BIS study examines ways to improve catastrophe insurance

Better data, modelling techniques and financial awareness are among the areas authorities should focus on if they want to encourage households and companies to insure against economic losses from natural catastrophes, a report from the Bank for International Settlements (BIS) has said.

The paper, published on December 2 by the BIS’s Financial Stability Institute, notes there is a significant gap between insured and total economic losses against natural catastrophes.

The authors, Denis Garcia Ocampo and Carlos Lopez Moreira, say this protection gap can threaten financial stability. This, they say, is especially relevant in countries where the financial services industry is exposed to natural disasters through the real estate sector.

“Rapid recovery is crucial for economic and societal resilience, particularly in emerging market and developing economies where SMEs [small and medium-sized enterprises] drive economic activity and employment,” they write.

The authors say parametric insurance – which aims to quantify the severity of the event and create a “parameter” or “index” – is a “promising solution”. Once a threshold of the parameter is met, the payout mechanism would be triggered, thereby avoiding the lengthy claims process associated with many traditional insurance policies.

However, the authors say adoption of parametric insurance has been limited due to basis risks, product complexity and regulatory barriers. To understand the challenges, they conducted a survey with 12 insurance supervisors and seven market participants involved in the parametric insurance market.

A key concern arising from the survey, the authors say, is that the payouts must align closely with the actual losses. On this, the authors recommend insurance supervisors improve their data collection processes, and that market participants improve their catastrophe risk-modelling capabilities.

Other recommendations include increasing financial literacy and awareness among consumers, improving risk-based pricing methodologies and enhancing collaboration with stakeholders.

The authors conclude that parametric insurance can be a “complementary risk management” tool for households and businesses in countries that are particularly prone to natural disasters. They call for multi-sectoral co-operation to make parametric insurance more viable in the future.