Perspectives interview with Eugene Gurenko – The World Bank Group

Eugene Gurenko is a Lead Insurance Specialist at the joint World Bank/IFC Finance and Markets Global Practice. He has worked at the World Bank Group since 1998 where he has helped to develop catastrophe risk management solutions for the World Bank client countries,including the Turkish Catastrophe Insurance Pool - currently one of the largest earthquake insurers in the world.

What are some of the reasons behind the significant protection gap (the difference between economic and insured catastrophe losses) in emerging markets?

Screen Shot 2016-02-29 at 11.53.53 AMTypically the level of insurance penetration is correlated to GDP per capita, but in an interesting way. It's an S-curve. Therefore you have a disproportionately small amount of insurance coverage when a country is in the early stages of economic development, when wealth accumulation is in its infancy, and then it skyrockets and catches up as the country develops.

In emerging markets, insurance consumption is maybe a third, quarter or even a fifth of what you find in developed countries. And that is across all lines, not just property catastrophe insurance. As countries become wealthier they become more risk averse, because they can afford to allocate more resources to insurance to protect the increasing stock of wealth and reduce volatility of earnings and adverse business outcomes of other sorts.

EGurenko[1] copyInsurance for natural disasters is a unique story for many reasons. Typically, catastrophe insurance premium accounts for just one to two percent of total premium in developing countries, which is very small.

An important driver behind this outcome in most markets is the complexity of modelling these catastrophe risks. This gap is being closed by commercial risk modelers - switching to pay per use type of approaches - which makes modelling more affordable. So more models are becoming available, but for developing markets it still remains a problem.

A second issue is on the supply side that can be universally found in any market regardless of whether it's developing or developed, is the fact that regulating catastrophe risk is extremely difficult and must rely on risk-based regulation, which is in its infancy. Solvency II has just been launched in Europe and even there the issue of risk-based regulation of catastrophe risk is far from perfect. The lack of proper risk-based supervision translates into under-reinsurance of catastrophe risk and unsustainable competition on price of catastrophe insurance which in the end makes the business line uneconomical for market players.

The third main challenge is on the demand side where there is considerable moral hazard and distorted expectations in the system. When it comes to post-disaster compensation to a large extent this phenomena of distorted public expectations has been the result of ad-hoc untargeted disaster compensation policies practiced by most governments around the world which often have been perpetuated by extensive post disaster aid provided by the international donor community to countries regardless of their ex-ante risk prevention and mitigation record. The combination of these two factors makes the general public rely on state aid in the aftermath of natural disasters where governments act as insurers of of-last-resort.

In Serbia there were terrible floods in 2014. Around 500,000 houses were damaged, but only about 1,000 had received insurance payments. Even though a lot of people were affected and there was huge economic damage, estimated at €1.5 billion, in the aftermath of this disaster very few people have taken out catastrophe insurance. This is because government and international donors stepped in to compensate people and help them rebuild houses. While this approach may be commendable on moral grounds, it is not sustainable in the long-run as governments cannot afford to act as insurers of the growing catastrophe risk exposures of private businesses and households around the world.

Are public private catastrophe pools one solution to this problem?

In many cases pools are the only solution and there are a number of examples of how public private partnerships can close this penetration gap. However, the creation of such pools must also come with compulsory insurance requirements introduced through national legislation.

A good example is the Turkish Catastrophe Insurance Pool, created with the assistance of the World Bank after the Izmit earthquake in 1999. Today the TCIP provides cover for around six-and-a-half million homes, whereas before the creation of the pool only 300,000 homes were covered by the private insurance market. In Romania, a similar pool covers over two million properties, whereas almost none were insured before the pool was set up.

In terms of future catastrophe pools, the Philippines might be a possibility and the World Bank is working very hard to help them launch one. Indonesia might be another possibility, but again it's a work in progress.

What is the potential role for the capital markets in taking on some of the peak risks in catastrophe pools?

Certainly the capital markets have a role to play in risk transfer when it comes to pools. Pools, like any insurance entity, must look at their risk accumulations and transfer the peak risks to either the reinsurance or capital markets.

The choice is usually driven by different business considerations, primarily the price of capital capacity. Once capital market solutions become competitive, compared to those offered by traditional reinsurers, there is a clear role to be played.

How are concerns over climate change and other macro trends, such as urbanisation, likely to drive the development of catastrophe risk insurance solutions?

Certainly climate change helps to focus the minds of governments, businesses and individuals on their growing risk exposures to weather extremes as the adverse effects of climate change cut across so many areas of national economies. As a result, we are seeing growing demand for weather risk management solutions, of which insurance is one.

Given the huge cost implications and uncertainty with regard to potential unforeseen outlays that businesses, governments and individuals may incur due to extreme weather events, many are becoming more inclined to use insurance as a mainstream risk management tool. They know they can no longer afford to assume such growing economic uncertaintydue to weather risk, which hasn't been the case in the past.

Urbanisation is one of the important drivers of the growing economic losses due to natural disasters. It's no less important than climate change itself. When you have more concentrated assets and populations in urban areas, and when those areas are hit by catastrophes, the losses are exponentially higher.

When you have these high concentrations of wealth and economic activities in one place, you also discover growing independencies among different sectors of the economy, different trading systems - supply chains, etc. And if you are a large company, you and your suppliers should be concerned about the disruption that can be caused by weather, and how that disruption can affect the global value creation chain, of which you are part of.

Local governments and urban authorities have really been behind the curve so far in terms of how they manage their fiscal risk arising from their communities' exposures to natural disasters. So talking to them, raising their awareness of these risks is important. And it will clearly become an important step forward for insurance as an industry if some of these cities adopt proactive disaster risk management practices.

Posted: Monday, February 29th, 2016