The Global Protection Gap

By Mowen Lee | Vol: 41 Issue: 3 | Oct 2018
  • General Insurance


There were 330 separate natural catastrophe events across the world in 2017 amounting to a total cost of USD $353bn, the second costliest year ever for natural disasters after 2011. The insured cost of natural catastrophes was USD $134bn meaning the global protection gap was USD $219bn (economic cost less insured cost). 

The graph below illustrates the global top ten natural catastrophe events by economic cost in 2017 and for each event, highlights the percentage economic loss insured. 

Image 1

Source: Graph constructed by Mowen Lee 

The graph reveals some interesting observations about the protection gap: 

  • The protection gap is relatively lower in the US, a market where insurance penetration has historically been high. For example, 85% of losses resulting from US wildfires in California were insured. 

  • The protection gap is higher in developing economies. For example, less than 10% of losses were insured in China from flooding and Typhoon Hato

The protection gap has steadily widened since 1970 and become an important issue that warrants the attention of the insurance industry and of governments worldwide.

Image 2

This essay seeks to answer why and how the protection gap should be addressed by:

  • Reconciling the anomaly between underinsurance and excess capacity in reinsurance markets

  • Analysing how reinsurers can utilise excess capital along with alternative capital to reduce the protection gap

  • Suggesting how the insurance industry and government can work together to reduce the protection gap 

Reinsurers, insurers and government all play an important role to reduce the protection gap and although it is tempting to say one plays a bigger role than the other, the interconnected nature of risk management means all play an equally important role to reduce the protection gap


Underinsurance is the gap between the amount of insurance that is economically beneficial and the amount of insurance purchased . Although underinsurance is traditionally linked to developing countries where the insurance industry is immature, underinsurance is also prevalent in developed countries like the US, Australia and Japan. Some key economic and behavioural reasons individuals and business underinsure are outlined below .


The cost of insurance is one of the biggest reasons of underinsurance. Homeowners may elect to self-insure by using savings or credit rather than buy an insurance policy. Similarly, governments facing budgetary pressure may find it difficult to justify taxpayer money spent on purchasing insurance for 1 in 100-year natural disaster events. Overall, there is a strong positive correlation between insurance penetration and the relative wealth of countries as highlighted in the graph below . 

Image 3

Perceptions about risk

People may be reluctant to purchase insurance for low probability high loss events, such as natural disasters, due to availability bias3. Availability bias is when people evaluate the likelihood of an event based on prior experience. Given natural disasters are rare events that most people are unlikely to have encountered, the ‘past experience’ people are seeking is non-existent. Another reason for underinsurance is an expectation government will provide post-disaster financial assistance, reducing the need for insurance. However, in the United States between 2014-16 only 11% of Federal Emergency Management Agency (FEMA) funds were allocated to individual assistance whilst 74% was allocated to public infrastructure assistance3.

Insurance for certain perils may be unavailable 

Sometimes insurance for certain perils is unavailable or difficult to purchase. For example, terrorism is an emerging risk in many developed countries such as the US, UK and Australia however, terrorism insurance is often excluded in property and liability policies because it does not satisfy one of the key principles of insurance – unpredictability – where losses must be unforeseen with respect to time, location and magnitude . The unpredictability and variety of terrorist attacks means underwriters have limited data to estimate potential claims in terms of frequency or severity and with potential losses that can far exceed any natural disaster, terrorism sits outside the risk appetite of many private insurers. Fortunately, in Australia, the Australian Reinsurance Pool Corporation (ARPC) has been established to guarantee reinsurance cover for up to $10bn, providing capacity for insurers to offer terrorism coverage in the market. 

Lack of financial development in some markets 

Access to insurance is a problem in developing economies where marketing and distribution of insurance products can be extremely difficult in rural communities. Poor financial literacy may mean accuracy of underwriting information collected is unreliable, resulting in potential adverse selection problems. In developing Islamic countries traditional insurance products are forbidden and only Sharia-compliant insurance solutions, which are globally less developed than traditional insurance, are permitted3.


What has led to excess capital?

Although the frequency and economic cost of natural disasters have risen steadily between 2015-171, reinsurance pricing has declined every quarter since the beginning of 2013. 

Part of this anomaly is explained by changes in the purchasing behaviour of primary insurers who are centralising reinsurance purchases. However, the sustained softening of reinsurance pricing is mostly explained by the emergence of alternative capital, such as collateralised reinsurance, catastrophe bonds, sidecars and industry loss warranties (ILW) over the past decade .

Image 4

Although in 2017 alternative capital only represents 13.7% of global reinsurer capital, growth in alternative capital has far outpaced traditional capital and this trend is likely to continue as investors continue to seek above-average returns uncorrelated to equity and interest-based securities post global financial crisis. 

There are advantages and disadvantages that must be considered when evaluating the attractiveness of traditional reinsurance versus alternative reinsurance[1].

Image 5

How can reinsurers use excess capital? 

The next section will highlight ways reinsurers can use excess capital to reduce the protection gap and outline the important roles of insurers and government. 


Capacity to support emerging risks

Beyond natural disasters, one of the biggest emerging global risks facing government and business is cybercrime . There is a sizeable protection gap in cyber coverage, with only 33% of companies having purchased cyber insurance and most of those companies hailing from North America. Reinsurers have a crucial role to support the continuing development of cyber insurance for insurers. To do so requires overcoming the challenge on how to underwrite emerging risks, like cyber, in the absence of critical mass loss experience . But with excess capital and a burgeoning alternative reinsurance sector, traditional reinsurers may manage risk appetite by transferring a portion of cyber risk to alternative capital markets until such a time meaningful loss information becomes available. 
Most importantly, underwriting collaboration with other lines is key to developing cyber risk maturity as cyber is never just an ‘IT issue’. Cyber claims can extend to property damage, business interruption and third party loses. 

Apart from cybercrime, examples of other emerging risks that will require reinsurer support include autonomous vehicles and robotics manufacturing. 

Parametric insurance 

Parametric insurance does not indemnify pure loss as with ordinary insurance but agrees to make payment upon occurrence of a triggering event. For insureds, parametric insurance reduces the burden of underwriting information to be prepared and increases the speed of claims processing. 

Reinsurers can partner with local insurers and government in developing countries to offer parametric insurance for risks such as floods, earthquakes and droughts. For insurers, application of parametric insurance minimises problems of adverse selection and moral hazard as claims are based on an objective index that people cannot manipulate. For customers, parametric insurance eliminates the administrative burden of acquiring insurance (i.e. completing proposal forms) as individual underwriting is not required. Most importantly, timeliness of payouts will be increased as losses won’t need to be documented. A recent placement success was in early 2018 when Aon Securities helped the World Bank structure the largest ever catastrophe bond covering earthquakes, providing USD 1.36bn capital markets protection to four developing countries; Chile, Columbia, Mexico and Peru . 

Value-add risk services  

Most organisations will not have the capability to quantify losses from cybercrime, terrorism and political instability and therefore will not know how much insurance to purchase. With marketplace knowledge and claims information at hand, reinsurers can invest in the development of consulting services that help organisations quantify risks through scenario analysis and risk modelling. 


Understanding the value of insurance 

Insurance is often perceived as a ‘grudge’ purchase only considered after a near miss event. Part of this behaviour can be explained by availability bias and laconic attitudes, such as the ‘she’ll be right’ mentality in Australia. However, insurers – via brokers – have a crucial role to educate and inform clients about risk and probability. To minimise underinsurance, brokers must be prepared to challenge clients to identify plausible worst-case scenarios and assist clients to articulate and quantify risks . 

Access to insurance 

Access to insurance is a major problem, particularly for remote communities isolated from urban centres. Traditional insurance providers do not reach 3.8 billion customers in developing markets . To bridge this gap, insurers must leverage mobile payment technology and build distribution partnerships with rural banks and microfinance institutions. 

Insurance product design   

Bundling insurance with other financial products can help frame the availability of insurance into the consumer mindset. An estimated 1.8 million Australian households do not have home and contents insurance  and with almost all retail banks now offering property insurance, positioning insurance as an ‘opt-out’ feature of a mortgage package can be an effective framing technique4. 


Emergency management 
Household preparedness in the wake of natural disasters stems from advice provided by emergency services. In Victoria, Emergency Management Victoria (EMV) has been established to take overall responsibility for the coordination of major emergencies. Not only does EMV play a lead role to coordinate an interagency response with police, ambulance and the fire brigade but it also engages directly with local communities via educational outreach programs aimed at building resilience . With most of the developing world still lagging in emergency management coordination and response , governments from developed countries lots to offer in terms of sharing leading practice.   

Mandatory public-sector insurance programs

Public sector insurance programmes can be implemented to ensure coverage of critical public infrastructure such as hospitals, schools and railways. In Victoria, the Victorian Managed Insurance Authority (VMIA) has been established as a ‘captive’ insurer to protect the state’s balance sheet. By pooling state-wide risks together, VMIA can secure favourable reinsurance in terms of coverage and price and these benefits are passed onto government agencies. Additionally, default risk is minimised due to the low sovereign risk of government. This “peace of mind” is reassuring for the community in the event of catastrophes. 

Collaboration with the private sector

Federal governments have a coordination role to bring together local government, research institutions and insurers to build risk resilience and protect national economies from large catastrophe losses. In Australia, the Turnbull government will contribute $26m per year for national disaster resilience and has pledged to consult the insurance industry about its new National Resilience Taskforce . The success of this taskforce may help reduce the taxpayer bill for natural disasters, which has cost the economy $18bn per year for the past 10 years. 


Image 6

Source: Diagram constructed by Mowen Lee

The interconnected nature of risk management means a coordinated approach between the insurance industry and government is required to close the protection gap. 

Who plays the bigger role in closing the protection gap will vary on the industry and regulatory maturity of each country. In developed countries, industry maturity is relatively high so the protection gap stems primarily from behavioural perceptions inhibiting the adequate purchase of insurance. In developing countries, there are significant shortcomings with risk management regulation and access to appropriate insurance and so industry and government have an equally important role to play. 

What is certain is that catastrophe losses are indiscriminate of time and location.  Whether in developed or developing countries, a collaborative approach to risk management is critical to close the protection gap. 


1. Aon Benfield (2018). Weather, Climate & Catastrophe Insight – 2017 Annual Report. Retrieved from: (Accessed on: 3 April 2018) 
2. Geneva Association (2014). The Global Insurance Protection Gap. Retrieved from: (Accessed on: 3 April 2018) 
3. Holzheur, T. and Turner, G. (2017). The Natural Catastrophe Protection Gap: Measurement, Root Causes and Ways of Addressing Underinsurance for Extreme Events. Retrieved from: (Accessed on: 3 April 2018) 
4. International Monetary Fund (2017). World Economic Outlook Database October 2017. Retrieved from: (Accessed on: 4 April 2018) 
5. Insurance Information Institute (2016). Background on: Terrorism risk and insurance. Retrieved from: (Accessed on: 4 April 2018) 
6. Aon (2018). Reinsurance Market Outlook January 2018. Retrieved from: (Accessed on: 6 April 2018) 
7. McKinsey & Company (2013). Could third-party capital transform the reinsurance markets? Retrieved from: (Accessed on: 6 April 2018) 
8. Aon (2017). Global Risk Management Survey 2017. Retrieved from: (Accessed on: 10 April 2018) 
9. McKinsey & Company (2017). Global reinsurance: Fit for the future? Retrieved from: (Accessed on: 10 April 2018) 
10. World Bank (2018). World Bank Affirms Position as Largest Sovereign Risk Insurance Risk Provider with Multi-Country Earthquake Bond. Retrieved from:  (Accessed on: 8 May 2018) 
11. Middlemiss, N. (2018). Are brokers doing enough to close the protection gap? Insurance Business Australia. Retrieved from: (Accessed on: 10 April 2018)
12. Centre for Financial Inclusion (2018). Inclusive Insurance: Closing the Protection Gap for Emerging Customers. Retrieved from: (Accessed on: 10 April 2018) 
13. Siljanoski, L. (2016). Underinsurance: Something you should always avoid when insuring your property. Retrieved from: (Accessed on: 10 April 2018) 
14. ANZIIF (2017). Insuretech 101 | Vol 40 Issue 4 | Nov 2017. Retrieved from:  (Accessed on: 8 May 2018) 
15. Lipka, M., Hackett, C. (2017). Why Muslims are the world’s fastest-growing religious group. Retrieved from: . (Accessed on: 10 April 2018) 
16. Vantage (2015). Sharia Compliant Insurance. Retrieved from: (Accessed on: 10 April 2018) 
17. Emergency Management Victoria (2017). EMV’s Strategic Plan 2020. Retrieved from:'s_Strategic_Plan_2020a.pdf. (Accessed on: 11 April 2018)
18. Bündnis Entwicklung Hilft (2017). World Risk Report Analysis and Prospects 2017.  Retrieved from: (Accessed on: 11 April 2018)
19. Insurance News (2018). Industry to have say on new resilience taskforce. Retrieved from: (Accessed on: 17 April 2018)

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