Why Does the Protection Gap Exist?

April 28, 2016

Our society is facing an enormous challenge. The "protection gap"—the difference between economic and insured losses—highlights the significant burden that society is carrying today when a natural disaster strikes. These circumstances are not just a growth opportunity for AIR Worldwide and the insurance industry; they represent a responsibility to act. For that reason, AIR gathered a panel of experts during Envision 2016 to discuss this issue.

The panel participants were Erwann Michel-Kerjan, Executive Director of the Wharton Risk Management and Decision Processes Center, Glenn Pomeroy, CEO of the California Earthquake Authority (CEA), Ian Branagan, Senior Vice President and Group Chief Risk Officer at Renaissance Re, and Milan Simic, Executive Vice President at AIR Worldwide. Why the protection gap exists today and the obstacles to closing it were at the heart of the discussion.

Poor Awareness of Risk

Global populations and wealth have been rising over the past decade, but this growth has increased potential for losses due to poor understanding and management of the risk. For example, land usage trends are becoming a driver of risk as more valuable properties are being built on vulnerable locations like floodplains or near the coast. As a result, insurers are either not willing to provide coverage or the available coverage is either too restrictive or unaffordable for a risk that buyers believe (correctly or not) is unlikely to occur any time soon. Not considering the risk or not fully understanding it at the point of property development or purchase has the unintended consequence of widening the protection gap.

Government Bailouts

When governments act as the insurer of last resort, demand for insurance is hampered by the public's belief that the government will ultimately absorb all the recovery costs in the event of a disaster. When a disaster occurs, governments are put in a no-win situation; either they take on these extreme and unsustainable costs that further this perception, or they leave the underinsured public to deal with the recovery themselves. In the latter scenario, as people discover that funding and resources are not available, governments and politicians are then blamed risk and losing their standing and the public's faith. This catch-22 creates an economic and moral hazard as it enables processes and behaviors that will create costs for others to deal with down the line.

Capital Allocation Inefficiencies

By some measures, there is enough reinsurance capital available to cover a significant portion, or even all, of the protection gap. In addition to the issues mentioned previously that affect demand for insurance, there are capital allocation inefficiencies that highlight a need to also address the supply side. For example, competition between reinsurers and quasi-governmental agencies to solve this problem can result in a duplication of efforts that makes it hard for that capital to reach the target consumer. Recently, international agreements such as the Sendai Framework for Disaster Risk Reduction have attempted to create common frameworks and priorities, allowing the market players to compete on the aspects of closing the gap where they can create the most value.

Panel Discussion

In addition to the causes mentioned here, our panel touched on what public and private organizations are doing today to help close this gap and what opportunities exists to create a more resilient society. To learn more, please watch the video of the panel discussion below.

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