The Disaster Insurance Protection Gap

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any insurance coverage for it. In the United States, many households are uninsured against natural disasters because the coverage is excluded from standard homeowners insurance. Although estimates suggest that upward of 85 percent of homeowners have property insurance, standard policies do not cover floods or earthquakes. Standard rental policies exclude these perils, too. Homeowners or renters must buy a separate policy for each of these risks, and most households don’t.

The Federal Emergency Management Agency (FEMA) considers onehundred-year floodplains—areas with an annual flood risk of at least 1 percent—as high risk for flooding, yet take-up rates (the share of people who purchase a certain insurance product) for flood insurance inside this area are, on average nationwide, only around 30 percent. There is, however, wide geographic variation, with flood insurance purchases higher in coastal areas and lower in riverine floodplains.5 In California, only slightly more than 10 percent of homeowners have earthquake insurance.6 In areas near the New Madrid fault in Missouri, only about 13 percent of households have earthquake insurance.7 In addition to low disaster insurance take-up among households, many small businesses also do not have adequate insurance coverage against disasters either.8

Even disasters that are covered under a standard property policy, such as wind damage from hurricanes or wildfires, typically have limitations on how much the insurer will pay. For example, it is common in the Southeast for a homeowners policy to have a separate—and much higher—deductible if the damage is from a hurricane (aptly called hurricane deductibles). In the event of damage from a hurricane, homeowners must pay a larger share of the damages and get less from their insurance company than for other types of disasters. Similarly, in Missouri, many insurance companies that offer earthquake insurance have higher deductibles for that coverage.9 In chapter 3, we will see why insurers put these types of restrictions in place or refuse to insure certain disasters or locations altogether.

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In addition to having higher deductibles for some disasters, insured households may not have enough coverage to fully rebuild in the case of a severe loss. Underinsurance—not having enough insurance to cover the full costs of rebuilding a completely destroyed home—is, unfortunately, increasingly common and often unrecognized by consumers until it is too late. This is due to several factors: problematic calculations of the costs to fully rebuild, incentives to offer cheaper but inadequate coverage, a lack of awareness by consumers, a lack of data from insurers to examine the issue, and that homeowners must update their coverage over time, though very few actually do so.10

Both supply and demand challenges contribute to the protection gap and to holes in coverage. As will be discussed in chapter 3, disaster insurance is difficult to provide and is more expensive than other types of insurance, which causes private firms to put limitations on the coverage offered. There are also demand difficulties that will be discussed in more detail in chapter 5. First, many people may not see the value in insurance or understand the role it plays in their finances. It is hard to appreciate the financial upheaval a disaster can cause without experiencing one. Unfortunately, learning the value of insurance after the fire or storm is too late. Also, as already mentioned, no one likes to buy insurance. There is no immediate gratification from securing an insurance policy, which can make it hard for people to be motivated to buy one. In addition, many people may not understand the risks they face. Governments and the private sector often do a poor job of communicating about disaster risks. There is also a lot of research demonstrating that people are generally not very good at thinking about disaster risks and evaluating them.

One of the biggest challenges, though, is the cost. Disaster insurance is fundamentally more expensive than nondisaster types of insurance, as will be discussed in chapter 3. When disasters are systematically carved out of standard property policies, like homeowners and renters insurance, households must buy additional stand-alone policies to cover the

28 understanding disaster insurance

damage from floods, earthquakes, and other disasters. For many, this cost is prohibitive. We will return to innovative models that can make disaster insurance more affordable in chapter 11.

The end result is that many people do not insure against disasters unless they are forced to do so. Since not having access to insurance after a loss can impose costs on others or on taxpayers, the government often mandates insurance. You can’t drive without some type of insurance to make sure that you can compensate others if you cause an accident. You can’t take out a mortgage without homeowners insurance to protect the bank’s asset. And you have to buy flood insurance if you have a mortgage and live in a high-risk area mapped by FEMA—an attempt to make sure those at risk of flood damage do not rely on taxpayer assistance.

Mandates don’t cover all disasters or everyone at risk, however. As such, the protection gap is a growing problem, and not just in the United States, but globally. This gap means that many families will suffer when the next disaster comes—and come it will. Disaster recovery, without the financial resources that insurance provides, can devastate households and communities, leaving long-term or permanent negative impacts. It can bankrupt households and businesses and stall rebuilding and recovery for years, if not decades. As the myriad drivers of the gap suggest, there is not just one silver bullet solution. Perhaps that is why Edward Mishambi, from Renaissance Re, has said that closing the protection gap “requires all hands on deck.”11 It is a big job that needs everyone’s help.

Many people are thinking about how to close the protection gap— how to make disaster insurance more available and affordable in the face of growing losses—and we will explore those solutions in this book. There are innovators working to make insurance deliver greater benefits to society and to make sure insurance actually helps people quickly get back on their feet after a disaster. We will also meet innovators who want to use insurance to actually reduce losses and help protect not just property, but ecosystems, too. These innovators are rethinking how payouts

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are made, how contracts are structured, and how the fundamental business models of insurance can be improved. We will delve into all these possible solutions in the following chapters. But to understand if these ideas will work and how to scale those that are promising, we first need a deeper understanding of why disasters can be so difficult for the private sector and what role government can and should play.