Insights and Commentaries
The role of insurance in enhancing societal resilience
Balancing decisions using a science-based approach to ensure sustainable profitability
The toll of floods on lives and livelihoods has become more severe as global warming worsens, land use changes, and economic density increases in sensitive regions. Based on Swiss Re Sigma data (1970 – 2019), floods – including those associated with coastal storm surges, tropical cyclone and convective storm activity – incur costs of up to SGD66 billion annually. With only 30% of flood losses being insured, the protection gap continues to widen particularly in areas with low insurance penetration, rapid economic growth and acute physical climate change impacts such as in developing countries like the Philippines and Bangladesh within the APAC region. This leads to overall reduced societal resilience to the peril. As such, how can the insurance industry play a role in closing this protection gap?
Fundamentally, insurance quantifies risk. This shapes risk attitudes and behaviours, enabling private individuals, governments and global partners to measure the cost of flood events and use this as part of a broader risk management framework, including mitigation measures and planning controls. Insurance cannot eliminate flood risk, but working as part of the broader management framework, it can promote an environment in which risk is reduced to a “sustainable equilibrium” and where communities benefit from the transfer of risk to insurers and averaging across the industry, whilst insurers can sustainably support communities into the future.
As a start, insurers need to be more transparent in sharing their technical view of risk, estimated based on bespoke catastrophe modelling tools and in-house expertise. By engaging with local councils who stipulate zoning conditions for developers, insurers can influence societal resilience sooner rather than later by sending a pricing signal regarding the future insurability of assets to be built. This helps to redirect investment away from hazardous to safer areas, or to ensure that protective infrastructure is built to safeguard against flood risk.
In fact, this practice is implicitly gaining momentum as insurers and catastrophe model vendors help to assess mortgage portfolios for future physical climate risk impacts such as coastal flooding from sea level rise. For large corporations – especially those in the manufacturing sector with complex supply chains – insurers and brokers who possess insight into flood claims at an industry level should leverage this information and work closely with their clientele to identify key risk drivers, improve site level flood resilience, and recognise positive risk management measures through reduced premium charges.
In the aftermath of flood disasters, instead of rebuilding in the same flood prone areas, insurance payout conditions could be attached, prompting authorities to consider if such that funds could be used to migrate impacted homes to safer areas: effectively ending an otherwise vicious disaster risk cycle.
Risk based pricing will have a limited effect unless there is broad consensus within the industry around underlying technical risk. This ought not to differ significantly in the areas of highest risk. What is arguably more important is that pricing should not deviate from this technical view of risk. Unfortunately, this may not happen in practice for several mutually reinforcing reasons, namely: short termism, unrealistic top line premium growth targets, the case of being “too big to fail”, well-meaning but poorly conceived flood subsidies (such as the National Flood Insurance Program in the US), ample and under-priced international reinsurance capacity, and the structural issue of reverse auction (particularly in corporate insurance) which often leads to the cheapest quote[1] being taken up regardless of pricing adequacy.
To this end, market reform is key. For example, if regulators act decisively to remove moral hazard, insurers who continue to embrace short termism will be more likely to face financial ruin, particularly if their books are overweight on short tail hazards such as flood. Instead of bail outs, impacted policyholders of these failed insurers could be supported directly by the state (as insurer of last resort), thus promoting accountability.
The other challenges stipulated above are largely underlying problems with the industry and can be overcome through improved education and maturity, specifically with a greater appreciation for scientific expertise. Instead of being rewarded for chasing unrealistic growth targets based on excessive, and at times uninformed risk-taking, insurance executives need to demonstrate that fact-based decisions based on a rigorous, science based approach are balanced against commercial factors to ensure sustainable profitability. High profile insurer insolvencies following Hurricane Andrew (1992), and about twenty years later following the Christchurch earthquakes and Thailand floods (2011) suggest that these key lessons may not have been learnt.
Similarly, brokers should show more interest in the subject matter of their trade that would help facilitate true price discovery, rather than being purely transaction focused or gravitating to the whims of a capricious commercial market.
[1] Even after normalising for counterparty, and credit ratings risk.
