21 May 2018 - 15:40
Insurance and natural catastrophes
How the insurance industry is dealing with the increase of the natural disasters?
If we examine the past five years, we notice a drastic rise in the number of disasters caused by man or nonetheless directly attributable to him – think for example of the attack on the Twin Towers in 2001, or the explosion of the Deep Water Horizon rig in the Gulf of Mexico – and a considerable increase, with the exception of 2017, in natural disasters. The latter includes two main sub categories: earthquakes and weather-related disasters (flooding, hurricanes, storms, hail…) with science for some time identifying climate change as the main cause of the latter.
NASA, first and foremost, as well as almost the entire scientific community, agree that atmospheric pollution and excessive production of CO2 are the cause of the greenhouse effect and the resulting rising temperature of the planet.
Since the industrial revolution, the average temperature of our planet has risen just short of one degree, but two thirds of that variation occurred from the second half of the 1970s. The warming of the earth’s surface, which is clearly not uniform, is in its own turn at the basis of climate upheaval, the main cause of many of the major disasters that have struck our planet over the past twenty years, and for which we are mere passive spectators and powerless victims.
From this reasoning we can say with practical certainty that while natural per se, a large part of the floods, storms and whatever else are the indirect responsibility of humans.
The toll of these phenomena in terms of human lives remains extremely high and unpredictable, considering their increasing intensity and frequent occurrence in places typically not exposed to such risks before.
During 2017, 151 catastrophic natural events claimed over 8,000 victims, of which “only” slightly over one thousand were due to earthquakes. The previous year, however, there had been 191 events with little fewer than 7,000 deaths (of which 1,400 were the result of earthquakes).
Another cause for concern however is the rise in the property damage caused by these events, a rise definitely related to the increasing violence of such phenomena and their occurrence in more advanced economies where, inevitably, the cost of the devastation can reach staggering figures.
Just go back in time to 2001 and think of the dramatic consequences of the explosions at the Fukushima nuclear power plant in Japan after the cooling system shut down for three reactors. The tsunami caused by a violent earthquake off the coast in the Pacific Ocean in fact caused the flooding and consequent black-out of the uninterrupted power supply which had been foolishly built just a few metres above sea level.
Even today, no exact figure has been calculated for the damage caused by this disaster occurring just over 200 kilometres in a straight line from Tokyo. It has been very roughly estimated as somewhere between 200 and 600 billion dollars, considering on the one hand the costs of fully decontaminating the area, which ought to take almost half a century and thus with indirect costs that are extremely difficult to quantify.
But even without considering the most extreme cases, like the one above, just think that last year property damage caused by natural disasters worldwide exceeded the astronomical figure of 300 billion dollars, the equivalent of the entire wealth produced in one year by a country like Denmark. And almost 90% of those regards just weather.
It is also very interesting to underline that the percentage of damage insured out of the total damage caused, again on a worldwide scale, has remained at a stable percentage of about one third of the total, increasing to just over 40% in 2017, even if that increase may have been impacted by the hurricanes that hit the United States, in particular last autumn’s hurricane Harvey, responsible for a loss of up to 70 billion dollars alone.
One certainty is that the potential demand for insurance coverage for this kind of risk is growing, as is the cost of insurance, considering the greater frequency and intensity of this kind of event, together with its occurrence in high economically developed areas and the kind of devastation caused.
In fact, the cost of direct damage does not constitute the final balance since it does not take into proper account the indirect effects which are often the result of stops and interruptions in production.
In any case, the insurance industry has always succeeded in defining solutions to replace or complement what is mainly, in national emergency situations, funded by the State or by local government bodies. And that is not all. As for the need to insure against major risks, sporadic yes but with serious economic implications, “financialisation” solutions have been identified for the latter by issuing what are known as cat-bonds on capital markets. These securities incorporate the insurance premium in the yield and guarantee high returns and, above all, are decorrelated with financial market trends and transfer to investors – which are typically institutional – the risk of losing the principal in the event of the catastrophe occurring and in proportion to the actual extent of the damage resulting from the insured event.
For further information read the press release about Lion II Re, the catastrophe bond issued by Generali on floods and windstorms in Europe and earthquakes in Italy.