The insurance protection gap is generally defined as the difference between total and insured loss costs. Globally, 2021 total losses from natural disasters were estimated to equal approximately USD 280 billion, of which approximately USD 120 billion, or 43%, were covered by (re)insurance.(1) This gap was smaller than many previous years because a higher proportion of losses occurred in the US, which has one of the most developed insurance markets in the world, with high penetration.
The protection gap varies significantly among high-, medium- and low-income countries. In Asia, on average, the protection gap is estimated to be approximately 90%, using historical records as well as analytical analysis. The Lloyd’s report(2) on the protection gap placed several Asian countries in the top ranks, based on estimates of the relative insurance gap cost, with Bangladesh, Indonesia and Philippines holding the top 3 places, respectively.
The figure below depicts insurance penetration by displaying the property-casualty premium as a percentage of gross domestic product (GDP) measured against premium per capita. The plot shows the differential level of protection gap in Asia Pacific—South Korea was excluded, as its insurance penetration is the highest (almost at 5%), an outlier within the Asia context.
With the changing climate, natural catastrophes are becoming more frequent, and the intensity for certain perils is likely to increase, severely affecting several countries in Asia. Urbanization and subsequent unplanned urban development and expansion are escalating in several Asian cities. These dynamics are expected to accentuate the challenges associated with the protection gap.
To measure this protection gap, the most appropriate approach is to use the uninsured portion of the economic losses, due to the lack of data and details. However, it is worth noting that this gap may be smaller in actuality, because a portion of these economic losses is neither desirable nor economically credible to be considered for insurance coverage. Hence, these losses would be excluded. These portions of losses may include risk retentions, deductibles and coverage limits associated with the insurance policies. Additional components of these losses are unmeasurable risk, moral hazard and adverse selection, as well as the more suitable self-funding approach by individuals for the high-frequency/low-severity losses.
The size of the insurance penetration gap may differ by sector, subject to the exposures that are affected, as shown in the figure below. For example, corporates and manufacturing industries usually tend to insure their physical properties and production sites as part of their risk management framework. However, residential homeowners may consider insurance to be an additional expense or simply may not be able to afford adequate protection, so the size of the protection gap is usually much larger.
Nevertheless, a large component of losses that is not covered by insurance ultimately may need to be assumed by governments and taxpayers. The public sector assumes an increasing share of climate costs around the world, particularly in developing countries, where private insurance for both businesses and individuals is less prevalent. Financing gaps, if not rectified, often may create long-term fiscal instability for governments. It is imperative to understand the key challenges associated with the prevailing protection gap in Asia and put forth innovative solutions to bridge it.
There are multifaceted challenges associated with the protection gap. Broadly, these can be segregated into political, economic, technical and social disciplines.
The political challenges include the limited will and incentives to implement the necessary policies to reduce the protection gap. In the economic context, affordability, whether it is the individual or the state, remains one of the biggest barriers to using insurance. There are also technical hurdles, due to the lack of data and tailored products with the ability to address the affordability issues, win the confidence of buyers and eventually increase insurance penetration.
The lack of trust in insurance, societal and cultural beliefs such as, “the next disaster will not happen to us,” or the assumption that the government will step in to assist, limits the usage of insurance. Additionally, most of these challenges intersect each other, adding to the complexity. For example, investments in mitigation measures may not earn the same goodwill for public officials as the provision of post-disaster relief.
Pandemic Revealed Substantial Protections Gap, Helped Spur Creative Solutions
The outbreak of the COVID-19 pandemic and associated lockdowns highlighted significant vulnerabilities in the health and financial security of many economies. Businesses of all sizes and sectors were impacted by the crisis resulting from the substantial protection gap. There were no instruments in place for future pandemics.
With recognition that the risks were too large to be assumed by the private insurance sector alone or governments alone, several public-private initiatives were begun, such as the introduction of the Pandemic Risk Reinsurance Program in the US or Chubb’s Pandemic Business Interruption Program.
Marsh McLennan quickly established over 30 national “Pandemic Re” teams to support discussions at national levels around the design and delivery of pandemic risk insurance solutions. All these initiatives are at different stages, but more significant is the effort put in place to develop solutions for one of the largest economic losses ever seen, using public-private partnerships.
From sovereign nations to individuals, there is a wide range of protection gap financing needs. Government needs may include access to immediate payments for emergency relief measures or forgone tax revenues, while for individuals they may include loss of property or income. The available solutions to bridge the insurance protection gap need to be expansive and extend from the micro level (individuals) to the macro level (sovereign states). A collaborative approach between the public sector and private-sector insurance industry is crucial, especially in regions where the insurance protection gap is wide.
The insurance industry is capable and well-resourced to develop the technology and products needed to cover the protection gap. Industry innovators must meet people’s needs and balance affordability. Bespoke micro-insurance products are one example that can provide much-needed relief after a disaster. Parametric-based products and solutions are evolving, with a focus on reducing the basis risk. They provide immediate relief after a severe event, and they can be developed for and employed at any level—macro to micro. An important role of the industry is to build trust in insurance by advising and educating the public.
Risk mitigation remains among the most essential tasks for governments. It helps to reduce losses, and aids in the availability and affordability of insurance. Government schemes, such as mandatory insurance for specific sectors and perils, and public insurance initiatives are also effective in reducing the protection gap. However, it is the cooperation between the private and public sectors, through public-private partnerships, that may be the most-effective solution. Government distribution networks and infrastructure can be used by private institutions to channel their products and solutions. The government, in partnership with the private sector, may develop subsidized schemes, helping individuals obtain necessary protections. With the support of the insurance industry, governments can introduce ex ante solutions at sovereign and sub-sovereign levels. Another example of a public-private partnership is the establishment of a (re)insurance pool with a government guarantee.