Narrowing the gap between insured and economic damage from natural hazards

As the Swiss Re graph on this page indicates, there is more often than not a wide gap between insured (blue line) and economic – or total – natural disaster losses (red line). Consider the 2013 floods in southern Alberta. While the insured loss came in at around $1.7 billion, the total loss was somewhere in the neighbourhood of $6 billion.

What do gaps like this exist? There are several reasons.

First and foremost, the gap between insured and economic losses is greatest in countries where penetration of insurance products is low, as is generally the case in developing or non-industrialized countries. Simply put, when comparatively little insurance has been purchased, correspondingly little will be paid out in claims and most of the damage will land in the ‘economic or ‘uninsured’ loss category.

But there are other, sometimes subtler reasons why there can be a gap between insured and economic losses.

A  gap may exist if insurers offer a product but for one reason or another don’t sell much of it. A good example is earthquake coverage for Canadian homeowners. While Canadian insurers offer an endorsement for damage from shake, only about half of B.C. homeowners and around 2% of Quebec homeowners buy it.

This problem can be classed as one of ‘underinsurance’ – which can take other forms, like failure to insure to value. Whether through fault of the seller or of the buyer, a large number of Canadians don’t purchase enough insurance. Often they find this out the hard way, after their home and belongings have been destroyed in a total loss. Along with increases in house values (due to market forces) and replacement costs (due to inflation), it is common for homeowners not to report new large purchases, or renovations that add value to their home, such as additions and basement renovations.

Large deductibles, caps and limits may also widen the gap between insured and economic damage, as policyholders are increasingly being expected to retain more risk, particularly as frequency and severity of catastrophe losses increase. Part of this includes the new trend of assigning different deductibles according to the hazard.

A gap may also exist if no coverage is available. A good example here is homeowners insurance for overland flood in Canada, a product not currently available on a widespread basis.

Also, there may be a gap between insured and economic losses because a type or category of business may not be desirable for an insurer to write. This lack of availability may be temporary (coming as a result of a short-term crisis, as happened with terrorism coverage after 9/11) or it may be permanent (as with certain kinds of speciality commercial coverages, such as fidelity or pharmaceutical liability). Some lines of business are just too poorly understood, are difficult or impossible to model, require very particular expertise, or are just too volatile (or all of the above).

And probably one of the biggest and most common reasons for the gap between insured and economic losses comes from damage to uninsured public infrastructure. While many governments and public utilities buy insurance from the private market or participate in reciprocal exchanges, many either self-insure or insure only part of their assets. Further, there are categories of asset that are very difficult or even impossible to insure, like roads and culverts. The uninsured portion can easily add billions to the economic losses from a large loss event (and is responsible for a significant portion of the $6 billion total loss incurred from the Alberta floods).

For governments and society at large, narrowing the gap between insured and economic losses oftentimes means the difference between speedy recovery after a large hazard event and no or very slow recovery. Insurance and reinsurance claims dollars equal liquidity.

For insurers and reinsurers, narrowing the gap can spell opportunity.

Providing insurance – including microinsurance – in developing countries means opportunity.

Selling more of a product that is already on offer means opportunity.

Getting a handle on insuring to value so we can better serve insureds means opportunity.

Reversing the trend of leaving more risk to insureds means opportunity.

Developing and offering new products like overland flood insurance for homeowners means opportunity.

Providing traditional insurance or reinsurance or catastrophe bonds, indexed linked securities and other non-traditional risk transfer products to all levels of governments means opportunity.

Shifting risk from public tax rolls to private balance sheets means opportunity.

In a mature insurance market like Canada’s, where competition is fierce and organic growth often appearing impossible, such opportunities should be welcome.

After all, insurers are in the business of placing risk on their balance sheets for the right price. They are not in the business of not placing risk on their balance sheets for no price.