Underinsurance of flood risk

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January 27, 2022 at 1:34 PM

Flooding is bad

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Flooding in Malaysia has displaced over 40,000 people, according to the country’s disaster agency, and reports revealed at least one fatality in every 10 missing people.

Flooding in Malaysia has displaced over 40,000 people, according to the country’s disaster agency, and reports revealed at least one fatality in every 10 missing people. As of Dec 20, 2021, rivers were above the danger level in almost 30 locations in Pahang, Selangor and Kelantan. The magnitude of such a disaster is not determined by floodwaters alone but also the pattern of vulnerability in which people live. The lives and livelihoods of many poor people are hardest hit by flood disasters.

Arguably, of all the disasters in Malaysia, floods are the most frequent and bring the greatest damage annually. In 1996, floods brought by Tropical Storm Greg in Keningau claimed 241 lives, caused more than RM300 million damage to infrastructure and property and destroyed a few thousand houses. The December 2006 floods in Johor caused 18 deaths and RM1.5 billion in damage. In 2008, floods occurred in Johor again, killing 28 people and causing damage estimated at RM65 million. 

With the government providing a total allocation of RM200 million in efforts to address the impact of current flood events, it is noticeable that flood disaster management in Malaysia has been over-focused on a top-down government-centric approach. This worked in the past when the population was sparse, and when the public were largely made up of lowly educated citizens. Now, it is time for a radical change towards a more “bottom-up/risk-spreading” approach.

Given the perceivably high-level exposure to flood risk (and actual losses from flooding), flood insurance is undeniably one of the most crucial risk transfer tools that can make an important contribution to financial management of flood risk by spreading the risk across domestic and international reinsurance and capital markets and reducing the share of losses absorbed by households, businesses and governments.

However, according to a study conducted by Zurich Malaysia, nearly 74% of homeowners in Malaysia are not covered against flood risk, although the National Disaster Management Agency (NADMA) believes that 4.8 million people nationwide live in flood-prone areas. This means that only two out of 10 households in flood-prone areas are insured. The statistics tell that there are underlying challenges faced by private insurers attempting to introduce flood insurance in Malaysia. The low penetration rate is the most important reason why flood insurance is not broadly available, notwithstanding the challenge to model actuarially sound insurance premiums that are affordable for households to pay. 

This leads to significant underinsurance of flood risk and leaves the government with difficult decisions on how to best protect vulnerable populations without exacerbating moral hazard or reducing households’ incentive to reduce their risk. These challenges have led to identifying the appropriate role of the government in supporting financial protection against flood risk, and where government intervention is necessary, the most efficient and effective approach.

There is a wide variety of approaches across countries to protect households and businesses against flood risk. In many countries (Japan/Turkey/Switzerland), private insurance companies offer coverage for flood-related damages and losses either as part of standard property and business interruption policies or available as an optional add-on to such policies. In some countries (the US/South Korea), coverage for flood damage may only be available from a public insurer, especially for properties deemed to be at high risk of flooding. In other countries (Canada/Australia), government assistance may be the only source of compensation available for losses from flood events. While the spectrum of flood insurance solutions varies from country to country, it also illustrates the extent in which a public public-private partnership (PPP) could potentially provide a more sustainable option over the long term.

One example of a flood insurance model anchored on the PPP approach is Flood Re, which was established in 2014 in the UK. Flood Re, which is a not-for-profit fund, is privately owned and operated by insurance industry, albeit with public accountability to Parliament. It is uniquely designed to simultaneously support the insurance industry and, more importantly, promote the affordability of flood insurance. One appealing aspect of this structure is the fact that the government’s role is limited. Unlike other disaster insurance schemes where the government absorbs the losses beyond a defined threshold, the government in this case bears no financial liability. Importantly, Flood Re is intended to be an interim measure. The scheme will end in 2039, beyond which there will be a free market for flood insurance in the UK. Starting from 2039, the policyholders are expected to pay premiums based on their level of risk to flooding without any subsidies.

Closer to home, following Thailand’s devastating flood in 2011, which is by far one of the worst disasters, Thailand introduced the National Catastrophic Insurance Fund (NCIF) to provide additional reinsurance capacity at subsidised rates to enable domestic insurers to continue offering coverage against natural disaster risks at affordable rates, not only to households and small and medium enterprises (SMEs), but also to the industrial sector. However, despite the fund’s focus on affordability, media reports indicated that premiums had actually rose following the disaster and at some point, the NCIF faced the prospect of being closed as premiums normalised, potentially relieving the government of the financial burden. While the NCIF continues to exist, it is important to note the inherent challenges in running such schemes viably. 

Considering the recent catastrophe in Malaysia, it is timely for the Malaysian government to take a serious look into designing a robust flood insurance scheme, ideally under a collaborative PPP structure to ensure that more affordable flood insurance can be offered. Targeted flood insurance subsidies for the bottom 40% income group (B40) living in high-risk areas should be introduced and insurance companies should be incentivised to provide more optional add-on policies to minimise financial loss from these events. 

One might argue that reducing flood risk through financial management alone is not sustainable. Yes, it is certainly true! Hence, there is a need to integrate structural and non-structural measures as part of a holistic flood risk management approach. Structural measures such as building dams, barriers and evacuation shelters need to be intensified, while non-structural measures, such as an early warning system and public awareness programmes, need to be embarked on. Chosen initiatives would have to be carefully managed by the appropriate agencies with targets around reducing fatality/damages and increasing the recovery speed.

Originally published on theedgemarkets.com by Wan Najwa Wan Sulaiman
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