Climate-Related Risk and Vulnerabilities in IsDB Member Countries: The Role of Insurance/Takaful Sector

07 Mar, 2022

Introduction

Climate change is a systemic risk for the whole world. Due to the growing frequency and intensity of extreme weather events, developing countries are increasingly exposed to the effects of climate change. By 2030, climate change has the potential to push up to 132 million people into extreme poverty, making it more difficult for countries to revert to inclusive growth (World Bank, 2020).[1] Furthermore, many developing countries, including IsDB MCs, lack developed markets for climate-related insurance, impeding poverty reduction and economic development that can limit their ability to prevent and respond to the impacts of climate change. As a result, safeguarding communities from climate-related disasters is more critical than ever in terms of sustainable development and poverty reduction.


Economic Loss of Climate-Related Events

The frequency and intensity of climate-related catastrophes have risen. Figure1 illustrates the global cost of natural disasters in 2020. The overall economic impact was US$210 billion, of which US$82 billion was insured. The figure for insured losses was significantly higher than the 30-year average of US$41 billion.[2] The gap between uninsured and insured losses continues to grow, while the worldwide underinsurance gap continues to grow unacceptably big, reaching US$162 billion in 2020.

Figure 1: Loss Events Worldwide 2020


Source: Munich Re, NatCatSERVICE (2021)

According to the Global Climate Risk Index 2020, two of the world’s top ten countries most impacted by climate change over the last two decades were IsDB MCs, notably Bangladesh and Pakistan (Table 1). These countries have been impacted by repeated extreme weather events such as typhoons, droughts, storms and flooding. Among IsDB MCs, Mozambique, Malawi, and Afghanistan were the most affected in 2020. Mozambique was the hardest hit country, with a Climate Risk Index (CRI) of 2.6 due to the fatal tropical Cyclone Idai. On the other hand, Brunei joined the group of countries that have been mostly unscathed by weather-related calamities, with no fatalities or severe damages reported. Climate change-related disasters can have a severe economic impact on IsDB MCs, with IsDB MCs potentially suffering greater losses than most of the world’s regions.

Table 1: Climate Risk Index 2020 (Top 10 IsDB Countries)

CountryGlobal CRI Score1/Fatalities (Rank)2/Fatalities per 100,000 inhabitants (Rank)Losses in US$ million (PPP) (Rank)3/Losses per unit GDP in % (Rank)
Mozambique2.672342
Afghanistan16.0011113316
Niger18.1717124611
Sudan19.8322252312
Bangladesh23.507292028
Indonesia24.83331639
Pakistan25.008391425
Comoros25.33676654
Iran27.002245821

Note: 1/ Lower index scores indicate higher risk. The following weighting is applied: fatalities (1/6); fatalities per 100,000 inhabitants (1/3); absolute losses in PPP (1/6); and losses per unit GDP (1/3); 2/Only weather-related events – storms, floods, as well as temperature extremes and mass movements (heat and cold waves etc.) – are incorporated; 3/ The indicator “absolute losses in US$” is identified by purchasing power parity (PPP)

Source: Germanwatch (2021)

Climate-Related Risks and the Insurance/Takaful Sector

Climate change is becoming increasingly relevant to financial and insurance regulators. Financial authorities are getting increasingly concerned about climate change. Several countries have taken legislative and regulatory measures to mitigate the risks of climate change to their national financial systems. As a result, climate-related regulations and legislation are anticipated to increase in the future. Climate change-related disasters pose financial risks to financial sector losses and macroeconomic consequences (Figure 2)[3]. Climate-related financial losses, liability concerns, and regulatory changes will affect insurance firms’ business operations and underwriting.

The insurance business is confronted with various barriers that impede the spread of efficient risk transfer solutions and investments in green assets and sustainable infrastructures necessary for climate change adaptation. It is critical to address many critical challenges, including restricted access to risk information, affordability and high premium costs, and a lack of client knowledge. Moreover, insurance firms’ investment in greener assets is hampered by present structural and regulatory constraints, including a lack of well-defined asset classes, capacity allocation in relevant markets, and fragmented climate legislation.

Climate change affects the insurance sector across several lines of business, including property and liability, health, and life insurance. Generally, insurance may be a critical instrument in two areas of climate change adaptation. First, it facilitates the flow of funds necessary to assist people and infrastructure in recovering from catastrophes, with countries with more insurance coverage recovering more quickly. Second, insurance contributes to a wider knowledge of climate change risks and supports policies that enable societies to increase their protection and resilience in the face of climate-related calamities. This is an opportunity for the insurance industry to provide products that address the needs of populations and businesses.

Figure 2: Tracking Natural Disasters to Financial Sector Losses


In 2020, total global insurance premiums contracted by only 1.3% year-on-year in real terms. Global insurance premiums reached US$ 6.3 trillion in 2020. The non-life sector expanded continuously (1.5%) owing to the hardening of commercial line rates in advanced economies. Insurance premiums in developing economies (excluding China) fell 2% as a result of weak economic activity. In 2020, 4.4% of the life industry was severely impacted, led by advanced markets, which declined by 5.7%. This was mostly due to a decline in the life savings business since the labour market shock associated with the Covid-19 economic shutdowns resulted in substantial declines in household income.

Across the IsDB MCs, Indonesia continued to contribute the largest share with US$20.5 billion, equivalent to 0.33% of the global total premiums, followed by Malaysia with US$18.4 billion (0.29% of the total global premium market) (Figure 3). Iran and the UAE contributed 0.25% and 0.19%, respectively, to worldwide market shares. On the other hand, Ivory Coast, Bahrain, Jordan, and Tunisia collectively contributed less than 0.01% of the worldwide market, with US$0.67 billion, US$0.79 billion, US$0.83 billion, and US$0.9 billion.

Figure 3: Insurance/Takaful Premium: Global vs. IsDB Member Countries

Source: Swiss Re (2021); World of Takaful

In general, most of the IsDB MCs saw contractionary growth in 2020, with the exception of Morocco and Qatar, which expanded by more than 7%. Turkey and Malaysia both had strong growth of 5.8% and 6.8%, respectively, but at a slower pace than the previous year. On the other hand, Lebanon’s market contracted significantly by 47.3%, while Nigeria’s market contracted by 14.8%. On average, IsDB MCs’ penetration rate was 1.8% of total GDP. The penetration and density rates of IsDB MCs varied significantly. In 2020, the average insurance density (premium per capita) was US$237 per capita in IsDB MCs. Malaysia maintained its lead among IsDB MCs, with a penetration rate of 5.4% and a per capita premium of US$455.

In terms of the Takaful industry, the worldwide contribution is estimated to be US$35.5 billion in 2020, representing less than 1% of global insurance premiums. Iran continues to be the largest Takaful market in the world, followed by Saudi Arabia and Malaysia. The general Takaful continues to dominate the family Takaful, with a share of total Takaful contributions of US$29.9 billion (84.3%) and US$5.6 billion (15.7%), respectively.

Table 2: IsDB MCs Insurance/Takaful Penetration and Density Rate 2020

 Real Growth
(%)
Penetration
(% of GDP)
Density
(per capita, USD)
World Market Share
(%)
Takaful Market
(%)
Algeria-11.30.7240.02
Bahrain6.12.46410.0131.7
Bangladesh-8.20.480.0211.0
Egypt8.80.7230.0412.5
Indonesia-9.41.9750.335.9
Iran-192.31900.25100.0
Jordan-4.12.1820.0111.0
Kazakhstan2.80.7670.02
Kuwait-9.11.12700.0218.7
Lebanon-47.31.82290.02
Malaysia6.85.44550.2922.4
Morocco7.34.51380.08
Nigeria-14.80.360.020.5
Oman-5.91.62230.0213.5
Pakistan-9.50.8100.0312.0
Qatar7.90.95250.0245.0
Saudi Arabia-0.91.62810.16100.0
Tunisia-0.12.3760.025.0
Turkey5.81.51280.174.5
UAE0.83.31,2910.1913.0
World-1.3
Source: Swiss Re (2021); World of Takaful

Conclusion

Climate change can exacerbate catastrophic risks that are a potential source of loss for societies and businesses. The insurance industry is uniquely positioned to identify the risks that climate change imposes on societies and their livelihoods. It also has the capacity to devise innovative risk-transfer solutions that minimise the financial consequences of uncertainty.[4] Moreover, the insurance industry can contribute to building financial resilience. The G7 Climate Risk Insurance Initiative (G7 CRII)[5] acknowledges the role the insurance industry can play in climate risk management and climate risk insurance and risk financing. 

Climate change presents a hurdle to the insurance sector in helping to mitigate the aftermath of natural disasters and creates a further risk to society. There is a consensus that the main categories of climate change risks to insurers’ balance sheets are: physical risks,[6] transition risks,[7] and liability risks.[8] Equipping the insurance industry with practical and analytical tools to assess the financial impacts of climate change can help: i) (re)insurance companies to proactively manage the associated increasing financial risks and ii) the broader society to increase resilience through improved assessment and management of the impact.[9]

Climate change adaptation and mitigation measures are a complicated process. Climate-related risks should be based on granular and forward-looking measurement. Climate change cannot be solved by any single industry or government. There is a need for more collaboration between regulators and the insurance sector in order to create climate change risk management solutions. While insurance is primarily a private market mechanism, a comprehensive strategy enables governments to mitigate risks and shift costs when appropriate. It will also enable the public and commercial sectors to set priorities and safeguard societies from the financial consequences associated with climate threats.


[1] World Bank (2020).  Poverty and Shared Prosperity 2020:  Reversals of Fortune.  Washington, DC: World Bank

[2] Munich Re, NatCatSERVICE (2020).

[3] Sandra Batten, Rhiannon Sowerbutts, and Misa Tanaka, “Let’s talk about the weather: The impact of climate change on central banks,” Bank of England Staff Working Paper No. 603, May 20, 2016.

[4] For example, Climate Risk Insurance utilizes the application of insurance instruments to risks associated with climate change.

[5] G7 Initiative on Climate Risk Insurance “InsuResilience”, Fall Meeting of the Consultative Group, 28 October 2015, Berlin. https://www.gfdrr.org/sites/default/files/1c_InsuResilience.pdf

[6] The risks arising from increased damage and losses from physical phenomena associated with both climate trends and events.

[7] The risks arising from disruptions and shifts associated with the transition to a low-carbon economy, which may affect the value of assets or the costs of doing business for firms.

[8] The risk of climate-related claims under liability policies, as well as direct claims against insurers for failing to manage climate risks.

[9] A framework for assessing financial impacts of physical climate change: A practitioner’s aide for the general insurance sector Bank of England, May 2019.


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