown until a catastrophe happens.

Mitigating secondary perils – challenges and opportunities   

Traditionally, natural catastrophe insurance and pricing for catastrophe risks is mostly influenced by the loss impact of primary perils. The experience in 2018 and 2017 shows that insured losses from secondary events can be significant. This means that re/insurers need to enhance risk assessment, monitoring and modelling tools, and develop strategies to overcome the complexities of secondary peril risk assessment and modelling.

Secondary perils can happen anywhere, tend to be localized and can be significantly influenced by human interventions (e.g. human role in triggering wildfire) and thus are relatively complex to model. In a changing world of rapid urbanization and a changing climate, traditional approaches relying on historic loss data to map, price and underwrite risks are unlikely to be adequate. This underscores the importance of having an adequate view of the present climate conditions and built environment along with considerations of forward-looking trends linked to rising temperatures and urbanization in developing risk views for underwriting and risk management.  

Traditional cat modelling approaches should leverage new technologies and data such as machine learning and social media to build robust secondary perils tools. More importantly, it requires insurers, reinsurers, clients as well as partners from the industry and public sector, working together in a collaborative ecosystem that enables data access throughout the value chain and invests in new approaches for risk assessment. 

New approaches such as satellite imagery, mobile data, suitable for a region can be developed to assess local risks posed by weather-related secondary perils, providing insights that enable creation of a greater product range and more targeted distribution of catastrophe covers. In a November 2018 report, The Geneva Association recommended integration of climate models and the impact on critical infrastructure into catastrophe models to understand the secondary wave of impact, providing opportunities to take mitigation measures1.

At the same time, our sigma observations indicate an important opportunity for the industry to close the protection gap. Only half of the last year secondary perils' losses were insured. It is challenging to incentivize an individual to purchase insurance protection for rare perils like earthquakes - perceived to be rather remote. On the contrary, coverage for secondary perils can be an opportunity to drive insurance penetration due to the relatively frequent nature of these perils. Secondary peril covers for heavy precipitation or landslides can provide a crucial first step to incentivize customers in realizing the value of insurance and motivate the purchasing of a comprehensive natural catastrophe insurance addressing more remote perils. In less mature markets in Asia, this can contribute significantly to driving greater risk awareness and developing a stronger insurance culture.

In China, Swiss Re has partnered with Mao County to provide the country's first county-level natural catastrophe programme that insures Mao County and the Tibet Plateau. In addition to earthquakes, the programme insures the county against the impact of secondary events such as landslides, heavy rainfall and public safety accidents. In another example, Swiss Re has supported insurance solutions covering secondary perils such as excess rainfall from hurricanes in addition to wind damage for the Caribbean Catastrophe Risk Insurance Facility (CCRIF).

Catastrophe events in 2017 and 2018 resulted in large losses to many aggregate reinsurance programs, underscoring the need for review of both frequency and severity assumptions related to secondary perils. With increased demand for tailored reinsurance programs including aggregate reinsurance structures to protect earnings rather than just simply protect capital, robust methods and tools to assess frequency and severity risks will be critical in developing new products to insure these risks efficiently and sustainably.

Secondary perils need the same level of attention and resources as primary perils, if not more.