Weathering the storm: Creating the tools to handle natural disasters

As one of the countries most exposed to natural catastrophes (NatCat) such as earthquakes and floods, Indonesia’s relatively low insurance penetration has historically meant that the government must shoulder the lion’s share of losses. With earthquake and flood policies usually sold as standalone covers, a growing incidence of catastrophes has driven increased penetration, albeit from low levels. “Natural catastrophes like earthquakes and tsunamis have been driving premiums for property insurance in Indonesia, as well as flood risks for certain big cities such as Jakarta and Bandung in West Java,” Arman Juffry, president director of Jardine Lloyd Thompson Indonesia, said in Zurich Insurance’s report on strategic risk in Asia in 2013. New regulations for property tariffs, including flood policies, enacted in 2014 should help sanitise competition and ensure sustainable underwriting practices. Meanwhile, donor-backed efforts to establish a new index-based earthquake insurance model under the existing domestic NatCat reinsurer Maipark should significantly expand coverage when it is rolled out.

Floods

While Indonesia has faced a growing incidence of natural disasters, the level of insured losses remains low, reflecting a significant insurance gap, according to SwissRe. In total the country has suffered Rp100trn ($10bn) in NatCat losses in the decade to 2013, according to Maipark, although the government has covered most of this. Torrential rains in January 2013 caused floods that were significantly more severe than similar occurrences in 2002 and 2007, according to Fitch. These affected the central business district, touching over 100,274 homes in 31 districts, including the Presidential Palace, according to the National Disaster Management Agency (BNPB). The flooding also caused a total of Rp32trn ($3.2bn) in damages, although claims reached only Rp3trn ($300m), according to reinsurance broker AON Benfield. Given that roughly half of non-life risks were placed with reinsurers or retroceded, given non-life insurers’ low capital base, the impact on underwriters’ balance sheets was contained. The Association of General Insurance Companies reports that total flood-related losses in 2013 reached Rp638bn ($63.8m), of which Rp600bn ($60m) was for property policies and the balance in motor. Although substantial floods occurred again in January 2014, they were concentrated in areas with lower insurance penetration, according to Fitch, which estimated that budgeted flood claims were not likely to reach Rp1.5trn ($150m) as of February 2014, roughly half the amount paid out the previous year.

Earthquakes

Alongside regular flooding, Indonesia is also exposed to significant, albeit poorly insured, earthquake risks. “Indonesia’s earthquake hazard exposure is among the highest in the world, both in terms of human mortality and economic losses,” Frans Sahusilawane, Maipark’s president director, said in an International Finance Corporation (IFC) press release in October 2013. This is in line with global trends as the incidence of NatCat events has tripled in the last 30 years, according to Maipark.

Maipark estimates that some 12m Indonesians live in zones prone to earthquakes, representing a total economic exposure of $79bn. This represents a significant unhedged exposure for lenders, particularly smaller regional banks and microfinance institutions. In major urban areas like Yogyakarta in Java or West Sumatra’s capital Padang, the most-exposed lenders could lose between 15% and 35% of their income, according to Maipark. Extrapolating from current rates of investment in property and infrastructure, SwissRe estimates that the current $10bn insurance gap would rise to $28bn by 2023. Focusing on flood risks, the reinsurer estimates the flood insurance gap would reach the lower but still considerable sum of $23bn by that date. In the absence of adequate insurance cover, the uninsured losses are either shouldered by public finances or written off as unrecoverable losses.

Pricing NatCat

Originally structured as the Indonesian Earthquake Reinsurance Pool in 2003, Asuransi Maipark Indonesia is a domestic reinsurer incorporated in 2004 specialising in NatCat. Backed by all nonlife underwriters and reinsurers as shareholders, the reinsurer sets a benchmark for earthquake insurance policy pricing, promotes discipline by selling such policies as standalone covers, and has developed a database of hazards and exposures to build local capacity to manage such potentially large risks. Shareholders are required to cede between 5% and 25% of insured sums, with a ceiling of $2.5m per risk, and must follow the set earthquake premium tariff. From January 2014 the mandatory cession was raised to 15% of all insured sums with a higher single-exposure ceiling of $3.5m.

Depending on zone, location, form of occupancy and structure, the tariffs range from 0.104% to 0.33% of the insured sum. The reinsurer’s gross premiums have grown in line with the industry’s, albeit from a low base, at 16.99% to Rp105.2bn ($10.5m) in the year to September 2013, according to Fitch, which rates Maipark BBB+ with a stable outlook. While the reinsurer’s exposure is set to rise in line with the legal cession increase, its strong risk-based capitalisation ratio of 1080% in September 2013 gives it ample room for growth.

While Maipark regulates earthquake tariffs, standalone flood covers have been highly under-priced in recent years, with policy discounts of up to 50%, according to Fitch, as the sector’s fragmentation has resulted in intense competition. Over the first two months of 2014 the new insurance regulator, Financial Services Authority (OJK), has introduced strict new tariffs setting floors and ceilings for premium rates on flood, earthquake, volcanic eruptions and tsunamis as part of its overhaul of pricing oversight for the property and motor classes (see analysis).

New Models

While OJK has focused on curbing excessive competition between non-life underwriters in acquiring new business, particularly in flood covers, Maipark is working to establish new disaster risk modelling tools that should help drive penetration. In early 2014 the reinsurer is finalising the first stage of its flood model for Jakarta, based on its 10-year database of NatCat risks. “With this model, we can contribute to the regulators and insurance industries in enhancing our knowledge on flood handling, starting from Jakarta,” Sahusilawane told the Jakarta-based foundation Disaster Risk Reduction in December 2013.

Since October 2013 it has also partnered with the IFC to develop an earthquake index insurance (EQII) product as a hedging instrument for lenders in disaster-prone zones. The IFC’s Global Index Insurance Facility aims to use index insurance with parametric triggers for claims payments to enhance risk management in disasters and agriculture. The project builds on the IFC’s experience of rolling out such a product in North Peru in 2011, which was sold through a leading microfinance lender (Caja Nuestra Gente) and provides pay-outs even before flooding based on weather patterns.

The EQII product in Indonesia aims to expand penetration and allow banks to hedge their loan-book risk and continue to lend in an area following an earthquake.

“The project will increase the resiliency of [financial institutions] FIs to earthquake disruption and facilitate more rapid recovery following a severe seismic event,” according to the IFC in October 2013. While independent consultant GlobalAgRisk and AON Benfield will still be working on the product’s details in 2014, the model will most likely involve a subsidised excess-of-loss feature, before transitioning to the global reinsurance and capital markets through issuance of catastrophe bonds for instance. Once the product is rolled out through Maipark, the IFC expects the product to provide cover for a total of $5m in loans to individuals and small and medium-sized enterprises by 2015 and $50m by 2019.

Indonesia faces a significant and growing insurance gap in coming years. While the regulator seeks to ensure fair competition amongst non-life underwriters, Maipark’s efforts to develop NatCat risk modelling tools and standardised products will be key to expanding penetration. Authorities, keen to transfer a larger share of NatCat risk to market-based instruments, are key supporters of this trend. Government at all levels will also need to enhance efforts at mitigating risks in the first place by consistently enforcing building regulations.