Swiss Re warns re/insurers of the growing threat of secondary perils

Swiss Re’s latest Sigma report points out that the catastrophe experience of 2018 reaffirms that the loss impact of secondary peril events is anything but “secondary”.

According to Swiss Re, total economic losses from natural catastrophes and man-made disasters in 2018 were $165 billion. Insurance covered $85 billion of those losses which, the reinsurer says, made up the fourth highest one-year aggregate industry payout ever, and above the previous 10-year annual average of $71 billion.

Of 2018’s insured losses, $76 billion were due to natural catastrophes and of those, more than 60 percent of claims were to help populations impacted by secondary peril events. As Swiss Re also points out, 13,500 people lost their lives in all of the catastrophes of 2018.

Swiss Re categorises secondary perils as independent small to mid-sized events, or secondary effects of a primary peril. Their associated losses have been rising due to rapid development in areas exposed to severe weather conditions. Swiss Re expects this trend to continue given ongoing trends in terms of urban developments.

Urban trends

“The acceleration in secondary peril losses is due to urbanisation and associated development of flood-prone areas along coast lines and on river plains,” says Vineet Kumar, head of Swiss Re's Cat Perils Asia Hub.

“Other factors include development in areas vulnerable to fire risk, such as the wildland-urban interface, as well as long-term climate change.

“According to the United Nations, 55 percent of the world’s population live in urban areas. That is expected to increase to 68 percent by 2050 (ie, the addition of another 2.5 billion people). With urbanisation and associated growth in asset concentration in exposed areas, and also long-term climate change projections, we expect the trend of growing losses from secondary perils to continue.”

Swiss Re also stresses that the world is getting warmer, leading to more occurrence of extreme weather conditions and associated secondary perils (such as drought and wildfires) and secondary-effect peril events (such as torrential rains, and storm surge-induced flooding).

It also points out that the single biggest natural catastrophe insurance loss event of 2018 was Camp Fire in California ($12 billion), a so-called secondary peril.

The reinsurer says that indicative of a growing trend, the combined insured losses for 2017 and 2018 resulting from natural catastrophes were $219 billion, the highest ever for a two-year period, with more than half due to secondary and secondary-effect peril events.

Swiss Re says that stakeholders in building resilience—including insurers—are well advised to pay more attention to the growing risks these perils present. The global all-catastrophe protection gap of the past two years combined was also very large at $280 billion, and more than half of that resulted from independent secondary and secondary-effect peril events.

“Insurance pricing for catastrophe risks is mostly influenced by the loss impact of primary (particularly mega-sized) perils,” says Kumar. “However, as the experience of 2018 shows, insured losses from secondary events can also mount to high levels. This is a trend the insurance industry must act on so that we can continue to underwrite catastrophe business sustainably. This also means improving risk modelling capabilities for secondary perils.”

Swiss Re adds that the paradox is that the insurance industry is well capitalised to absorb this risk. It estimates that total capital in the non-life re/insurance market (including alternative capital) was more than $2 trillion at the end of 2018.

It adds that the main explanations for the underinsurance are lack of consumer risk awareness and poor understanding of catastrophe insurance covers, and on occasion hesitation to provide cover where risk assessment is uncertain.

Given their unique features such as being highly localised, modelling secondary peril risks can be difficult, more so than for peak peril losses where the industry has tended to focus.

Mind the gap

“The combined global natural catastrophe protection gap of 2017 and 2018 was $280 billion, and more than half of that resulted from secondary perils,” says Kumar.

“The existing protection gap is an opportunity for the insurance industry to grow and to help more of the global population be better prepared to manage the financial hardship that disaster events can inflict.”

The Swiss Re Sigma report says that this includes fostering consumer awareness, and developing a greater product range and targeted distribution for catastrophe covers. It states that in the face of rising losses from secondary and secondary-effect peril events, by leveraging latest technologies insurers can focus more on developing appropriately regionalised models to assess the risk posed by the perils, the variables of which will likely be in a continual state of flux due to ongoing land use changes and more frequent occurrence of extreme weather events.

“The main explanations for underinsurance are lack of consumer risk awareness and poor understanding of catastrophe insurance covers, and on occasion hesitation to provide cover where risk assessment is uncertain. Insurers need to improve their risk modelling capabilities for secondary perils,” says Kumar.

“By leveraging the latest technology, insurers can focus more on developing appropriately regionalised models to assess the risk posed by secondary perils and develop a greater product range and targeted distribution for catastrophe covers,” he says.

Finally, the Sigma report underlines that insurance’s main value proposition is to absorb and manage risk and that re/insurers can also build socioeconomic resilience through their investment activities, in particular by being able to invest more in long-term infrastructure projects.

It concludes by pointing out that there are many examples of disaster-mitigating defences having been strengthened as part of reconstruction efforts after a catastrophic event. With a more conducive investment and regulatory environment, insurers can play a much more effective role in ex-ante preparation.

According to Swiss Re Institute estimates, global re/insurance assets amount to approximately $30 trillion. Even a small part of this could unlock a significant amount of capital for deployment into long-term resilience-building infrastructure projects.

In addition, says the report, public-private partnerships in infrastructure would bring additional benefits of reducing the burden of project costs on governments and develop a broader culture of effective risk-sharing.