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Understanding and addressing global insurance protection gaps

Source: Asia Insurance Review | May 2018

Global Cyber Life & Health Nat CAT

Dr Kai-Uwe Schanz of The Geneva Association offers an updated quantification of protection gaps in the areas of Nat CAT, cyber, healthcare and pension risk. Risk exposures, driven by digitisation, urbanisation and climate change, as well as value accumulation and concentration, tend to outgrow insurance premiums, leaving individuals, households, firms and the public sector alike underinsured.
The most appropriate definition of insurance protection gaps is the difference between the amount of insurance that is economically beneficial and the amount of coverage actually purchased. The insurance protection gap is hard to measure and subjective. Therefore it is replaced by an indicator comparing covered loss to total economic loss. This figure, however, needs to be put into perspective as a certain level of risk retention makes economic 
No progress in shrinking the natural catastrophe protection gap in lower income countries
According to Munich Re, the Nat CAT protection gap (uninsured losses as a share of total losses) has narrowed steadily over the past 30 years, from 78% to 70%, and from 0.3% to 0.2% of the world’s GDP.
   Despite this gratifying global trend, the protection gap remains massive, with only about 30% of catastrophe losses insured. In addition, this global trend masks huge differences between the various country income groups. Progress in terms of shrinking the gap has basically been limited to high- and upper middle-income countries. 
   Alarmingly, there was hardly any progress in lower middle- and lower-income countries, with protection gaps persisting in excess of 95%. Those countries remain extremely vulnerable (see Figure 1). Using a Monte Carlo simulation tool for a sample of 30 countries and extrapolating the results, Swiss Re projects the future protection gap at more than $150bn pa or about 0.25% of global GDP.
Uninsured Nat CAT losses as a share of GDP for different country income groups, 10-year moving averages, 1989-2016
The cyber protection gap is estimated at about 90% –  in the face of major hurricane-like economic loss scenarios
The least researched protection gap is cyber risk. Some studies put the annual global economic cost of cyber incidents at around $400bn, almost 0.5% of global GDP and almost twice the average annual amount of natural disaster losses.
   Current annual gross premiums for global cyber insurance are estimated at $3bn to $3.5bn, about 1.5 per thousand of global non-life insurance premiums, according to Lloyd’s. Swiss Re expects the global cyber insurance market to grow briskly to $18bn by 2025. However, this would still be less than 1% of the global non-life insurance market. A comparison of the current cumulative global damage from cyber incidents with today’s cyber premiums generated by the insurance industry suggests that virtually all cyber losses remain uninsured and, from a macro perspective, insurance-based transfer of cyber risk still lacks any real relevance. Lloyd’s recently attempted to quantify the cyber risk protection gap, based on modelled economic loss scenarios of up to $53bn (ie, equivalent to losses from a major hurricane) and protection gaps of about 90%.
Healthcare – out-of-pocket expenses amount to about 2% of global GDP
It is even more challenging to quantify the healthcare protection gap, primarily on account of the institutional and legal complexity of healthcare systems, as well as the huge differences in the quality and availability of healthcare services.
   Out-of-pocket expenses (OOP), ie, the share of the expenses that the insured must pay directly to the healthcare provider, without reimbursement by a third party such as an insurer or the government, can serve as a very rough indicator of healthcare protection gaps. When people incur co-payments or fees for healthcare services, the amount of such OOP expenses in relation to income can reach financially catastrophic proportions for the individual or the household. World Health Organization research shows that catastrophic expenditure can occur in all countries at all stages of development.
   The macroeconomic proportions of OOP are sizeable. Across the various country income groups defined by the World Bank the GDP share of total national OOP ranges from 1.8% to 2.4%. This ratio is just an illustration of the healthcare protection gap and could even be compared with the natural catastrophe protection gap’s long-term annual average GDP share of 0.3% globally. In light of rising levels of income per capita and unabated medical inflation, the healthcare protection gap is set to grow further.
Why individuals and businesses buy less insurance than is economically beneficial
On the demand side, affordability remains a relevant obstacle primarily in developing and emerging insurance markets. In addition, numerous empirical studies suggest that a lack of awareness, as a result of poor financial literacy or general education, plays an important role in explaining underinsurance, even in countries with higher levels of per-capita income.
   Product appeal and service quality are of great importance, especially in advanced insurance markets, and they include the ease of buying insurance cover and the rising customer expectations in the wake of digitisation.
   Policyholder trust in the context of insurance protection gaps is particularly relevant for developing and emerging markets, which are frequently characterised by relatively weak legal and regulatory systems for enforcing payment of valid claims.
   Cultural and social factors can also help to understand insurance protection gaps, ranging from differences in risk aversion to factors attributed to religion, as shown by various empirical analyses focusing on low-income countries.
   Behavioural biases are of more general relevance. One example is loss aversion, ie, individuals being more sensitive to small losses than large gains. In insurance, the premium is a certain and near-term expense, whereas the claim benefit is uncertain and distant and is therefore perceived as a potential loss.
   However, insurance protection gaps do not only reflect demand-side issues. Equally important are insurance market imperfections that hold back insurance supply. Transaction costs are one of the most prominent examples.
   Protection gaps also need to be addressed through the prevention and reduction of losses, eg government-sponsored building codes. Also, in many advanced insurance markets, governments step in as insurers or reinsurers of last resort for certain risks which defy the most fundamental criteria of insurability.
   In addition, insurers have to step up their game. For example, irrespective of an economy’s stage of development, digital and mobile technologies can go a long way in addressing protection gaps by simultaneously promoting affordability, awareness and product appeal. A 
Kai-Uwe Schanz is senior adviser at The Geneva Association.
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