Evaluating Catastrophe Insurance

By: Alka Parikh
The utility of disaster insurance, a relatively new concept for India, is still being debated. This insurance would perhaps be useful only if a foundation is laid for a social and physical disaster mitigation infrastructure.
Planning n Mitigation

Disaster plans, which are integrated into regular development plans, are now drawn by each state in India and steps are taken to make changes in infrastructure, administration, communication devices, emergency services, etc., to mitigate the losses caused by disasters.

Currently, two types of funds are in place: the Calamity Relief Fund (CRF) and the National Disaster Response Fund (NDRF). They provide for only immediate relief to the victims of natural calamities. The expenditure on restoration of infrastructure is required to be met from the plan funds of the respective states. Since 1990, each state has a CRF based on the recommendations of the Ninth Finance Commission. Contributions by the central government and state government are in the ratio 3:1 under the CRF. This decentralisation gave much needed autonomy to the states to assess their need for disaster relief. The CRF amount was based on the average expenditures made by the state in previous years. If the CRF is insufficient for a state confronted with a disaster, it may request the use of NDRF, which gets its funds from the National Calamity Contingency Fund. The initial corpus of Rs 500 crore is provided by the central government and additional amount as required for their disaster comes from levy of special surcharges on the central government taxes. In this way, the government ensures that it does not fall short of funds when a disaster occurs—the fund can be replenished by levying surcharges. The Prime Minister’s Relief Fund is also available for disaster situations.

Until 1990, states were required to apply for central aid in the event of a disaster; a visit by the central team to the affected area determined the amount of aid. There was, and even today is, a large difference between the amounts requested by the states and the amounts delivered by the centre—the amount being awarded depending on the capacity of the state to convince the centre. For example, Assam requested for central aid of Rs 12,000 crore in 2012, while the package announced by the Center was Rs 500 crore (Economic Times, July 10, 2012); the additions to this package however, are not known.

Catastrophe Insurance

A large proportion of India’s population is poor, implying high disaster vulnerability. Therefore, for the Indian government, disaster management is a humanitarian rather than a financial issue. It is also understood that Indian citizens will come together to support victims; it would be perceived as their duty towards the nation. Raising money through levying of surcharges for the victims of disaster would not be a complex task. There would be national consensus on providing relief and little resistance to levy of surcharges. The corporate sector and citizens are also expected to respond to the appeal for donations to the Prime Minister’s Relief Fund. This amounts to little interest in the national policy-making circles in developing a financial instrument to raise money. It is felt that funds can be raised as and when required, through various fiscal instruments that the government has at its disposal. The private corporate and citizens are also expected to respond to the appeal for donations. In such a scenario, the government has not felt the need to evolve new financial instruments. Also, states in India are used to seeking help from the Central government whenever a disaster occurs. It might not be easy to change that attitude. Additionally, the mechanism of CRF is well in place now, effectively reducing the need for urgent funds.

The states of India or the Panchayati Raj Institutions cannot be attracted into buying catastrophe insurance. As most of the local bodies have very limited funds, it would be difficult for them to pay the premiums, primarily because the premium rates for catastrophe insurance in disaster prone regions would be quite high.

After the Mumbai floods in 2005, the General Insurance Corporation alone had settled claims worth Rs 650 crore. Post the World Trade Center attack, India created its catastrophe insurance mechanism for terrorist damage. Taj and Oberoi Hotels received the first disbursements from this catastrophe insurance mechanism after the 2008 Mumbai attacks. The exact amount of dispersal is not known but it is reported that insurance companies significantly raised their premium for terrorist cover after that.

There are hardly any insurance firms that offer catastrophe insurance in India, and at present it is merged into life or general insurance. The problem is, it is not a common practice to include natural disasters as part of the acceptable causes for damage. Thus the insurance companies also need to design a suitable insurance product for India.

An attempt was made by the All India Disaster Mitigation Institute (AIDMI) in this direction. With support from two public sector insurance companies, AIDMI distributed Afat Vimo (Gujarati for disaster insurance) which covers five risks: life, trade stock, livelihood assets, house and house contents of the policy holder. The scheme covers damage or losses through 19 types of disasters including earthquake, fire, cyclone, landslides and lightening strikes. About 7200 policies have been sold till now in earthquake affected areas of Gujarat and Kashmir and in tsunami affected areas of Tamil Nadu. However, renewal rates of these policies are not clear. The general track record of renewal rates of most insurance policies has been poor in India. Also, no claim settlement has been done till now because none of these areas have been affected by such major disasters since. Thus the utility for the buyers and the viability of operating the insurance for the sellers are yet to be tested.

Insuring families

The need for insurance has been felt more for private property than by states. For example, the compensation given by the government does not go beyond Rs 1 lakh for the construction of a house. Equipment damages are seldom met by government assistance. High risk areas that experience a flood every year receive very little assistance because they are low impact disasters. Insurance can be of help in such circumstances.

Health is the other priority concern. Injuries caused by disasters are treated free of charge by government hospitals. Citizens can also be treated for free, up to a certain cost, if they are covered by medical insurance. However, the cost of post-operative care is not covered by any mechanism and the compensation given by government for injuries is too meagre to cover such costs. The loss of income due to injuries or the permanent loss of income due to disabilities is also not covered under any insurance instrument yet.

Unless the insurance company spreads its risk cover over many geographical regions, it will be difficult for it to meet claims. It would either become bankrupt or increase the premiums considerably, creating a cycle where either the insurer or the insured would suffer losses. When an insurance company feels that it has assumed too much risk, it can pay a premium and procure insurance from a bigger company that can pay a large amount in case the event occurs. It is a means of sharing or spreading the risk by the insurance company. Reinsurance mechanisms thus would have to be strategically used to meet with such situations. However, most reinsurance policies compensate the insurer for part losses that exceed a certain amount. The maximum covered amount is also determined. Again, this would either prove to be an expensive option for the insurer or it would be ineffective in saving them from incurring huge losses.

If the supply of insurance is hindered, the demand for catastrophe insurance is likely to be affected. It has been a major challenge in India to convince people to buy insurance of any kind. Even if people do buy insurance, they pay the premiums just once. Under such circumstances, it would become especially difficult to convince people to buy insurance against disasters that are considered a ‘once in 100 years’ phenomenon.

There is little demand for disaster insurance even in nations which have very well developed insurance markets. F Michale and V Bruggman’s 2013 paper ‘Catastrophic risks and first party insurance’ from Deutsche Gesellschaft für Internationale Zusammenarbeit (GIZ), the German Society for International Cooperation, reveals that the demand for catastrophe insurance was found to be as low as 15-50 per cent in Germany and USA. Therefore doubts remain about the viability of offering market based catastrophe insurance provided by the private firms at market rates without any subsidies. The authors observed that even though there is evidence of limited interest in catastrophe insurance, there are cases where insurance purchase increased after experiencing a disaster, as was the case after the Florida floods caused by storm Debby in 2012. The authors also note that as the memory of the disaster faded, the policies were cancelled, as was seen after the 1994 California earthquake.

It has been suggested that if people prefer insurance against events with high probability and low losses, they would accept insurance against low probability catastrophes if this insurance is sold for extra cost added to insurance against highly probable events (A Fares and E Abou-Bakr, 2012, ‘Economics of insurance against natural catastrophes: Overburdened arab insurers’, article in Review of Economics and Finance).This seems to be a viable option.

Conclusion

The provision of catastrophe insurance would be useful only after a strong foundation is laid for social and physical disaster mitigation infrastructure. That said, the case for introducing catastrophe insurance for families is convincing. A new catastrophe insurance product needs to be devised that combines catastrophe insurance with other products to make it more acceptable and attractive for the buyer. It can be distributed by NGOs which can educate people about the product. The National Bank for Agriculture and Rural Development (NABARD), the apex bank for agriculture and rural development in India, could be roped in to support disaster insurance to help financial institutions pool risks. The government could be involved to pay or subsidise premiums to make it affordable for the poor. There is a need to develop index based insurances which give out the claims if the event exceeds some limit of the index; for example, drought is declared only if the region has rain deficiency of more than 50 per cent. Or else, there is a need to develop other suitable insurance products for high probability low impact disasters.

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