Confronting the cost of catastrophe
Natural disaster losses are high and rising. And climate change is further driving up the risk. How can we make insurance more available to help protect us?
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2018 provided a possible template for the “new normal” – a year when a large number of smaller natural catastrophes, often linked to extreme weather, contributed to the fourth highest annual insurance pay-out.
Half of the economic losses caused by these disasters were uninsured. These costs were borne by the individual victims of the disasters or by the national governments forced to step in after the event.
There is ample capital in the insurance industry to cope with these losses. But individuals and small businesses often don't think about insurance as a way to mitigate risk or aren't aware of their options in the first place.
A combination of better risk awareness and policy incentives could help make insurance more widely available and close the protection gap. This would result in a more resilient society, able to better cope with the likelihood of more frequent and more severe catastrophes.
By traditional standards, 2018 should have been an unremarkable year for natural catastrophes. There was no single major disaster that caused massive destruction, such as Hurricane Katrina in 2005, the Japanese tsunami in 2011 or Hurricanes Harvey, Irma and Maria in 2017. But a larger number of smaller disasters took an immense toll. 13,500 lives were lost. According to the Swiss Re Institute, economic losses from natural catastrophes amounted to USD155 billion, triggering USD 76 billion in insurance pay-outs and contributing to the fourth highest ever.
Taken with previous years, a clear trend is emerging – a “new normal” of higher-frequency, more severe localised events, many related to extreme weather, that are causing ever greater damage.
One of the driving factors behind this trend is climate change. 2018 was the fourth warmest year on record, and the past five years have been the five hottest. Although the link between global warming and major events like hurricanes is uncertain, there is much clearer evidence for the link with heatwaves, droughts, wildfires and floods. These can cause significant damage – the single biggest insurance loss event of 2018 was Camp Fire in California, which cost USD 12 billion.
But insurance protection is not keeping up – globally, the gap between total and insured losses is growing. And this is reducing the ability of individuals, businesses, communities and nations to recover from increasingly common shocks.
In harm’s way
Although climate change is a factor behind this trend, it is by no means the only one. The fact that more people are living and working in areas prone to being affected by natural disasters is also significant.
“60% of all the new homes built in recent years in the US are in what we call the wildland-urban interface – areas which are the first to be affected by wildfires,” says Lucia Bevere, author of the Swiss Re Institute’s sigma report. “We are observing longer wildfire seasons, and more large wildfires, so if the risks aren’t mitigated, we will see growing losses.”
This is part of a phenomenon seen across the globe, as increasing urbanisation and competition for space is driving development on formerly marginal land. Cities are expanding in coastal areas and on floodplains, particularly in Asia, exposing many more people to potential risks.
“In 1980, 200 million Chinese lived in urban areas, by the year 2000 it was about 500 million, and today it's over 800 million. Globally, the urban population is predicted to be over 60% by 2030,” explains Martin Bertogg, Swiss Re’s Head of Catastrophe Perils. “So irrespective of climate change, if severe weather affects a newly developed densely populated area, what was once a small localised event is now a catastrophic event.”
It’s not just the number of people now in harm’s way – concreting vast stretches of land reduces the earth’s capacity to soak up excess water, making flooding both more likely, and more severe.
So why is the protection gap not narrowing?
Part of the answer is psychological. Humans have a built-in “optimism bias” – even though we know bad things like natural disasters happen, we assume they won’t happen to us. This has traditionally been amplified by the long interval between natural disasters that affect any given community – we don’t remember experiencing flooding or wildfires, so we underestimate the risks.
This tendency is particularly dangerous as we build on new land that has historically been sparsely inhabited. Those areas may have been subject to frequent natural disasters that haven’t gained attention because few, if any, people lived there at the time. Now, within the space of a few years, we may have built entire cities in those locations, with their inhabitants unaware that the risk of regular fires or inundations is high.
The extreme weather events of the past few years are beginning to change people’s perceptions of risk. But there are also things both the insurance industry and policymakers can do to increase the likelihood of individuals and businesses taking out adequate insurance. New industry collaborations and partnerships with the public sector are key in raising greater risk awareness.
Better communication of available insurance options is equally important, as is sharing more of the success stories of insurance helping individuals or businesses get back on their feet quickly. For example, many homeowners wrongly assume their household insurance policy will cover flood risk, and that they don’t need separate natural disaster insurance. In less mature markets, many people are unaware that insurance exists to cover what they may see as an unfortunate fact of life.
There is also plenty of scope for incentives that encourage and reward buying insurance and mitigating risks. For example, this year Italy remembers the tenth anniversary of the deadly L'Aquila earthquake. Seismic events are relatively frequent in Italy, but only 2% of people there have earthquake insurance, as they have been accustomed to relying on the government as insurer of last resort. It took billions of euros of public money and, sadly, more devastating seismic occurrences in 2012 and 2016 for Italian society to realise that insurance can make reconstruction faster and more efficient. The government has now introduced tax breaks, both on insurance premiums and on measures to retrofit buildings and make them more resilient. It is hoped that this will bring much-needed changes.
Incentives of this kind have the double benefit of reducing the scale of any losses borne by those affected, and offloading risk from the public sector to the private.
With so few people insured against natural disasters, the burden of compensating for losses and paying for recovery falls overwhelmingly on either the individuals who have suffered, or the public purse. Not only can this prove ruinous to individuals and businesses, it can put a tremendous strain on national budgets – particularly in countries that already struggle to fund public needs. Even when public funds are available, the recovery process is considerably slower versus being able to draw from insurance funds.
At the same time, there are huge reserves of untapped insurance capital – more than USD 2 trillion at the end of 2018 – that are more than capable of absorbing the risk. While a generation ago insurers were wary of natural disaster cover, advances in technology have made it much easier to accurately assess risk. For example, data on flood risk now allows mapping tools with an unprecedented level of detail.
“We have the tools, capacity and capital available to relieve people from risk,” argues Martin Bertogg. “Consumers can purchase some peace of mind, knowing that if a natural disaster does happen, they will be able to rebuild their lives, homes, and businesses rapidly. And clearly there is an opportunity for the insurance industry to sell more. It is a win-win situation.”