Natural catastrophe underwriting in Asia: Turning a lost decade into a sustainable future
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Despite the inherent uncertainty of natural catastrophes, the insurance industry made significant progress in understanding and predicting them as accurately as possible. Yet recent events have reminded us how far we have to go.
From 2011 to 2020, natural catastrophes repeatedly dealt out blows to the re/insurance markets in Asia. In addition to a series of events with global magnitude in 20111, Typhoon Jebi hit Japan in 2018, resulting in USD 12 billion of insured losses from a single event. This foreshadowed another series of devastating events, including two more typhoons in Japan in 2019, as well as extreme flooding and bushfires in Australia in 2019 and 2020.
These disasters highlight stark gaps between modelled and actual losses, and point to a ‘lost decade’ for natural catastrophe underwriting. They led to market disruption and even increased difficulty in accessing re/insurance capital, which can challenge coverage in local markets – as happened in Thailand following the country’s 2011 floods.
While this is an acute issue in Asia, it also transcends the region. The global re/insurance market has been re-evaluating its risk appetite and modelling in response to unprecedented natural catastrophes over the past 18 months, ranging from hailstorms in France, Germany and Austria, to flooding in South Africa. At the time of writing, the US state of Florida is grappling with widespread damage from Hurricane Ian.
Persistent gaps between modelled and actual losses will put pressure on the re/insurance industry’s ability to provide adequate protection for the long term. It’s therefore critical to ensure insurers have access to high-quality data and robust models to better price natural catastrophe risk for the region, so that protection remains feasible and businesses and communities retain the capacity to recover and rebuild.
Reckoning with a shortfall
Natural catastrophes have become a looming shadow for Asia’s insurance industry because they are not only increasingly severe, but also more frequent and appear in different forms, such as floods, hail and bushfires. This underscores the need for underwriting margins that are adequate to cover a range of base loss costs, and account for rising volatility.
Concerningly, the nominal actual losses accumulated in 2011-20 amounted to roughly double the losses modelled for that period in Asia Pacific (see Figure 1). Even when adjusting for extreme outliers by applying a longer time horizon, or taking an optimistic view by removing events with the greatest losses (such as the Tohoku Earthquake in Japan in 2011), a notable gap between actual and expected losses remains. Premiums earned during the period barely covered the cost of actual losses, let alone additional expenses such as underwriting and capital costs.
Figure 1: Comparison of total nominal actual vs expected (modelled) nat cat reinsurance losses in Asia Pacific during the ‘lost decade’ of 2011-20
The industry has been responding by revising its models. However, our progress is not yet sufficient to close the gap completely. Asia still lags behind other regions in terms of natural catastrophe risk data and modelling, with a 92% protection gap over the 2000-2020 period, compared to 70% in the US and Western Europe. Recent events, such as the floods in Australia in 2022 and Malaysia in 2021, still caught the industry off guard. The 2022 flooding in Australia, which affected coastal areas of New South Wales and south-east Queensland, resulted in the highest losses in insured value that the country has ever seen. And no major vendor provided any models that predicted this scenario.
In such a diverse and rapidly developing region, more comprehensive data and models have emerged as essential. At present, even in many of Asia’s most digitally advanced markets, it is still the norm to draw from the CRESTA tool, the historical industry standard for risk assessment, or province-level data. Flooding in South Africa, which led to significant losses for Japanese insurers,2 exposed data-related blind spots along the global insurance value chain. This call for data is two-fold, once for granular exposure data to feed models, and secondly for detailed post-event claims data experience to facilitate model building and updates.
Until models adapt and steps are taken to address these shortfalls, underwriters must be pragmatic in accounting for uncertainty and unpredictability in pricing. This may include approximate and forward-looking underwriting in situations where credible models are unavailable or limited – an increasingly important skill as we adjust to rapid changes in the economy and climate.
Piecing together accurate risk assessment
As natural catastrophes occur, it’s important not to let the key lessons pass us by. Incorporating their impacts into risk views in a timely manner will make for more sustainable underwriting.
On a heartening note, insurers in some markets are already starting to adjust their natural catastrophe risk pricing to better align with updated base risk views. In Japan, for example, vendors and other stakeholders revamped their models in response to the severe typhoons in 2018 onwards. These tweaks reflected not only the lessons learned, but also broader improvements derived from evaluating historical experiences, such as typhoon-induced flood risks, more accurately.
For the industry to prevent another lost decade in Asia, market prices must reach commensurate levels with a rapidly evolving risk. Natural catastrophe risk models are the most helpful assets elsewhere and for Asia, where these models incorporate takeaways from past events while meticulously reflect present day conditions. Strong and ongoing commitment is needed from stakeholders across the insurance value chain to sourcing better data, sharing it more transparently and being more proactive in factoring new information into risk assessment. By tightening the focus on thorough, high-quality data and models, we can ensure our industry suffers fewer shocks in future, and the people and businesses of this region remain resilient to whatever lies ahead.