Optimal levels of risk diversification for natural catastrophes have not been achieved due to various regulatory restraints that limit the scope for diversification, according to The Geneva Association.
It said that the increasing trend in a number of Asian jurisdictions towards barriers to the cross-border provision of (re)insurance services – for example, through minimum levels of reinsurance to be placed locally, additional capital requirements for foreign reinsurance branches and special credit risk charges applied in respect of foreign reinsurers – is regrettable.
The leading international insurance think tank, in its report “Insuring Flood Risks in Asia’s High Growth Markets”, said: “These restrictions are set to reduce the benefits of cost-efficient global diversification of risk, making insurance more expensive for domestic policyholders. In addition, any attempts to increase the national retention of risk may turn out costly in the event of a major disaster, which could result in a severe strain of the balance of payments due to the loss of exports and the higher cost of imports following such an event.”
Diversification through pooling can help
The Geneva Association made the comments in discussing how diversification through pooling can reduce the total capital requirements for insuring catastrophe risks and thus lower the cost of insurance.
The report proposes solutions to the considerable protection gap that exists for flood losses in Asia. The region’s economic rise has translated into a massive increase in asset values and their concentration in areas prone to flood risks.
By 2070, Asia is expected to account for 50% of all global assets exposed to flood risk. Current flood defence systems are inadequate with Asia’s annual flood losses having the potential to grow to US$500 billion by 2050 based on current defence systems.
What insurers can do
The report suggests that to tap into the full potential of diversification, insurers could consider the following:
• Establish a global catastrophe capital reserve which is owned by global (re)insurance companies.
• Set up an independent statistical agency to compile global catastrophe loss indices by the following aggregates:
a. multi-regions of the same peril: total losses from flood in various regions and countries such as the US, Canada, Germany, UK, China, Australia, etc.;
b. multi-perils: total losses from wind, earthquake and flood;
c. multi-years: accumulation of losses over time.
• Introduce an innovative catastrophe insurance product with a two-tier limit: The first tier has a fixed basic limit paying out immediately without haircut or delay. The second tier has a flexible limit which may be subject to a haircut according to one of the reported global catastrophe loss indices.