The Takeaways:
- Insurance matters all the time — oftentimes we don’t see until hit by a catastrophe. In the end, buying insurance could be the best investment you ever make in your life.
- Earthquake insurance coverage is not a decoration number to make the insurance book pretty, it can be the difference between life and death.
- Coverage must be enforced to save lives and get the places quickly up from disasters.
- Reinsurance matters especially for catastrophic events to keep insurance carriers on their feet rather than bankrupted or out of business.
- Some governments like China emphasized political mobilization of citizens to stay safe in pandemic, which has its own liability and risk. It is better to have risk management (e.g., massive social lockdown) and risk transfer (i.e., insurance coverage) at the same time.
Earthquake News in the Words of a Financial Rating Agency
According to financial ratings agency Fitch on Thursday February 9, the initial earthquake and numerous aftershocks struck southern and central Turkiye and western Syria on 6 February had claimed more than 17,500 lives so far from a maximum magnitude of at least 7.8, the most severe earthquake in the region since 1999.
The toll is expected to rise as rescuers comb the rubble for survivors. On top of that, insurable losses are hard to estimate as conditions change all the time. At this time “they appear likely to exceed USD2 billion and could reach USD4 billion or more. However, insured losses could be much lower, perhaps around USD1 billion, due to low insurance coverage in the affected regions.”
“The Turkish Catastrophe Insurance Pool (TCIP) was created after the Izmit earthquake of 1999 to cover earthquake damage to residential buildings in urban areas. However, it does not cover human losses, liability claims or indirect losses, such as business interruption. Moreover, earthquake insurance cover is technically mandatory in Turkiye, but is very often not enforced in practice. As a result, many residential properties are not insured, particularly in many of the affected areas, where low household incomes constrain affordability.”
Six Lessons Learned
- Importance of insurance coverage: The low insurance coverage in the affected regions highlights the importance of having adequate insurance coverage. It’s crucial to understand the risks that you face and to make sure you have the right coverage in place to protect yourself, your family and your assets.
- Risks in underinsured regions: Natural disasters can strike anywhere and perhaps in least expected times. They can result in significant losses for sure. In regions where insurance coverage is low, the economic impact of a disaster can be even more devastating. This highlights the need for governments and insurance companies to work together to increase insurance penetration in these areas.
- Preparedness is key: While insurance can help mitigate the financial impact of a disaster, being prepared in advance is crucial. This includes having an emergency plan in place, taking steps to secure your home and property, and staying informed about potential threats. We don’t have detailed information on how well the Turkish people were prepared but judging from the low coverage rate we have reason to suspect a low preparedness this time.
- Reinsurance matters by sharing and spreading risk among insurance companies. Major catastrophes almost always rely on reinsurance to save insurers.
- The importance of accurate loss estimates: Accurate loss estimates are critical for the insurance industry to respond appropriately to a disaster. Insured losses from a disaster can have a significant impact on the financial stability of insurance companies and the broader economy. It is reasonable to think that preparedness and accurate loss estimates are linked such that when one is low, the other is low as well.
- Some places (e.g., China) have emphasized risk management (e.g., massive social lockdown and tests) during pandemic, but doing that without developing a good system of risk transfer (i.e., insurance) has its own risks. What we need is both risk transfer and risk management.
One Knowledge Point: Insurable vs. insured losses
In the above news by Fitch, there is a big gap between insurable loss and insured loss. Below is the highlighted difference between the two.
Insurable losses refer to the potential losses or damages that an individual or business can be covered from an insurance policy. This could include losses due to property damage, liability, theft, natural disasters, and other covered events as outlined in the insurance contract. Insurable losses are the losses that the insurance companies are willing to provide coverage for.
Clearly not all losses are insurable. Uninsurable losses are risks or events that cannot be covered by insurance due to various reasons, such as reputational risk, regulatory risk, trade secret risk, political risk, and pandemic risk. In addition, some risks may also be considered uninsurable due to the absence of adequate data or the difficulty in predicting the likelihood and severity of the losses.
Insured losses, on the other hand, refer to the actual losses that occur and are covered by an insurance policy. When an insurable loss occurs, and if the individual or business has insurance coverage, they can file a claim to receive compensation for the covered losses. The compensation provided is limited to the terms of the insurance policy, including the maximum coverage amount, deductibles, and exclusions.
From the Turkish earthquake we can see sometimes there can be a huge gap ($3 billion) between insurable ($4 billion) and insured losses ($1 billion), due to a low coverage rate and unenforced mandatory insurance in certain jurisdictions.
But Turkiye is not alone. According to this report, the cost of storm damage in an average year results in USD 19 billion in uninsured losses from flooding in the US, compared to USD 5 billion in insured losses. This is due to the fact that only one in six homes in the US has flood insurance, and many risks related to flooding are considered uninsurable.
Reinsurance Matters
From the Fitch news we also learned that the bulk of the insurance cost will be covered by reinsurance and there is no major impact on the rating of the insurance companies.
So what is reinsurance? This article provides a highly readers friendly answer:
“At its most basic level, reinsurance is insurance for insurance companies. If there is a catastrophic event that affects many homeowners, like a hurricane or strong earthquake, those losses can be so staggering that paying claims could cause an insurance company to become insolvent.”
Reinsurance works by allowing insurance companies to purchase insurance policies from other insurers, thus spreading the risk across multiple companies. This helps to reduce the likelihood of large payouts for a claim and allows insurance companies to remain solvent by recovering all or a portion of their losses through the reinsurance process. For example, in a hurricane or strong earthquake that affects many homeowners, the losses can be too high for a single insurer to pay all the claims, causing the insurance company to become insolvent. In such a case, reinsurance allows the insurance company to transfer some of the risk to another insurance company, reducing the potential for insolvency.