When secondary perils aren’t so secondary

Expert highlights an area which tends to be overlooked, leading to massive losses

When secondary perils aren’t so secondary

Risk Management News

By Gabriel Olano

Risk managers, as part of their task to secure their organization from perils, may tend to focus on the ‘big’ or primary perils and potentially overlook what are called ‘secondary perils,’ which are defined as high-frequency, low-to-medium severity loss events. When these smaller, secondary perils add up, the damages sometimes cause more significant losses than those triggered by huge events. To use an idiom, it’s death by a thousand cuts.

“The impact of secondary perils, perhaps owing to its name, is under appreciated compared to that of primary perils,” Alex Pui (pictured), natural risk catastrophe manager for Asia-Pacific at Swiss Re, told Corporate Risk and Insurance. “Although there were no mega-disasters in 2018 in terms of resulting financial losses, the combined insured losses of all natural catastrophe events still amounted to US$76 billion, ranking within the top 10 highest catastrophe-loss years. Instructively, more than half of the losses stemmed from secondary peril events.”

Pui classified secondary perils in two categories – independent secondary perils and secondary effects of a primary peril. The former includes riverine and flash floods, extreme rainfall, landslides, forest fires and damaging convective thunderstorms (e.g. hailstorms, tornadoes); while the latter includes tsunamis, storm surges, as well as liquefaction and fire following earthquakes.

“As we saw in 2018, warm temperatures and dry conditions have led to large wildfire spread, drought, and record-setting precipitation events across the globe,” he said. “With urbanisation, associated growth in asset concentration in exposed areas, and long-term climate change projections, the trend of growing losses from an increasing incidence of secondary perils is expected to continue.”

Insurance, which is one of the most effective tools in transferring risk, may fall short when dealing with secondary perils, with models not always taking them into account. Pui gave the example of US flood risk models as those that tend to focus on primary peak loss-generating perils such as hurricanes.

“First, catastrophe modelling tools were traditionally geared towards assessing loss estimates associated with severe catastrophes, rather than used as a basis for accurate risk-based premium pricing,” he said. “In addition, secondary perils such as wildfire and flood are highly localised, and made more unpredictable due to human intervention, thus are more complex to model.

“In some cases, these considerations help explain poorly suited insurance solutions. For others, they reveal a mismatch between the design of available covers and consumer requirements. To overcome such issues and help narrow existing protection gaps, the insurance industry needs to better understand and include high-frequency secondary perils in their claims monitoring, risk assessment, pricing and management activities.”

Climate change
Planning for secondary perils is especially important in the face of climate change. Asia-Pacific, for better or for worse, is one of the world’s climate hotspots and bears the brunt of climate change. Asia’s large and growing populations and economies exacerbate the issue.

Pui said that sea-surface temperatures in the Northwest Pacific basin have increased by up to 0.5C per decade since the 1970s. This means that typhoons in the region are more likely to reach higher peak intensities due to higher energy availability.

“In fact, we may be already seeing this – manifested in the recent trifecta of Typhoons Manghkut, Hato and Haima,” he said. “Although these storms were estimated approximately as one-in-25-year return period events, they occurred one after another for three consecutive years running.”

He added that between 2014 and 2017, Asia was impacted by 217 storms and cyclones, as well as 236 cases of severe flooding. These affected 650 million people and caused at least 33,000 fatalities.

“Secondary perils, such as torrential rainfall, are causing disruptions to rail and air traffic, as well as prompting officials to shut schools and offices, as we’ve seen in Mumbai and Southwest Japan in recent years,” Pui said. “Due to the high-frequency nature of such secondary perils, businesses face frequent and costly interruptions.”

Industry’s response
Pui stressed that the influence of secondary perils is of growing importance in the estimation of losses for the insurance industry and its sustainability. Furthermore, insurers should acknowledge that there will be a growing share of losses coming from secondary perils, and incorporate climate and land-use trends into their evaluations.

“Innovative insurance solutions can fill gaps left by traditional insurance which result in meaningful economic benefits,” he said. “Last year, we developed and launched HazeShield, a standalone haze insurance solution for businesses operating in Singapore. The risk model underpinning HazeShield was developed in partnership with Harvard University’s John A. Paulson School of Engineering and Applied Sciences. We have also worked with clients to structure parametric- or index-based solutions that protect against loss of attraction as a tourist destination due to cyclones, as well as developed covers against bushfires based on satellite imagery, supply chain disruption based on river-levels, and more.”

In general, Pui believes that the insurance industry must continue to play an educational role with respect to climate change risks and the increasing vulnerability of developing markets. Risk awareness should be perceived as corporate responsibility, not just to society but to also to shareholders.

“The benefits of pre- as opposed to just post-disaster financing has not yet been well-articulated enough to risk managers for them to fully grasp the value of insurance,” he said. “To this end, more education is required to change mindsets, with insurance no longer considered a grudge purchase but another tool in the kit to reduce volatility and ensure earnings stability.”

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