Tag Archives: protection gap

Closing the Protection Gap

Drought spells disaster for farmers across the developing world. Most lack insurance because conventional crop insurance is too expensive (where it is available at all). No rain means no income, no food and not enough resources to replant next year. With many countries from sub-Saharan Africa to Southeast Asia already facing an abnormal recurrence of climate risks, natural disasters around the world caused $232 billion of economic losses last year. Only a small fraction of this was covered by insurance.

Many developing economies depend on improving the productivity and resilience of sectors, including agriculture and tourism, that are vulnerable to climate hazards such as cyclones, heat waves, droughts and flooding. With economic losses from catastrophes growing faster than insured losses, adapting individuals and economies to climate-related impacts has become a major societal priority, outranking other risks like aging populations, terror attacks and social unrest. New insurance products designed to create disaster-risk-financing mechanisms, where no other risk-transfer tool is available, are increasingly being seen as part of the solution in closing this protection gap.

Many of these products are parametric, as opposed to indemnity, otherwise referred to as traditional, insurance. Increasingly recognized as a valuable form of transfer for climate and other natural disaster risks, parametric insurance contracts are based on objective and transparent indices, such as cyclone wind speed, earthquake shaking intensity or amount of rainfall, and payments start to be made as soon as the index reaches a preset threshold. As no costly visits are required to assess the losses, payouts can be made quickly to hard-to-reach insureds in remote locations. Crucially, protection against unpredictable but potentially devastating risks — previously unthinkable with traditional insurance — is now possible.

Rapid relief 

For the insured, ease of use, speed, certainty of amount of payout (without dispute) and the resulting ability to plan ahead ensure more rapid relief when disaster strikes, which in turn increases financial resilience. 

For the insurer, parametric insurance allows for a more scientific pricing of products that respond to specific isolated parameters, rather than the physical losses that might result from any number of a wide range of occurrences. Together with lower claims management costs, this scientific approach makes lines of business commercially viable that were not previously.

Contrast this with a complex insurance claim on a traditional policy, which may take a long time to adjust and be paid, due to the need to develop claim details and financial components as well as address issues like valuation and other conditions.

A hard sell

This does not solve the issue of how to persuade people in Africa, who are generally somewhat insurance-averse, to buy insurance. This form of risk management requires a certain level of prosperity, as it means spending money on something you hope you will never need. 

However, this challenge can be surmounted. African governments and policymakers understand the cost-benefit analysis, combined with the experience from developed countries showing that insurance can play a cost-effective role in a country’s efforts to increase disaster resilience. 

The African Risk Capacity (ARC), launched by the African Union in 2013, demonstrates what is possible. Set up as a mutual (known as ARC Ltd.), and designed to provide rapid payouts to covered nation state members, initially for droughts but planned to include floods, tropical cyclones and epidemics, the insurance pool started with four countries and now has a dozen or so policyholders and 34 member states. ARC has become highly efficient in pooling risks and their transfer at very low marginal cost to the global reinsurance markets and now protects tens of millions of people. 

This is a remarkable achievement when you consider that until recently the concept of selling droughts in Africa to the global reinsurance market would have been unthinkable.

Insuring the ‘uninsurable’ 

Parametric insurance solutions have mostly been used in the reinsurance space around catastrophe risks, but the boundaries defining what is “uninsurable” are being increasingly pushed to new limits. A policy covering hurricane-related damages to coral reefs was purchased in 2018 to cover a part of the vast Mesoamerican Reef along Mexico’s Yucatán Peninsula. Once verified, the agreed policy would be paid within one week. Such a rapid disbursement of funds is crucial as much of the initial reef repair following a severe storm needs to be done very quickly to avoid further damage and set up a successful recovery.

See also: Increasing Regulation on Climate Change

Not just for developing countries

These same innovative parametric applications being adopted in emerging economies also have significant potential in developed markets. In contrast to emerging economies, where the problem is more likely due to cover being unavailable, businesses in developed countries are increasingly seeking protection against losses for which traditional insurance is not best-suited. 

Emerging climate risks are a key driver behind this growing demand for more innovative insurance products in both the public and private sectors. The impact from a crop loss following a major weather event or supply chain delays is smaller in developed markets, but still significant. The Bank of England, for example, downgraded its expected first quarter GDP growth from 0.4% to 0.3%, following the impact on businesses from the “Beast from the East” – the cold weather snap that hit the U.K. in the winter of 2018.

Whether it’s reducing the protection gap, financing resilient infrastructure or improving risk management and return optimization across the financial sector, insurance technology and innovation has a decisive role to play in responding to climate risk and smoothing the world’s transition. While protection gaps remain an issue as greater costs are borne by the uninsured, these gaps are closing slowly. Innovative risk transfer structures and new products based on parametric triggers have a key role to play and will continue to help increase resilience of households and companies to growing climate risks.

COVID-19 Risk and Buyers’ Psychology

Despite all the attention devoted to the continuing devastation from COVID-19, compliance with mitigation measures is not turning out to be universal. Even public officials have been bending the rules. Indeed, a recent study from the U.K.-based behavioral science consultancy Dectech found that nearly a third of those surveyed had spent time with someone outside of their household despite restrictions on such socializing.

Similarly, many families are underinsured, suggesting that perhaps they do not see the value of such financial protection, or do not understand their risk in not having it.

Is the problem that people just don’t understand the risks of this pandemic, or is the issue with risk in general?

A handful of studies published since the summer have examined the psychology of how the public perceives the pandemic’s risks. What can these results tell us about the public’s perception of COVID-19 risk, and how can this information help insurers understand consumer mindsets and needs?

Understanding the threat of COVID-19

When people understand that a reasonable threat exists they will generally be more likely to take actions to avoid it. This was shown to be the case during 2014’s avian flu epidemic, and COVID-19 research has consistently been telling a similar story — the larger the threat people feel, the more likely they are to take protective measures such as washing hands, wearing masks, social distancing and even panic shopping.

But the bigger challenge may well be the public’s sense of the threat in the first place. In one U.S. study, half of the respondents substantially underestimated their risk of dying if infected. Perhaps more worryingly, older respondents and individuals with underlying health conditions also underestimated the virus’s potential threat despite understanding that they were at higher risk than the population average.

See also: How to Leverage Behavioral Science

A well-established finding from behavioral economics is that humans are often poor at understanding their own risk objectively. For example, a majority of people implausibly believe they are better than average drivers, and many also believe their chances of avoiding cancer are better than other people’s, despite no objective basis for the belief. This comparative optimism — the belief that negative events are more likely to happen to others — might also explain how people are perceiving the risk of COVID-19. A study early in the current pandemic on perceived risk and self-reported personal behavior conducted by researchers at the California Institute of Technology found that participants perceived a high level of risk to the general population but tended to rate themselves as being at lower risk than the average person. This perception was not influenced by whether the respondents were actually at lower risk than average.

This finding, replicated by a group of researchers from the U.K., U.S., Europe and Australia using the U.K. data, also suggests that, despite the inescapable factual information available about COVID-19, people still believe “it won’t happen to me.”

Perhaps most interesting is the finding that factors beyond objective facts influence COVID-19 risk perception. According to a study from the University of Cambridge of almost 7,000 individuals in 10 different countries, although participants had relatively high threat perception, men, who are statistically far more likely to die from COVID-19, were less likely to report feeling threatened by the pandemic than women. The researchers also found that risk perception can be amplified by how a person’s friends and family are perceiving the risk and by their having existing prosocial values (values that promote behavior benefiting society as a whole). The Cambridge study also showed that the most powerful predictor of COVID-19 risk perception was direct personal experience with the disease.

Clearly, despite all the objective information we have at our disposal, visceral experiences — i.e., concrete evidence obtained and interpreted through our own senses, emotions and social interactions — and existing attitudes are powerful drivers of people’s reactions to external threats.

Is risk knowledge or a feeling?

These studies paint a picture of reactions to the COVID-19 pandemic that are consistent with psychologists’ view of risk perception: Perceiving a threat may push people to take action, but perceiving a threat accurately is not guaranteed. While perception of COVID-19 risk is relatively high on the scales used in the studies, it is still underestimated and subject to biases such as over-optimism and social influence, and context such as pre-existing worldview, direct personal experience and gender identity.

Risk, to humans, is subjective — fundamentally about what one is feeling. Fear, disgust and the prospect of guilt and regret turn people away from danger, and, when not sure how to respond, humans look to other people’s behavior and their own expectations for answers. This is how people experience the world first-hand, and this experience, rather than objective facts, frequently dominates judgments and decisions.

To understand the physical effects of COVID-19, seeing someone in a hospital bed who is either intubated or on mechanical ventilation is likely to have a far more powerful visceral effect on a person than case numbers. People can empathize with the horror of the situation and grasp the risk in a way that knowledge of the numbers just cannot achieve.

Perhaps this was the idea behind one U.K. city’s campaign to promote compliance with COVID-19 restrictions. Its shocking slogan, “Don’t Kill Grandma,” sought to elicit an emotional response to promote a personal understanding of COVID-19’s risks rather than presenting statistics and then expecting a highly rational and analytical response.

Communicating to inspire protective action

Should communicators use shock tactics such as fear appeals to help people gain an appropriate understanding of risk? One of the most widely discussed uses of fear appeals, i.e., tactics designed to elicit emotional discomfort and motivate particular responses, are the campaigns to push smoking cessation. Cigarette packets in the U.S. are required to display warning messages, and in the U.K. must have both warning language and harrowing images of the physical effects of smoking, in the hopes that user exposure to these horrifying images may promote behavior change.

Fear appeals can be effective, but there are serious caveats. Overly shocking communications can make people disengage and ignore or react defensively to the intended message altogether. Finding the right balance of engaging emotions while sustaining people’s attention is vital for risk communicators. In particular, being able to show that a risk is personally relevant and that one’s own actions can minimize the danger of a particular risk are key elements of making fear appeal messages work.

Insurance marketers face a similar challenge in persuading consumers to protect their assets and finances. It can be off-putting to communicate risk by scaring potential customers. Also, the industry is dominated by a highly objective and numbers-based understanding of risk, but, as the COVID-19 research shows, people do not usually think of risk statistically.

See also: COVID and Power of Personal Connections

Insurers can learn from the COVID-19 research that, while it is difficult for people to appreciate intangible risks, communicating risk in terms of lived experiences, whether their own or that of others, might be a powerful tactic. From this perspective, it is unsurprising that insurance sales increase in response to emotively striking but objectively unimportant events, such as widely reported floods leading to increased insurance demand in unaffected areas, and the death of Kobe Bryant generating a spike in life insurance sales. For insurers, this might mean finding ways to approach customers at moments when risk events are salient and emotionally resonant — when such events and people’s interactions with the information are spurring thinking about caring for their families, health and homes. These could be important opportunities for demonstrating the value of insurance products.

COVID-19 communications and insurance marketing share a conundrum. Objective risk for humans is often intangible. Insurers seek to understand and communicate health and financial risk objectively, but also need to acknowledge that customers might not receive that objective message. Exposing the risk by creating or exploring feelings that resonate with lived experience, identity and expectations are going to count for far more than just bare facts.

New-Generation Life Policies With Insurtech!

After the financial crisis in the European Economic Area (EEA), life insurance business was significantly influenced by volatile market conditions, low interest rates, pressures from regulatory bodies, changing customer demographics and investment patterns.

These undesired economic conditions caused a dramatic increase in the protection gap. The insurance protection gap or underinsurance shows us the difference between the amount of actual need for insurance coverage and the amount that is purchased. This significant gap reached $21 trillion in the U.S. 58% of American families would not be able to cover their expenses just a few months after a loved one from their families passed away. European Union countries are in a similar situation. Sadly, the coverage gap reached $17 trillion in the EEA. Moreover, inequality is widening faster than ever. Current social security systems are strained because people live longer lives and job security is not a given anymore.

When we look at other contributors to the protection gap, we see the negative perception about life insurance among customers. Life insurance is found to be very complicated and requires very bureaucratic processes to acquire, and policy premiums are not affordable. So, simplifying life insurance, especially for the new generation of insurance buyers, will be crucial for insurers’ future. The key of success is definitely insurtech!

See also: Where Will Unicorn of Insurtech Appear?  

When we examine the classic life cycle of a life insurance product, we see five main steps. These are:

  • New business and underwriting support
  • Agency and distribution management
  • Policy admin support
  • Claims management
  • Shared services

With insurtech, these steps will be converted to standardized, efficient and optimized processes. The necessity for new product introduction will be performed while maintaining consistency and maximum quality in customer services.

With insurtech, buying a life insurance policy will be converted to a digital customer experience, and this is a brand new business model. With insurtech, life insurers will:

  • create easy-to-understand and non-advisory life products,
  • have customer-centricity for creating life products,
  • have automated UW (underwriting) decision processes that enable instant decision,
  • reach target customers via different distribution channels,
  • use predictive analytics to transform business with measurable variables easily and
  • provide a high level end-customer satisfaction.

See also: Insurtech Can Help Fix Drop in Life Insurance 

Creating a straightforward and informative online journey for life customers, via insurtech, will be the unique solution for the penetration problem that life insurers face.

Real Reason for the Protection Gap

For several years, AIR has written about, presented about and created infographics around the problem of the “protection gap”—the difference between economic losses from extreme events and what is actually covered by insurance. For the most part, our discussions have focused on the macro-level issues of global (re)insurers and governments, catastrophe models and data. However, to learn more about the micro-level issues that may be contributing to the protection gap, I recently attempted to buy flood insurance on my townhouse condo in a suburb of Boston. As with any condo, there are two insurance policies at work here — a condo master policy and my condo HO-6 policy. In my case, there are two separate local insurance agencies.

I called the agent on the master policy and asked whether I was covered for flood, knowing full well that I wasn’t. He correctly answered no, but quickly countered, are you in a flood zone? I responded no, and he appeared to be unsure as to why anyone would want flood coverage unless their bank required it for their mortgage. The same scenario played out with the insurance agent on my HO-6; she was confused about why anyone would want coverage that they wasn’t required by their mortgage lender. This time, I pushed a bit and explained that I had a friend who lived outside of a flood zone and had suffered a flood loss. That motivated her to initiate the process to sell me flood insurance.

See also: The Myth of the Protection Gap  

She emailed me a form that looked photocopied and asked me to fill it out, which I had to do by hand. Filling out forms by hand is one of the activities that I find most irritating in life, as my handwriting is absolutely illegible, even to me. Thankfully, the necessity of actually handwriting anything has declined dramatically in the past few years, but the technological changes that have made that possible have apparently not reached the independent insurance agency system in the U.S.

But I had bigger problems than my handwriting. Many of the questions that were being asked on this form were ones I didn’t know the answer to, even after working at AIR for 10 years. The questions I easily knew the answers to were occupancy, year built, whether I had a basement and whether my house was elevated. Construction type was also an easy one for me, but I’m not sure that would always be the case for the typical customer.

Here are some of the questions that I and the average consumer would find challenging:

  • Foundation: slab or pilings
  • Type of pilings: wood, concrete, driven or poured
  • Base flood elevation
  • Lowest floor elevation
  • Post-firm or pre-firm enclosure (luckily, I don’t have an enclosure)

At AIR, we’ve been talking about the protection gap and how to close it at a very macro level, but this exercise gave me a more practical feel for why the protection gap exists at all—including in developed countries. The ability to properly quantify flood risk does exist, from AIR and other modeling firms. And as we know all too well, there is currently enough capital to insure the risk. But those capabilities break down somewhere within the insurance value chain.

As my own experience illustrates, there is a lack of willingness of the front-line insurance distribution system—in this case, insurance agents—to push the coverage. To the extent customers are aware of the risks and ask their agents to buy flood or earthquake coverage (a rare situation, to be sure), the process of getting this coverage is cumbersome and antiquated, to say the least. On this point, there are a slew of venture-backed startups dedicated to making the insurance purchase “mobile first,” but to date these startups appear to be more focused on auto, renters or lower-value contents coverage, and have not yet made inroads into streamlining the process of purchasing flood or earthquake coverage.

See also: Future of Flood Insurance  

Closing the protection gap will require a concerted effort on the part of every player in the insurance value chain—from agents, to carriers, to reinsurers and to those of us in the modeling industry. I also believe it will require technology that identifies those who need coverage and places that coverage in a seamless way, as the status quo doesn’t appear to be doing the job. Getting the entire insurance value chain on the same page to make the necessary investments to close the protection gap is easier said than done, of course, but that’s the real problem that needs to be solved if we are serious about closing it.

An Opportunity in Resilience Analytics?

In my post last month, I discussed why the insurtech revolution should be focusing more on addressing the protection gap, thereby growing the pool of insurable risks, rather than figuring out how best to eat the insurance incumbents’ lunch.

At a conference in February, Tom Bolt of Lloyd’s noted that an increase of 1% in insurance penetration can lead to a 13% drop in uninsured losses and a 22% drop in taxpayers’ share of the loss. The key to increasing penetration is lowering distribution costs to make products more affordable. That is where insurtech can come in. Many recent startups have business models looking to tackle the excessive intermediation costs that exist in the current insurance value chain.

Sadly, when a catastrophe strikes areas of low insurance penetration, those communities not only suffer from the difficulties of having to seek aid—which can take three-plus months to reach affected zones—but also face the prospect of a significant drag to economic growth. It is unsurprising, therefore, that governments in vulnerable countries are keen to improve their “resilience” and seek solutions to better prepare themselves for catastrophes by working with the likes of the World Bank, the UN and the recently established Insurance Development Forum (IDF). Interestingly, AIR Worldwide announced recently the Global Resilience Practice, which will be led by former U.S. presidential adviser Dr. Daniel Kaniewski.

See also: InsurTech Need Not Be a Zero-Sum Game  

As well as providing low-cost distribution models in new markets, a related opportunity I see for insurtech is working together with the insurance industry in the growing field of resilience analytics. As Robert Muir-Wood recently pointed out on RMS’ blog, the claims data gathered by insurers — which historically has been used for the pricing and managing of risk — have the potential to also be used to reduce the potential for damage before the event. Insurtech companies could work with government authorities to pool this claims data, leveraging it with other key data from external sources and then using the results to influence urban resilience strategies. There are inevitable doubts over the willingness of insurers to share their data, but agile and thoughtful startups are likely better placed to be able to find insights in a world of abundant unstructured data than the more technologically challenged incumbents.

The current size of the protection gap is a failure of the insurance industry, and any companies that can help address it will not only be first movers in new markets but will also be adding social value and much-needed resilience to vulnerable communities all over the world.