Dr Konstantinos Chalkias (Birkbeck, University of London), Professor Paula Jarzabkowski (The University of Queensland and Bayes Business School), Dr Eugenia Cacciatori (Bayes Business School) and Dr Rebecca Bednarek (Victoria University of Wellington) reflect on how government and industry work together to address a grand challenge – the issue of disaster uninsurability. They co-authored Disaster Insurance Reimagined (Oxford University Press, 2023), a book that proposes potential solutions to the growing crisis in disaster insurance, moving beyond individual case studies to analyse the broader themes of how knowledge, control, and responsibility affect the insurability of risk.
The growing problem of uninsurability
Disaster insurance plays a crucial role in protecting individuals from disasters and also in securing economic and social stability at the country level. Floods in Australia and South Africa, hailstorms in France, winter storms in the US and Europe, as well as droughts in Europe, China and the Americas in 2022 resulted in eye-watering economic losses of $275bn, but about half of these economic losses were insured. That meant that insurance helped mitigate the financial impact of disasters on individuals, providing socioeconomic stability by building a safety net for many of those affected by disasters. Insuring risk in this way alleviates poverty and displacement, playing a key role in reducing the burden on public resources, as high insurance coverage decreases the reliance on public funds for recovery and relief efforts post-disaster.
Floods are the most common and widespread natural disaster in the UK, with 1 in 6 properties being at risk of flooding.[1] Climate change has made devastating disaster events, such as Storm Desmond in 2015, 59% more likely,[2] with the number of people across the UK currently living in areas at significant risk of flooding expected to double by the 2050s.[3] This problem is further exacerbated by increasing urbanization and a pressing need for new housing development in the UK. Both increase the prevalence of building, homes are built in flood-exposed areas, or on land that does not naturally drain water. With climate change intensifying the frequency and severity of disasters, alongside increased urbanization which increases the impact and geopolitical instability adding to the costs of goods and materials used in repairs, the economic losses from disasters will only keep increasing in value.
A pivotal question revolves around whether the current form of disaster insurance can continue playing a key role in shouldering much of the economic burden in the face of growing losses. Insurance operates on the fundamental principle that the premiums of the many pay the losses of the few. large number probabilities. The idea is that the probability of any given insured risk is relatively low, allowing insurers to underwrite numerous risks with the understanding that not all of them will result in a payout. This approach enables insurers to manage and distribute risk effectively across a diverse pool of policyholders. However, insurers grapple with heightened risk perceptions and an increased likelihood of losses surpassing premiums collected. Combined with potential adjustments in reinsurance costs, the situation becomes more complicated. To navigate this evolving landscape, insurers increase premiums, limit coverage in high-risk areas, or reconsider their market capacities. For instance, one in eight Australian households is already facing home insurance affordability stress,[4] while insurance companies are withdrawing from California and Florida, two hurricane- and wildfire-prone US states.[5] [6] This has detrimental effects with an ever-increasing financial burden being put on individuals and governments, leading to increased public debt and socioeconomic deprivation. Striking a balance between providing disaster cover for society and managing their financial stability becomes imperative for the insurance market.
Protection Gap Entities (PGEs): Innovative approaches to tackle uninsurability
An increasingly prevalent response is launching not-for-profit disaster insurance entities, known as Protection Gap Entities (PGEs). These are typically brought about by government legislation negotiated with private sector insurers and other stakeholders, to secure insurance coverage.[7] There are multiple examples of governments intervening in disaster insurance markets via PGEs worldwide, which vary substantially in the types of disasters covered, their role in the insurance market, their structure, and their governance.[8] Some of these PGEs have long histories, with countries such as New Zealand, France, and Spain establishing public entities during the 1940s to increase insurance availability. Other PGEs, like the Caribbean Catastrophe Risk Insurance Facility (CCRIF), are multi-sovereign risk pools that provide vital liquidity – rather than full reconstruction – immediately after a disaster, so enhancing government response effectiveness and easing fiscal burdens. They use parametric insurance, which pays out a predetermined amount not based on actual losses, but when a particular parameter (for instance, cumulative rainfall amount over a specific period) or index of parameters reaches a determined threshold. Unlike traditional insurance, which typically requires a detailed and lengthy assessment of losses and damage, parametric insurance relies on predefined parameters.
More recently, we have witnessed governments looking for solutions to the steady increase in disaster losses while insurance from the private sector is becoming less affordable and available. An example of that is Flood Re in the UK, which is privately owned but publicly accountable to Parliament. The scheme is funded by an industry levy imposed on insurers in the UK based on their market share. Flood Re operates as a reinsurance pool. When an insurance company sells a policy that includes flood coverage, it can transfer the flood risk portion to Flood Re in return for a premium. This transfer helps insurers manage their exposure to high-risk properties. The premiums charged by Flood Re to insurers are based on the Council Tax band of the property rather than the flood risk they bear, making property insurance affordable and available for high-risk properties in the UK. In the event of a flood claim, Flood Re reimburses the insurer, for the cost of flood claims. Following the introduction of the scheme in 2016, four out of five householders with a prior flood claim saw price reductions of more than 50%, and 100% of these households could get quotes from at least two insurers (compared to only 9% before the scheme was launched).
Is it enough? Uninsurability and the question of resilience
While PGEs can resolve the issue of insurance affordability and availability, they do not resolve the underlying problem of increasing disaster losses. Funding reconstruction post-disaster is critical for socioeconomic stability. However, insurance restores insured properties to their pre-disaster condition, typically without incorporating measures to mitigate future risk or increase disaster preparedness, so leaving properties vulnerable. As the impacts of climate change become more pronounced, disaster insurance has a critical role to play in enabling adaptation to these changes and fostering resilience.
In a time of increasing risk, the need for innovative approaches, regulatory measures, and collaborative efforts is imperative to enhance protection. Insurance must evolve to take a leading role within the broader context of protection, leveraging the sector’s knowledge and expertise to strengthen the connections between financial and physical resilience. Actors in various sectors need to align their efforts if more households are to be protected from floods, such as those which have affected the country in recent months. The government and the insurance industry must accept that their collective responsibility for protection and risk sharing is necessary for our societies. Government agencies and policymakers such as the Environment Agency and National Infrastructure Commission, need to ensure that policy and advice are geared towards increased adaptation and resilience; these bodies, together with independent bodies such as the National Flood Forum, Local Resilience Forums and others must provide advice and support, whilst keeping the profile of the issue high enough to hold policymakers to account.
Clearly, creating an ecosystem that connects the different stakeholders is key, but it does not come without challenges. Most importantly, the various stakeholders have different and often contradicting interests and objectives. For instance, insurers lean more towards market interests which are aligned with the commercial aspects of the business (it is easy to forget that they are profit-making entities), while governments focus on social objectives which contribute to securing the well-being and welfare of their citizens (see Chapter 3: Disaster Insurance Reimagined). Building meaningful interconnections requires the navigation of nuanced challenges posed by the differing timelines in insurance and political spheres. In the insurance realm, the focus on annual renewals fosters short-term risk management strategies, potentially overlooking broader and more systemic risk mitigation that unfold over a more extended period (see Chapter 5: Disaster Insurance Reimagined). Conversely, in the political arena, recurring election cycles encourage policymakers to prioritise initiatives that yield visible results within their term in office, potentially neglecting complex, long-term challenges that extend beyond the electoral cycle. This threatens our ability to address the evolving nature of risks and governance effectively.
Striking a balance between the different interests and objectives, as well as between short-term responsiveness and long-term vision among stakeholders becomes crucial, as the control and responsibility for enabling insurability and resilience are frequently shared among them. PGEs, with their expertise, political capabilities, and position at the intersection of various stakeholders in the insurance and resilience landscape, emerge as a vehicle to create an ecosystem centred around disaster protection (see Chapter 6: Disaster Insurance Reimagined).
References
[1] Skouralis, A., & Lux, N. (2023). The impact of flood risk on England’s property market. Real Estate Research Centre, Bayes Business School, City, University of London.
[2] Friederike E L Otto, et al (2018). Climate change increases the probability of heavy rains in Northern England/Southern Scotland like those of storm Desmond – A real-time event attribution revisited. Environmental Research Letters, 13(2).
[3] Betts, R.A., Haward, A.B. and Pearson, K.V. (2021) The Third UK Climate Change Risk Assessment Technical Report. Climate Change Committee, London.
[4] Paddam, S., Liu, C., Philip, S. (2023). Home Insurance Affordability Update. Actuaries Institute. Sydney.
[5] Gall, M. (2023). Why insurance companies are pulling out of California and Florida, and how to fix some of the underlying problems. The Conversation.
[6] Sellers, M. (2023). Major insurance company abandons homeowners in two key states. Insurance Business Mag.
[7] Jarzabkowski, P., K. Chalkias, E. Cacciatori, R. Bednarek, (2023). Disaster Insurance Reimagined: Protection in a Time of Increasing Risk. Oxford: Oxford University Press.
[8] Jarzabkowski, P., K. Chalkias, E. Cacciatori, R. Bednarek, (2018). Between State and Market: Protection Gap Entities and Catastrophic Risk. Cass Business School, City, University of London.