What do you think when you hear the term, natural catastrophe(nat cat) protection gap? The recent earthquake in Nepal? TyphoonHaiyan in the Philippines? Chances are, you associate the issuemore with developing countries.

You may be surprised to learn that the U.S. currently has thelargest protection gap among countries globally. According to a newSwiss Re Sigma report, “Underinsurance of property risks: closingthe gap,” the annual expected uninsured losses fromearthquake, flood and wind damage in the U.S. (the largest nat catperils) total more than $30 billion, based on Swiss Re’s naturalcatastrophe models. This means that, of the total estimated naturalcatastrophe losses in the U.S. of $55 billion annually, more thanhalf aren’t insured.

Such modeling of future risks is vital as underlying risks don’talways show up in historical event data. For example, Floridahasn’t seen a major hurricane in more than a decade, but still hasa high risk.

Earthquakes make up the largest share of expected losses, withan estimated $20 billion of risk remaining uninsuredannually. Despite the risk of devastating economic lossescreated by a major earthquake, few people buy earthquake insuranceeven in the highest-risk parts of the U.S. In California, residentsspend a lower share of their incomes on earthquake insurance thancitizens of other earthquake-prone regions such as Japan and NewZealand.

Windstorm perils create the second highest risk, with nearly $8billion uninsured annually, on average. Although the majority ofwindstorm risks in the U.S. are insured through standard homeownerspolicies, the country still has the largest absolute value ofuninsured windstorm risks in the world, due to its high exposure tohurricanes. Although more than half of flood risks areinsured, an estimated $2.7 billion in flood losses remain uninsuredannually, contributing to the protection gap during both riverinefloods and hurricane storm surges. Higher population density,increased property development and climate change also areincreasing these risks, especially in coastal urbanareas.

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 ofthe U.S. in 2012, is a recent example of the impact of naturalcatastrophes on our highly urbanized coastal cities. Total economiclosses were approximately $70 billion, with the highest losses inthe hardest-hit states of New York and New Jersey. Only $27.5billion, 39%, of Sandy losses were covered by either privateinsurance or in-force National Flood Insurance Program (NFIP)policies. Hurricane Sandy served as a stark reminder thathurricanes are a concern not only for the U.S. Gulf Coast,Southeast coast and Florida.

An even more expensive example of the impact of naturalcatastrophes on highly advanced economies was Hurricane Katrina,the costliest hurricane to make landfall in the U.S., and thecostliest disaster in the history of insurance, with almost $131billion in economic losses and $80 billion in insured losses.Katrina was an eye-opener on storm surge and flood exposure. Duringthis storm, levee systems meant to protect the city of New Orleansand its population failed dramatically, well below their designlimit, with more than 50 breaches in the New Orleans metropolitanarea. As President Obama said on Aug. 27, 2015, "What started outas a natural disaster became a manmade one."

Although both Katrina and Sandy provided invaluable insight intostorm surge hazards and how we can become better prepared, manyforecasts project that the protection gap problem will onlyworsen.

Rising sea levels in particular are expected to drive upexpected economic and insurance losses from hurricane-driven stormsurge 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 inthe study, with a 1-in-80 annual chance of experiencing a $15billion storm surge loss. Miami faces a 1-in-125 chance, New York a1-in-200 chance, and New Orleans a 1-in-440 chance. These risks areexpected to increase greatly over time, by even as much as 350% insome cities by the year 2100.

Survivors of Napa, Calif., earthquake looking at damage(Photo: AP/Noah Berger)

Earthquake risk

Earthquake risk is a concern in other cities, particularly inCalifornia and the Pacific Northwest. With earthquake insurancepenetration in exposed areas alarmingly low, uninsured modelledlosses from quakes total $20 billion annually. Only about 10% ofCalifornia homeowners have earthquake insurance, despite the factthat 80% live in an earthquake zone, according to the Insurance Information Institute. The WestCoast 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 the1811–1812 New Madrid earthquake sequence, and found that if it wereto occur today, economic losses would be approximately $300 billionin the cities of St. Louis, Mo., Memphis, Tenn., Nashville, Tenn.,Little Rock, Ark., and Indianapolis alone. Insurance would coverjust half of that, yet it would still be the costliest insuranceevent ever.

As risk exposure outpaces insurance protection, losses can makea serious dent in the world’s economy. Total uninsured losses fromnatural catastrophes have increased from 0.07% of gross domesticproduct (GDP) in 1975–1984 to 0.19% of GDP in 2005–2014, accordingto the Sigma Underinsurance report. This burden isn’tspread evenly, though. In fact, some countries with the highestexposure 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 inemerging markets has increased alongside rapid economic growth, theemerging market share of the global protection gap has alsoincreased. Many of these countries are less resilient in dealingwith the financial shocks from large catastrophes.

Historically, most governments have financed disaster expensesonly after a catastrophic event has taken place, however,this approach is financially unsustainable and lengthens therecovery time. But what’s preventing society from ensuring adequatefinancial protection for exposed populations before theseevents occur rather than inflicting financial hardship onindividual 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 thefirst place.

Sigma’s Underinsurance report cites low awareness,which leads not only to underinsurance, but also to low levels ofinvestment in the prevention or mitigation of risks. For example,research on individual behavior during Hurricane Sandy revealedthat only 37% of homeowners who owned removable storm shutters putthem up, and only 54% of residents whose homes were less than ablock away from the water indicated that they had flood insurance,according to the same report.

Other causes of underinsurance include a lack of knowledge aboutinsurance products and their availability, affordability and anoverreliance on government for post-disaster relief.

Closing the gap will require individuals, insurers and thepublic sector to change behavior and strengthen resilience againstnatural hazard risks. Innovative simulation tools, which can modelexpected future losses for different types of perils, also will becritical.

At the same time, government and the insurance industry need towork together to strengthen the resilience of cities againstnatural catastrophes. This includes taking steps to toughenregulatory environments, enforce building codes and managevulnerabilities in areas where there is population density and highconcentrations of assets. Public/private partnerships will be keyto 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 countrieshave addressed the protection gap. These measures also may provehelpful in developed countries:

• Step up product innovation. Insurers arecreating 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 ofuninsured property risk exposure, could be another way to close theprotection gap.
• Consider all types of risk transfer products.There are options such as index-based insurance that rely on thecharacteristics of the insured event, such as the Saffir Simpsoncategory of a hurricane or the Richter scale for an earthquake, asopposed to the actual loss.
• Shore up mitigation, building standards andzoning. Building codes have reduced risks and improvedinsurability in many mature markets. Research has shown thatimproved building codes can reduce hurricane damages, therebydirectly reducing the amount of post-disaster government aiddistributed to homeowners. Other mitigation measures includediscouraging development of high-risk areas through zoning, orproviding incentives to relocate from high-risk areas afterdisasters.
• Improve public sector programs. The costs ofnatural disasters and extreme weather events place an increasinglyheavy burden on government budgets. The U.S. National FloodInsurance Program is in debt and greatly in need of reform to beready to face future storms. Between Katrina and other storms in2008 and 2012, the NFIP now owes the U.S. Treasury $24 billion. Anexample of reducing the fiscal vulnerability of the public sectoris Mexico, where the government has developed a holistic disasterrisk-financing strategy, which combines risk mitigation, riskmodeling, and traditional and parametric insurance to allow thegovernment 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 worktogether to close the gap between economic and insured losses. Bytaking steps to make insurance more accessible and strengtheningour resilience in vulnerable cities, we can reduce risk exposureand property damage, and demonstrate that we can act swiftlybefore the worst can happen—not after.

Monica Ningen is Head of Property Underwriting for the US& Canada and Chief Property Underwriter for Swiss Re.