The increasing frequency and severity of floods mean that more people want insurance cover. However, the risks and costs are soaring. Will companies rise to the challenge?
Until recently, the reinsurance sector has focused mainly on mitigating the threats posed by primary perils such as earthquakes and hurricanes. However, the risks posed by so-called secondary perils – including flash floods, torrential rain, landslides, hailstorms, tornados and winter storms – are growing.
In particular, the increasing occurrence and severity of flooding is leading to a conundrum for the insurance industry. Insufficient insurance penetration coupled with inadequate modelling and rising populations in flood hazard areas means that it is a problem for insurers, and consequently the reinsurance market, to meet the demand for increased cover.
The extension of the national flood insurance programme (NFIP) in the USA in July has highlighted the dilemma insurers and reinsurers face. This programme provides cover for homes and small businesses, delaying by five years the requirement of homeowners living in newly designated flood hazard areas to buy flood insurance.
Consequently, pressure has mounted on insurers contracted to the programme as the US government forces them to take on more risk, most notably covering wind damage as well as flood damage. The American Insurance Association (AIA) president Leigh Ann Pusey warned that these updated requirements will force some insurance companies “to take a hard look at whether they want to continue participating in the programme”.
While the threat of flooding grows, meeting the challenge of covering this risk may prove to be too great for many insurers.
There is no question that the risk – and costs – of flooding have soared. Swiss Re head of cat perils and treaty centre Andreas Schraft says: “Since 1970, insured flood losses worldwide have increased at an average rate of 12% per year (7% adjusted for inflation). Flooding is the main driver of so-called secondary losses, which contribute to around 30% of the global catastrophe loss amount. Depending on the way flood is insured it even dominates the loss history in some markets.”
Munich Re’s head of research for hydrological hazards, Wolfgang Kron, points out that floods in Britain in 2007, along with the lower Danube in 2006, the Alps in 2005 and central Europe in 2002, all set new loss records in the regions where they occurred. Meanwhile, the latest Swiss Re Sigma study reports that the economic loss wreaked by natural catastrophes in 2009 totalled $62bn, of which $26bn was insured. More than half of this loss burden was triggered by secondary perils.
Furthermore, since 1980, there has been an average of 33 secondary peril loss events per year, compared to an average of six primary peril loss events per year. And while primary perils continue to trigger the most natural catastrophe losses globally, in Austria, Germany and Canada, secondary perils are the principal sources of loss, exceeding half of these countries’ total natural catastrophe loss over the past 30 years.
Understandably, there are increasing calls for the insurance and consequently the reinsurance market to cover these growing risks. Munich Re’s head of corporate underwriting, Heike Trilovszky, points out that while claims from the primary market have risen in accordance with increased flooding, the insurance density for floods remains much lower than that for hurricanes or earthquakes.
“When you look at the major flood events, you see a huge amount of non-insured losses. The share of the insurance industry of that is really small,” she says. “The problem is that, in many markets, it is not standard to buy protection against floods. Plus, many insurance companies are not comfortable with this risk because it is a technically difficult risk.”
Indeed, the $36bn gap between the total economic loss and the insured loss of last year shows that lack of insurance cover continues to leave people and governments vulnerable. The US NFIP, for example, is already $19bn in deficit. Willis Research Network managing director Dr Gero Michel believes that while the reinsurance sector would welcome the opportunity to take on more flood risk, many obstacles stand in its way. “On the one hand the insurance and reinsurance sector would like to become more involved; on the other hand there is the risk that some of the policies are not coverable,” he says.
So what is the problem? One of the major obstacles is that flood peril is not particularly profitable, as not enough people take out adequate levels of insurance. “As few insurance schemes are compulsory, it is common that only policyholders who are highly exposed to flood will carry a flood insurance policy while others will opt out,” Schraft says. This, he explains, generally “does not allow for a large enough community of risks to guarantee a win-win solution for both the insured and the insurer”. Schraft adds that only by making flood cover mandatory can governments ensure that there is a sufficiently broad client base for flood insurance and incentivise insurers and reinsurers to develop risk transfer products and risk assessment methods to manage this flood risk.
The lack of compulsory flood cover can also exert a downward pull on rates, which can be a problem following a catastrophic event. Chadbourne & Parke LLP partner Joy L Langford says: “It is also possible that the public sector involvement in property insurance will deter private insurers from charging rates sufficient to cover losses, to maintain necessary surplus for catastrophic events and/or to purchase reinsurance”.
Another problem is that flood peril is notoriously difficult to assess as climate change continues to intensify the severity and frequency of floods. In addition, there are different types of flooding that can make risk assessment even more difficult.
Schraft points out that, while river floods affect large areas over time, flash floods develop rapidly and intensely affect smaller areas.
Then there are storm surges that affect coastlines as low air pressure causes sea levels to rise as winds push water onto the shore. Tsunamis have also proven to be a major trigger of floods in the Northwestern US. “All of these factors need to be taken in to account when assessing flood peril,” he adds.
Continued developments on coastlines and flood plains also make it a difficult task for insurers to take on flood risk. According to Munich Re’s Kron, today more than one-tenth of the population lives within 5km of a coast, while 15 of the world’s largest cities are located on coasts. He also points to an OECD study which recently showed that 113 million people will live in the most populated coastal cities by 2070, a five-fold increase on today.
At the same time, assets in the 20 cities with the highest concentration of flood-exposed values are predicted to increase from a value of $2.2bn to $27bn in the next 60 years. Kron argues that development on floodplains continues as increased flood control measures lull people into a false sense of security, “leading people to expose more and more objects to the risk of flood”.
Get it right
As the threat of flooding grows, catastrophe risk modelling company RMS senior analyst Helen Dewar points out that the lack of market-wide data for flood modelling technology continues to be a stumbling block for increased insurance penetration for flood risk and adequate risk assessment. She adds that, during the 2007 floods in the UK, half of those floods affected areas away from established flood plains. This, she warns, proved to be an important lesson for both insurers and reinsurers to invest in better modelling techniques.
“One of the key things for the insurance market is to capture the exposure data. For example, flood risk can vary within postcodes. If you only have postcode data, that really isn’t going to be able to differentiate your risk as much as you might like,” she explains.
Schraft emphasises that meeting increased challenges posed by flooding requires a collaborative approach. “They require a multi-stakeholder partnership in which the insurance industry, governments and property owners play distinctive key roles. Governments need to implement mitigation measures including urban planning, for example avoiding building in flood plains, and flood protection,” he insists. It seems that only then will the market meet increased reinsurance requirements for flood risk. GR