Why We Need Community-Based Catastrophe Insurance

August 17, 2020

This article originally appeared on BRINK on July 30, 2020.

The impacts of COVID-19 on individuals, communities and insurers are continuing to unfold and no doubt present uncertainty. However, the current disruption also serves to highlight the importance of lessening reliance on federal financial relief and, instead, creating financial resilience at the community level.

As disaster losses escalate around the globe, the difference between economic damages and the amount that is insured — known as the natural catastrophe protection gap — is an issue of increasing focus for community leaders and policymakers.

According to catastrophe modeler AIR Worldwide, only about 25% of economic losses from natural catastrophes are insured globally, and the uninsured portion could potentially exceed $1 trillion in a particularly bad year.

Without disaster insurance, households and small businesses are often left struggling to repair and rebuild, reliant on competitive public relief dollars that can be stretched thin. Research has found that having insurance improves recovery outcomes: It can lessen the negative impact of a catastrophic event on the broader economy and speed rebuilding, sustaining economic activity and protecting credit ratings. The reach of its potential impact means that closing the protection gap is an important public policy concern.

Many attempts have been made to address the protection gap; however, a persistent lack of insurance coverage is continually made apparent following rare and large events. Reasons for the lack of catastrophe coverage range from perfectly rational affordability concerns to a litany of behavioral biases exhibited by consumers, insurers and regulators.

In short, individuals and businesses are often only compelled to buy coverage by law or as a condition for accessing credit; so coverage levels generally remain quite low.

A Need for Innovation

New models of catastrophe insurance delivery need to be considered, given that many disasters are specific to a location and given concerns regarding coverage levels and pricing. One such approach, which the Wharton Risk Center, Marsh & McLennan Advantage, and Guy Carpenter are exploring together is Community-Based Catastrophe Insurance (CBCI).

In a CBCI program, a community — loosely defined as any public entity, special purpose district or public agency — arranges insurance protection for its community members. Models of CBCI can range from relatively hands-off, where the community simply helps arrange coverage for its members with an insurer or insurers, to very hands-on, where a community sets up its own captive insurance company. Coverage can also be offered as a voluntary community benefit or as a requirement of community membership.

While adding an insurance program to the already long list of community administrator responsibilities is no small ask, the potential benefits may well exceed the effort while supporting broader community preparedness objectives. Specifically, CBCI may be used to address issues related to catastrophe insurance availability and/or low demand through awareness campaigns or other delivery mechanisms.

The Issue of Affordability

Similarly, CBCI could make coverage more affordable. Catastrophe insurance is often perceived as expensive or beyond the ability of individuals or small businesses to pay. Communities can use their size to enhance buying power on behalf of community members and reduce related administrative costs. Communities could also choose to couple CBCI with a public means-tested assistance program to help lower-income households afford coverage.

CBCI can also help align incentives for investment in community-level disaster mitigation. Investments in physical resilience (e.g. sea walls, levees, nature-based solutions) are often difficult for communities with budgetary constraints to rationalize since they do not produce direct monetary benefits like other forms of community infrastructure (e.g. utility assets, toll roads). CBCI can help to monetize some of the benefits of community resilience in the form of reduced insurance premiums for community members, something which would be difficult to negotiate with the litany of private carriers insuring assets in the community. Furthermore, engaging in community-based insurance allows for continuous risk assessment and modeling that can serve to better inform decision-making around mitigation and risk reduction.

In addition to the above benefits, CBCI can enhance the fiscal resilience of local governments by increasing coverage rates among citizens. It can also enhance community solidarity and self-sufficiency, which may be particularly beneficial in areas which have suffered from shared hardship.

A Framework for Success in the Face of Challenges

While studies have been conducted on the potential for Community-Based Flood Insurance, and models exist in other insurance sectors and internationally (e.g., Community-Based Health Insurance), actually implementing a CBCI program in the U.S. will require a community and willing industry partners to address some unique challenges. The first of which is its novelty: The uncharted nature of CBCI combined with the regulatory uncertainties of structuring a program, the need for broad stakeholder engagement and uncertainty regarding market capacity serve as barriers and explain a lack of case studies. However, it remains clear that the insurance industry working alongside communities can overcome these challenges and align interests to leverage CBCI as a tool to drive further community resilience.

Through taking a thoughtful approach toward examining community protection gaps and aligning private market risk analytics and risk transfer capacity, CBCI solutions more readily come into focus. Community leaders may ask: What disaster risks do we need to address? What does our community need from a CBCI program? Do we have the resources and ability to implement this program?

The lack of certainty that came with the COVID-19 crisis has, in some ways, presented us with opportunities to strengthen community resilience. It is also important to remember that hurricane season in the Atlantic is just beginning, wildfire season along the North American West Coast isn’t far behind and it is always earthquake season in many parts of the world. While CBCI isn’t likely to be a panacea for the broader protection gap, it clearly serves as one of the most promising opportunities for public-private partnership to increase community and individual resilience.

Christopher Sykes, Managing Director, Guy Carpenter and  Alex Bernhardt, Director, MMC Advantage contributed to this article.

Photo: Residents riding a boat past a flood damaged house in China on July 15, 2020.  STR/AFP via Getty Images

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