Learning is more than half the battle – climate head’s perspective on the insurance gap

"The most urgent lever is to start improving resilience"

Learning is more than half the battle – climate head’s perspective on the insurance gap

Risk Management News

By Kenneth Araullo

When it rains, it pours – an expression that is especially relevant in our current climate. As the world comes to terms with the effects of climate change, the insurance industry is doing its part to keep everything afloat as the storms and waves come crashing across almost all regions.

It’s the wildness of the weather and its refusal to bow down to any mortal standards that is keeping us from any reasonable long-term forecasts. The proof is in the figures, Munich Re chief climate and geo scientist Ernst Rauch (pictured above) explained, and it goes all the way back to more than five decades ago.

“Let me start by saying that the basis for my answer is that Munich Re has been collecting and analysing data from natural catastrophes worldwide since the 1970s,” Rauch said in conversation with Insurance Business’ Corporate Risk channel. “I refer to this, because just looking at the last 10 years, from 2013 to 2022, reveals that half-year figures do not tell us what the final numbers for the complete year will end up being.

“If we look at the last 10 years in Asia, we see the percentage of insured losses from half-years made up anywhere between 4% in 2019 to 82 % in 2016 of the respective total year-end insured losses. We also see a wide range of half-year economic losses spanning from 29% in 2014 to 75% in 2016 of the respective year-end economic totals,” he said.

If these numbers have anything to tell us, it is that any forecast on how the next six months will go in terms of nat cat losses is essentially a shot in the dark. In its latest natural catastrophe report, Munich Re reported that overall losses amounted to $110 billion, a figure in which only $43 billion is insured. These figures present a damning case for more insurance; identifying the root issue was easy enough, but tackling it is another beast entirely.

“It always depends on the type of event and where it takes place,” Rauch said. “Is it in a densely populated region? Is it in a region with high insurance penetration? The insured losses depend on where a natural disaster hits. In some countries, the insurance penetration is close to zero – essentially, nothing is insured. In other Asian countries, the insurance penetration is significantly higher. So, it is just as much about the region as it is the type of event. For instance, flood events are typically less-frequently insured compared to wind events, like typhoons.”

Vulnerability – an equalizer

In a world filled with inequality, the climate offers little comfort in that we are all somewhat equal when it comes to vulnerability. Rauch said that almost all Asian countries are vulnerable to the whims of the changing climate, but this same sentiment can be applied across the world.

“Asia faces exposure to a number of natural disasters, be it geophysical events like earthquakes or weather and climate disasters like wind storms or flooding,” he said. “Some countries are more often affected by natural disasters simply because of their sheer physical size, China for example. Others like Vietnam, Korea or Japan is smaller but are located in tropic or sub-tropic regions where [there] is a high probability of cyclones or typhoons. Typically, coastal regions are more vulnerable to these events than inland areas due to often higher concentrations of people and property values.”

With this in mind, coastal regions should be greatly emphasized as we continue to tackle climate issues. It is a risk affecting many Asian countries, Rauch noted, although he also cautioned that while climate change is a big issue, it should not completely distract us from the tremors that can come from below.

“In addition, some countries have earthquake exposure like Japan or some regions in China,” Rauch said. “If you analyse the highest insurance payouts for natural disasters, in Asia between 1980 to 2022 Japan has been the best insured. Just consider the Fukushima earthquake in 2011 or typhoons like Hagibis in 2019. No other Asian country has a similarly high natural disaster insurance penetration. Regarding insurance payouts for natural disasters, Japan is followed by China, Thailand, and India.”

Small improvements

Asia’s status as an emerging sector also means that it is still quite undeveloped when it comes to some aspects. The natural catastrophe protection gap across Asia stood at an average of 92% over the last 40 years, Rauch said. However, the good news is that it’s slowly improving, although it remains to be seen if it can improve fast enough to matter.

“Now, having said this, we can see a little bit of a silver lining at the end of the horizon. Just looking at the last 10 years from 2013 to 2022, the protection gap decreased in Asia moderately – down to 88%, meaning that between these years 12% of the natural catastrophes were insured and 88% were uninsured,” Rauch said.

Rauch compared this figure to Organization for Economic Co-operation and Development (OECD) countries outside of Asia, and the results speak for themselves; whereas in the 1980s the natural disaster protection gap was at around 75%, today it averages around 50%.

“The figures show that there is still a lot of work to do around the globe when it comes to protecting people and the economies we all live in. Our industry’s role is to dampen the negative impacts from natural disasters on people and businesses and to reduce the financial shocks from such events to governments, thus stabilizing economies and ultimately promoting growth,” he said.

Regulations and learning, not AI

From a climate expert’s perspective, there are many avenues to close the insurance gap. Rauch himself placed an important emphasis on government intervention, especially focusing on a collaboration between the public and private sectors for a better, more resilient country.

“Regulation can and does play a significant role, especially when it comes to developing public-private partnerships and solutions. Regulations making certain insurance solutions mandatory, like insurance against earthquakes or flooding, are powerful tools to reduce the consequences of unavoidable damage. In a public-private natural disaster insurance partnership, governments or public authorities define the range of coverage and the financing elements while the private sector takes care of the insurance protection and claims handling,” he said.

Rauch cited the Toka Tū Ake EQC in New Zealand as a shining beacon of what can be possible with proper regulations in place. Created in 1945, It is a mandatory program that requires every homeowner and every business to buy insurance up to a first loss limit or cap. In doing so, people, their livelihoods, and financial wellbeing are protected in case of earthquakes – or, more recently, even slides caused by extreme weather events.

“Other such examples are the US National Flood Insurance Program and the Turkish Catastrophe Insurance Pool (TCIP) – the latter was introduced after the major earthquake in 1999 – and provided people in Turkey with about US$5 billion of support after this year’s devastating earthquake in February,” he said.

“So, governmental action in the regulation and development of such mandatory programs, or at least supporting the development of private sector programs is helpful. I would say it is the most relevant driver in closing, or at least significantly reducing, the protection gap.”

But what about AI? Many in the industry are touting it to be a great leap forward for insurance – an evolution, even. However, while he does see some use cases for it, Rauch believes that AI will not be a major driver in the battle to close the insurance gap.

“This question is better left to our experts in this field, but from what I can see so far, I don’t deem it highly likely that AI –at least in the near to mid term – will be a major driver in closing the protection gap. Why? Because the challenge on closing the gap is not on the supply side, it is much more on the demand side,” Rauch said.

Catastrophe models will likely benefit from these emerging technologies, Rauch said, but the bottleneck remains on the side of demand. This area will need a different approach, something which can be done without large language models and their affinity for faster, more efficient processes.

“This has a lot to do with information and education,” Rauch said. “I do not see AI helping very much in this regard within the next few years. People need to understand what their exposure is, what probabilities they face, and what concrete measures they can take to improve resilience and ultimately reduce their vulnerability to natural hazards. This is about building codes. It’s about land use planning. As said, it is a topic of demand. Munich Re is interested in offering more risk transfer solutions also in Asia. It is our core business.”

Rauch did concede that the technology has its uses, especially in putting more transparency on individual risk situations. However, in this current stage, what will close the insurance gap is education and information, especially for non-OECD countries where the gap is the widest.

“The most urgent lever is to start improving resilience,” he said. “It begins with teaching risk awareness in schools and making valuable information about natural disasters available and transparent to the broader public, across all levels of society.

“Munich Re published a world map of natural hazards already back in the 1970s. It was an early visual aid to help people understand which regions are more exposed to tropical cyclones or earthquakes. This is now a digital system available to our clients. You can pinpoint any location in the world, and you get the local hazard score for flooding, for wildfires, for tropical cyclones, and other perils. Just using this sort of information is the first big step toward closing the protection gap.”

A challenge on the resilience front

In the end, regulations and better learning all build towards better resilience, something that Rauch believes should be at the core of the protection gap. As weather-driven events around the world increase, it will lead to higher premiums; this, however, should be expected, as buying risk without adequate pricing will never be sustainable.

“Strengthening resilience and reducing people’s vulnerability will help both to soften the societal and economic shock of Nat cat events and keep premium rates more stable, more affordable,” Rauch said. “And again, all this starts with increasing public risk awareness and then taking action – improving building codes and land use planning.

“The insurance industry has a wealth of data and knowledge, and using this knowledge is a way forward both in terms of keeping people safe and insurance economically sustainable. Climate change is a massive loss driver. We see strong indications of this very clearly in our own analysis. The short and mid-term solution for how we handle the changing risk landscape is putting more focus on vulnerability and resilience topics.”

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