Is it time for China to embrace catastrophe insurance?
The most powerful autumn storm to hit China since 1949 made landfall on 6 September.
Super Typhoon Yagi caused four deaths and 95 injuries. More than 720,000 in Guangdong province had to relocate, while half a million people were affected in Hainan province.
Five or six huge turbines were also severely damaged at a wind farm in coastal Hainan, according to its operator.
These turbines were insured, but not all losses will have been, and the widespread destruction has brought catastrophe insurance back into the spotlight.
It has been a particularly harsh year for floods and other natural disasters in China, with 32 million people affected in the first half of 2024, according to the Ministry of Emergency Management. Direct economic losses totalled CNY 93 billion (USD 13 billion), about two-and-a-half times more than the equivalent period in 2023.
China, though, is prone to these kind of events. Between 1989 and 2018, floods, typhoons, droughts and other natural disasters caused the death of 195,820 people, and direct physical losses of CNY 11.2 trillion (USD 1.7 trillion), according to a World Bank report. In the past three decades, they have inflicted direct economic losses equivalent to 2.25% of gross domestic product (GDP), the report found.
Climate change is only going to boost the frequency and intensity of natural disasters. Recovery and rebuilding is hugely expensive, with money usually coming from government emergency funding and charitable donations. However, other sources of money, such as payouts on catastrophe insurance policies, can also play a role.
Catastrophe insurance spreads the risk and cost of property damage and deaths and injuries arising from natural disasters.
Such products are only just appearing on China's insurance markets, with coverage rates still low and the products themselves in need of improvements. As of 11 July, Chinese insurers had received 95,000 claims this year, involving losses they estimated at CNY 3.2 billion (USD 450 million) and payouts made or expected of CNY 1.1 billion, according to the National Financial Regulatory Administration. Munich Re, a reinsurance company, reported in 2023 that only 5% of disaster-related economic losses were insured in China that year, far below the global average of 38%, leaving a USD 23 billion shortfall in insurance coverage.
Expanding coverage: From earthquakes to extreme weather
According to a 2020 report from the World Bank, China used to provide compensation for disaster losses via government aid and charitable donations, with a very limited role for insurers. However, the 2008 earthquake in Sichuan led to changes, with the government realising how insurance could be important for rapid rehabilitation and recovery. This was both in terms of insurers paying out to governments that fund disaster relief and individuals buying insurance.
The data shows the amount of compensation paid out accounted for only 0.2% of direct economic losses arising from the 2008 earthquake. That figure had risen to over 10% for the 2021 flooding in Zhengzhou. However, according to China Youth Daily, most of those payouts were on property or life insurance policies - not catastrophe insurance.
China has conducted a number of pilot projects at the national and local levels to build a catastrophe insurance system. In 2015, over 40 insurance companies formed the China Residential Earthquake Insurance Pool (CREIP), which has played a positive role and made payouts totalling CNY 100 million (USD 14 million), according to China Banking and Insurance News.
And in 2014, the year before CREIP was formed, local catastrophe insurance trials were launched. This saw local governments setting up insurance schemes based on local risks and needs, with governments taking out catastrophe insurance on behalf of all residents. After a disaster, the insurer would pay out to the local government, which would manage disaster relief work.
Shenzhen took the lead, and its catastrophe insurance now covers 16 types of disaster including storms and flooding. It also provides payments of up to CNY 250,000 (USD 35,000) per person for injuries or death arising from disasters.
Guangdong launched trials of "catastrophe-indexed insurance", with payouts linked to the intensity of downpours or wind speeds. Once an index reaches a certain level, the insurance companies pay out without further investigation, handing funds directly to local governments.
By 2023, these local insurance schemes were running in 74 cities across 15 provinces, with 270 million people covered, according to a report from the People's Insurance Company of China.
In February this year, those trials influenced reforms of CREIP, which expanded from covering only earthquakes to include typhoons, flooding, downpours, landslides and other disasters, with a doubling of payouts.
"Catastrophe insurance is a quasi-public good, requiring sustained financial support from government. This policy expands the coverage and payouts of catastrophe insurance and will help encourage take-up of policies," said Liu Huixin, executive director of the Climate Finance Center at the International Institute of Green Finance, Central University of Finance and Economics, Beijing.
Climate risk awareness driving uptake of catastrophe insurance
Disasters are destructive, but rare enough that members of the public and businesses are not keen to spend on insurance. This in turn makes it harder for insurers to sell it.
Most developing nations, including China, have low take-up of catastrophe insurance, a 2019 report by the Asian Development Bank found. On the demand side, consumers can't afford it or lack the financial literacy or trust in the product needed, while the supply side is hampered by a lack of data and technical capacity. And both sides are affected by regulatory and institutional frameworks, the report found.
A lack of consumer enthusiasm is not unique to China, though. American homeowners in high-risk flood zones underestimate the likelihood of flooding, and only become more likely to purchase insurance after a flood occurs, according to a paper from the Stanford Institute for Economic Policy Research.
After a 2018 earthquake in Songyuan, Jilin province, there was a rush for insurance, with 6,837 local people taking out earthquake policies in just eight working days, according to China Banking and Insurance News. Similarly, an earthquake in Ya'an, Sichuan, saw villagers queuing up for earthquake insurance.
Liu Huixin says climate risk awareness is rising, partly due to the higher frequency of natural disasters. This means commercial and government catastrophe insurance policies are more likely to be taken up by companies, organisations and even individuals.
The problem of evaluating climate risks
From an underwriter's point of view, insurance companies need to consider catastrophe risks and then set premiums to cover their expected payouts and operating expenses, with a little left over for profits. But catastrophe risks are harder to calculate than those associated with more traditional products, which is one reason why catastrophe insurance remains rarer in China.
In 1996 the People's Bank of China concluded that the maths behind earthquake risks wasn't up to the task, and ordered insurance companies to remove coverage from their policies, according to China Banking and Insurance News. In 2008, after the Sichuan earthquake, some companies started covering earthquake damage again, but the expense meant these never became popular.
Today, faced with the complexities of climate change, the insurance industry remains cautious about covering natural disasters. A downpour in Zhuozhou, Hebei, in 2023 saw a number of book warehouses flooded, resulting in heavy uninsured losses. Huang Ping, CEO of BooksChina.com, told media that he had insured book warehouses in the past, but the insurers later refused to renew the policy, saying it was no longer offered. "The risk of flooding and fire is too high" to turn a profit, an industry insider told media.
The conventional models aren't accurate enough when applied to climate risks
-Liu Huixin, Central University of Finance and Economics
"The conventional models aren't accurate enough when applied to climate risks. We need catastrophe-specific models to evaluate exposure, vulnerability and potential losses," Liu Huixin told Dialogue Earth.
The catastrophe-specific models she refers to are quantitative tools designed to assess climate risks and associated losses. These combine maths, mapping and computer modelling to evaluate the risk of a disaster and potential losses.
Many insurance companies have said catastrophe-specific models could help them predict losses and control risk, and so avoid financial difficulties arising from unexpected payouts. Liu Huixin explained further: catastrophe-specific models require data on the weather, disaster-reduction measures, the economy and industries. There are data-security issues with bringing those together, so sustained technological support is needed both for building the models and sharing the data.
Felicia Liu is a lecturer in sustainability at the University of York's Department of Environment and Geography. She told Dialogue Earth that insurance companies need both models and actuarial science to back up their products. This requires specialised knowledge and training, as well as repeated testing of the models.
She added that the insurance companies are both risk absorbers and asset managers. It isn't just more frequent and harder to predict disasters that are making insurance companies less able to take on the risks. Macroeconomic factors mean the returns on their investments aren't meeting expectations, which makes them less willing to take on more risk and promote related products.
The other side of catastrophe insurance
Insurers and policymakers are paying more attention to the insurability and pricing of climate risks. Particularly in areas where catastrophe insurance is market-led, increasing numbers of natural disasters can be expected to lead to bigger payouts and so higher premiums. In the mid- to long-term, this may impact on policy affordability.
In the US, climate change has already disrupted the industry. Insurance companies made losses on homeowner insurance in 18 states in 2023, compared to eight states in 2013, according to the New York Times [$]. Bigger climate risks have led insurers to increase premiums by at least half, cut the scope of coverage, and leave some states entirely.
Liu pointed out that it's not just about money. Being insured can change behaviour. An insured party may reduce spending on measures to adapt to climate change, for example. On the other hand, the insurance company might be more inclined to take actions on climate change.
They could, for example, offer cheaper insurance to those who attempt to adapt. The European Insurance and Occupational Pensions Authority says climate-related adaptation measures, such as anti-flood doors or warning systems, can reduce the policyholder's physical risk exposures and insured losses, and so be rewarded with lower premiums.
The main role of catastrophe insurance is to reduce the losses of those affected by disasters, and also to help the government improve disaster-relief efforts and enhance fiscal resilience to natural disasters. But as Liu points out, insurance companies manage big portfolios and their investment choices could have a big impact on climate change.
A report into the insurance industry, which she contributed to, found that after suffering losses in 2023, many insurance companies around the world chose to seek short-term profits from fossil fuel extraction. "There's no question that's foolish, Liu said. "The insurance companies should apply climate risk pricing and models consistently across the business, and in particular give full consideration to climate factors in their underwriting and asset management operations."