Thursday, June 28, 2012

Catastrophic risk insurance: Willingness and ability to pay

Catastrophic risk insurance assumes specific importance when we talk about disaster risk reduction or climate change adaptation or sustainable development since  risk insurance has been advocated and effectively used in small scale to achieve these broad goals in most instances. However, the spread or uptake of risk insurance in the Asia-Pacific region and  elsewhere remained negligible (compared to sales of Coke or cell phones?) due to several bottlenecks arising from policy and information imperfections. While part of the problem can be attributed to policy level imperfections, it is surprising to see that a subject that can greatly benefit corporate sector (really?) also seems to suffer same limitations that many other public policies face and the so called efficient and effective private sector seems to be oblivious to this fact that they are not able to reach out to a section of society that needs them most. The intriguing question here is, how come the same corporate sector that is extremely successful in selling a sugared drink (such as Coke or Pepsi) which in most opinion is useless and probably has least intrinsic value of whatsoever is failing to sell a very useful product such as risk insurance to the very same masses!

"If I could convince my son to ride bicycle without fear by wearing a helmet, I am sure our marketing agents are more than intelligent and can very well communicate the risk to adult population they are targeting!!!"

I am sure several people have already talked and written on this subject very extensively but I feel that there is definitely more than that meets the eye. In a quest to get even with this, I have been brainstorming (and writing) on this issue for quite some time and this is what I could come up with to summarize what may be limiting the spread of risk insurance in most cases:

1) Affordability: The issue of affordability could be put at the top of all the bottlenecks limiting the spread of risk insurance in the developing Asia-Pacific. Though insurance premiums in most of the developing Asia-Pacific region are lower than that of those in the developed countries, the annual insurance premium costs are still not affordable for most of the income groups in the developing countries. Part of the high insurance premium costs emerge from the high residual risks and low spread in terms of number of insured (i.e. poor development of the insurance portfolio). 

But, mind you, the cost of premium cannot be brought down beyond a point since the premium should meet lot of other expenses of the insurance company as well. Can we think about subsidizing the premium? Though this option appears to be most lucrative proposition for most policy makers, as they tend to go towards populistic measures, there are several others that go against this option. The argument here is sending proper price signal is important to make the insured feel the importance of [not]indulging in reckless risk taking behavior! Then the question is how do we bring down the price to an affordable level?

The price issue has two components, one is ability to pay and the second is willingness to pay. I think there is not much research on these points, if the success in uptake is achieved by targeting more on willingness to pay than on ability to pay.  I would be very happy to see an approach that targets both these components of price rather than getting lost in some kind of obscurity. 

2) Residual risks: High residual risks are one of the major causes for the poor risk insurance coverage in the region. The high residual risks are due to poor disaster risk mitigation mechanisms, lack of or poor enforcement of laws and codes such as building bylaws, structural codes, and laws pertaining to land use planning.

3) Presence of insurers and reinsurers: One of the reasons behind poor penetration of insurance and insurance prices above affordability is limited presence of private insurers and reinsurers. Reinsurers play an important role of providing shock absorbing capacity to the insurers. To date, very few national (e.g. General Insurance Corporation in India, China Reinsurance Company in China, Zenkyoren or Zenkoku Kyousai Seikatsukyoudoukumiai Rengou Kai in Japan) and international (e.g. Munich Re, Swiss Re, Toa Re, Axis Re) reinsurers operate in the region. Hence, there is a very high potential for the expansion of the reinsurance sector. Insurers and reinsurers cannot afford to operate in the region unless there is sufficient enabling environment including efforts to reduce the residual risks.

4) High premium costs: The high residual risks, lack of optimum number of insurers, low competition, and low number of insured population all lead to the higher premium costs than what they could be in the Asia-Pacific region.

5) Policy environment: Though risk insurance is a ‘market instrument’, its dynamics are determined or governed by the principles of an open market, government policies and regulatory guidelines act as precursors for flourishing of the sector and ensures the effectiveness of the instrument. Hence, the role of government in promoting the culture of risk mitigation by promoting awareness generation, and designing and implementing structural and non-structural disaster risk mitigation codes and laws including institutional mechanisms and regulations for promoting risk insurance is paramount.

Though there has already been significant improvement in terms of policy support to insurance sector, as observed from the high growth rates of insurance sector in the region, the support is still not comprehensive enough. For example, currently, most developing countries in the Asia-Pacific region are at the nascent stages of formulating national disaster risk mitigation plans and policies and haven’t fully utilized the potential of risk insurance in promoting risk reduction. Traditionally, strong emphasis of most governments on disaster response over mitigation is known to hinder the public participation in risk insurance schemes. Limited financing is the major reason behind the poor emphasis on disaster risk mitigation in the region.

6) Cultural and perceptional issues: General lack of awareness and misplaced perceptions about dealing with the risk in general and about the risk insurance in particular among the common people and business sector also serves as a bottleneck. Sociological research has indicated the existence of behavioral situation that can be characterized as ‘lethal attitude’ which suggests that things will happen whatever is done and that things are beyond ones’ control, which limit the risk mitigation behavior of individuals.

7) Lack of data: Infrastructure for collecting and managing the systematic and comparable data on past risks, vulnerabilities, disasters, and the nature of disaster losses provides important information for designing risk insurance schemes which is either not fully developed nor readily available and accessible to the risk insurance industry and for the general public in most of the developing nations in the Asia-Pacific region.

Another important challenge, which didn’t receive much attention in the region, that could undermine the implementation of an affective insurance facility is the liability challenge that insurers will have to deal with due to not reporting their climate related risks to their shareholders, and probability for high insurance payouts due to high potential for yield losses in a changing climate scenario. As a result of these limitations, most of the initiatives couldn’t be scaled-up to cover larger, and sometimes important geographic areas and socio-economic groups that could benefit from insurance related instruments.

For more information, write to me and I will be happy to send a full paper that I have been working on this subject. 

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