Insurance For Extreme Weather Events

Jeffrey is a Botanist, an award-winning marketeer and a well-regarded senior executive in the Insurance sector. He is particularly passionate about parametric solutions and its applications. In 2021 he received the Imergey Luminaries Award APAC, which honours professionals in a variety of industries and regions who are building communities, followership and starting thoughtful conversations. CEO INSIGHTS ASIA Magazine listed Jeffrey as one of the Top 10 Chief Marketing Officers in Asia for 2022.

In a conversation with Prisila, a Correspondent at Asia Business Outlook Correspondent, Jeffrey Khoo, who is a globally well-known expert in insuring weather, for his views on the current extreme weather situation that has plagued many countries. Here are some of the key points brought up during the interview.

What is the current situation with insurance for extreme weather events?

Allow me to start with my home ground here in Singapore, which is relatively a very small country in terms of its size. Our recently released 3rd National Climate Change Study has detailed climate change projections up to 2100. The study highlighted that at the end of the century, Singapore could experience increased extreme weather with higher frequencies of very hot days, more extreme daily rainfall as well as longer and frequent dry spells. Ultimately, this would impact food and water resources. The reality is that globally every country will be facing the impact of climate change in varying degrees of severity.

As a consequence of the increased frequency of extreme weather events, a number of insurers have reduced coverage offered. At the end of the day, insurance companies are not charity organizations. They are not financially supported by government funds and would need profitability to exist.

For instance, with extreme weather events multiplying, home insurance providers in the US are rapidly raising insurance premium rates or even exiting the business altogether. This has resulted in many homes being uninsured, as the premiums have in certain cases increased threefold!

Could you share a bit more about the term Protection Gap in Insurance

In reality when an insurer or a reinsurer is faced with increased losses, they must balance the need to preserve capital to pay policyholders’ claims with increased demand for coverage on these risks. The difference between total economic loss and what is covered by the insurance solution is often referred to as the protection gap.

One important fact needs to be highlighted. Taking reference from AON’s 2023 Weather, Climate and Catastrophe Report, it was reported that natural disasters had caused global economic losses of around $313 billion in 2022. However less than half of this amount was insured. This creates a large protection gap for many to fall through.

A large protection gap inevitably increases the vulnerability and suffering of people, not to mention severe damage to the economy. The direction now is essentially for the insurance industry to develop innovative ways to both mitigate and transfer risks.

"The insurance sector has the deep expertise to model risks and could work with government regulators to offer reasonably priced and yet effective products to transfer risk"

What would be some innovative methods to help narrow the protection gap

The key here is to spread the risk beyond the insurance market.

An increasingly acceptable method would be to deploy funds from the capital markets instead of only relying on traditional insurance capacity to insure a risk. Take for example, catastrophe bonds and insurance-linked securities would be a way to transfer risk to investors.

Generally, investors would not want to deal with complicated and lengthy claims procedure of traditional insurance. As such, most of these covers have to be via a Parametric insurance structure where there is no need for any lengthy claims assessment or worse, any disputes. In parametric insurance, payouts are triggered when pre-agreed parameters are achieved during the duration of the cover. The cover could be designed with triggers such as the amount of rainfall or windspeed. Unlike traditional insurance, the cover need not be year-long and only covers the riskier time period. Importantly, parametric risk allows claim payments to be released much faster when a severe weather event hits, which effectively means funds are made available quickly to help mitigate the situation. There have been instances when traditional home insurance is repackaged, enabling uncovered perils to take on a parametric payout within the insurance package.

Here are the challenges in using capital markets funds. The issue revolves around the return of investment. If I were to tell an investor to use his money as capacity to underwrite a weather event and in return, he will get only 10%, with the risk of losing the entire invested amount should a weather event hit, it would be a hard sell. He could find other investment opportunities in the market that could give him the same amount of return with lesser risk.

But if I were to promise a 25% return to the investor, there would likely not be many clients who would be willing to pay at least 25% of the payout as premium. There needs to be an appropriate balance of risk and return. Essentially, we have to deal with the “expectation gap” between insured and insurer.

In my view, at some point “expectation gap” will reduce, as the new normal would be to pay higher premiums to receive a cover. However, a better understanding of weather events through data analysis could be a great help to lower the risk for investors.

Additionally, the market could be expanded to fill the protection gap with potential government capital or donor capital. For example, increase public-private partnerships where insurance structures rely on public funds to help reduce the protection gap. Governments could explore alternatives for certain insurance covers that are simply too expensive for the consumer.

The insurance sector has the deep expertise to model risks and could work with government regulators to offer reasonably priced and yet effective products to transfer risk. AI is a powerful tool that could be used to analyze data and innovate new insurance products.

From a more pragmatic view, building regulators, developers and city planners can help ensure new building standards to limit damage due to extreme weather. This will effectively help control the premium rate to consumers. For example, a well-designed weather-ready roof and construction can be an effective mechanism in reducing the extent of wind or fire damage. While such techniques exist, it will take time to implement and could require additional funding support.

To this end, insurers should increase collaboration with governments to develop innovative solutions that complement current insurance products.

In conclusion, where do you see the road ahead for this new normal?

It is important to strike a balance between mitigation and adaptation. For investors, risk and return must make commercial sense, otherwise the funds will not flow. Insurance is not the only solution to mitigate risks, therefore increased discussion between stakeholders will go a long way to help. The weather is only going to get worse, so we need to work out viable solutions quickly.