Author | Swiss Re Swiss Re Institute
Article|China Insurance, Issue 10, 2023
According to the Swiss Re Research Insurance Resilience Index, as of the end of 2022, about 60% of the world's insurable crop risk exposure is uninsured, while the natural disaster property protection gap is 76%, and global health and death resilience has improved, but there is still huge room for improvement. Research shows the need to reshape resilience against four major risks. There are two strategies to consider in rebuilding resilience: reducing expected losses and increasing insurance protection.
Loss prevention benefits households, businesses, governments and economies
Loss prevention is a key way to structurally enhance micro (household) and macro resilience. Reducing expected losses not only narrows the insurance protection gap, but also protects the economy's ability to grow, financial resources, and mitigates the impact of disasters on the economy. Derogating investments can also generate additional economic benefits. For example, risk reduction measures can enhance macro resilience by increasing household incomes and economic growth potential, and driving project progress. Investment in solutions can also drive technology and market innovation. Strengthening loss prevention requires the investment of financial resources. For example, investments in preventive health management or improved healthcare infrastructure can strengthen health resilience; Investments in smart agricultural systems can reduce the impact of natural disasters (e.g. storms, droughts) or disasters (e.g. fires, pests and diseases) on crop yields. Investments in building codes, zoning or flood protection can also reduce property damage.
Swiss Re research focuses on climate adaptation investments aimed at mitigating losses associated with natural disaster risks. Over time, climate change is expected to increase the frequency and severity of extreme weather events, as well as the resulting potential losses. Since the accumulation of asset values in areas vulnerable to natural disaster risk is one of the main factors contributing to the continued rise in catastrophe losses, and the agricultural sector in developing countries bears more than one-fifth of the economic impact of large and medium-sized natural disasters, adaptive investments in infrastructure, real estate and crops are particularly important to generate benefits that exceed costs, with low-income countries benefiting the most.
We estimate that global emerging markets will need about $100 billion per year over the next 10 years to make infrastructure, real estate, and agriculture resilient to natural disasters (see Table 1), accounting for one-third of the total adaptation investments needed across all sectors of emerging market economies. The Climate Policy Initiative estimates that real global adaptation spending in emerging economies is only about $41 billion per year (see table 1, column 3), about one-seventh of our estimated total annual needs, of which only about 10% goes to agriculture and infrastructure. In terms of sources of funding, almost all adaptive investments we have tracked so far have come from the public sector, with more than 60% ($28.6 billion) of investment coming from developed countries to developing countries for cross-border financing, and only 2% ($1 billion) from the commercial sector. The actual investment is insufficient, and the corresponding adaptive investment demand gap still exists.
The benefits from adaptive investments to improve infrastructure, buildings and crops will be several times the cost, ranging from 2:1 to 10:1. Specifically, the benefit-cost ratio of infrastructure impairment investments reached 4:1, commercial real estate 4:1, and dryland crop production 5:1 (see Table 2). Loss prevention can also improve the insurability of assets through risk reduction. Emerging markets face dual pressure on resilience, with higher adaptive investment needs (costs) and lower insurance depths likely to coexist, but this also means that the resilience dividend in low-income countries is relatively high as a percentage of GDP, generating much higher returns per $1 of GDP than upper-middle-income countries, and requiring a lower absolute size of investment.
Broaden the scope of risk protection to help improve micro and macro resilience
When adequate loss prevention measures are in place, risk transfer will play an important safeguarding role. There are complexities and limitations in risk reduction measures, for example, infrastructure mitigation investment faces fiscal expenditure constraints, renovation is the main challenge of commercial real estate, crop adaptive investment faces base constraints and insufficient financing, and the gap in adaptive investment demand is still huge. In this context, risk transfer can come into play. Insurance, loss prevention, and boosting economic growth complement each other, and all three need to be strengthened to enhance financial resilience.
Insurance protects assets and income from negative shocks, encourages long-term financial planning and investment in family property, small business, education, and health, and provides financial support in the event of catastrophic household spending, loss of assets, or loss of earning capacity. Insurance has a strong correlation with protecting the interests of low-income groups in society and eliminating inequalities, and it can also provide financial incentives for derogation (Figure 1).
In addition, insurance can strengthen the resilience of the entire economy. After a natural disaster, the reconstruction of houses and the recovery of the economy require a lot of money. Insurance payouts can permanently shift resources to areas where the economy needs to recover, reducing disruptions to economic activity and reducing financial stress on households and businesses. Otherwise, reconstruction funds will need to come from other sources, which will reduce the amount of money available for consumption and investment, and will dampen future economic growth.
Transferring risk to insurance markets can also enhance the second-order effects of disaster recovery, thereby enhancing macroeconomic resilience. Businesses in disaster-stricken areas may be more willing to invest in the aftermath of a disaster if they reasonably expect their customers to rebuild or return to the market after receiving insurance benefits. This micro-level decision will have a positive impact on the entire macro level. The European Insurance and Occupational Pensions Authority (EIOPA) estimates that a large-scale disaster that results in direct losses of more than 0.1% of GDP could reduce GDP growth by about 0.5 percentage points in the quarter when the proportion of insured losses is low, but the economic impact of losses is negligible if adequate insurance is insured.
Another way insurance can help mitigate disaster losses is by mitigating the impact on public finances and reducing the need for commercial borrowing. Governments often provide financial support to households and businesses that do not have adequate insurance coverage, leading to rising deficits and constraining fiscal spending in other areas. Previous analysis found that for advanced economies, the deeper the insurance depth, the lower the government's post-disaster spending. In countries with deeper insurance coverage, the actual impact of disasters is less and does not lead to higher deficits. Similarly, advanced economies with higher levels of insurance protection had lower levels of debt in the business sector in the years following the event. Many emerging economies have more limited access to financial resources and credit, so insurance can play a more important role as a shock absorber.
Insurance helps improve micro and macro resilience. The buildup of financial resilience at the household level to cope with significant risks can affect the economic interests of the entire country. As a result, in many countries, public sector protection schemes often cover death and health risks to some extent. For natural disaster risks, many governments focus on risk mitigation and adaptive investments, while risk transfer is primarily handled by the commercial (property) insurance market.
summary
Boosting insurance resilience requires a full recognition of insurance's potential in risk transfer, and governments, regulators, insurers and companies need to work together to expand insurance coverage. Innovative insurance product design is needed to improve the efficiency of risk transfer. Data and model analysis innovations can extend insurance coverage to emerging under-protected risk pools, including comprehensive coverage across multiple risks, derivative insurance related to procurement behavior, or index insurance solutions. It is important to have a sound legal and regulatory framework to improve the practicality of risk transfer solutions, such as the introduction of mandatory insurance (health insurance, work-related injury insurance, etc.) in many economies. The government can also incentivize residents to increase insurance coverage through tax and regulatory systems, and advocate risk-reducing investments. Microinsurance and new distribution channels (such as the Internet) can improve access to protection, and public-private partnerships can improve the insurability of special risks.