'Disaster risk financing: the role of insurance
in new public-private partnerships'
Speech by Luigi Federico Signorini
President of Ivass
ANIA Insurance High Level Conference
Rome, 20 September 2024
Ladies and gentlemen,
Once again we are seeing dramatic images of floods, damages and losses. The images
that we just saw in the walk-in video for this conference are surely older, but could
have been taken yesterday. Our hearts and thoughts are with those that have been
hit, not just this time but also in the previous months, some repeatedly. We must
hope that human life has been spared this time, although I understand that as of this
morning some are still missing.
This is another reminder of the seriousness of the climate issue. We cannot be in denial.
The accelerating change in the Earth's climate has increased the frequency and intensity
of river and coastal floods, landslides, droughts and forest fires worldwide. Europe,
in particular, is warming quite fast; according to Copernicus (the European satellite
monitoring system), the average temperature for European land in August 2024 was
more than 1.5°C above the 1991-2020 average for the same month. In addition to
climate-related events, other natural disasters such as earthquakes, tidal waves, volcanic
eruptions and bradyseism can have a dramatic impact on the economy and society.
The issue of natural disasters and, more generally, catastrophe risks, once confined to
scholars of the 'hard' sciences, such as physicists and biologists, has become an area
of concern for economists, sociologists and lawyers as well. As a consequence, one
sees among other things more and more attempts at measuring the economic impact
of natural events in a reliable way. The 2023 European State of the Climate Report
estimates the direct damage to property generated in 2023 by floods, inundations and
fires (disregarding, that is, indirect effects) at more than €13 billion, and the human
toll at 151 deaths1. Over the past few years, there has also been a growing attention
in international fora2 to natural disasters as a potential source of systemic financial
stability risk.
The literature on disaster relief suggests that a purely ex-post approach to damage repair
and loss compensation is likely to be sub-optimal. Prevention is of course necessary at
various levels. In my speech, as befits the occasion and my role, I shall concentrate on the
role a well-regulated insurance industry can play. It is not a minor role.
Compensation can be very costly for the public finances when an event occurs. It is
also difficult for the private insurance market to provide adequate cover for rare but
catastrophic events. Ex-ante risk mitigation and damage prevention and limitation are
therefore desirable. Moreover, the nature of catastrophe risk appears to require an
appropriate interaction between public relief intervention and private insurance schemes.
Certain valuable principles for policy-makers have recently been summarised in a
'decalogue' for natural-disaster management,3 drawn up by the OECD and the IAIS,
the International Association of Insurance Supervisors, under the auspices of the Italian
G7 Presidency - the 'high-level framework' that has been repeatedly mentioned this
morning. Ivass has actively contributed to this document with technical input. The
OECD-IAIS framework states that an effective mechanism for protection against natural
catastrophes requires the cooperation of many stakeholders, both public and private.
On this point, last year I mentioned the pros and cons of two ways of sharing the costs
of a catastrophic event: public intervention and private insurance. I also claimed that
an adequate diffusion of insurance cover is not just a question of individual choice,
but has elements of a collective issue. Let me add that another factor is the action of
charities and volunteers, for whose work we should be deeply grateful.
Allow me to recapitulate very briefly the main points I made on that occasion.
Public intervention will always be necessary to some extent, because not all risks are
effectively insurable and because, in the case of truly catastrophic events, some form
of coordination of the reconstruction and its financing is indispensable. Its drawbacks
however are, first, that when an event occurs, there is uncertainty about whether
compensation will be provided and to what extent, who will be eligible and under
what conditions; second, that experience tells us that the implementation of relief
measures often comes very late after the event; third, that the distribution of the
tax burden being naturally based on pure, discretionary ex-post mutualisation, it can
hardly be designed in a way to create the right incentives for ex-ante risk prevention
or mitigation.
Private insurance contracts exploit the opportunities of diversification between
uncorrelated risks, and can rely on risk transfer and pooling techniques, with
benefits ultimately shared between the insurer and the insured. If well designed
and implemented, it is certain, prompt and directly commensurate with the damage
individually suffered; it can provide powerful incentives for prevention. However, if
there are no provisions for mandatory coverage, it is subject to adverse selection.
Moreover, it cannot achieve the redistribution goals that public intervention may
instead wish to pursue.
A recent study made by the Bank of Italy together with the University of Florence4 looks
at hydrogeological events that took place in Italy between 2010 and 2018 and their
effect on firms survival and performance. In the three years following the event, the
affected companies are significantly more likely than others to exit the market; even
if they survive, their profitability declines and staff numbers decrease. Insurance can
mitigate those effects at the individual level. In addition, the existence of externalities
makes underinsurance of such risks also as a matter of public interest. The destruction
caused by a natural disaster has consequences that go beyond those directly affected,
through the dense network of interdependencies that characterises economies. The
swifter availability and granularity of insurance relief compared with that provided
by discretionary ex-post public interventions should contribute to reducing these
consequences.
It is not only insurance that can provide incentives to make businesses and households
less fragile and more resilient to disasters. Supervisors, for instance, have been
insisting for some time that banks should take physical and other nature-related risk
into account when screening the financial merits of projects. Risk mitigation measures
should be a factor in setting conditions for loans and other forms of financing.
As is well known, Italy is particularly exposed to seismic and hydrogeological risk,
including landslides and river floods, as we were sadly reminded yesterday. It also has
a 9,000-km coastline, of which 3,400 km, especially in the upper Adriatic Sea, can suffer
coastal floods. Yet according to analyses by various research centres and EIOPA5, Italy,
along with Greece, shows in Europe the highest protection gap, i.e. the gap between
natural-catastrophe (Nat-Cat) risk exposure and insurance protection from such risks.
From 1980 to 2022, about 97 per cent of the losses incurred from earthquakes and
floods were uninsured, the highest underinsurance level (thus measured) for this type
of risk in the European context6.
The protection gap arises from both the demand and the supply side of the insurance
market. Several aspects can explain the public's wariness in demanding protection:
low awareness of risk and/or of the availability of insurance products; difficulties in
understanding complex policies (with regard e.g. to guarantees, benefits, exclusions);
high prices. An expectation that public sources will compensate some losses may
also indirectly play a role. On the supply side, insuring against catastrophe risks can
entail, if and when rare but high-impact events occur, heavy and concentrated losses
for insurers. Modelling such tail risk is difficult, especially as climate change is likely
to shift the probability distribution of climate-related catastrophic events in ways that
are hard to predict. This makes provision of insurance technically challenging and may
induce insurance companies to raise the price of cover significantly. Much the same
issues arise for reinsurance: in fact, as the effects of climate change become apparent,
insurance companies are finding it increasingly difficult to reinsure themselves in the
market.
These special features of catastrophe risk appear to call for carefully designed
measures to improve the framework for Nat-Cat insurance and provide some form of
public co-insurance (so to speak), while leaving the market to perform its allocative
tasks as efficiently as it can. We therefore welcomed the introduction of a mandatory
Nat-Cat insurance scheme for businesses, together with a set of policy support tools,
by the 2024 Budget law. In fact, we had been advocating such a move for some time.
The law will bring Italy closer to other European countries (including France and Spain)
and non-European ones (including the United States and Japan) that have already
provided for either mandatory or semi-mandatory models of insurance against natural
disasters.
The technical details need to be defined by a decree to be issued by the Minister of
Economy and Finance and the Minister of Enterprises and Made in Italy, which is now,
as you heard, in the process of being finalised.
Several points are crucial for a successful implementation. The scheme must be
technically sustainable on the insurers' side and affordable for the insured, so that
universal coverage is smoothly achieved. It is also essential that reimbursements are,
and are perceived to be, quick and predictable. The extent of the cover offered (and
demanded) needs to be adequate. The implementing decree will specify a number of
important details, including the events to be covered and the criteria for exclusion.
Such elements will largely shape contractual practices concerning e.g. the amounts
insured, indemnity limits, deductibles and excesses. The success of the scheme hinges
on a careful definition of them. All the main actors concerned should have a voice in
discussing the technical details. It is also important to ensure the consistency of the
new provision with the existing prudential and supervisory rules for insurance. There
are many technical issues, but they can be solved. We must go ahead. We are ready to
provide any technical assistance that may be required.
The experience gathered from the implementation of the business insurance scheme
will also be useful in case an extension of catastrophe risk coverage to households is
envisaged. Legislative initiatives in this direction are being considered7
Ladies and gentlemen,
Let me conclude by saying that, in general, there are two further key ingredients
for reducing Italy's insurance protection gap: greater awareness of risk (and of the
risk-protection tools available) on the public's side; constantly improving clarity and
transparency on the industry side. Citizens and businesses that are well informed on
risk will likely be prepared to seek more protection, and to adopt mitigating measures
that reduce the risk of loss and at the same time improve the conditions at which
insurance can be provided.8 Insurers, for their part, should constantly strive to improve
the structure and language of contracts, as well as all aspects of the distribution of
policies. Ensuring that contracts are as clear, simple and readable as possible, and
that potential customers are in the best position to understand the price and extent
of coverage and other conditions, is important not only in the name of fairness, but
also in order to guarantee that market competition functions effectively. Insurance
education and transparency: at Ivass, we are committed to contributing to both these
aims, within our mandate, as best we can.9
7
See initiatives on the draft framework law on post-disaster reconstruction.
8
See Guiso L. and Jappelli T., 'Are People Willing to Pay to Prevent Natural Disasters?' CSEF, working
paper no. 723, June 2024.
9
On the domestic front, Ivass participate in the work of the Sustainable Finance Table at the MEF, of
which CONSOB, COVIP, MIMIT and MASE are also members. There, among other things, the Bank has
promoted the establishment of a Working Group on the Insurance Protection Gap (IPG) to enhance
the role of insurance companies as providers of protection for businesses and households against
physical risks arising from natural disasters and climate change. At the international level, Ivass is
working on the European Commission's project called 'Technical Support Instrument 2023 - Flagship
ESG Risk Management Framework for the Financial Sector'. As part of this project, in-depth studies
will be conducted on the causes of low insurance coverage against natural disasters in Italy, and
possible prevention measures and policy recommendations will be identified to close our protection
gap. Finally, Ivass contributes to the debate on the Insurance Protection Gap taking place in the
international insurance and non-insurance cooperation fora of which it is a member: the IAIS, the
Network for Greening the Financial System (NGFS), the Sustainable Insurance Forum (SIF) and the
Forum for Insurance Transition to Net Zero (FIT).