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Catastrophe insurance

Higher insurance penetration usually speeds recovery from natural disasters, but not in the US due to a fragmented insurance market, says new report from the Centre for Risk Studies at Cambridge Judge Business School.

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Countries with higher insurance penetration usually bounce back faster from natural disasters, but the “fragmented” nature of US insurance coverage results in slow recovery despite high insurance penetration, according to a new study by the Cambridge Centre for Risk Studies.

Most countries with high insurance penetration of three to four per cent (measured by non-life premiums relative to GDP) such as in Western Europe, Japan, Australia and South Korea have an average recovery rate of less than 12 months, but the US has a recovery rate of more than three years despite insurance penetration of more than four per cent. Globally, each percentage point of insurance penetration reduces recovery times by almost a year, the report found.

The US is “anomalous” given the wide variance of insurance coverage and availability there, particularly flood insurance, so recovery times from disasters such as Hurricanes Andrew (1992), Katrina (2005) and Sandy (2012), and the Great Mississippi and Missouri River Floods (1993) have been much slower than following major events in other well-insured countries, says the report, which looked at 103 catastrophes (including floods, earthquakes and cyclones) globally, mostly over the past 30 years.

“Flooding was a major driver of impact for which a significant insurance protection gap remains” in the US, while the “complexity” of US insurance products (with multiple products for different hazards) may dent US insurance efficacy, says the 35-page report.

The report outlines the growing economic impact of natural disasters over the past three to four decades. Annual average loss from such catastrophes rose from an average of $27 billion in 1970-1980 to nearly $200 billion in 2010-2019, driven by global economic development and the increasing value of assets in hazardous areas, particularly in fast-growing regions such as Southeast Asia. Global flood occurrence was about three times higher in the 2000s than in the 1980s, while storm frequency nearly doubled.

In the US, increased incidence of flooding over time has resulted in property owners refusing or unable to pay higher premiums, leading to lack of coverage for vulnerable communities despite high insurance penetration nationwide. The report highlights how the Federal Emergency Management Agency (FEMA) is overstretched, so there is a need for increased private investment in risk management along with greater responsibility of vulnerable people and communities to control exposure and be prepared for disasters.

The report also found scope for product development in terms of “building back better”, and incentivising investment in resilience before and after a disaster: countries with high insurance penetration have only slightly higher quality of recovery than countries with lower penetration. The report supports the strong and proven cost-benefit arguments in favour of investment – on average, pre-disaster investment in resilience outweighs the costs, in terms of mitigated losses, by a ratio of four to one.

The report entitled Optimising Disaster Recovery: The Role of Insurance Capital in Improving Economic Resilience was prepared by the Centre for Risk Studies at Cambridge Judge Business School, and was supported by reinsurer AXA XL Reinsurance. The report is the culmination of a multiyear series of disaster recovery studies, as part of work to understand the insurance protection gap, undertaken by the Risk Centre in collaboration with AXA XL Reinsurance over the past decade. The next stage of the project is converting the data into a website database that can be accessed worldwide.

A major theme of the report is that preparation and investment are key to faster recovery from the impact of natural disasters, not only from physical destruction but also the associated economic and societal impacts. Economic recovery is faster than societal recovery in nearly 60 per cent of cases, and is particularly pronounced in the first six months.

“This project provides much needed quantification of resilience and recovery after natural catastrophes, as much of the ‘evidence’ to date has only been anecdotal,” says Daniel Ralph, Professor of Operations Research at Cambridge Judge and Academic Director of the Cambridge Centre for Risk Studies. “With climate change events, including floods and storms, increasing in frequency, it is more important than ever to understand the levers of recovery for communities and companies.

“The report looks mostly at vulnerable communities, but there also are clearly lessons for corporates in terms of preparing for catastrophe, investing in ways to recover more quickly, and more effective decision-making and implementation if disaster strikes,” says Professor Ralph. “Assessing the impact of surprises requires effort in delineating the kinds of surprises that are possible, and then stress testing your organisation across the gamut of those events – stress-testing via scenarios is the key to planning for surprise.”

Climate risk is at the “heart of this study, and it is important to remember that risk is a function of hazard, exposure, and vulnerability,” says Jonathan Gale, Chief Underwriting Officer, Reinsurance at AXA XL Reinsurance, in a foreword to the report.

“We wanted to bring out comparative information related to speed of recovery – how quickly employment and productivity returns to normal (economic) and how quickly people are back in their houses and power is restored (societal). We also wanted to focus on the quality of recovery, that is whether the post-disaster normal is better than the pre-disaster state in terms of the economy and the resilience of the community to future events from the perspective of infrastructure and economic resilience.”