100-billion-dollar insurance gap that leaves the world exposed

100-billion-dollar insurance gap that leaves the world exposed

By Caroline Fouvet

Insurance is the art of selling peace of mind; it offers protection when the best made plans fail. However in reality, we are all, to put it mildly, woefully exposed. Recent estimates suggest that a US$ 100 billion ‘protection gap’, has emerged which could threaten public finances and the insurance industry. The gap – the difference between the average cost of natural disasters and the amount insured – has the potential to widen significantly in coming decades, as climate risks increase. The problem is compounded by the fact that at the same time, the global population and infrastructure investment is set to rise, leaving more lives and assets in harm’s way.

However despite these risks, the insurance industry lags behind other institutional investors’ consideration of climate change impacts. According to the Asset Owners Disclosure Project (AODP) Global Climate Index, “only 8% of insurers have staff dedicated to integrating climate risk into the investment process, half as many as pension funds”.

More risk, more cost

Climate change is increasing costs for insurers. In 2016, natural disasters caused US$ 210 billion of economic losses, with floods accounting for the largest share (US$ 62 billion). Further, as insurers are also asset managers their portfolios are also threatened by climate change. According to AODP, 116 global insurers were responsible for US$ 15.3 trillion of investments in 2016, while only one in eight were taking tangible action to manage climate risks to their portfolios.

Catastrophe bonds

To better manage risks and enhance investment strategies, what are the tools that the insurance sector can leverage to better consider climate impacts? Concrete options are already being used around the world. For instance, catastrophe or “cat” bonds are issued by reinsurers to cover damage costs when these hit a pre-determined threshold. When this occurs, the bond defaults and the principal paid by the investor goes to cover the issuer’s indemnities.

These bonds are based on catastrophe models that use climate and weather data to effectively assess and price the costs of catastrophic events. Acclimatise recently showcased the work of US National Centers for Environmental Information (NCEI) whose meteorological information feeds into the models. The cat bond market is booming and 2017 marked a new record with a US$ 29 billion issuance.

Applying indicators

Other innovations include the newly released Actuaries Climate Index (ACI), developed by North-American actuarial organisations. The ACI provides a indicators of the frequency of extreme weather events and the extent of sea-level change. This information is then used by underwriters to assess and price climate-related risks and opportunities.

Public-private partnerships

Insurers are also increasingly relying on public-private partnerships to reduce their overall risk exposure. Such partnerships typically allow the public sector to benefit from financial returns, while the private sector is backed by the treasury. Governments and international organisations can, for example, expand the availability of insurance schemes by temporarily subsidising premiums.

Climate change threatens the insurance industry both in terms of increasing the size and number of pay-outs on insured assets, and through risks to insurers’ own investment portfolios. Several solutions are available to increase the climate resilience of the insurance sector, but with little action being taken by the bulk of the industry, it seems that this time it is the insurers that need work harder to find some peace of mind.

Cover photo by Alex Wong (Unsplash license)

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