Protection gap remains at an estimated US$1.3 trillion: Swiss Re

Disaster risks are increasing, but insurance hasn’t kept pace as the estimated US$1.3 trillion gap between insured and total losses remains stubbornly large, said a new report from Swiss Re.

Launched at the World Bank/IMF annual meetings in Lima, Peru, the Disaster risk financing: Smart solutions for the public sector report found that the economic cost of natural catastrophes has grown markedly in the last 40 years. However, the protection gap – the difference between economic and insured losses – remains large, despite the availability of innovative insurance solutions. [click image below to enlarge]

Narrowing this gap helps strengthen a country’s financial resilience, Swiss Re said in a press release on Wednesday. “The insurance industry is already rising to the challenge of underinsurance in both developed and developing countries through innovative risk management measures,” said Swiss Re’s Group CEO Michel M. Liès in the statement. “The risk landscape is becoming more and more complex as the world becomes more interdependent. No country can afford to be left unprotected.”

The report said that the increased risk is “mainly due to economic development and population growth, a higher concentration of assets in exposed areas and also, increasingly, climate change.” For the first time in history, more people live in urban centres than in rural areas and “many cities are on the coast and are threatened by floods and storms, while the vital agricultural sector remains exposed to weather-related events such as drought. But insurance has not kept pace.”

On average, only about 30% of catastrophe losses have been covered by insurance over the last 10 years, Swiss Re reported. That means that about 70% of catastrophe losses – or US$1.3 trillion – have been borne by individuals, firms and governments.

Governments typically shoulder the cost of relief and recovery, but also pay for reconstruction of infrastructure and, in the case of underinsured individuals or businesses, they even fund private rebuilding efforts. Yet, most governments will seek the funds only after a catastrophic event, and often revert to increasing taxes, borrowing or soliciting international aid, often incurring high costs and delays, the release said. These events can wipe out years of hard-earned development gains, with Rating agency Standard & Poor’s recently publishing a report warning that a country’s disaster preparedness could be linked to its credit rating going forward.

As a first priority, governments should enable a functioning insurance market, Swiss Re recommended, which will help absorb a major part of disaster losses suffered by individuals and businesses. Pre-event financing solutions can also alleviate the remaining financial burden on governments. Post-disaster financing (such as debt financing or donor aid) should only come into play to cover residual losses once all other risk transfer solutions have been exhausted, Swiss Re said.

“For risk protection to be effective, funds need to be quickly available in the wake of a natural catastrophe, meaning that financing arrangements must be in place already beforehand,” said Martyn Parker, chairman of Swiss Re’s Global Partnerships, a unit that works with public sector clients. “Financial preparedness lowers the volatility of the state budget and improves planning certainty for the public sector, besides making a country more attractive to investors.”

The study points to a number of countries working in collaboration with insurers to innovative solutions. Mexico, for example, is a pioneer in securitizing earthquake and hurricane risk. Uruguay has developed an ingenious risk transfer mechanism to mitigate the risk of low rainfall on its hydroelectric power generation. Central American and Caribbean governments have insured their risk against hurricanes and earthquakes, while the Africa Risk Capacity insures several countries against drought risk.