Parametric Insurance: closing the protection gap

Every year, natural disasters wreak havoc across the world, causing immense harm and destruction wherever they strike. In their wake they leave long-term damage to millions of livelihoods and undermine efforts to build sustainable economic growth. The Bank of International Settlements calculates that in some cases, especially in developing markets, the worst natural catastrophes can permanently reduce a country’s GDP by almost 2%.

In 2017, the hurricanes that devastated parts of the US and the Caribbean, the earthquake in Mexico and flooding in Asia emphasised the ever-increasing risk posed by natural catastrophes. Weather related catastrophes are thought to be increasing in frequency and severity due to climate change. This trend, combined with population growth and increasing urbanisation, means more people are being impacted more often.

In fact, the number of weather-related loss-events has tripled since the 1980s and inflation-adjusted insurance losses in the same period have increased from an annual average of USD 10 billion to USD 50 billion, according to data from Munich Re. The economic losses caused by natural catastrophes in 2017 look set to be among the worst in recent memory, with Swiss Re data estimating such losses at USD 300 billion in 2017, compared to an average of USD 178 billion for the previous 10 years. With an estimated USD 131 billion of these losses insured, the protection gap is clear.[1]

An issue for developed and developing markets

The protection gap, which measures the difference between insured and uninsured losses, is an issue all over the world. The protection gap means that individuals, businesses, communities and whole nations are less resilient than they could be if the gap were closed. Only about 30% of losses from natural catastrophes have been covered by insurance in the past ten years. In middle or low-income countries the uninsured proportion of economic losses often exceeds 90%. This situation is set to get worse. The International Monetary Fund (IMF) has concluded that countries located in the tropics, the vast majority of which have a low GDP, will bear the brunt of more regular weather-related shocks.

Figure 1.1

As the graphic in Figure 1.1 from Swiss Re for 2014 indicates, although the protection gap may be widest in the developing world, its financial impacts are more substantial in the world’s economic powerhouses. For example, in absolute terms the US, Japan and China account for the biggest share of the global property protection gap, with expected annual uninsured losses of more than USD 81 billion, which is more than two thirds of the total gap of USD 120 billion for the sample countries.3

While developed nations might be better prepared for the rise in extreme weather events, such as tropical cyclones, IMF data shows that they are just as likely to be affected. This makes adequate risk management crucial globally to build resilience and avoid significant negative impact on the global economy.

Figure 1.2

Goverments are waking to the power of insurance to build resilience

There is a growing international consensus that increased insurance penetration can improve global resilience. Insurance continues to play a unique and vital role in society, as it has done since its foundation, allowing individuals, businesses and communities to rebuild after disaster strikes.

A Lloyd’s study in 2012 showed that, in a sample of five large developed and developing economies, a one percent increase in insurance penetration would lead to a reduction in the disaster burden on taxpayers of 22%.5 In short, closing the protection gap through appropriately designed insurance solutions can help mitigate the effects of natural catastrophes by enabling communities to get back on their feet quicker and more efficiently.

In the last several years there have been a number of positive initiatives that seek to bridge the global protection gap. In 2015, the G7 launched its InsuResilience initiative, which aims to deliver climate risk insurance to 400 million of the world’s most vulnerable people by 2020. This global partnership has since been expanded to and adopted by the G20 and to the “V20” (a group of 49 nations considered most vulnerable to climate change).

In 2016, the insurance industry, with the support of leaders from the World Bank and the United Nations, formed the Insurance Development Forum (IDF), in which Clyde & Co is involved. The IDF aims to extend the use of insurance and risk management techniques to build greater global resilience.

At the G20 meeting in July 2017, the UK announced the establishment of the London Centre for Global Disaster Protection, in combination with the World Bank, to help developing countries plan for disasters and assess what insurance they might need as part of a risk mitigation strategy. The IDF and the London Centre will provide key platforms for knowledge sharing and capacity-building to help facilitate the deployment of insurance to contribute to global resilience.

Parametric Insurance can help close the gap

By its nature, parametric insurance brings with it the ability to provide rapid funding for relief, recovery and reconstruction efforts, and so may have the greatest potential impact in countries most dramatically affected by natural perils and where the protection gap is currently large. Technological developments and improved risk modelling have laid the groundwork to enable the take-up of parametric insurance to accelerate.

The global protection gap can be narrowed in a number of ways and there is no simple or one-size-fits-all solution. But novel forms of risk transfer hold a lot of potential. Parametric insurance is one of those

The percentage of insurance that employs parametric triggers is growing. Clyde & Co offices around the world – particularly in Asia, Latin America and Africa – are seeing an uptick in requests for policy wording advice and regulatory guidance as parametrics increasingly enter the mainstream of insurers’ and reinsurers’ product portfolios.

[1] Data from Swiss Re Sigma, 20 December 2017. http://www.swissre.com/media/n...

[2] Geneva Association, harnessing technology to narrow the insurance protection gap, source of stats: Swiss Re

[3] http://institute.swissre.com/r...

[4] International Disaster Database, IMF

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Nigel Brook

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