Narrowing the Protection Gap: Climate Change and the Public Sector

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Evolution of more resilient risk transfer solutions

As our climate continues to change, the number and severity of significant disasters is projected to increase. The disaster burden not only strains individuals, but governments as well. Disaster risk financing and public-private partnerships can open new opportunities to unlock risk capital and expand risk transfer solutions. Partnering is key for tackling the most pressing challenges of the day and new thinking by insurance professionals, capital providers, policymakers and regulators is needed to create win-win arrangements.



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Eric Stenson: I'm Eric Stenson from Guy Carpenter. Welcome to this episode of Fo[RE]sight, a Guy Carpenter podcast series bringing you unmatched insights on trending challenges and our solutions delivered by Guy Carpenter experts on the vanguard of thought leadership within the reinsurance industry.

Today, Guy Carpenter’s Joe Becker, Senior Vice President, Broker, North American Public Sector Team, and Ruth Lux, Head of Public Sector, UK, Europe, Middle East and Africa, will discuss themes regarding climate change and how it affects the public sector, what could work as potential-public private solutions as well as ways to address resilience. They will dig into how insurance professionals can help address growing protection gaps, what the appropriate role is for governments, and how resilience helps facilitate effective risk transfer. Over to you, Joe.

Joe Becker: Thanks, Eric. As our climate continues to change, the number and severity of significant disasters is projected to increase. Even in today's environment, it is not until after the event’s physical destruction passes that survivors realize the financial burden that's left for them. Many find that they were either under-insured for the disaster or worse, that they didn't have any coverage.

This burden not only strains individuals, but governments as well, as they are forced to step in and provide basic necessities for those impacted. I'm excited to join my colleague, Ruth Lux, in discussing how we, as a society, must address these protection gap issues. So, Ruth, how can we fix the protection gap?

Ruth Lux: Thanks, Joe. Well, the insurance protection gap is hard to measure and typically refers to the difference between covered loss and total economic loss. It's worth noting that a certain level of risk retention may make economic sense. But, before we can close the protection gap, we first need to close the awareness gap. If customers are not aware that there is a protection gap, then they won't look to protect themselves in the first place.

Now the same goes for the penetration gap, which is the difference between those who have and those who have not bought cover. Both of these gaps exacerbate the problem of the protection gap, but to truly close the penetration gap, insurers must close the knowledge gap and our understanding of the threats that are coming over the horizon must be invested in so that we can truly understand them and talk to the customer knowledgeably.

Now, public-private partnership solutions are definitely part of the answer to the problem. Firstly, they share the burden between the customer, the insurance industry and the government. Secondly, they incentivize behavior in the customer. And thirdly, they encourage better understanding by the industry of the risk and how to model and price it. And finally, they encourage the industry to incentivize the mitigation of the risk by promoting activity that is accredited by the relevant agencies and designed to ensure that whilst the event will still occur, its impacts will have been lessened.

Now, all of these things combined lead to resilience. But, Joe, I would love to hear your thoughts on how you look at the problem.

Joe Becker: Ruth, I think that's a great way of looking at the issue. When I think about the protection gap, I find it helpful to understand how the gap developed and recognize that the drivers of inadequate financial protection are different between regions and between perils. At its most basic, protection gaps arise either out of a lack of available, affordable and easy to understand coverage, or because there's a lack of awareness of the risks.

Ruth, your description of the awareness gap and penetration gap are helpful reminders that this lack of awareness manifests both in customers and within the insurance industry. I think to address the existing knowledge and penetration gaps, we need to first focus on education and making sure homeowners are aware of all the potential significant risks. Concurrently, as a society and as an industry, we need to continually improve our understanding of the world and how we quantify the dangers that we face.

Ruth Lux: Right.

Joe Becker: This may seem like a daunting task, but I think there's actually good news here. Recently, there has been a significant and public dialogue about the benefits of mitigation and the need to quantify risks due to climate change. Because climate change threatens to disrupt so many different industries, the potential impacts are being discussed and debated across virtually every public sector and in every community.

These discussions are helping make individuals more aware of the risks they face. In some cases, education will not be enough. Financial and availability constraints will persist if the private sector deems particular risk geographies as uninsurable. This is where governments will have to step in and play a larger role in shaping how we respond to these risks. In some areas, managed retreats will be the most cost-effective program.

A good example of this is the buyback programs in the US that help remove homes from floodplains after major events. In other areas, incentivizing community and home hardening so those communities can better withstand existing and increasing risks will be the most beneficial. As insurance professionals, one area we focus on is how we can bring risk capital into the equation by incorporating the latest resiliency measures into our risk calculations and by developing innovative risk transfer solutions to help diversify balance sheets.

Ruth, I know were involved in planning around the recent COP 27 meeting. Would you mind sharing Guy Carpenter’s involvement in the event?

Ruth Lux: Yeah. Thanks, Joe, absolutely! So, Guy Carpenter (and Marsh McLennan more broadly) participated in COP 27, which is the 27th United Nations Climate Change Conference. And we organized a series of important events. This year there was private sector leadership on climate adaptation. Adaptation has often been seen as secondary to the transition efforts targeting effects more than cause—but as the sheer breadth and complexity of achieving the ambitious 1.5-degree target becomes evident, the collective focus on bracing for the physical impacts of climate is growing. The private sector is increasingly seeking ways to manage its own long-term exposures while engaging constructively with communities, clients and policymakers. Now, central to those efforts will be insurance industry leadership.

Global leaders increasingly view the sector as possessing the holistic set of capabilities that are most critical to effective risk mitigation strategies: science-based data and analytics, an innate focus on risk identification and reduction, an ability to price and diversify risk, access to risk capital, broad distribution networks, program development, long-term investment capital, and a host of other factors.

Guy Carpenter co-hosted a pre-COP 27 conference in Cairo together with the Insurance Federation of Egypt and Marsh, focused on adapting to a changing climate in the management of catastrophic risks in Egypt, and which resulted in a natural catastrophe pool being muted by the Egyptian government. We also hosted a series of other events, and roundtables at COP 27 itself.

It was an engaging and impactful COP, not least because of the innovative insurance industry leadership and commitment to scale its impact to climate risk-reduction, and Marsh McClennan’s efforts more broadly, to blend parametric insurance and other capital sources to craft finance solutions for extreme-heat exposures. COP 27 highlighted, without a shadow of a doubt, the important role insurance can play in protecting people, families, and communities.

Joe Becker: Thanks, Ruth. Can you give a little insight into how we should be thinking about government’s role in insuring large risks, and potentially uninsurable risks? And what are the benefits of insurance versus government funding?

Ruth Lux: Thanks, Joe. Well, I think that's really the heart of the topic and, you know, a really interesting question. So let me start by saying that it's clear that the threats we face today do not stop at borders. They are indiscriminate in their reach, and they are too great to be tackled individually by people, single companies or even individual countries. Secondly, I'd like to add that there is an acceleration of pre-existing critical global risks affecting businesses and society, such as digital dependency, cyber, civil unrest and geopolitical interactions.

And there will be narrowing opportunities for action on many of them. Now, protection gaps have always existed, and we should avoid considering them all as inherently bad. There may be good reasons why individuals do not want to insure against all of their economic vulnerability. In terms of solving protection gaps, increased insurance is one method, but mitigation is the other.

For governments providing financial protection against risks that are uninsurable by private insurance and reinsurance markets alone entails a choice between backing an insurance solution, or, delivering financial support directly to those in need. The key is finding the balance that can support short-term and long-term financial and resiliency goals.

An insurance solution could have a number of advantages over direct government financing, particularly where government support mechanisms are established hastily in the midst of a crisis. An insurance solution could provide ex ante transparency and certainty on the level of benefits that will be provided, and could leverage the existing claims payments infrastructure to deliver those benefits quickly, particularly if the trigger for paying claims is simple, such as in the case of a parametric coverage.

An insurance solution could crowd in private capital from insurance, reinsurance and capital markets into absorbing some of the losses, even in cases where the majority of the risk is borne by the government. And, an insurance solution could also provide incentives for policyholder risk mitigation through premium discounts. For example, and I know that you know this example well, Joe, Flood Re is a landmark industry and UK government scheme that makes affordable flood insurance available to more than half a million homes in high-risk areas. The scheme allows government to protect those most at risk for flooding and creates a platform to share UK flood risk with private reinsurers through reinsurance.

The scheme has been successful in improving product availability for a majority of homes at risk of flooding in the UK, with 4 out of 5 households with previous flood claims achieving more than a 50% price reduction. 94% of the insurance market now offers the scheme.

Joe Becker: I want to pick up on your comment about the role of insurance solutions. As we consider what is insurable and what isn't, we should recognize that some large risks will not be able to be wholly insured by the private market, but that doesn't mean that those risks should simply be abandoned. Beyond just macro concepts of government intervention in insurance markets, there is also a concept of local governments taking a more active role in mitigating against the known risks.

Local communities are often the ones that know most about the risks they face and empowering them to make sound financial decisions about their future is key, both to getting community-level buy-in, but also to direct funds towards the most impactful mitigation projects. Local communities can also have the benefit of being more nimble when thinking about different insurance solutions, such as community-based catastrophe insurance schemes.

In some cases, legacy programs require government to take an active role in the risk management of specific risks. The NFIP in the US is a perfect example of this. For nearly 55 years, the NFIP has relied solely on government—and therefore taxpayer funding—of their risk management. However, in 2017, they began to engage both the reinsurance and capital markets to de-risk a portion of their public balance sheet by purchasing reinsurance for the first time.

The benefits were quickly demonstrated during Hurricane Harvey, and the program has grown since then. By purchasing reinsurance, they have demonstrated that there is a financial appetite for a peril that was once considered uninsurable. I feel that this is a major contributor to the thriving private flood space demonstrated by the number of new private flood programs in the US.

While engagement with the private market wasn't the only reason, new programs have started to pop up demonstrating that ultimate risk bearers—the reinsurers in this case—are interested in taking on this peril was a key component to its accelerated growth.

Ruth Lux: Joe, thanks. That's really interesting. And if you don't mind, I'm going to move on to a slightly different topic. And I think it'd be great to focus on national resilience. And I'd like to ask what role can reinsurance play in bolstering national resilience?

Joe Becker: Reinsurance can absolutely play a vital role in developing national resilience. At its core, reinsurance prices and transfers risk on that price. This means that there's an incentive for maintaining sound financials and to make investments in mitigation. This incentive is reflected through the pricing and capacity offered by reinsurers, even at a homeowner scale, protection in the private market means fewer public funds are required to support impacted homeowners after a disaster.

This, in turn, allows government dollars to be spent helping those who are most in need and hopefully by pre-funding resiliency measures for future disasters. As communities and nations work towards building resilience, too often they rely on post-disaster financing to fund mitigation efforts. Reinsurance offers an avenue to offload some of that risk currently sitting on the balance sheets, which ultimately frees up more funds to improve mitigation.

This, in turn, leads to reduced insurance premiums, which allow for investments in additional mitigation. While this cycle doesn't continue indefinitely, it helps increase awareness of the risks and allows for reduced risk-transfer costs, which are vital to close the protection gap. Ruth, where do you see reinsurance fitting into this conversation about national results?

Ruth Lux: Thanks, Joe. Well, I share your view on most of the points that you just made. But put simply, reinsurance can play an important role in bolstering national resilience. But it is important that we define what kinds of resilience we need, whether we share risks and costs appropriately between sectors, whether we regulate well for resilience, whether our efforts are underpinned by the best data and analytics, and whether we innovate and communicate as we ought to.

Now, this is a pivotal moment for re-energizing resilience efforts at the national level. In order to secure long term well-being and prosperity, a whole-of-society response is needed in mitigating critical risks and being prepared for crises.

For governments, the key to efficiently and effectively exercising public power lies in balancing costs, in regulating for resilience, and adjusting data-sharing arrangements to ensure sharper crisis management. Disaster risk financing and public private partnerships can open new opportunities to unlock risk capital and expand risk transfer solutions.

Partnering is key to tackle the most pressing challenges of the day. And new thinking by insurance professional roles, capital providers, policymakers and regulators is needed to create win-win arrangements. A variety of risk capital and related risk-management services are required to address the growing level of risk faced by society in today's world so that more resilient risk-transfer solutions can evolve.

We work with many different national governments at all levels to identify risk and help those governments assess and quantify their risk and how much they have on their balance sheet, before then pricing the risk and then transferring it to the private markets. Now this is risk transfer. This assists governments in managing their debt and their contingent liabilities.

So Joe, before we wrap up, I'd love to get your thoughts on key recommendations for our listeners. And with that in mind, it'd be great if you could outline one key recommendation on what can be done at both the national and a subnational level to strengthen and increase the use of insurance against disaster risk.

Joe Becker: Ruth, I'll go back to a comment I mentioned earlier. One key area that people should focus on is the education on the art of the possible. There are so many different ways that disaster financing can be structured; each will have its benefits and its drawbacks. Understanding how these different financing mechanisms can benefit a community is crucial to developing a robust program.

However, during the education process, a key concept that needs to be communicated is that pre-disaster financing is significantly more cost effective than post-disaster financing. So, while it's important to have a broad understanding about what is possible, the most effective insurance policy is the one that is in place during a disaster.

Ruth, what would be your one recommendation?

Ruth Lux: Well, effective disaster risk financing, DRF, is timely. DRF should provide support when it's needed. In addition, this may be before a crisis to reduce impacts. It's important to ensure that finance will be triggered at an appropriate time for the actions that it's supposed to fund. Also, success breeds success. Strong pilot projects scale up country interest and global momentum.

Joe Becker: Interesting perspective. I'd like to recap for our listeners just what we discussed today. First, we defined and spoke about how we, as insurance professionals, can help address the growing protection gap issues. Then we spoke about the role of government, and finally, we spoke about how resilience can help facilitate risk transfer, ultimately improving public balance sheets.

I’d like to thank you, Ruth. I really enjoyed this conversation.

Ruth Lux: Yes. Thanks, Joe. Me, too.

Eric Stenson: I’m Eric Stenson and thank you to Guy Carpenter’s Joe Becker and Ruth Lux for sharing their insights on many factors concerning climate change with the public sector, including how insurance professionals can help address the protection gap, the role of government, and how resilience helps facilitate risk transfer, ultimately improving public balance sheets. Anyone wanting to learn more, or who would like to engage with a Guy Carpenter expert directly should visit guycarp.com and click on Explore Solutions.

Please look for the next episodes in our series, as we address additional themes connected with the reinsurance environment. And thank you to our audience for sharing this time with us and listening to Fo[RE]sight, a Guy Carpenter Podcast Series.