The flooding in Thailand last year was a wake-up call to companies and insurers alike.
It disrupted global supply chains and caused up to $30 billion in economic losses -- of which only $12 billion was insured, according to Swiss Re. Munich Re put the overall loss at $43 billion, of which only $16 billion was insured.
As with many emerging economies, Thailand has an increasing number of middle-market businesses, a generally low penetration of insurance and a high risk of catastrophe. That risk of catastrophe may be growing ever higher due to the impact of climate change.
While experts hedge on whether any one specific event was due to climate change, the overall threat of weather-related perils remains strong.
"What we see from the change in the statistics is more of these [weather-related] events and we see a greater portion of high-intensity events," said Professor Peter Höppe, head of geo risk research at Munich Re in Munich, Germany.
"The problem," he said, "is you can never say, 'This is an effect of climate change or this is a natural effect.' But from the statistics, we see growing evidence for the thesis that climate change is already playing a role."
Regardless, risk exposure is growing in emerging markets. Adding to the hazard is high population growth -- which means more people and businesses are locating in higher risk areas, he said.
And does it really matter whether any specific event can be placed at the door of climate change when factory walls tumble and roads wash out?
In upper-middle-income economies, as defined by the World Bank to include countries such as Brazil, China, Turkey, Russia, Thailand and Mexico, natural catastrophes from 2007 to 2011 totaled an average annual loss of $32 billion, with only $3 billion in insured losses, according to Munich Re.
In lower-middle-income economies, including India, Indonesia, Vietnam, Bolivia, El Salvador and Nigeria, Munich Re determined annual average losses during that time frame to be $6.8 billion, with $1.17 billion insured.
"What we tend to see," said Simon Young, CEO of Caribbean Risk Managers Limited in Kingston, Jamaica, "is the big companies will have insurance. ... For the middle companies, insurance is sometimes a luxury and what you tend to find is they generally try to buy it, but if the economic situation is really tight or they have had a bad year, it may be something they will drop off the budget."
While insurers have been working on microinsurance products for small businesses in developing nations, there are not many insurance solutions geared to the middle market. Instead, governments of emerging economies are stepping in to fill the loss gap by providing subsidies and capital improvements to protect their developing industries.
"In the emerging markets, less than 7 percent of the [worldwide] economic loss [from climate-related disasters] is insured," said Nikhil da Victoria Lobo, senior vice president, public sector, at Swiss Re in New York. The remainder "is largely being transferred to the shoulders of the public sector ... ," he said.
With globalization, what happens in Thailand doesn't stay in Thailand.
Swenja Surminski, senior research fellow at the Grantham Research Institute on Climate Change and the Environment at the London School of Economics in London, said that "for a large chunk of companies, the supply chain ends in these emerging economies, so there is quite a huge exposure for a big part of our economy in the Western world that is heavily depending on these emerging economies."
"There is a growing risk, and there is not much insurance there," she said. "Thailand was a huge wake-up call and now big companies are worried and concerned about supply chain risk."
Governments need to "put in place plans to reduce risk and mitigate risk," she said. "That happens to some degree in Europe and the U.S. It's a relatively new theme in emerging economies."
Some operations in emerging economies are insured through their U.S. supply-chain partners, said John Nevius, a shareholder with the law firm of Anderson Kill & Olick in New York.
That is complicated for a variety of reasons, he said. Emerging economies generally do not have strict building codes or prohibitions against building in flood plains. In addition, flooding for a supply-chain partner in Thailand, for example, wouldn't be covered by the U.S. partner's insurance policy unless the U.S.-based company had flood insurance on its own operations.
"What we have seen," Nevius said, "is disputes and litigation of business-interruption coverage where you have a midlevel company that has overseas suppliers, and then, say, a monsoon or a flood impacts their international distribution system.
"You may be able to get coverage for these international types of losses, but chances are you will have to fight over them and pursue your claims in the U.S., and you may or may not be able to get surplus lines coverage from the domestic market or the international market, like Lloyd's of London," he said.
In fact, one recent lawsuit (not involving Nevius' firm) states that an AIG unit denied a Thailand flood claim, contending the entire country is in the "100-year flood plain or its worldwide equivalent."
The lawsuit was filed by Federal-Mogul Corp., an automotive parts company, following $88 million in damage to its property in the Rojana Industrial Park in Ayotthaya, Thailand. The company, whose policy had a $30 million flood sublimit for "high hazard zones," claims there is no recognized delineation of flood plains in Thailand.
LOW INSURANCE PENETRATION
According to reinsurance brokerage Guy Carpenter & Co., non-life insurance penetration in emerging markets in September 2012, was 1.3 percent of GDP, compared to 3.6 percent in industrial markets.
"We find no studies that have shown empirically that climate change has already affected insurance demand," write Surminski and her co-author Nicola Ranger in a paper on the impact of climate change on non-life insurance demand in Brazil, Russia, India, China and South Africa.
"The impact of climate change is not far from anyone's lips," said Julian Roberts, executive director of the agribusiness unit at the Willis brokerage in London. "It's significant, but do you then make long-term strategic decisions around it? That's the more interesting question. Some do and some don't."
Insurance penetration "rarely happens spontaneously" in emerging economies, he said, noting it often begins with government programs or public/private partnerships that subsidize losses or use capital improvements to stem potential hazards.
India, he said, offers a state-sponsored index-based agricultural insurance program that "obviates the need for complex loss adjustment," and China recently began investigating doing the same. In addition, other countries in Asia and Latin America are working on programs to support important sectors such as agriculture, he said.
Angelika Werner, NatCat R&D manager at Willis Re in Munich, said insurers need to devote more attention to understanding current risk in emerging markets. "It's about the quality of risk evaluation that enables insurers to design a product," she said.
The use of an index-based program, also known as parametric insurance, has been a good solution for hurricanes and earthquakes in the Caribbean, said Young, whose company is also facility supervisor of the Caribbean Catastrophe Risk Insurance Facility, a nonprofit risk pool for 16 countries in the Caribbean.
The public/private risk-pooling solution -- started in 2007, a few years after Hurricane Ivan caused billions of dollars of losses -- uses a model-loss approach to project "a reasonable estimate of what the impact will be on the ground," based on input data on the storm or earthquake location, Young said. Payouts occur very quickly against the estimate, he said.
Since its inception, the insurance pool has paid out for five different events to seven countries, he said.
Discussions have taken place as to whether the parametric instrument could be extended to the business community, he said, but that is still being debated.
In conjunction with the World Bank, a similar concept is being piloted in the South Pacific, where the collection of islands has "very similar profiles and levels of development" as in the Caribbean, Young said. In addition, a drought risk pool concept is being worked on by the World Food Program and the African Union.
Victoria Lobo pointed to Mexico as one of the "leaders in the field of prefinancing or insuring its disaster risk."
Following an earthquake in 1985, building codes were changed and government and industry began creating a framework to follow when disaster struck, said Dario Luna, head of insurance and pensions at the Ministry of Finance in Mexico City. He noted that insurance penetration in the country is "quite low."
"We transfer the risk absorbed by a government program that sets rules and procedures to deal with the economic costs of emergency situations and reconstruction needs of critical assets," Luna said of his country's multifaceted program. "We are probably the only country in the world doing this."
The program, Fondo Nacional de Desastres Naturales or FONDEN, recently finished "a several year project to build up the largest asset inventory that Mexico has ever had and the most sophisticated modeling of risk we have ever had by collaborating with the World Bank and the National University of Mexico."
He said the project has provided valuable information for disaster risk management, in particular for designing financial instruments to pay for the costs of disasters.
Mexico recently issued its third catastrophe bond, consisting of three separate notes totaling $315 million for earthquakes and Pacific and Atlantic ocean hurricanes. The catastrophe bond is a better instrument for dealing with the costs of emergencies "because the payment is much faster than the reinsurance," Luna said.
The bond´s triggers are parametric, with the monies held in escrow and paid out to FONDEN when the "characteristics of the event" meet specified levels, he said.
In order to finance part of the reconstruction of critical assets affected by disasters, Mexico also has a reinsurance catastrophe loss program of $450 million.
With Mexico holding the presidency of the G20, Luna said, the country took the opportunity to raise awareness of the importance of disaster risk financing strategies among finance ministers representing countries with 80 percent of the world's output, by sharing knowledge and creating a framework to facilitate the adoption of disaster risk assessment and risk financing.
Victoria Lobo said more effort must take place to increase the global understanding of weather-related risk.
"When you put a public price tag on climate risk, it serves as a benchmark that private-sector enterprises can use to buy similar coverages for themselves," he said. "That's the most powerful reason to do that."
ANNE FREEDMAN is senior editor of Risk & Insurance®. She can be reached at firstname.lastname@example.org.
December 18, 2012
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