Risk-based pricing key to mainstreaming Asia’s disaster proofing

Arup Chatterjee (pictured), who specialises in insurance and contractual savings at the ADB’s Office of Regional Economic Integration, says that while better research and data would allow for more transparent mapping of different risks, “risk-based pricing can motivate insured individuals and businesses to reduce their exposure to risk (and thereby reduce their premium) by discouraging risky behaviour”.

“Managing increasing risks is a challenge for the insurance industry (faced with increasing pay-outs) as well as an opportunity (more risk can lead to more business),” Chatterjee says.

“Well-designed insurance policies can contribute towards mainstreaming disaster proofing in economic and financial decisions.”

Chatterjee says that issues that need to be addressed include improving the low take-up rate of disaster insurance, moving towards systems with a higher degree of risk-based pricing, and improving the accuracy and comparability of risk data and risk modelling.

“Insurance pilot projects need to be initiated and lessons from such pilots, across the world, should feed in scaling up the most promising approaches at the national level and regional levels,” he says.

Speaking to SR following the release of the ADB’s latest Asian Economic Integration Monitor, Chatterjee pointed out that households in south-east Asia were disproportionately affected by disasters. This was due to high exposure levels as well as limited access to effective risk management strategies.

“Less than 10% of natural disaster losses in the region are insured, as several market imperfections have impeded the development of markets for transferring natural disaster risks,” he says.

“Adverse selection and moral hazard are inherent to all forms of insurance, and transaction costs for servicing insurance contracts and controlling these information asymmetries are extremely high relative to the sum insured.

“Limited spatial risk-pooling potential resulting from the co-variate nature of natural disaster losses further impedes the development of domestic insurance markets, unless local insurers can transfer the risks to international markets.”

Nat cat threats

The Asian Economic Integration Monitor is a semi-annual review of Asia’s regional economic cooperation and integration. The April 2014 issue includes a chapter with the theme, ‘Insuring against Asia’s Natural Catastrophes’.

It points out that over the past two decades, Asia has borne half the estimated global economic cost of natural disasters (about $53 billion annually), which could potentially wipe out gains from economic growth in many economies.

It also states that the gap between total economic losses and insured losses can be so wide that it might outstrip a government’s ability to act as an insurer of last resort.

“Regional cooperation along with better and more effective national policies to offer disaster risk financing instruments is therefore critical,” the report concludes.

It also states that that the key priorities for developing disaster risk financing markets and strengthening financial resilience should include business continuity planning, enhancing technical and institutional capacities, and coordinating various governmental authorities across all levels.

Manila-based Chatterjee says that in the absence of an efficient and fair insurance market, public disaster assistance and highly subsidised public insurance programs have to bear the brunt of supporting affected populations.

“The increasing frequency and intensity of these co-variate shocks and misplaced incentives for risk taking or under investment in risk mitigating activities among vulnerable populations can jeopardise the sustainability of such programs,” he says.

“Without proper targeting, these programs could further crowd out private insurance demand impeding the development of a healthy domestic insurance market.”