Optimising disaster recovery
Catastrophes such as hurricanes and floods can be devastating for an economy, but there is considerable variation in how quickly countries can pick themselves back up after a crisis. A new report by AXA XL sought to better understand these discrepancies.
“The case for re/insurance is clear but is seldom adequately explained.”
Jonathan Gale, AXA XL
Every percentage point increase in insurance penetration reduces disaster recovery times by almost 12 months, according to a report by AXA XL and the Centre for Risk Studies (CCRS) at Cambridge Judge Business School.
The report, “Optimizing Disaster Recovery: The Role of Insurance Capital in Improving Economic Resilience”, analyses the impact that re/insurance has on the speed and quality of recovery following natural disasters. It also outlines the growing economic impact of natural disasters over the past three to four decades.
It examines more than 100 case studies, mainly occurring in the last 30 years and varied in terms of geography and the income levels of impacted communities.
“We wanted to focus on the quality of recovery, that is whether the post-disaster normal is better than the pre-disaster state in terms of the economy and the resilience of the community to future events from the perspective of infrastructure and economic resilience,” says the report.
The report argues that insured losses generally comprise only a small portion of the total loss generated by natural catastrophes, given the size of the global protection gap. It defined insurance penetration as non-life premiums divided by a country’s gross domestic product (GDP).
“In 2017, of the $330 billion natural catastrophe-related losses, under $140 billion (42 percent) was recovered through insurance,” the report says. “The global protection gap for natural catastrophe risk amounted to over $190 billion.”
The report examines the relationship between economic development and insurance penetration, a relationship it admits is complex. “Generally, economic development is the most important factor affecting insurance penetration,” it says. “Increased income allows for greater spending on insurance while economic development increases the stock of assets at risk, leading to greater demand for insurance to protect those assets.”
What is not clear, AXA XL says, is “whether insurance development causes economic growth, or if economic growth promotes insurance penetration”.
Either way, the report finds that events in countries with high insurance penetration of 3 to 4 percent, including western Europe, Japan, Australia, and South Korea, have an average recovery rate of less than 12 months. Conversely, those with very low insurance penetration, such as Bangladesh, Haiti, Nepal and the Philippines, have a recovery rate of more than four years.
“Economic recovery was found to be faster than societal recovery in almost 60 percent of the cases.”
The US was found to be an anomaly, having high insurance penetration of more than 4 percent, but a recovery rate average of just over three years. This is due to the fragmented nature of coverage, particularly flood, disaster response and scale of loss, the report says.
The quality of recovery for very high and high insurance penetration countries is better than pre-loss levels, while the reverse is true for countries with lower insurance penetration—although the report noted the differences are quite small.
Economic recovery was found to be faster than societal recovery in almost 60 percent of the cases, and is particularly pronounced in the first six months.
The report also notes that annual average loss from such catastrophes rose from an average of $27 billion in 1970–1980 to nearly $200 billion in 2010–2019. It concluded the rise was driven by global economic development and the increasing value of assets in hazardous areas, particularly in fast-growing regions such as south east Asia.
The report finds interesting differences between the impacts of different types of catastrophes on economies (Figure 1).
Figure 1: Impact varies by disaster type, and disaster may even have a positive effect on economic output
“In general, storms and earthquakes are destructive and primarily impact physical capital, while floods and droughts disrupt productivity,” the report says. “There is also evidence to suggest that natural disasters are also able to promote long-term economic growth, in a process of creative destruction.”
The report gives the example of floods that can positively impact agricultural output, in turn leading to industrial growth. Flooding was not the only potentially regenerative type of catastrophe, however: a destructive catastrophe can have a longer-term economic benefit if it causes society to “build back better,” the report says, particularly via an injection of capital into an economy.
The report argues that recent major disasters have demonstrated that physical damage no longer represents the only significant impact from a catastrophe.
“Indirect losses, such as business interruption, contingent business interruption, or the loss of a company’s market share, have assumed completely new dimensions,” the report says.
“Increasingly, these losses are not limited to the damaged region but felt throughout globalised trade and finance systems.” AXA XL says that in the biggest catastrophes the interconnectivity of modern business means that the spillover effects result in consequential amplifiers of this shock throughout the global economy.
The report examines the advantages and disadvantages of governments imposing mandatory insurance coverage as a way to manage the risk of natural disasters ravaging an economy.
“Where mandatory insurance schemes exist, the necessity to spend huge amounts of public money on financial relief and reconstruction of private property is reduced,” it says, although this also comes with a reduced willingness by insureds to pay more for coverage to cross-subsidise other, more expensive risks.
“Conversely, voluntary insurance schemes often fail to reach large parts of society due to a lack of risk awareness, and so these people are dependent on state aid,” says the report. “Therefore, insurance cover must be based on adequately risk-priced premiums that somewhat cross-subsidise to make them affordable but are nevertheless acceptable to the majority.”
The report finds that, in the most extreme catastrophes, the capacity of the re/insurance sector and financial sector to bear the loss is limited. This puts the onus on the state to act as the reinsurer of last resort, to assume losses that exceed the capacity of the private sector, it says—a role it admits many governments are reluctant to take on.
Jonathan Gale, AXA XL’s reinsurance chief underwriting officer, says: “The case for re/insurance is clear but is seldom adequately explained. We wanted to bring out comparative information related to speed of recovery—how quickly employment and productivity returns to normal (economic) and how quickly people are back in their houses and power is restored (societal).”
Professor of operations research at Cambridge Judge Business School and academic director of CCRS Daniel Ralph adds: “With climate change events, including floods and storms, increasing in frequency, it is more important than ever to understand the levers of recovery for communities and companies.”