response to green paper on the insurance of natural and man made disasters

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Language: English UK

Risk Dynamics London | Brussels | Amsterdam. July 13th 2013.

Risk Dynamics is a registered entity under the European Transparency Register with

Identification number 096750411574-91.

Risk Dynamics Response to Green Paper on the insurance of natural and man-made disasters

Dr. Sebastian Rath, Principal Advisor

[email protected]

mailto:[email protected]

Risk Dynamics

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© Risk Dynamics - Confidential

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Risk Dynamics discussed the questions raised in the Green Paper* with European and global insurers and reinsurers. Additionally, the author collated individual responses to selected questions posed in the Green Paper via a dedicated on-line survey on the internet, reaching out to a wide range of insurance risk professionals and risk managers in insurance and reinsurance groups, including Chief Risk Officers and Heads of Catastrophe Risk modelling in such risk carriers.

The responses to the questions of the Green Paper given on the following pages are a summary of the feedback that Risk Dynamics gathered over the period of one month. These responses are addressing a set of selected questions that have been raised in the Green Paper. These responses emphasise the view of the risk carriers, their risk management and pricing functions, while also reflecting the view of the insured person. The questions that have been selected are a conscious choice in order to ensure a timely reply in this consultation process of the European Commission.

* GREEN PAPER on the insurance of natural and man-made disasters. Published by the European Commission on April 16th 2013. Available at: http://ec.europa.eu/internal_market/consultations/2013/disasters-insurance/docs/green-paper_en.pdf

About this response to the Green Paper

on the insurance of natural and man-made disasters

July 2013 2 RD Response to Green Paper on Insurance of Catastrophe Risk

http://ec.europa.eu/internal_market/consultations/2013/disasters-insurance/docs/green-paper_en.pdf

http://ec.europa.eu/internal_market/consultations/2013/disasters-insurance/docs/green-paper_en.pdf

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Responses to Questions 1 in the Green Paper

Market Penetration

What is your view on the penetration rate of disaster insurance in the European Union?

Please provide details and data to support your arguments.

Is more research needed to understand any possible gaps in insurance supply and demand, insurance availability and coverage?

The penetration rate is deemed somewhat appropriate when compared in an international context. At the same time our respondents indicate that there remains potential for increasing the disaster insurance penetration rate. Overall the penetration rate is deemed to be rather variable across the EU member states, explaining that our respondents feel that there are peril regions where such increase in penetration rate may be feasible and appropriate.

[not covered in this response]

The majority of our respondents indicated that more research would be required. While the understanding of the catastrophe risk itself improved substantially with a growing number of complex catastrophe risk models, there remain areas where this understanding is evolving. The supply and demand depends on the understanding of risk, for example the local frequencies of flood risk is European river catchment areas. At the same time many European member states have different catastrophe risk covers. Therefore it is not straightforward to compare the supply and demand for such different coverages available at present.

Questions 1 of the Green Paper Responses to these questions

July 2013 RD Response to Green Paper on Insurance of Catastrophe Risk 3

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Product Bundling

What further action could be envisaged in this area?

Would mandatory product bundling be an appropriate way to increase insurance cover against disaster risks?

Are there any less restrictive ways, other than mandatory product bundling, which could constitute an appropriate way to increase insurance coverage against disaster risks?


In our dialogue with risk carriers we established that this question raises difficulties around structuring sustainable insurance solutions, at the same time if offers new opportunities. Risk carriers consider that product bundling could offer viable options to increase insurance against disaster risk for specific products with appropriate distribution and pricing structures.

Alternative schemes are risk pools, where lower risks and their associated price structure subsidize higher risks. The challenge of this approach is to maintain incentives that are enforcing risk mitigation.



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Compulsory disaster insurance

Which compulsory disaster insurance, if any, exists in Member States?

Are these insurance products generally combined with compulsory product bundling or obligation for insurers to provide cover?

Is compulsory disaster insurance generally accompanied by a right for the customer to opt out of some disaster risks?

What are the advantages/possible drawbacks?

Would EU action in this area be useful?

For natural catastrophes there already exist national solutions, for example the French Cat. Nat.-scheme or the Spanish Consorcio-scheme. Some EU members states established compulsory disaster insurance for earthquakes or floods. A comprehensive analysis was published 2012 by the Joint Research Centre (‘Natural Catastrophes: Risk relevance and Insurance Coverage in the EU’).



The advantage of compulsory schemes is a flat risk selection process that is not skewed, for example by the product distribution or pricing. Amongst the disadvantages is the lack of incentivising high risk mitigation in compulsory schemes as the pricing mechanism of the compuslory scheme supports suchrisk.

Where approporiate and where substantial catastrophe risks are currently not covered sufficiently, our respondents expressed an interest in further thought leadership in this area.



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Pricing & incentives promoting prevention & mitigation

Could risk-based pricing motivate consumers and insurers to take risk reduction and management measures?

Would the impact of risk-based pricing be different if disaster insurance was mandatory?

Do insurers in general adequately adjust premiums following the implementation of risk prevention measures?

Indeed, our respondents confirmed that risk-based pricing could motivate both, consumers and insurers, as it is an appropriate and un-biased view of the materiality of the risk.

Indeed, the pricing structure for mandatory schemes may well lead to a different risk selection process, with different incentives and possibly to a different approach to risk mitigation.

Insurers and re-insurers face substantial complexity around the availability of appropriate risk prevention measures at various scales. For example, the pricing structure of local direct insurers may in some instances have access to detailed and up-to-date information on river bank protection measures for pricing flood risk. On larger scales, portfolios of such individual risks are managed using complex physical risk models. Such models aim to include granular and up-to-date information. However, in practice risk prevention data on large scales is often not sufficiently made available yet, and access as well as consistency may be limited. Therefore the ability to adequately adjust premiums following the implementation of risk measures varies. There are increasing numbers of examples of cases where insured’s successfully renegotiate terms with their insurers where they can provide appropriate information. At the same time recent catastrophe events in Europe have shown that risk prevention measures also have an inherent possibility of failure, for example due to operational issues or on exceeding the stress limit to which they were designed.



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Are there specific disasters for which flat-rate premiums should be suggested?

Should flat-rate premiums be accompanied by caps on pay-outs?

Perils with a higher frequency have a better predictability as they have more observed data points indicating the severity distribution of events and reducing the uncertainty around establishing a pricing structure. Therefore flat-rate premiums may be more appropriate for such perils.

Where considering flat-rate premiums risk carriers are in favour of caps on pay-outs. As they accept less flexibility on the pricing structure, appropriate limitations of potential downsides are required to balance the economic viability of the risk transfer from insured to insurer.



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What other solutions could be offered to low-income consumers who might otherwise be excluded from disaster insurance products?

Alternative solutions proposed by the participants of our survey include government grants, pool coverages, micro insurance schemes as well as local risk mitigation schemes. The activities of non-profit organisation are also recognised as an important element of the solutions in this area.



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Long-term disaster insurance contracts

Is there a case for promoting long-term disaster contracts?

What would be the advantages/drawbacks for insurers and the insured persons respectively?

There might be advantages for specific peril regions. Such cases require detailed assessments.

Where such products are viable, their advantages may include a reduction in the volatility of the pricing for such long-term insurance covers. For the insured person the product pricing experience may become more consistent may therefore be perceived as an advantage. The drawbacks for both, the insurer and the insured, may arise in circumstances where the nature of the long term contract impairs the capacity of the insurer to respond to changes in the risk profile. Such situations may result in a sub-optimal use of the risk carrier’s capacity in the short-term, and, at in its most extreme, increase the systemic risk and limit the viability of the risk carrier.



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(Pre-) Contractual information requirements

Do you think there is a need to harmonise pre-contractual and contractual information requirements at EU level?

If so, should the approach be full or minimum harmonisation?

What requirements concerning the commitment should be included, for instance:

● – the nature of the insured risks, ● – adaptation and prevention measures to minimise the

insured risks, ● – features and benefits (such as compensation of full

replacement costs, or depreciated, time value of assets), ● – exclusions or limitations, ● – details for notifying a claim, for instance, if both the loss

and its notification must fall within the contract period, ● – who and to what extent bears the costs of investigating and

establishing the loss, ● – contractual effects of a failure to provide relevant

information by the insurer, ● – the remedies, costs and procedures of exercising the right

of withdrawal, ● – contract renewals, ● – complaints handling?

Respondents to our survey indicate that such harmonisation may be beneficial.

Respondents to our survey indicate a preference for a sensible harmonisation approach with emphasis on essential regulation achieving greater harmonisation rather than a possibly costly and possibly bureaucratic attempt to achieve full harmonisation.

Regarding the proposed list of commitments respondents of our survey convey

● a high level degree of consensus that the nature of the insured risk and the exclusions and limitations could be considered.

● a lower level degree of consensus that the following elements could be included: contract renewals; contractual effects of a failure to provide relevant information by the insurer; who and to what extent bears the costs of investigating and establishing the loss; details for notifying a claim; features and benefits.

● A low level degree of consensus that the following elements could be included: complaints handling; the remedies, costs and procedures of exercising the right of withdrawal.



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Insurance Terms and Conditions

Do deductibles, excesses co-insurance and other exclusions effectively prevent moral hazard?

What alternative terms and conditions could be appropriate for disaster insurance, given that the insured party may be unable to take effective risk reduction measures against a disaster?

Respondents to our survey indicate a degree of consensus that moral hazard can be contained by the terms of the insurance cover. At the same they indicate that the effectiveness of these terms alone remains limited. For example. claims settlement and loss adjustment processes are important additional components ensuring effectiveness in managing moral hazard.

Alternative terms and conditions may, for example, rely on an interpretation of the effectiveness of incentivising strategies that draw on the use of a holistic risk monitoring, risk containment and partial disaster risk mitigation strategy, together aiming at a better control of the disaster risk.



response to green paper on the insurance of natural and man made disasters

Economy & Finance