Closing protection gap: the right thing to do

The key to tackling the protection gap will be innovation, which is partly why XL Catlin is so focused on making a difference in this space, says Charles Cooper, chief executive of Reinsurance at XL Catlin and a member of XL Group Ltd’s leadership team.

“Insurance in developed countries is a very mature, slow-growing business. In emerging markets it is a much higher growth business, driven by an increase in the penetration rate of insurance. Given our innovative origins, we believe XL Catlin is well positioned to help close the insurance gap, but the problem is too great for any one company to solve on its own,” he says.

“We are looking to work with governments, policymakers, other insurance and reinsurance companies to help increase the take-up rate for insurance around the world in both developed and developing countries.”

He notes that the company is also uniquely positioned because it has an insurance and a reinsurance platform. The insurance gap is an area of business where there can be growth opportunities for both sides of XL Catlin’s business.

“Beside all this, it is the right thing to do,” Cooper says. He notes that XL Catlin is working with Cambridge University in the UK on a paper looking to illustrate how following a disaster, areas with a high take-up rate and utilisation of insurance have a quicker rate of recovery than those with a low take-up rate of insurance.

“It is much more effective to have pre-disaster event financing than post-disaster event financing. The latter can drag the growth rate of an economy or region down following a major event,” he adds.

Not just developing markets

Cooper stresses that, although it is largely associated with developing markets, the lack of insurance is far from exclusive to them. In California, for example, the take-up rate of homeowners’ insurance for earthquake protection is around 10 percent. “Therefore 90 percent of California’s homes go without any earthquake protection at all. It is the most egregious example of the protection gap in the developed world,” he says.

He adds that the National Flood Insurance Program (NFIP) in the US has seen a steady decline in take-up rates over the past decade. Properties in high-risk flood areas with mortgages from federally regulated or insured lenders are required to have flood insurance and under Freddie Mac/Fannie Mae rules any house on a flood plain must carry flood insurance—but the current estimate is that only 53 percent of those homes actually buy that insurance. “That’s another big gap,” Cooper says.

He offers another example. In Japan after the 2011 To-hoku earthquake, the estimated insured loss was about $30 billion. The total insured loss and the economic loss was somewhere between $200 billion and $300 billion, depending on whether you exclude the nuclear event at Fukushima. “Clearly there are huge gaps in the developed world, such as these in the US and Japan,” Cooper says.

He explains that the developing world is driven by a slightly different dynamic: the low insurance penetration rate—insurance premium divided by the GDP of the country—is the biggest challenge. In India it is less than 1 percent, more like 0.5 percent. In the developed world this varies by country, but it’s typically between 4 and 5 percent.

“There’s a huge opportunity in India and we’ve just opened an office in Mumbai,” he says. “The growth rate in the emerging markets is around 5 percent per year, versus growth rates that are pretty much stagnant in the developed world.”

Worse not better

The problem is also getting worse where you might least expect it, Cooper adds. Total gross written premiums as a percentage of GDP in the developed world, including the US, are dropping.

“That tells you that insurance is becoming less relevant in the global economy. The insurance industry should worry about this, because it is a problem that’s getting worse instead of better,” he says.

“We look at this huge opportunity where the insurance penetration rates are very low, and in some places where they’re getting low. We believe that insurance is the most effective way to provide financing for these types of events.”

He says the reasons for low insurance penetration—and thus large protection gaps, vary widely.

“In some places insurance is not a cultural norm. There are economic reasons. In some places it’s just not affordable, and there are also governmental, regulatory reasons. In certain countries, there are classes of business that are required, such as workers’ compensation in the US which is mandated,” he notes.

Another reason is that there are many perils for which the government steps in and assumes all the risk. “There are numerous examples, but we are starting to see that it is driven partly by innovation, and partly by the emergence of alternative capital into the insurance space,” Cooper says.

That has reduced the cost of risk transfer to the private market. However, governments are starting to retain less risk than they used to, and they are starting to transfer some of the risk back to the private market. One example of this is the NFIP, which has just bought some reinsurance.

“That’s a very good thing for a lot of reasons,” says Cooper. “Any time the government gets involved, politics can trump sound economic decisions which is one of the biggest reasons that governments don’t make good risk-takers.

“The other important reason is that insurance can act as a powerful financial disincentive for irresponsible behaviour. Risk-based insurance premiums will penalise people who participate in high-risk activities.

“For example, if you’re a bad driver you’ll pay a high insurance premium. If you’re a good driver you’ll pay a lower premium. There’s a societal benefit to that—insurance is charging the bad driver more.

“It’s the same thing if you build a house that’s on a flood plain, or right on the coast. You should pay a higher premium than the person who has built his house 400 feet above sea level.”

An industry-wide solution

Cooper is optimistic about the industry’s ability to reverse this trend for the benefit of all. The key is that the industry works together and pools expertise, talent and capital.

He believes reinsurers, brokers and governments all have an important part to play in solving this problem. “Quite often it’s a broad group of people who get involved, including consumer advocates and special interest groups whose interests are aligned with re/insurance companies. There are opportunities for the industry to work with a broad range of groups: governments, the Insurance Development Forum (IDF), and the World Bank,” Cooper says.

“The problem is that the insurance gap is on such a great scale that it does require a broad approach. No one insurance or reinsurance company is going to solve it and it’s not going to be solved in the short term. This will take a continuing push.”

He adds that the challenge is not just about closing the gap. It’s also about making sure that the gap doesn’t get any wider. “It is getting wider in places—the insurance penetration rate is going down in many developed countries. In the developing world the gap is closing, or at least is starting to close, as the insurance penetration rate there is rising, but there’s still a long, long way to go.

“Typically what happens is that no-one does anything until something really bad happens—and that provides the stimulus that everyone needed.”

Charles Cooper is chief executive, Reinsurance at XL Catlin and a member of XL Group Ltd’s leadership team. www.xlcatlin.com