What will be the cost of future disasters as insurance penetration and assets grow?

Buildings levelled in the Sichuan earthquake, Dujiangyan, Sichuan, China, May 18 2008

China’s rapid economic growth, huge population and megacities give it an increasingly exposure to natural catastrophes. With the country prone to earthquakes, typhoons, floods and other perils, (re)insurers will face a growing exposure in the coming years.

Many predict China will become the next ‘peak zone’ as demand for catastrophe (re)insurance grows and the assets at risk continue to increase in value. Swiss Re forecasts that China will become the second biggest non-life market in the world by 2121.

“Insured exposures have roughly doubled in the past five years, causing awareness of all the perils and the ability for companies to model multiple perils,” says Milan Simic, managing director of AIR Worldwide.

The insurance market in China has experienced rapid growth in recent years, with total premium income up by 8% year-on-year to more than CNY1.55trn ($248bn) in 2012, according to the China Insurance Regulatory Commission. However, insurance density and penetration are still relatively low, especially as coverage against natural catastrophes is not widespread.

China is dramatically underinsured, according to a report by Lloyd’s. It found that China alone comprises 47% of a global non-life insurance shortfall in 2011. Its underinsurance amounted to $79.57bn, making China the most underinsured country analysed in monetary terms.

Exposed to every peril

April’s Sichuan (Lushan) earthquake served as a reminder of China’s significant catastrophe exposures. The M6.6 earthquake occurred on the morning of 20 April, approximately 115km from the city of Chengdu, killing up to 200 people and leaving tens of thousands injured.

The earthquake struck the same region as the Great Sichuan (or Wenchuan) Earthquake of 12 May 2008, which killed almost 70,000 people.

“Effectively, it was a relatively small event in comparison with 2008,” said Simic. “But it has raised awareness. That part of the country is one of the most seismically active parts of the country and there is some evidence that this recent event was indirectly caused by the rupture of the same fault in 2008.”

While Sichuan is one of China’s most populous regions, it is also one of the largest by geographic area. The hardest hit areas were farming villages on the edge of the Tibetan Plateau.

With minimal damage to the region’s commercial and transport centres, little insurance impact is expected from the quake. In addition, insurance coverage in the key quake area remains low, at less than 1% in terms of the ratio of insurance loss to economic loss.

Economic losses from the May 2008 M7.9 quake amounted to $124bn, while total insured losses were about $366m.

On average, economic loss from natural catastrophes in China is 3% of the annual GDP of the country, according to Swiss Re, which predicts the country is poised for a ‘perfect storm’.

In the first half of 2012, various natural catastrophes affected more than 110 million people in China, resulting in a direct economic loss of $49bn. In August 2012, Typhoon Haikui hit the country’s eastern coast causing an insurance loss of $232m.

Inland flooding is the most widespread hazard, affecting one in four people every year. However, it is currently the least costly peril from an insurance perspective, as it tends to impact rural communities.

China tops Swiss Re’s list for the highest flood risk in emerging markets, followed by the other BRIC nations.

Earthquakes and typhoons have the potential to create the largest insurance losses. For AIR’s Simic, the most costly scenarios are earthquakes affecting one of China’s megacities. “Large cities like Beijing and Chengdu are all in the areas of relatively high seismicity and if they were affected they could cause much more significant losses than we saw in this event and the 2008 event.”

At present, such an event would be significantly underinsured. “Anyone who has a standard policy would have cover against wind perils, whereas for earthquake you have to buy a new policy or extension policy that will cover you against the earthquake peril,” he adds.

Drought is another significant risk for the Chinese, particularly as it would have a big impact on food security for the country, which is already under pressure to feed its 1.4 billion people. In the future, climate change is expected to cause more droughts.

Over the years a public private approach to insuring China’s catastrophe exposures has been mooted. Global and regional (re)insurers have voiced their support for a natural catastrophe pool to cover natural perils and include public and private property.

Such an initiative would require detailed data for earthquake, typhoon and flood perils as well as catastrophe modelling expertise. “Modelling is something that has to be the first step and we’ve seen that in all the countries that have set up pools, from the Turkish Catastrophe Insurance Pool, the Romanian pool, and now more recently with the Dutch flood initiative,” said Simic.