October 24th, 2016

From Public to Private

Posted at 1:00 AM ET

frankland-nick-hs-smNick Frankland, CEO EMEA, Guy Carpenter


The gap between insured losses and total economic losses remains stubbornly large - Swiss Re estimates that only 30 percent of global catastrophe losses in the ten years prior to 2015 were covered by insurance. Consequently, the remainder of the loss, USD 1.3 trillion, was borne by individuals, firms and governments, and this burden is increasing. Swiss Re estimates uninsured losses more than doubled from 0.08 percent of global gross domestic product (GDP) for the ten years from 1976 through 1985 to 0.17 percent for the years 2006 through 2015.

Statistically, this may not appear to be a huge burden on GDP, but averages may not capture the full story and the impact can be substantial. For example, the April 16, 2016, Ecuador earthquake  in which more than 650 people died, incurred losses estimated at USD 5 billion with no more than 10 percent covered by insurance. In an effort to finance the cost of recovery, the government of Ecuador increased the sales tax from 12 percent to 14 percent, imposed an immediate one-time wealth tax of 0.9 percent on net worth greater than USD 1 million and a one-time income tax charge of one day’s pay and five days’ pay on monthly incomes of more than USD 1,000 and USD 5,000, respectively. The government increased taxes on corporations and announced the sale of some state-owned assets.

The protection gap also occurs in more developed parts of the world. Europe has been hit by several catastrophes this year. Significant events include flooding in southern Germany in May and Paris in June; the destruction of acres of commercial greenhouses and other property damage by hailstones the size of tennis balls in the Netherlands; and the Italian earthquake of August 24. Munich Re estimates the cost of catastrophe losses from hydrological events alone in Europe in May and June 2016 at USD 5.2 billion, with only 46 percent of loss covered by insurance. In 2011, the German federal government hastily established a state fund of EUR 8 billion to cover the costs of infrastructure and private property flood losses.

Transferring risk from the public sector to the private sector is an important means of mitigating and reducing the cost of catastrophic losses to public finances. The use of pools and other mechanisms to spread the potential cost of losses to the private sector is well established in Europe with many schemes operating to cover natural catastrophes, terrorism and nuclear risk. Nevertheless, gaps remain and in Europe, the growing severity of the flood peril, driven by climate change, has been a catalyst for new developments. Most notable was the launch of Flood Re in April 2016, a U.K. government scheme that enables insurers to reinsure the flood element of homeowners insurance policies at a fixed reinsurance premium based on the properties’ taxable valuable. It is supported by a small levy on all policies and enables insurers to offer cover on flood-prone properties that ordinarily might be considered uninsurable. The scheme has generated significant interest in Europe, and Guy Carpenter has a leading role in developments.

An integrated and coordinated approach to collaboration between the insurance industry, governments and other public bodies is increasingly recognized as an effective method of creating sustainable risk-transfer mechanisms. More strategic discussions among governments, non-governmental organizations, the scientific and academic communities and the insurance industry will help to promote better disaster risk management and the implementation of pre-event insurance solutions.

The protection gap presents opportunities for the (re)insurance industry far beyond the catastrophe segment. New risks in areas such as technology, science, medicine, climate change, population growth, food security and urbanization offer challenges and provide opportunities for profitable growth. Some of the risks are very complex or were previously little understood, yet today we better understand risk than at any time in history. We have better science, data and analytics, and tools to understand, measure and price risk. Concurrently, significant market capacity exists due to the inflow of large amounts of capital looking for opportunities to transfer risk.

Guy Carpenter, GC Securities* and Marsh are committed to helping our clients understand the evolving landscape and advising them as they engage and take advantage of promising opportunities. We believe these opportunities will expand as public and private sector entities work more closely to improve societies’ resilience to risk.

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*Securities or investments, as applicable, are offered in the United States through GC Securities, a division of MMC Securities LLC, a US registered broker-dealer and member FINRA/NFA/SIPC. Main Office: 1166 Avenue of the Americas, New York, NY 10036. Phone: (212) 345-5000. Securities or investments, as applicable, are offered in the European Union by GC Securities, a division of MMC Securities (Europe) Ltd. (MMCSEL), which is authorized and regulated by the Financial Conduct Authority, main office 25 The North Colonnade, Canary Wharf, London E14 5HS. Reinsurance products are placed through qualified affiliates of Guy Carpenter & Company, LLC. MMC Securities LLC, MMC Securities (Europe) Ltd. and Guy Carpenter & Company, LLC are affiliates owned by Marsh & McLennan Companies. This communication is not intended as an offer to sell or a solicitation of any offer to buy any security, financial instrument, reinsurance or insurance product.

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