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Severe weather trends could leave more consumers out in the cold as insurance protection gap widens

17 April 2024 Thabiso Rulashe, Head of Investor Relations and Strategy at Santam
Thabiso Rulashe

Thabiso Rulashe

Climate change-induced extreme weather events have remained elevated across the globe in the last decade, proving disruptive to both economic and social activities.

According to the global reinsurance broker, Aon, the 2023 economic losses due to natural catastrophes was 22% above the 21% century average – raising questions about the long-term affordability and sustainability of cover for vulnerable communities.

The effect of climate change in South Africa has created further unpredictability and uncertainty in weather patterns. In the past few years, the country has experienced prolonged drought periods, intense rainfall activity leading to floods/storms, bursts of hailstorms and wildfires. These events have tended to be severe and they pose significant threat to livelihoods.

While the impacts of climate change vary by region/province, according to GreenPeace, the interior of Southern Africa is understood to warm at twice the global average rate – a likely catalyst being heatwaves which have become a common occurrence. Conversely, the coastal cities have experienced a significant increase in the frequency of flooding.

While the flooding in urban areas is driven by both natural and human factors, the severity of damage has been compounded by a range of structural challenges that are amplifying the severity of loss events and ultimately pushing the cost of insurance into the realms of unaffordability. Some examples include poorly maintained road, rail and ports infrastructure and the well reported shortcomings in municipalities’ water and sanitation infrastructure, to name a few.

The inter-connectedness of risks becomes evident when you consider how poorly maintained infrastructure magnifies the potential losses, insured or otherwise, due to climate change related extreme weather events. For example, neglected stormwater drainage or sluice gates can magnify flood damages; shortages of firefighting equipment, access to water or manpower can delay firefighting responses, leading to total instead of partial losses. To illustrate this cost, the Santam Insurance Barometer Report 2022/23 reported that the economic cost of the April 2022 KwaZulu-Natal floods was estimated at R54 billion, with half that total carried by the insurance industry.

Although the insurance industry has over time withstood evolving risks, each year natural disasters and extreme weather events continue to increase in frequency and intensity resulting in widespread losses and damage to infrastructure. The impact of natural disasters is multi-faceted – and the insurance industry must look at its financial resilience and as well as the ability to honour claims.

The unpredictable nature of natural disaster events also means that the ability of underwriters to effectively measure, predict and price risk will be affected. It may lead to premium increases in vulnerable areas which may impact affordability issues. We have observed that in the US, this has become a real issue, where some insurers limiting or pulling cover from fire-and flood prone areas leaving houseowners with limited cover options.

Unfortunately, as is often the case, the vulnerable are likely to be worst affected as increasing losses will likely widen the protection gap. Described as the difference between economic losses and insured losses, the protection gap is a global phenomenon largely impacting emerging economies and the poor in general as most losses in those segments are still uninsured. Globally the protection gaps stands at 69%, meaning about $262bn of economic losses were not covered in 2023 (source AON). In the EMEA region, which SA is part off, the protection gap is 83%.

In the context of South Africa, the protection gap is further exacerbated by macroeconomic factors such as low growth, rising unemployment and the cost-of-living crisis to mention a few. These factors continue to place pressure on the consumer, further widening the protection gap. Swiss Re estimates South Africa’s natural catastrophe protection gap to be $0.5bn.

Public-private partnerships have been earmarked as an essential response mechanism in facilitating the protection of vulnerable communities. The insurance sector specifically has a role to contribute to resilience of cover for communities and to increase the net of cover by lowering access barriers and developing solutions that drive financial inclusion. Narrowing the protection gap is vital to contribute to resilience benefits and helping to reduce social and economic impact of extreme weather events.

Additionally, the use of enabling technologies and innovative risk transfer mechanisms that can aid towards building the resilience of societies prone to natural disaster has become increasingly important. Therefore, responding to the increased frequency and severity of climate events by raising premiums to cover likely future payouts is no longer the only feasible solution.

The traditional insurance approaches that are predominantly based on historical loss figures, should be complemented by the use of geospatial tools and AI to develop more nuanced views of risk exposure. This is key to improving the industry’s analysis of climate trends. Additionally, conducting climate scenario analysis will help organisations to test the resilience of their business against different climate conditions. Partnering with academic institutions and key experts in mitigating climate risk exposure is also becoming increasingly important.

This will however mean investing in and implementing robust data governance to further enhance current risk management processes. Additionally, the adoption of these technologies is not without any red-tape and the industry needs to play an active role in advocating for an enabling regulatory environment to facilitate innovative product development.

The ripple effect of this will be felt by clients who through the adoption of innovative products will to an extent be cushioned from the effects of the changing risk landscape.

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