The protection gap: the benefits of self-interest

“Protection shortfalls in healthcare are even more pressing than in the natural disasters space which naturally receives most of the media attention.” Kai-Uwe Schanz deputy managing director and head of research and foresight at The Geneva Association.

· $100 billion in catastrophe losses remain uninsured year after year
· Major cat events of March 2019 highlighted protection gap vulnerabilities
· Cyber protection gap 'close to 100 percent'
· 'Less than satisfactory levels of trust' in insurers allows gap to endure

The protection gap is a problem that is often described as perennial, but getting a better grip on the issue is crucial for the future credibility of the re/insurance industry, says Kai-Uwe Schanz, deputy managing director and head of research and foresight at The Geneva Association.

“We are talking about our industry’s relevance to society. Persistent protection gaps will not help our industry’s long-term licence to operate,” he tells Intelligent Insurer.

The global protection gap debate is “dominated by natural disasters”, says Schanz, which is no surprise given the widespread devastation and dramatic scenes that fill television screens when they occur. It was nature that most recently highlighted the growing protection gap in mature markets with a trio of storms —Ciara, Dennis and Jorge—that tore across Europe in the early part of 2020.

For people without sufficient cover, the flooding and damage it brought were heart-breaking. The US has also experienced heavy floods, caused by the wettest 12-month period (June 2018 to May 2019) since 1895. Like Europe, the US damage revealed that protection gaps are widening in these markets in spite of high levels of insurance penetration.

Steven Bowen, director and meteorologist at Aon’s Impact Forecasting team, cites an earlier event to illustrate the problem. “In 2017, Hurricane Harvey caused $125 billion of damage but only $30 billion of this was covered, because most of the damage was flood related,” he says, adding: “People just don’t realise they need flood cover.”

However, as the frequency of extreme weather events rises, which is linked by many experts to climate change, people are becoming more aware of the need for insurance cover.

Climate change has also been cited by many in the industry as a factor in the extreme weather events of 2019, including Hurricane Dorian, typhoons Faxai and Hagibis, and wildfires in California and Australia.

Risk modeller RMS put early insured losses from Dorian in the US at up to $1.5 billion, while Faxai insured losses were estimated at up to $9 billion, and the insured losses for Hagibis were between $7 billion and $11 billion.

A wider gap

These figures tell the story only of insured assets. Schanz says: “Year after year, approximately $100 billion in catastrophe losses remain uninsured—equal to roughly two-thirds of all economic losses. In low income countries the protection gap is close to 100 percent.”

Cyclone Idai, which hit Mozambique, Zimbabwe and Malawi in March 2019, is an example of a natural catastrophe hitting an area with a wide protection gap. It killed more than 1,000 people and affected more than three million, causing a humanitarian crisis. At the time, Aon estimated total economic damage to infrastructure in Mozambique alone at $1 billion.

Michal Lörinc, senior catastrophe analyst at Aon Impact Forecasting, says: “The major catastrophe events of March 2019 highlighted the continued vulnerabilities which exist in both developed and emerging markets.

“In an increasingly volatile era for weather events and their impacts on a growing exposure, it is essential that resilience and risk mitigation planning will become more pronounced in the public and private sectors.”

In the wake of Idai, the World Bank stepped in to provide $700 million of support for the storm-hit nations. It also activated the International Development Association (IDA) Crisis Response Window (CRW) to provide up to $545 million in total for affected countries, which was in addition to nearly $150 million in resources that had been made available from existing projects.

Speaking at the time, World Bank group president David Malpass said: “Cyclone Idai caused catastrophic damage earlier this year that affected millions of people, and this tragedy has been compounded by Cyclone Kenneth.

“The World Bank Group is working closely with our partners to help the population recover from these terrible storms, build back stronger than before, and improve countries’ resilience to natural disasters.”

With all the resources and expertise at the re/insurance industry’s disposal, it is problematic that gaps persist, let alone that new ones are opening up. However, the industry is moving to collaborate with public and private organisations on fresh solutions, so watch this space (see box below).

Other risks

Natural catastrophe is not the only sector with a protection gap that re/insurers need to address. Schanz highlights another that may be even more urgent.

“According to our estimate, the health protection gap in emerging markets alone amounts to $300 billion, or 1 percent of these countries’ combined gross domestic product (GDP). The health protection gap measures the share of healthcare spending that causes financial stress (or even ruin) to householders.

“This figure suggests that protection shortfalls in healthcare are even more pressing than in the natural disasters space which naturally receives most of the media attention.”

Research from The Geneva Association, published in its 2019 report “Healthcare in Emerging Markets: Exploring the Protection Gaps”, reveals that people in emerging markets struggle to afford healthcare because overall expenditure in this area is outstripping growth in GDP: they can’t afford it.

Spending on healthcare has increased globally in the past 20 years from 8 percent to almost 10 percent of aggregate GDP, while higher costs for healthcare are being driven by communicable diseases and lifestyle diseases as emerging economies develop, the report finds.

But the global trend for higher healthcare expenditure has not led to increased penetration of private health insurance which, the association says, “remains insignificant, with a 2 percent share of total healthcare expenditure”.

Generally speaking, Schanz says that there has been little progress in narrowing the protection gap.

“Even though re/insurance capacity is ample and private-public partnerships are gaining momentum and effectiveness, total economic losses rise faster than insured losses. This may be a reflection of changes to the risk landscape in emerging markets, such as urbanisation and an increasing concentration of assets and values in catastrophe-prone coastal areas.”

He explains: “In many developing countries protection gaps reflect a combination of unaffordability, a lack of access to cover and a fundamental lack of insurance awareness.”

Schanz adds that technology, such as smartphones and better internet access, could make a difference here by bringing down the cost of distribution and claims settlement and by raising awareness “even through non-smart mobile channels” because extra information helps to build broader recognition and understanding.

Risk in the cloud

With this evolving digital world of opportunity comes a whole, relatively new, protection gap to worry about. Schanz highlights the relatively recent appearance of the cyber protection gap, which he says is “close to 100 percent”.

This hole in cover has been fuelled by accelerating dependence on the internet and interconnectivity, as well as widespread access to mobile devices and the internet of things—ironically, exactly the same things that will help to close a different gap.

Commenting on the large cyber insurance protection gap, Schanz says: “Again, this raises fundamental questions as to our industry’s relevance to the digital economy.”

Research published by global insurance broker Gallagher in February this year, showed that 39 percent of senior decision-makers in UK companies say cyber attacks are one of their biggest concerns, yet the majority of businesses, 82 percent, do not have specialist insurance in place.

The broker says the issue of “silent” cyber exposure is caused partly by the incorrect assumption that traditional insurance covers this risk.

Tom Draper, head of cyber at Gallagher, says: “The issue of cyber crime is one of the biggest risks facing businesses today. Clearly there are practical steps businesses can take to help protect against cyber attacks, but unfortunately the risk remains significant and many businesses are leaving themselves exposed to financial and reputational damage if they do not consider having specialist insurance in place.

“While there is evidence to suggest larger businesses are more commonly targeted, small and mid-size businesses are still very much exposed to cybersecurity breaches or attacks and may not have sophisticated protection in place; cyber criminals will be aware of this vulnerability.

“They are also liable to be caught up in cyber attacks aimed at third party suppliers or those targeted at common systems and software, such as the cloud, on which their business may rely," Draper says.

Onward progress

Schanz says that in the last 12 months he has been impressed by many examples of innovative parametric forms of cover.

Coming back to the example of cyclone Idai, Aon’s Bowen says parametric catastrophe bonds could be pivotal to scaling up the insurance industry in developing nations.

“People in these countries can’t afford insurance so when these humanitarian disasters occur, it puts a strain on governments who essentially act as an insurer. Catastrophe bonds could therefore be the key for unlocking insurance in these immature markets.”

In line with this, the World Bank completed an issuance of $1.36 billion of parametric earthquake catastrophe bonds in February 2018 to Chile, Colombia, Mexico and Peru. Following a magnitude 8 earthquake in Peru in May 2019, the parametric trigger was confirmed and a partial payout of $60 million was issued to the nation.

A matter of trust

Schanz welcomes the difference sovereign catastrophe bonds, issued by the World Bank, can make in addressing the gap, but there is a lot more to be done.

As The Geneva Association’s November 2019 report “The Role of Trust in Narrowing Protection Gaps”, written by Schanz, points out a key reason the protection gap endures is the less than satisfactory levels of trust in insurers. It finds that this “fundamentally impedes” insurance demand, leading to protection gaps, for example around technology.

A lack of trust colours every interaction, from expectations around claims payouts and product clarity, to an insurer’s ability to protect customer data in the digital age and to use advanced analytics responsibly.

However, again, technology can be part of the solution. Building greater trust, particularly in insurance technology, can bring more support to emerging markets, while in mature markets, new technologies can offer greater customer personalisation to better target products, which will foster trust and tackle longstanding holes in cover, the report finds.

In the report, The Geneva Association sets out a multi-stakeholder roadmap for harnessing trust to narrow the gaps between need and availability. Actions include “borrowing trust” through partnerships with non-insurance companies such as banks to reach new customers, better industry self-regulation to pre-empt bad behaviour, and promoting greater industry competition.

By addressing the protection gap, the insurance industry can help build stronger trust and secure its own future, while also helping our global society. In this instance, self-interest has benefits for everyone.

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Better together: a call for action

As representatives from the City of London, The British Red Cross, ClimateWise, Insurance Development Forum, AXA XL, Pool Re, MS Amlin and RenaissanceRe gathered for Aon’s “Collaborating to close the protection gap” event in February, sector leaders were keenly aware that urgent action was needed.

Aon chief executive officer Greg Case urged the global finance and insurance industry to work more effectively with governments, humanitarian and non-governmental organisations as everyone counts the cost of rising losses from natural catastrophes. He set out the goal to close the gap between the insured and uninsured to protect global communities and build scalable solutions through shared experiences.

“The protection gap places an immense financial strain on governments, businesses, communities and individuals. Yet, financial impact is only one aspect of the toll these disasters inflict,” he said.

“We also must consider the profoundly troubling humanitarian and social impact: lives lost, communities compromised and businesses, as well as individual livelihoods, disrupted.

“Considering the magnitude of the challenge, a solution is beyond the ability of any individual, organisation or even sector. We have absolute conviction, though, that, collectively, we can make a difference. Our hope is that we will forge a shared commitment to new ways of collaborating that will allow us to build resilience at scale,” he added.

The firm’s 2019 annual report showed that natural catastrophes have resulted in global economic losses of $2.98 trillion over the last decade, of which only $845 billion has been insured, creating a protection gap of 72 percent.

Aon’s research also shows that a significant protection gap persists in developing and emerging countries, particularly in Asia—where just 12 percent of economic losses, $151 billion out of $1.23 trillion—were covered by insurance in the last decade.

In Latin America and Africa insurance take-up rates were in the low single digits, meaning that virtually all losses were uninsured and local populations were entirely dependent on federal or international financial support for recovery.

Highlighting the importance of the UK insurance industry in tackling climate change, CBI vice president Lord Bilimoria told delegates at the event: “The openness and maturity of the London market, supported by its in-depth knowledge and skills, gives us the capacity and experience to assess, underwrite and mitigate some of the world’s greatest emerging risks.

“As set out in UN Principles for Sustainable Insurance, this sector has a crucial dual role to play, helping to drive sustainable action through the risks you cover and the investments you make."

Bilimoria added: “To tackle the climate emergency in the time left, we need to go faster and further than ever before. And business can’t do it alone. It must be done in partnership with government.

“In insurance, our members have three main asks. First, smarter regulation and effective incentives to support the growth of green and sustainable finance. Second, greater clarity on data and climate-related disclosures, and a long-term approach to developing a taxonomy to classify sustainable activities.

“And, third, a clear definition of an organisation’s fiduciary duties in relation to climate-related risk."

Graham Stuart, the UK government minister for investment, commented: “The UK’s insurance industry is one of the world’s leading markets, generating £93 billion worth of premium income, of which £43 billion is related to exports.

“It’s great to see the industry setting an example for others to follow to help create a better world for us all to live in.”