52953 EAP DRM KnowledgeNotes Working Paper Series No. 17 disaster risk Management in east asia and the pacific Catastrophe insuranCe poliCy for China By Jun Wang introduCtion The vast majority of China's population lies to the south- east of a line running from Beijing to Sichuan. This en- © The World Bank/Wu Zhiyi tire region is subjected to major floods each year, while typhoons affect the southern and eastern coastal areas and major earthquakes affect the western and northern margins. The average annual direct property damage is estimated at approximately USD 15 billion, and when combined with other immediate economic losses, including business interruption, disaster relief, and other costs, is considerably larger. As with other sectors, insurance in China is growing rapidly, with a compounded annual growth rate of 25 percent since 2001. The property insurance industry, nevertheless, is underdeveloped. Total property premiums in China are about USD 15 billion, whereas the losses from the Wenchuan Earthquake alone are likely to exceed USD 100 billion. According to most estimates, only 5 percent of property in China is insured, primarily among commercial and industrial users. When it comes to private dwellings, it is estimated that today only 1 out of 100 is insured against natural hazards. Clearly, the current property insurance market in China is dwarfed by the nation's need for catastrophe risk protection; at the present level of insurance penetration, China's insurance industry cannot provide significant compensation for large natural hazards losses. China Catastrophe insuranCe needs Given the magnitude of potential loss, the adverse social and economic consequences of large natural catastrophes for millions of people, and the considerable fiscal strain imposed on the government budget by natural disasters, China can benefit significantly by putting in place a national catastrophe insurance system that would seamlessly This working paper series is produced by the East Asia and Pacific Disaster Risk Management Team of the World Bank, with support from the Global Facility for Disaster Reduction and Recovery (GFDRR). This note was prepared for the Government of China as part of a series of good practice notes on post-disaster recovery following the Wenchuan Earthquake that struck on May 12, 2008. Content was coordinated by the China and Mongolia Sustainable Development and Country Management Units of the World Bank. The focus is on sector-specific lessons from past post- earthquake recovery programs in different countries around the world. 2 disaster risk Management in east asia and the pacific combine disaster risk insurance with risk-reduction and nia) and has been successful. The CCIP would be: risk-mitigation efforts. While such a system can take n A public corporation managed by an independent board any of several forms, in the end it should achieve the of directors with exemplary insurance, financial, and following objectives: related industry experience. Directors would be inde- n Reduce the financial vulnerability of homeowners as pendently nominated by several ministries (e.g., Min- well as small and medium enterprises (SMEs) to nat- istry of Finance and Ministry of Civil Affairs), private ural disasters by providing access to affordably priced industry, and the Chinese Academy of Sciences. catastrophe insurance. n Privately funded and financially self-sustainable, and n Reduce the fiscal risk exposure of the government to managed according to sound actuarial practices and natural disasters through a countrywide transfer of fi- subject to government insurance regulations.1 nancial responsibility for losses to private assets to the n Effective in promoting ex ante risk reduction to indi- private insurance industry. viduals and communities. n Create economic incentives for homeowners and n Established in a timely manner according to a sched- SMEs to reduce their physical vulnerability to natural ule specified by the State Council. disasters over time by engaging in proactive ex ante disaster risk management. elaboration n Provide for immediate post-disaster fiscal support for Participation: Catastrophe insurance would be com- provincial governments to support the indigent and pulsory for every registered homeowner and SME. The fund critical post-disaster infrastructure needs. most appropriate premium collection mechanism would n An additional related objective and benefit would be need to be determined. fostering the growth of the domestic insurance in- Risks covered: The CCIP would provide earthquake dustry. (and earthquake-initiated hazards such as tsunamis, landslides, and fires) coverage at the earliest opportu- China Catastrophe insuranCe poliCy nity, as fast as a program could be practicably created. Since a need for disaster insurance clearly exists in Chi- Flood, wind, and other natural hazard coverage would na and the capacity of the insurance industry is itself be dependent on the development of technical data, and too small to undertake this task, the government could could be added in a timely manner on a schedule to be consider the creation of a national catastrophe insur- specified by the government. Floods, because of their ance scheme, the China Catastrophe Insurance Pool unique characteristics, including scope for immediate (CCIP). The specific details for the CCIP would re- post-disaster mitigation action and use of soft loans, quire technical analysis, but the outline for an overall could be handled through a separate arrangement but policy for China is emerging. under the same administrative umbrella. fundaMental poliCy Policy terms and conditions: Coverage would be pro- The creation of a CCIP could either directly, or as a vided for damage to private residential dwellings and compulsory reinsurer, provide insurance for all private possibly contents as well as for damage to business residential dwellings and all SMEs for major natural premises. Several options exist, including: (i) policy hazards in return for a premium. This generic model limits similar to traditional insurance, with values set by is already used in a wide range of countries and states the owner and confirmed by the underwriter; (ii) a flat (e.g., France, Japan, New Zealand, Turkey, and Califor- minimum cover (e.g., cĄ 100,000) for all insured, with Catastrophe insurance policy for China 3 higher limits as an option; and, (iii) an insured limit to engage in risk mitigation efforts, each local govern- based on median property values in each participating ment would be required to adopt a disaster risk manage- province (or a similar formula). The best option should ment plan. The insurance premium rates would reflect be identified by further study within the time limits the progress achieved by communities in implementing specified by the government. their risk management programs. Risk rating: Risk-based pricing approach to risk, where Subsidies: The World Bank's accumulated knowledge of the premium rates charged to homeowners would vary and experience in a wide range of countries indicates that based on the location, size, and construction quality of inappropriate use of subsidies can easily undermine ef- their dwellings. fective insurance arrangements. If subsidies are applied, Risk underwriting: The compulsory insurance policies they should be explicit (i.e., the full price of risk should be would be issued by participating insurance companies transparent) and well targeted to the truly needy. and backed by the CCIP, which would act as a special insurance entity established for the purpose of under- sovereign fisCal hedging writing residential catastrophe insurance risk in the The public and private sectors, as experience indicates, country. The CCIP would act as a national aggregator require completely separate arrangements. The post-di- of catastrophe risk acquired from the sales of compulso- saster fiscal needs of governments have been met using ry residential insurance policies. All aspects of its man- financial instruments (i.e., the cases of Ethiopia, Malawi, agement and insurance operations would be outsourced and Mexico) and sovereign regional structures (i.e., Ca- to the private sector. The CCIP would be managed by a ribbean Catastrophe Risk Insurance Facility). Special professional insurance services company hired through legislation that deals exclusively with the post-disaster an open tender. funding needs of the public sector would be an ideal way to address the post-disaster needs of provincial govern- Claims settlement: In the aftermath of a natural disas- ter, property damages would be adjusted by participating ments, reviewing modern risk hedging instruments. insurance companies. To ensure consistency in loss assess- ments, adjusters would need to receive special training. next steps Given the need for a national catastrophe insurance The role of government: The key elements of govern- scheme, the Chinese government could consider pro- ment participation would include: (i) introduction of mulgating framework catastrophe insurance legislation special catastrophe insurance legislation; (ii) enforce- that states the fundamental principle for a catastrophe ment of the compulsory insurance requirement; and, insurance program and appoints a special working group. (iii) provision of a backstop contingent capital facility The working group would be composed of key ministries, to ensure the solvency of the program in case of highly private industry, and technical experts to develop the spe- unlikely catastrophic events. cific operating procedures and norms for the CCIP in a Risk financing: The CCIP would rely heavily on private timely manner. n reinsurance and its own reserves, which would be built over time from its own earnings. The government would be end note required to provide a backstop liquidity facility to the CCIP 1 In recognition of the different nature of catastrophe insur- ance from ordinary property insurance, a need exists for to pay claims from highly unlikely catastrophic events. a separate specialized regulatory framework that would be Incentives for mitigation: To encourage communities implemented by specially trained professional regulators. east asia and the pacific region The World Bank 1818 H St. NW, Washington, D.C., 20433 http://www.worldbank.org/eap Special thanks to the partners who support GFDRR's work to protect livelihoods and improve lives: Australia, Canada, Denmark, European Commission, Finland, France, Germany, Italy, Japan, Luxembourg, Norway, Spain, Sweden, Switzerland, United Kingdom, UN International Strategy for Disaster Reduction, USAID Office of Foreign Disaster Assistance, and the World Bank.