The Disaster Insurance Gap

Why most disaster losses in poorer countries are uninsured, and how new tools like parametric insurance and regional risk pools help.

When a disaster strikes, insurance can provide money to rebuild quickly. But in much of the world, most disaster losses are not insured. The difference between total losses and insured losses is called the protection gap.

How large is the gap?

Reinsurance company Swiss Re has estimated that in recent years, well over half of global losses from natural catastrophes were uninsured. In many low-income countries, almost all losses are uninsured. Even in rich countries, some risks, like floods, are often uninsured.

Why the gap exists

Cost: insurance may be unaffordable for low-income households.
Lack of data: insurers need data to price risk, which is often missing in poorer countries.
Distribution: selling and servicing small policies in remote areas is expensive.
Trust: people may doubt that claims will be paid.
Expectation of aid: some may assume government or aid will help after a disaster.

Parametric insurance

A newer approach is parametric insurance. Instead of assessing actual damage, which is slow and costly, it pays out automatically when a measurable event occurs, such as rainfall below a set level, wind speeds above a threshold, or an earthquake of a certain magnitude in a defined area.

Parametric insurance pays quickly and cheaply, but there is basis risk: the payout may not match actual losses. A farmer might suffer crop loss even though rainfall stayed just above the trigger.

Regional risk pools

Countries can pool their risks. The Caribbean Catastrophe Risk Insurance Facility, created in 2007, provides parametric insurance to Caribbean and Central American governments against hurricanes, earthquakes and excess rainfall. Because not all countries are hit in the same year, pooling makes coverage cheaper. Similar pools exist in Africa and the Pacific.

A fast payout

After a hurricane hits a Caribbean island, its government's parametric policy is triggered by the storm's measured wind speed. Within about two weeks, the government receives a payout. It can use this money immediately for emergency response and to keep paying public workers, rather than waiting months for aid or damage assessments.

Catastrophe bonds

Governments and insurers also use catastrophe bonds, which pay investors high interest but lose some or all of their principal if a specified disaster occurs. This transfers disaster risk to global financial markets. Mexico has used catastrophe bonds to cover earthquake and hurricane risk.

Thinking insurance prevents losses

Insurance does not stop disasters or reduce damage. It spreads the cost and provides money for faster recovery. Preventing losses requires safer buildings and planning; insurance complements, but does not replace, prevention.

Key takeaways

The protection gap is the share of disaster losses that is uninsured.
Cost, missing data, distribution and trust all contribute to the gap.
Parametric insurance pays quickly based on measured events, with some basis risk.
Regional risk pools and catastrophe bonds spread disaster risk more widely.