Worldwide development means that catastrophe claims will increase materially over time as a result of greater insurance density and increasing exposures, comments Lee Coppack.

The currently uninsured catastrophe potential is enormous. Insured losses due to natural catastrophes in 1997 were estimated at $4.5 billion, while economic losses were estimated at $30 billion, according to Munich Re's annual catastrophe review. The cost of catastrophes in 1997 was exceptionally low, with both insured and economic losses only about half those of 1996.

The gap between insured and economic losses indicates that in effect, only 15% of worldwide natural catastrophe losses in 1997 were insured. The main reason is the low insurance density in areas most affected by natural catastrophes.

This is almost certain to change, as with economic development comes an increase in insurance purchase and, therefore, in density. The global average penetration of non-life insurance in 1996 was 3.2%. For those in the lowest income class with average earnings of less than $2,000 per head, the take-up was only 1.1%, rising to 3% for those whose incomes are in the range $4,001 to $16,000 a year, according to Swiss Re's Sigma1. Among the fastest rates of growth in non-life business in Asia between 1995 and 1996 were South Korea, China, Malaysia and Thailand, all areas vulnerable to natural disaster, especially windstorm and flood.

Looking over a longer period, of the 40 most costly insurance losses between 1970 and 1996, there were 22 in the United States, three in Japan and 10 in various parts of Europe. Over the same period, the largest loss of life in disasters, natural and man made, was in India (9), Bangladesh (6), Iran (5) and Pakistan, the Philippines, Indonesia and Turkey (2 each).

High loss of life can indicate a number of things, including either comparatively dense population in the affected area or catastrophes which are geographically very extensive. Certainly there is a worldwide trend of migration away from the countryside and a concentration of people and values in big cities. The United Nations predicts that by 2025, approximately 60% of the world's population will be living in cities, compared to 30% of a population only one third the size in 1950.

Dr Wolf-Otto Bauer, a member of the Munich Re board of management has described the resulting accumulation of loss potential of nearly all classes of business as of "nightmare character".

In the countries with the most lethal disasters, insurance density is usually very low. (Table 1.) However, the two losses which appear on both lists may give some idea of the potential scale of insured losses with greater insurance penetration, although even in Japan it is not especially high. The Kobe earthquake in Japan in January 1995 killed about 6,000 people and resulted in insured losses of $2.6 billion (1996 prices). Munich Re estimates uninsured economic losses at about $97 billion. It also points out that more than 15% of all insurance payments were for insurance of the person - life, health and personal accident. Even Sigma does not offer information on insurance density in Honduras, but in September 1974, tropical cyclone Fifi killed about 2,000 people and resulted in insured losses of $1.6 billion in this Latin American country.

Nor do all the most expensive or the most deadly losses result from natural causes. The 1988 explosion on the North Sea oil platform Piper Alpha ranks as the eighth most expensive insured loss over the 16 year period with $2.7 billion in claims. Other large man-made losses, all in the US, include the 1989 explosion at the Phillips Petroleum refinery in California, the malfunction at Three Mile Island US nuclear power station in 1979 and race riots in Los Angeles in 1992. The two sets of forest fires in 1991 and 1993 can probably be considered man made, at least in part.

In terms of fatalities, the greatest deaths occurred in earthquakes and cyclones, but the list also includes three man made disasters in India: a dam burst in 1979 when 15,000 people died, the Bhopal chemical plant malfunction which resulted in 3,000 deaths and much disability, which has not been recorded, and a railway accident at Bihar in 1981 when about 2,500 people died.

Changes in risk

The growing world population and intensifying urbanisation do not just lead to an increase in insured exposures but can actually change the nature of risk.

Urban centres are attractive targets for terrorists because of the impact they can have. A large bomb in a sophisticated industrial or commercial centre can produce very large insurance claims, as the IRA campaigns in London demonstrated so clearly.

The combination of populations under pressure in cities with valuable property is a volatile one; race riots in Los Angeles in 1992 figure among the 40 mostly costly loss events since 1970.

The increased heat and exhaust gases associated with urbanisation and geological changes resulting from major building works can also affect risk. As Munich Re points out: "Big cities create their own climate, a problem that will be intensified by global climate change."

Looking at the 1997 catastrophes, Munich Re meteorologist Dr Gerhard Berz comments: "The fact that extreme atmospheric events accounted for such a large proportion of the losses is further evidence for us of the expected change in the environment and climate in many regions of the world. New extreme values for various atmospheric parameters like precipitation and wind velocity will often have catastrophic effects."

However, Munich Re adds: "Even radical environmental protection measures cannot prevent the occurrence of ever more and ever costlier catastrophes worldwide."

Reinsurers' response

On the whole today, the reinsurance industry does not want to take on more catastrophe risk, certainly not at the rates which it can obtain today from primary companies. As cedants get larger, they generally retain more risk, but reinsurers for their part do not want the volatility associated with peak risks.

As we have seen in Bermuda, the pressures of investment performance make it difficult even for reinsurers in a zero tax environment to build up substantial reserves in the form of shareholders' funds, because they cannot service the capital. Traditionally, German and Swiss reinsurers have had a greater cushion; national tax and accounting regulations allowed them to build up large equalisation reserves and shareholders had more conservative expectations.

Munich Re last year urged groups working on the reform of the German tax system to refrain from making any changes in tax treatment that might make it more difficult for insurers and reinsurers to set aside the necessary provisions in their balance sheets. Even if they do, with the global movement of capital, German reinsurers may find themselves under pressure from a more anglo-saxon approach to the valuation of their shares following their obligatory disclosure of their hidden reserves.

It is because of this pressure that Jacques Blondeau, chairman and ceo of SCOR, says he is a strong believer in catastrophe bonds "with a few caveats". He sees capital markets with their flexibility enabling reinsurers to transfer peak risks.

As he says, after a major catastrophe, rates will probably rise. To take advantage of the higher rates, reinsurers would need to raise more capital, but the rates would soon begin to flatten as a function of increased supply of capital. Table 2 shows what happened after Hurricane Andrew in 1992.

Says M Blondeau: "For a normal reinsurer to build up a huge fund of capital waiting for the big one does not make sense from an economic or financial prospective, since it would depress the return on equity."

Initiatives abound. Among the latest is an $80 million securitisation on behalf of Yasuda Fire & Marine placed by Aon Capital Markets. This bond is said to be the first of its kind, as it is indexed against insurance losses resulting from Japanese windstorms.

Munich Re's subsidiary American Re has created a broker/dealer subsidiary called American Re Securities Corp, which will originate and place catastrophe bonds and other securitised risk through the capital markets.

In London, Willis Corroon has launched an investment fund dedicated to trading in catastrophe risk derivatives to enable investors from outside the traditional insurance and reinsurance sector to invest in securitised cat instruments, such as cat bonds. Half the portfolio will be invested in cat options on the Chicago Board of Trade (CBOT).


Securitisation of insurance and reinsurance risk is the speciality of highly developed economies, such as the United States, Japan and Europe. How suitable it might be for such risks in developing areas is little discussed; after all, it is only a fledgling market in countries where there are large capital markets and good information.

The need of insurers in developing economies is most likely to be conventional reinsurance. There must be a question over the extent to which reinsurers can respond to demands for catastrophe protection since it will take premiums some time to catch up with the growth in exposures.

Comparing figures for the 1960s and the last 10 years, Munich Re established that the number of major natural catastrophes was three times larger and cost the world's economies eight times as much and the insurance industry 14 times after adjusting for inflation.

"The main reasons for this dramatic increase are the increasing concentration of population and values in the cities, which are often located in high risk zones, and in the greater susceptibility of modern industrial societies to disruptions in the infrastructure. A change in this development is not in sight."

Lee Coppack is co-editor of Global Reinsurance. She has been an insurance writer and analyst for nearly 20 years. E- mail:

1. Statistics in the section are taken from Sigma vol 4 1988.