What do you think when you hear the term, natural catastrophe (nat cat) protection gap? The recent earthquake in Nepal? Typhoon Haiyan in the Philippines? Chances are, you associate the issue more with developing countries.
You may be surprised to learn that the U.S. currently has the largest protection gap among countries globally. According to a new Swiss Re Sigma report, “Underinsurance of property risks: closing the gap,” the annual expected uninsured losses from earthquake, flood and wind damage in the U.S. (the largest nat cat perils) total more than $30 billion, based on Swiss Re’s natural catastrophe models. This means that, of the total estimated natural catastrophe losses in the U.S. of $55 billion annually, more than half aren’t insured.
Such modeling of future risks is vital as underlying risks don’t always show up in historical event data. For example, Florida hasn’t seen a major hurricane in more than a decade, but still has a high risk.
Earthquakes make up the largest share of expected losses, with an estimated $20 billion of risk remaining uninsured annually. Despite the risk of devastating economic losses created by a major earthquake, few people buy earthquake insurance even in the highest-risk parts of the U.S. In California, residents spend a lower share of their incomes on earthquake insurance than citizens of other earthquake-prone regions such as Japan and New Zealand.
Windstorm perils create the second highest risk, with nearly $8 billion uninsured annually, on average. Although the majority of windstorm risks in the U.S. are insured through standard homeowners policies, the country still has the largest absolute value of uninsured windstorm risks in the world, due to its high exposure to hurricanes. Although more than half of flood risks are insured, an estimated $2.7 billion in flood losses remain uninsured annually, contributing to the protection gap during both riverine floods and hurricane storm surges. Higher population density, increased property development and climate change also are increasing these risks, especially in coastal urban areas.
Rescuers on New Orleans streets after Hurricane Katrina. (Photo: AP/Dave Martin)
Impact on urban locations
Hurricane Sandy, which struck the most densely populated area of the U.S. in 2012, is a recent example of the impact of natural catastrophes on our highly urbanized coastal cities. Total economic losses were approximately $70 billion, with the highest losses in the hardest-hit states of New York and New Jersey. Only $27.5 billion, 39%, of Sandy losses were covered by either private insurance or in-force National Flood Insurance Program (NFIP) policies. Hurricane Sandy served as a stark reminder that hurricanes are a concern not only for the U.S. Gulf Coast, Southeast coast and Florida.
An even more expensive example of the impact of natural catastrophes on highly advanced economies was Hurricane Katrina, the costliest hurricane to make landfall in the U.S., and the costliest disaster in the history of insurance, with almost $131 billion in economic losses and $80 billion in insured losses. Katrina was an eye-opener on storm surge and flood exposure. During this storm, levee systems meant to protect the city of New Orleans and its population failed dramatically, well below their design limit, with more than 50 breaches in the New Orleans metropolitan area. As President Obama said on Aug. 27, 2015, "What started out as a natural disaster became a manmade one."
Although both Katrina and Sandy provided invaluable insight into storm surge hazards and how we can become better prepared, many forecasts project that the protection gap problem will only worsen.
Rising sea levels in particular are expected to drive up expected economic and insurance losses from hurricane-driven storm surge in coastal cities including Tampa, Fla., Miami, New York, Baltimore, New Orleans and Boston, according to a new study by Risk Management Solutions. Tampa, in fact, faces the highest risk of all cities analyzed in the study, with a 1-in-80 annual chance of experiencing a $15 billion storm surge loss. Miami faces a 1-in-125 chance, New York a 1-in-200 chance, and New Orleans a 1-in-440 chance. These risks are expected to increase greatly over time, by even as much as 350% in some cities by the year 2100.
Survivors of Napa, Calif., earthquake looking at damage (Photo: AP/Noah Berger)
Earthquake risk is a concern in other cities, particularly in California and the Pacific Northwest. With earthquake insurance penetration in exposed areas alarmingly low, uninsured modelled losses from quakes total $20 billion annually. Only about 10% of California homeowners have earthquake insurance, despite the fact that 80% live in an earthquake zone, according to the Insurance Information Institute. The West Coast isn’t the only earthquake-exposed location in the U.S., according to a Swiss Re white paper, Four earthquakes in 54 days. The report considered the 1811–1812 New Madrid earthquake sequence, and found that if it were to occur today, economic losses would be approximately $300 billion in the cities of St. Louis, Mo., Memphis, Tenn., Nashville, Tenn., Little Rock, Ark., and Indianapolis alone. Insurance would cover just half of that, yet it would still be the costliest insurance event ever.
As risk exposure outpaces insurance protection, losses can make a serious dent in the world’s economy. Total uninsured losses from natural catastrophes have increased from 0.07% of gross domestic product (GDP) in 1975–1984 to 0.19% of GDP in 2005–2014, according to the Sigma Underinsurance report. This burden isn’t spread evenly, though. In fact, some countries with the highest exposure have the lowest property insurance penetration. Typically, the protection gap is larger in emerging economies, where 80–100% of economic losses are uninsured. As the value of property in emerging markets has increased alongside rapid economic growth, the emerging market share of the global protection gap has also increased. Many of these countries are less resilient in dealing with the financial shocks from large catastrophes.
Historically, most governments have financed disaster expenses only after a catastrophic event has taken place, however, this approach is financially unsustainable and lengthens the recovery time. But what’s preventing society from ensuring adequate financial protection for exposed populations before these events occur rather than inflicting financial hardship on individual families, corporations and government entities?
Hurricane shutters on Florida home (Photo: Shutterstock/GJones Creative)
Reasons for underinsurance
It may help to examine the reasons for underinsurance in the first place.
Sigma’s Underinsurance report cites low awareness, which leads not only to underinsurance, but also to low levels of investment in the prevention or mitigation of risks. For example, research on individual behavior during Hurricane Sandy revealed that only 37% of homeowners who owned removable storm shutters put them up, and only 54% of residents whose homes were less than a block away from the water indicated that they had flood insurance, according to the same report.
Other causes of underinsurance include a lack of knowledge about insurance products and their availability, affordability and an overreliance on government for post-disaster relief.
Closing the gap will require individuals, insurers and the public sector to change behavior and strengthen resilience against natural hazard risks. Innovative simulation tools, which can model expected future losses for different types of perils, also will be critical.
At the same time, government and the insurance industry need to work together to strengthen the resilience of cities against natural catastrophes. This includes taking steps to toughen regulatory environments, enforce building codes and manage vulnerabilities in areas where there is population density and high concentrations of assets. Public/private partnerships will be key to financing risks where limitations exist.
Risk transfer is one way to address the gap. (Photo: Shutterstock/arka38)
Ways to address protection gap
Both Swiss Re reports outline ways that developing countries have addressed the protection gap. These measures also may prove helpful in developed countries:
- Step up product innovation. Insurers are creating new products to fill the coverage gaps. For example, private flood insurance products provide alternatives to NFIP, including excess coverage and reduced underwriting requirements. Working together with mortgage lenders, which bear a large share of uninsured property risk exposure, could be another way to close the protection gap.
- Consider all types of risk transfer products. There are options such as index-based insurance that rely on the characteristics of the insured event, such as the Saffir Simpson category of a hurricane or the Richter scale for an earthquake, as opposed to the actual loss.
- Shore up mitigation, building standards and zoning. Building codes have reduced risks and improved insurability in many mature markets. Research has shown that improved building codes can reduce hurricane damages, thereby directly reducing the amount of post-disaster government aid distributed to homeowners. Other mitigation measures include discouraging development of high-risk areas through zoning, or providing incentives to relocate from high-risk areas after disasters.
- Improve public sector programs. The costs of natural disasters and extreme weather events place an increasingly heavy burden on government budgets. The U.S. National Flood Insurance Program is in debt and greatly in need of reform to be ready to face future storms. Between Katrina and other storms in 2008 and 2012, the NFIP now owes the U.S. Treasury $24 billion. An example of reducing the fiscal vulnerability of the public sector is Mexico, where the government has developed a holistic disaster risk-financing strategy, which combines risk mitigation, risk modeling, and traditional and parametric insurance to allow the government to financially prepare for disasters.
We clearly can’t completely beat Mother Nature at her own game; hurricanes, earthquakes and floods will continue to occur. However, there are ways that both the public and private sector can work together to close the gap between economic and insured losses. By taking steps to make insurance more accessible and strengthening our resilience in vulnerable cities, we can reduce risk exposure and property damage, and demonstrate that we can act swiftly before the worst can happen—not after.
Monica Ningen is Head of Property Underwriting for the US & Canada and Chief Property Underwriter for Swiss Re.